Physical stock verification: why stock and books never match

Factory stock rarely matches the books because much of what happens on the shop floor is never entered. Material is used but not booked. Rejected parts and offcuts sit in bins. Stock lies on the floor or at a job worker while the books still show it in stores. The same part exists under two names. Negative stock lets all of this through without anyone noticing, and a wrong opening stock carries the error forward every year.

The fix has two halves. First, a proper physical stock verification: count everything in every location, and explain each difference before you adjust anything. Second, remove the causes, so the next count matches. This guide covers both, with a count format you can copy into Excel, a worked example, and how the difference is treated in the accounts and under GST.

Why doesn't physical stock match book stock?

Book stock is a calculation: opening stock, plus everything received, minus everything issued, as entered. Physical stock is what is actually on the racks. The two only agree if every movement in between was entered against the right item, in the right place, for the right quantity.

In many plants there are three numbers, not two. The stores register says one thing, the Excel sheet kept by production or accounts says another, and the shop floor shows a third. Each is updated by a different person at a different time, so each drifts in its own way.

Theft and damage do happen. But before you write anything off, look for movements nobody entered. That is often where the gap starts, and it is the part you can fix.

10 reasons for stock mismatch in a factory, and the fix for each

1. Three records and no single book

The register, the Excel sheet and the accounting software are each treated as the stock record, so none of them really is. When they disagree, people pick the number that suits the conversation.

Fix: Make one system the book of record for stock and stop updating the others. Paper can still record what happens at the gate, but stock balances come from one place.

2. Consumption is never booked

Material goes from stores to the line and the line uses it, but nobody records what was used. Or production is entered once a week, in one lump, from memory. The books keep the raw material that the racks no longer have.

Fix: Book production every day against a bill of materials, so the raw material it used is deducted automatically. Our guide to multi-level BOMs in ERPNext shows how sub-assemblies fit in. GST law expects the same discipline: a manufacturer must keep monthly production accounts showing the raw materials used and the goods made, including waste and by-products (CGST rule 56(12)).

3. Rejections and scrap disappear

A part fails on the line and goes into a red bin. Offcuts go into the scrap drum. Neither is entered, so the books still count them as good stock.

Fix: Book every rejection the same day, with its reason, into a separate rejected or scrap location. Add scrap to the bill of materials so it comes back into stock when you manufacture. In current ERPNext, that is the BOM's Secondary Items table, with the type set to Scrap.

4. Shop-floor stock is counted as stores stock

Material handed to the line without a transfer entry still sits in stores in the books. Count only the stores and you see a shortage. Count the floor too and the stock is all there, just in a different place.

Fix: Give the production floor its own warehouse, and move material to it with a transfer every time it leaves stores.

5. Stock at job workers is mixed in

Castings out for machining, parts out for plating or powder coating. They left on a challan, but in the books they never left stores. Or they left, came back, and the return was never entered.

Fix: Keep a warehouse for material at job workers and send and receive against it. Before a count, ask each job worker for a written statement of your material they hold.

6. Negative stock is allowed

If the system lets an item go below zero, a missing receipt or transfer never stops anyone. The issue goes through, the item shows minus 40, and nobody looks until the count. Negative stock also upsets valuation. ERPNext's own setting for negative batch stock warns that it "may lead to incorrect valuation rates".

Fix: Block negative stock. Then a shortfall stops the entry on the day, and someone has to find the missing receipt or transfer while people still remember it.

7. The same item exists twice

"Bearing 6203" and "6203 ZZ bearing". Purchase receives into one, production consumes from the other. One goes negative, the other keeps growing, and the total is right only if you add them up by hand. Duplicates are often made by someone who searched, did not find the item, and created a new one.

Fix: Let one person create items, with a naming rule and item codes. Everyone else searches first. Merge the duplicates you already have, moving their stock and history to the item you keep.

8. Opening stock was wrong from day one

When the system started, the opening stock was copied from an old register, or from a closing balance nobody had counted. Every report since has carried that error.

Fix: Count the item and post the count as a fresh opening on the count date. If you are moving from Tally, a count close to the cut-over date gives you an opening you can trust. Our Tally to ERPNext migration guide covers the cut-over.

9. Units don't agree

Wire bought in kg and issued in metres. Bolts bought in boxes of 100 and issued in pieces. If someone enters a box as one piece, the books are off by a factor of 100.

Fix: Keep one stock unit per item, and set the purchase and issue units with their conversion on the item master, not in someone's head.

10. Late entries and no cut-off on count day

Goods arrive and get used before the receipt is entered. Finished goods leave before the invoice is made. On count day, these look like shortages or excess.

Fix: Enter receipts when material arrives, not when the bill reaches accounts. On count day, note the last receipt, issue and dispatch numbers before counting starts, and hold movement until the count is done.

Once these ten are dealt with, what is left should be small: genuine loss, damage, or a miscount.

How to do physical stock verification, step by step

1. Pick the date and the cut-off. Choose a day when the plant is quiet, or the start of a shift. Write down the last receipt, issue, production and dispatch document numbers before counting starts.
2. Bring the books up to date. Enter every pending receipt, issue, production entry, rejection and transfer up to the cut-off. A count compared with stale books only measures the backlog.
3. Tidy up first. Put the same items together, separate damaged and rejected stock, and label every rack and bin.
4. Make count sheets by location, without the book quantity. People who do not know the expected number count what is actually there. This is called a blind count.
5. Count in pairs. One person counts, the other writes. Tag each bin once it is counted. For small parts, count a sample, weigh it, and count the rest by weight.
6. Count every location. Stores, production floor, finished goods, quality hold, rejected and scrap areas. For material at job workers, get their written statement as on the count date.
7. Recount the big differences. Use a different team for the recount.
8. Compare with the books and investigate. Find the reason for each difference before posting anything. The next section shows how.
9. Approve and post. The store in-charge and accounts sign the final sheets. Post the remaining difference with its reason.
10. Keep the sheets. Your auditor will want to see the signed count sheets and how each difference was dealt with.

Physical stock verification format (Excel)

Use one sheet per location. Print the first six columns for the count team, and fill in the rest after counting, so the count stays blind. You can copy this table straight into Excel.

Sr	Item code	Item name	Unit	Location	Counted qty	Book qty	Difference	Rate (₹)	Value of difference (₹)	Reason and action
1	BRG-6203	Bearing 6203	nos	Stores, rack B2	1,040	1,200	-160	45	-7,200	135 on the line, 25 rejected: transfer and book the rejection
2	BRG-6203	Bearing 6203	nos	Production floor	135	0	+135	45	+6,075	Issued without a transfer entry
3	BRG-6203	Bearing 6203	nos	QC bin	25	0	+25	45	+1,125	Rejected on the line, not booked
4

The figures are made up for illustration. At the top of each sheet, note the company, location, date and time of the count, the cut-off document numbers, the sheet number and the count team. At the bottom, leave space for "counted by", "checked by" and "approved by", with signatures. Add a batch or lot column if you track batches.

What is cycle counting, and does it work in a running factory?

A full count needs the plant to stop, and many factories cannot stop for a day. Cycle counting spreads the work: you count a few items every day or week, so every item is counted over a cycle without stopping production.

How to run it:

• Start with the items that hurt. Count first the items that show negative, keep stopping production, or are worth the most.
• Then set a rhythm. High-value and fast-moving items more often, slow movers less often.
• Count an item everywhere at once. Stores, floor, quality hold and job workers on the same day. Counting stores today and the floor next week tells you nothing.
• Fix the time of the count. Counting at the start of the day, before production, makes it clear that the day's production comes after the count.
• Post the count as the item's opening at that moment, and note the count date against the item, so you know which items are clean.
• Never let a counted item go negative. If it tries to, an entry is missing, and you find it that day instead of at year-end.

Stock reconciliation: how to treat the difference in the books

Explain first, adjust last

Every difference should end up in one of five places.

What you found	What to do
A movement nobody entered: consumption, a receipt, a rejection, scrap	Enter it on its real date
Stock in the wrong place: floor, job worker, quality hold	Transfer it
The same item under two codes	Merge the items
A counting mistake	Recount
A real loss or gain	Adjust through a stock reconciliation, with the reason written down

Only the last row is a true adjustment. If you post the raw count without this step, you write off stock that was used, moved or sitting under another code, and the same causes come back next year.

Value it at cost, and expense real losses

Two accounting standards cover inventory in India: AS 2 and Ind AS 2. Your CA will know which one applies to you. On the points that matter here, they agree:

• Inventory is valued at the lower of cost and net realisable value (AS 2 paragraph 5, Ind AS 2 paragraph 9).
• Abnormal amounts of wasted material are not part of the cost of inventory. They are an expense of the period (AS 2 paragraph 13(a), Ind AS 2 paragraph 16(a)). So abnormal wastage, such as a batch spoiled by a machine fault, is charged as an expense, not loaded into the cost of your finished goods.
• Ind AS 2 says all losses of inventories are recognised as an expense in the period the loss occurs (paragraph 34).
• The count is also when you find rusted, damaged or obsolete stock. Both standards note that the cost of such stock may not be recoverable, and it is written down to net realisable value (AS 2 paragraph 20, Ind AS 2 paragraph 28).

How the loss is shown in the final accounts is your CA's call. Your job is to give them a clear list: item, quantity, value at cost and the reason.

GST on stock that is lost or written off

Three parts of the GST law matter here:

• No credit on lost or written-off goods. Section 17(5)(h) of the CGST Act says input tax credit is not available on "goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples". If you claimed credit when you bought those goods, work out with your CA how much to reverse. Whether a particular process loss or scrap falls under this clause is also a question for your CA.
• Unexplained shortages are a risk. Under section 35(6), if you fail to account for goods, the GST officer can work out tax on them as if you had supplied them.
• Your stock account must show the losses. Rule 56(2) of the CGST Rules requires stock accounts with the opening balance, receipts, supplies, goods lost, stolen, destroyed or written off, and the closing balance, including scrap and wastage.

Put together: a loss you have recorded, with a reason, is far better than a gap you cannot explain. If you use ERPNext with the India Compliance app, a credit reversal can be posted as a Journal Entry of type "Reversal Of ITC", which the app's GSTR-3B report picks up.

What your auditor will ask

For companies covered by the Companies (Auditor's Report) Order, 2020 (CARO 2020), the auditor has to report:

• whether management verified inventory physically at reasonable intervals, and whether the coverage and procedure were appropriate;
• whether discrepancies of 10% or more in the aggregate for each class of inventory were found, and whether they were properly dealt with in the books;
• where the company has working capital limits above ₹5 crore secured on current assets, whether the quarterly stock statements filed with the bank agree with the books.

That last point matters if you borrow against stock. The stock statement you send the bank each quarter has to agree with your books, so a mismatch shows up there too.

Stock reconciliation example

A small fabrication and assembly unit counts its stock at year-end. The figures are made up for illustration. Six items show a difference.

Item	Book qty	Counted qty	First difference	What they found	Fix	Real loss
MS sheet 2 mm (kg)	4,800	4,240	-560	480 kg went into brackets made last week, never entered. 80 kg of offcuts in the scrap drum	Enter the production on its real dates. Book 80 kg as scrap	0
Bearing 6203 (nos)	1,200 in stores	1,040 in stores, 135 on the floor, 25 in the QC bin	-160 in stores	Issued to the line without a transfer. 25 rejected on the line	Transfer 135 to the floor. Book 25 as a rejection	0
Castings for machining (nos)	600 in stores	250 in stores, 350 confirmed by the job worker	-350 in stores	Sent on challan, never moved in the books	Transfer 350 to the job worker's warehouse	0
Grey paint (litre)	-40	15	+55	A 60-litre purchase was used before its receipt was entered. 5 litres used on the line, not booked	Enter the receipt on its real date. Book 5 litres as consumption	0
Front cover 75 (two item codes)	300 and -120	180	-120 and +120	The same part created twice. Purchase used one code, production the other	Merge into one item	0
Brass bush 20 mm (nos)	1,500	1,454	-46	No missing entry found after checking receipts, issues and rejections	Write off through a stock reconciliation	46 nos

If the store had simply posted the count, the books would have shown losses on MS sheet, bearings and castings and a gain on paint, and none of those would have been true. After investigation, only one item is a real loss: 46 brass bushes. At a valuation rate of ₹85 each, that is ₹3,910.

Notice the paint. Negative stock hid a missing purchase receipt. With negative stock blocked, the issue that took the paint below zero would have been refused, and someone would have entered the receipt that day.

The final steps:

1. Enter the missing production, receipt, transfers, rejection and scrap on their real dates.
2. Merge the two front cover items.
3. Post a stock reconciliation for the brass bush: counted quantity 1,454 at ₹85. In ERPNext, the ₹3,910 difference goes to the company's Stock Adjustment account by default.
4. Write down the reason, "shortage found at year-end count, no record of issue", and give your CA the list to decide on the expense and any input tax credit to reverse.

How ERPNext keeps stock and books in step

Good inventory management for manufacturing is mostly about booking each movement where it happens, on the day it happens. Here is what standard ERPNext gives you for that. We checked each point against the ERPNext version 16 source code.

Warehouses that match the plant

Warehouses can be grouped, so you can mirror the real layout:

• Stores for everything bought in
• Production floor for material issued to the line and work in progress
• Finished goods
• Quality hold, a group with rejected, rework and scrap warehouses inside it. A warehouse can be marked "Is Rejected Warehouse", and a purchase receipt can send rejected quantity straight to it
• Job workers: a Subcontracting Order asks for a "Job Worker Warehouse", so material at each vendor is tracked as its own location

Our guide to ERPNext for manufacturing covers this setup in more detail.

Negative stock switched off

In Stock Settings, "Allow negative stock" is off by default. There is also an "Allow Negative Stock" tick on each item, which overrides the global setting for that item, so keep that off too. With both off, ERPNext refuses an entry that would take an item below zero and shows an "Insufficient Stock" message with the quantity needed.

One caution for a plant that is already full of negative items: switching the setting off on day one blocks every production entry that uses one of them. Count those items first, then switch it off.

Stock Reconciliation in ERPNext

Stock Reconciliation is the document that posts a count:

• "Fetch Items from Warehouse" fills in the items in a warehouse with their current quantity and rate
• You enter the counted quantity, and ERPNext shows the quantity difference and the amount difference for each row
• The difference posts to the company's Stock Adjustment account unless you choose another account
• With the purpose set to "Opening Stock", it sets the opening at go-live, and the difference must go to an asset or liability account such as Temporary Opening
• It handles batch and serial numbers, and it has a barcode scan mode for counting

Reports that show where the gap started

• Stock Ledger lists every movement of an item with the quantity in, out and the balance after it, and the document behind it. When an item is wrong, this is where you find the day it went wrong.
• Stock Balance shows opening, in, out and closing quantity and value by item and warehouse for any period.
• Stock and Account Value Comparison lists documents where the stock value and the stock account in your ledger do not agree, for accountants who need the two to tie.

After an audit, set the "Stock frozen up to" date in Stock Settings. Stock entries before that date can then no longer be created or changed, except by a role you allow.

Batch and serial numbers where you need them

Tick "Has Batch No" for items you trace by lot and "Has Serial No" for items you track one by one. Decide before the first transaction, because ERPNext does not let you change either once stock has moved.

What we built on top for manufacturers

For manufacturers we work with, we built the following in a custom Frappe app on top of ERPNext. These are not part of standard ERPNext.

• Cycle count as the item's opening. For each count, the store quantity, the floor quantity and the date go in, and the app posts a Stock Reconciliation for both warehouses at the start of that day and marks the item as counted from that date, so that day's production is deducted from the counted figure.
• A guard so a counted item cannot go negative. Every stock entry and cancellation is checked at its own time and against every later balance, so a counted item can never go below zero in stores or on the floor, even through a back-dated entry.
• Line rejection into quality hold. When QC rejects a part on the line, the entry moves it into the Quality Hold group: supplier faults to Supplier Rejection for a debit note, repairable parts to Rework, the rest to Scrap. The warehouse follows from the type of rejection, so nobody picks it by hand.
• Item creation limited to one administrator. Create permission is removed for every other role, and a check in code refuses new items from anyone else. Item search was changed to match words in any order across code, name and description, so people find the item that already exists.

How Tanush Digital can help

We set up and customise ERPNext for manufacturers across India. When stock never matches, we start on the floor: we walk through your stores, line, quality area and job work with your team, set up warehouses that match how material really moves, and help you run the first count and post the reconciliation. Where standard ERPNext is not enough, we build the missing pieces as a custom Frappe app, like the cycle count and counted-stock guard above. See how we work on our ERPNext page, or contact us to talk it through.

Frequently asked questions

What is physical stock verification?

Physical stock verification is counting the stock actually present in every location, such as stores, the production floor, finished goods, quality hold and job workers, and comparing it with the stock in your books. Each difference is investigated, explained and then corrected.

Is stock reconciliation the same as physical stock verification?

No. Physical stock verification is the count. Stock reconciliation is matching that count with the books and posting the correction. Missing entries, wrong locations and duplicate items should be fixed first, so only real losses or gains go through as an adjustment.

How often should a factory count its stock?

There is no single right answer. CARO 2020 asks the auditor whether management verified inventory at reasonable intervals and whether the coverage and procedure were appropriate. A practical rhythm is a full count at year-end and cycle counts in between, with high-value and fast-moving items counted more often.

How do I stop negative stock in Tally Prime?

Tally's help describes a "Warn on negative Stock Balance" option, set from F12 (Configure) in a sales voucher, which shows a warning when stock would go negative. To see items already below zero, open the Reorder Status report, press Ctrl+J (Exception Reports) and select Negative Stock Items. In ERPNext, with "Allow negative stock" off, the entry is refused instead.

Do we have to reverse GST credit on stock that is lost or written off?

Section 17(5)(h) of the CGST Act says input tax credit is not available on goods lost, stolen, destroyed or written off. If you claimed credit when you bought those goods, work out the reversal with your CA. Record the loss and its reason in your stock account, because goods you cannot account for can be taxed as if you had supplied them.

What will the auditor ask about our stock count?

For companies covered by CARO 2020, the auditor reports whether inventory was physically verified at reasonable intervals, and whether discrepancies of 10% or more in the aggregate for any class of inventory were found and properly dealt with in the books. Keep the signed count sheets and a note of how each difference was settled.

Sources

• CGST Act 2017, section 17: blocked credits, including 17(5)(h), CBIC
• CGST Act 2017, section 35: accounts and other records, including 35(6), CBIC
• CGST Rules 2017, rule 56: maintenance of accounts, including stock and production accounts, CBIC
• Ind AS 2, Inventories, Ministry of Corporate Affairs
• AS 2, Valuation of Inventories, Ministry of Corporate Affairs
• Companies (Auditor's Report) Order, 2020, paragraph 3: matters to be included in the auditor's report, Income Tax Department
• TallyPrime help: sales FAQ, warning on negative stock balance, Tally Solutions
• TallyPrime help: Reorder Status and Negative Stock Items, Tally Solutions
• ERPNext documentation: Stock Reconciliation and Stock Settings, Frappe
• ERPNext version 16 source code: Stock Settings, Frappe on GitHub