Inventory Accounting for Medical Device Companies: COGS, Obsolescence, and Controls
Inventory accounting is a way for medical device companies to gain real-time insight into device expiry dates and device location. An efficient process can reduce overstock and stockouts by a significant margin and help to maintain positive cash flow.
Compliance and safety are always at issue, as regulatory bodies such as the FDA require strict lot tracking and the elimination of expired or dead stock.
The process itself focuses primarily on expiration dates, shelf life, traceability, and risk management. Done right, benefits include improved safety, cost reduction, better cash flow, more accurate demand planning, stronger client relationships, and overall operational efficiency.
In developing a process, the following three focus areas are particularly critical:
Cost of goods sold (COGS)
Inventory obsolescence
Internal controls
Taken together, they can support or challenge financial reporting, operational efficiency, and audit readiness, ensuring the company can stay profitable and compliant.
Types of Inventory in the Medical Device Industry
Medical device companies typically track three things for inventory accounting:
Raw materials: individual components used to make the device.
Works-in-progress (WIPs): partially assembled, mid-production, or devices undergoing quality testing.
Finished goods: subject to serialization and often under strict traceability controls.
What makes it all so much more complicated is that, due to the highly regulated nature of the sector, products are often subject to revisions, updates, or revalidation, causing inventory valuations to fluctuate wildly.
Documentation is also a big part of the compliance process. Lot numbers must be tracked, and detailed records must be kept for audit purposes. Understandably, this creates a significant administrative burden, adding labor costs and increasing the risk of error.
So, let’s look at the three categories in more depth.
Considerations for COGS
A myriad of things can be classified as COGS. Materials, labor, and manufacturing overhead are applied when directly related to the creation of a device.
Simple, in theory; however, if we take a broader look, the reality is a bit more nuanced. Case in point: a company with multiple product lines sharing resources may struggle to allocate costs efficiently. Overhead costs are also complicated to assign, as there are equipment depreciation costs, facility expenses, and QA/QC activities to consider.
Standard costing systems, in which predetermined amounts are used to value inventory and calculate COGS, may provide consistency, but they must be updated regularly to remain accurate.
Variance analysis must be applied to help finance teams understand the difference between the baseline standard and actual costs. When materials, labor, or overhead costs fluctuate, they may be a harbinger of more serious operational inefficiencies.
Additionally, you must consider the incidence of scrap and rework, as this tends to happen frequently in the medical device sector. In extreme cases, where a product is recalled or fails at the compliance stage, sudden cost spikes will impact profitability. Hence, these details need to be captured and tracked to ensure financial statements reflect the true cost of production.
The Risks of Inventory Obsolescence
Rapid technological advances can make medical devices obsolete overnight – but that’s not the only risk to consider. Product updates, changing regulatory standards, or the availability of parts and raw materials can relegate inventory to the junk heap in a nanosecond. Certain materials may also have expiry dates, adding another layer of risk.
Monitoring these variables is challenging without the right tools. Aging reports, turnover ratios, demand forecasts, and engineering change orders (ECOs) are key to the process, and without proactive management across all of these areas, unnecessary losses can result.
From an accounting perspective, timing is critical. Decisions must be made about when to record write-offs and write-downs, as these have implications for compliance and the maintenance of good accounting principles.
Write-offs and write-downs are quite different: whereas a write-off reduces the value of the inventory to its net realizable value, a write-down removes it from the books entirely. As you can imagine, either of these actions will impact the income statement, ballooning costs and shrinking margins. Any delays in recognizing these actions may lead to overstated assets, requiring corrections down the road.
Strong Internal Controls are the Backbone of Inventory Accounting
The right internal controls can help to reduce errors, prevent fraud, and ensure compliance with financial and regulatory standards. A solid set of controls also helps you breeze through audits and inspections, as you’ll have the documentation and rationale to defend any questions that may arise.
The most important controls to implement are regular cycle counts and physical inventory counts. These processes help you verify that your paper inventories align with reality. If there are discrepancies, you’ll need to investigate immediately to ensure data integrity.
In best practice, it’s a good idea to segregate duties to reduce the risk of error and manipulation. Assign purchasing, receiving, recording, and transaction approvals to separate individuals, and keep each process isolated.
ERP systems or similar technology platforms can support the process by improving accuracy, traceability, and visibility. With these systems, you’ll also have verifiable records to pull in case of an audit or to satisfy a compliance mandate.
But despite all efforts, mistakes can still happen. Manual systems are the biggest culprit, but poorly integrated systems and a lack of real-time data can also undermine your results.
Establishing standard operating procedures (SOPs) across locations, cross-training appropriate staff, and investing in a modern, automated system will serve you well.
Next Steps: Recommended Actions
Here are a few tips to help you get started:
Review standard costs regularly to ensure they align with reality.
Create clear policies to identify obsolete inventory.
Implement software systems to eliminate manual processes, automate tracking, and improve efficiency.
Prioritize inter-departmental collaboration (finance, operations, supply chain, QA/QC) to reduce risk.
Conduct periodic internal audits to support continuous improvement.
The Bottom Line
Inventory certainly isn’t anybody’s favorite thing to do. However, it is a critical function for medical device companies and can support accurate financial forecasting, compliance, and operational excellence.
Need help with this? The experts at Growise are here to help! Set up a call today, and let’s talk inventory!