Radio Frequency Identification (RFID) By Gigi Tat ACC 626

Radio Frequency Identification (RFID) By Gigi Tat ACC 626

Introduction: What is RFID? Radio Frequency Identification, or RFID for short, is an emerging technology intended to replace traditional bar codes and can be used by businesses in many ways. It involves transplanting a small microchip (RF tag) on an item or pallet, which can then be scanned by a reader using radio frequency waves. 1 The data stored on the RFID tag usually does not exceed 2KB, and can include information about the product such as product logistics and date of manufacture. A RFID system consists of three main components: a tag, a reader, and a computer system. 2 A RF tag is made of a microchip attached to a radio antenna, and can be applied or embedded into the packaging of a product. Tags can either be in a passive or active format, where active tags have read-write capabilities, greater memory capacity and a better range. Active tags are also typically much more reliable (i.e. fewer errors) and can transmit data at higher power levels, having operational ranges of hundreds of meters and a battery life of up to 10 years. 3 On the other hand, passive tags are much less expensive, with a starting cost range of $0.05 per tag compared to $4 per active tag 4, and are more durable since they are not self-powered by a battery. Additionally, tags can be read-only or read/write, where stored data can be read but not changed or can be altered and rewritten in the latter case. In order to assess the capabilities of RFID technology, accounting practitioners should have at least a basic understanding of how RFID works. Moving on to the second component of a RFID system, readers provide the linkage between the tag and the computer system, allowing data to be read from the tag and transmitted to the system. The computer system is the third component, and is often regarded as the most critical part of a RFID system. Software on the computer system must have the ability to store and filter the data being read from the tags so that it can easily be retrieved when needed. The intention of this paper is to address the impact of this emerging technology within a business setting and to educate accounting practitioners of the risks, opportunities and areas of potential application associated with RFID. The impact of RFID on inventory costing and valuation will also be addressed, as well as its impact in auditing. 1 Cairney, Tim and Higgins, Leslee N., RFID opportunities and risks, Journal of Corporate Accounting & Finance 17.5 (2006):51-57. 2 Ross Fink et al., Will RFID change inventory assumptions?, Strategic Finance 89.4 (2007):34-39 3 Radio-frequency identification 18 July 2008 < http://en.wikipedia.org/wiki/rfid>. 4 Attaran, Mohsen, RFID: an enabler of supply chain operations, Supply Chain Management: An International Journal 12.4 (2007):249-257. Page 1 of 12

Comparison of Bar Codes and RFID Recent advances in RFID technology have enabled the adoption of RFID systems in many companies who have traditionally used bar codes in their operations. Bar codes have long since become the standard for identifying and tracking objects, mainly applied in the areas of inventory and supply management. As most practitioners have probably come across the use of bar coding when conducting inventory counts, it is important that they understand the differences between the two methods. In order to better assist the practitioner in their understanding of RFID systems, a comparison of the two technologies have been provided in Exhibit 1. Exhibit 1 Comparison of Bar Codes and RFID Bar Code Bar codes require line of sight to be read. RFID RFID allows for information to be read by radio waves from a tag, without requiring line of sight scanning. Bar codes can only be read individually. Bar codes cannot be read if they become dirty or damaged. Bar codes literally cost pennies. Bar codes can only identify the type of item. Bar code information cannot be updated. Multiple RFID tags can be read simultaneously. RFID tags are able to cope with harsh and dirty environments since they are protected within a plastic cover and can be implanted within the product. RFID tags can range from $0.05 per passive tag, to $4 per active tag. RFID tags can identify specific items. Data can be over-written repeatedly on certain types of RFID tags. The range to read a bar code is typically no more than 15 feet. RFID tags can be read at much greater distances; an RFID reader can pull information from a tag at distances up to 300 feet. Sourced from David C. Wyld (2006) Taking the above comparison into consideration, accounting practitioners should be better able to assess how RFID can assist them during inventory counts or in the costing and valuation of inventory. Potential Opportunities of RFID Implementation The potential opportunities associated with RFID should be understood by practitioners in order for them to take advantage of this technology. Improvements in Inventory Efficiencies According to Rundh (2008), the most important advantage that RFID systems bring is the Page 2 of 12

capability of enabling product surveillance since inventory levels can be tracked at any point in the supply chain. 5 RFID technology enables companies to increase operational efficiency as a result of the improved responsiveness by having real-time tracking data. The ability to capture accurate and detailed product data enhances visibility in inventory flow, and enables the supply chain to better match supply and demand. 6 In Hingley (2007), it was reported that the use of a tag and reader can improve the efficiency and accuracy of locating inventory, helping to keep inventory levels at a minimum due to the availability of a real-time inventory count. In addition to improvements in inventory efficiencies, the deployment of RFID can also result in benefits such as cost savings, increased stock availability and time efficiencies. Cost Savings Karkkainen (2003) reported that Sainsburys, a supermarket chain in the UK, carried out an RFID practice run and found that while the initial investment was estimated to be between 18 million and 24 million, the total benefits achieved were an estimated 8.5 million a year, mainly through more efficient stock control and rotation. 7 As a result of increased processing speeds and the reduction in the amount of manual labor required, costs are dramatically reduced. Increased Stock Availability Having increased stock availability can be seen as an important competitive tool in ensuring customer retention and satisfaction. The real-time tracking capability offered by RFID allows for up-to-date inventory numbers, enabling greater efficiency when replenishing and forecasting. 8 Wal-Mart and Sara Lee reported a 20 percent reduction in replenishment cycle and a 40 percent more accurate forecast with a 32 percent increase in sales (Attaran 2007). Additionally, Saunders (2005) reported that when RFID tags were employed at item level, the traceability of products would be completely guaranteed; allowing suppliers to know precisely the amount of inventory on hand. 9 Smith (2003) reported that Procter and Gamble estimated that up to 16 percent of its items are out-of-stock on store shelves. Reduction in that number by 10-20 percent could result 5 Rundh, Bo, Radio frequency identification (RFID), Marketing Intelligence & Planning 26.1 (2008):97-114. 6 Martin Hingley et al., Radio frequency identification tagging: Supplier attitudes to implementation in the grocery retail sector, International Journal of Retail & Distribution Management 35.10 (2007):803-820. 7 Karkkainen, M., Increasing efficiency in the supply chain for short life goods using RFID tagging, International Journal of Retail & Distribution Management 31.10 (2003):529-536. 8 Hingley et al. 803-820. 9 Can smart tags DELIVER? 18 July 2008 < http://www.managementtoday.co.uk/search/article/461021/cansmart-tags-deliver/>. Page 3 of 12

in a revenue boost of 1-3 percent. With more than $40 billion in revenue, Proctor & Gamble can potentially save $400 million each year by implementing RFID. 10 This allows companies the advantage of knowing exactly what products are on hand in addition to how many, so that shelves stay stocked without increasing inventory levels or safety stock. Time Efficiencies Through implementation of RFID, human intervention is significantly reduced. 11 RFID systems offers the convenience of RFID readers, eliminating the need for individual scanning of every pallet or case as readers can scan multiple objects in one. Tags also provide information on a real-time basis, with no time delay between the stock moving and its movement being captured by the system. Potential Risks of RFID Implementation However, as with all new and emerging technological developments, RFID also has its share of acceptance problems and challenges. Among these are cost, security, and privacy issues. Cost According to Smith (2005), a major challenge to widespread acceptance of RFID technology is the significant investment involved with implementing a RFID system. The initial cost of investment and training may be relatively prohibitive for most companies, carrying a price tag of about $13 million to $23 million (Barut et al. 2006). However, it has been projected that there will be a dramatic reduction in the price of RFID tags over the next few years. In Smith s (2005) report, it was found that in 1999, the cost of a RF tag was $1. This cost has already been reduced to about half when purchased in small quantities today. Some estimate that over the next few years, the cost will drop to about several pennies per tag. Gillette has already made a deal with Alien Technology Corp. to purchase500 million tags for fewer than 10 cents a tag over the next few years. 12 Many in the industry are taking a wait and see approach to this technology until tag prices drop to less than a penny. At present, Wal-Mart and Gillette have taken up the initiative to have every pallet or case tagged until it is feasible to have a chip on an item-level basis. Security 10 Smith, Alan, Exploring radio frequency identification technology and its impact on business systems, Information Management & Computer Security 13.1 (2005):16-28. 11 Hingley et al. 803-820. 12 Smith 16-28. Page 4 of 12

Security is among one of the top issues facing companies that are considering deploying RFID. Smith (2005) indicates the possibility for competition to gather or steal information as identification information on passive RF tags can easily be stolen. 13 As a result, sensitive information can be related to competitors or to the general public. Furthermore, RFID is a wireless technology subject to third-party interception, unless the signal is secure (Muir 2006). Other security concerns surrounding RFID technology include viruses that can be embedded in RF tags (Liu and So 2006), electromagnets (RFID chip zappers) that can be used for personal access control or denial-of-service attacks, sniffing which allows unauthorized reading of tags, and spoofing which is a process of creating counterfeit tags. 14 Privacy As RF tags contain much more information than the generic information relayed from a bar code, many privacy advocates are concerned with the effect that RFID will have on consumer privacy. This issue is particularly a concern with the use of item-level tagging, where privacy advocates claim that the small size of item-level tags allow them to be potentially hidden from consumers, and scanned without the consumer knowledge for use in customer profiling (Cariney and Higgins 2006). For example, small passive RFID tags are increasingly being sewn into clothing, providing retailers with inventory tracking benefits (Cochran et al. 2007). However, the problem arises when these tags are not deactivated at the point of purchase, as it could inadvertently result in customers being tracked. Additionally, the use of RFID in credit cards makes it possible for hackers to read the full RFID tag on a credit card from as far as 30 feet (Cochran et al. 2007). Once read, the data can be copied and downloaded onto a counterfeit card for use. As such, appropriate measures need to be adopted to prevent improper use of RFID technology and to ensure that the full potential of this technology can be realized. Areas of Application As stated by Rundh (2008), the possibilities for RFID application are endless. Even though RFID can be applied in a wide range of areas, its most obvious impacts are in inventory or supply chain management. For example, clothing retailers like Prada and GAP have also undertaken RFID technology in their stores as a means to increase sales and reduce costs 13 Smith 16-28. 14 Bean, LuAnn, RFID: Why the worry? The Journal of Corporate Accounting & Finance 17.5 (2006):3-13. Page 5 of 12

(MGinity 2004). It is crucial for practitioners to understand what the technology can do and the ways in which it might be applied by their clients. Some areas in which RFID can be implemented are summarized by Attaran (2007) to include the following: 1. Shipping and distribution: In this industry, RFID technology affords suppliers the benefit of being able to accurately determine the location of a pallet as it travels through the supply chain and to make instantaneous routing decisions. 15 2. Retail industry: As mentioned earlier, RFID technology offers a very significant advantage over bar coding. Not only does it enable the gathering of real-time data to assist in inventory management, but also works to reduce labor and manual costs. 3. Manufacturing sector: This sector derives value from this technology through product tracking initiatives. Parts received from the production plant are tagged and tracked as they make their way through the assembly process, greatly helping manufacturers to maintain just-in-time (JIT) assembly lines. 4. Health care: RFID technology is being used in this industry to improve quality and reliability. In some cases, RFID tags are being embedded in patient wristbands to assist in identify patients and to allow automatic status updates. Other cases include the tracking of assets such as medial devices and wheelchairs and the matching of blood samples to patients. 5. Casinos: The gaming industry has also been taking advantage of the benefits that RFID can offer. The Wynn Las Vegas Casino, for example, has been using radio tags on betting chips to deter counterfeiting, card-counting and other illegal behavior 16. Dealers are also able to take a quick inventory of chips that have been wagered, which allow casinos to further monitor player statistics though individual wagers placed by players. Accounting Implications The use of RFID technology affects the areas of inventory management the most. At first glance, RFID s ability to allow for specific identification would appear to improve the accuracy of inventory costing. But it also adds the potential for abuse (Fink et al. 2007). The methods used in inventory costing will be explored in addition to the use of specific identification with RFID and its impact on inventory assumptions. 15 Attaran 249-257. 16 Attaran 249-257. Page 6 of 12

The three basic methods of inventory costing are weighted average cost, first-in first-out (FIFO) and last-in first-out (LIFO). In an effort to compare each of the methods with specific identification through RFID, a table is provided in Exhibit 2. According to current accounting standards, the inventory-valuation method chosen should be the one that most clearly reflects periodic income. 17 Although specific identification most accurately allows the proper matching of costs to sales, it is often deemed too expensive and impractical to use. However, with the declining cost of RFID, specific identification may soon be practically applied. With the apprehended decline in RF tag costs, companies will soon be able to use the specific identification method of inventory costing. When used appropriately, this method far exceeds the estimations currently used in practice (Fink et al. 2007). As specific identification provides the actual flow of both the physical inventory and its cost, a clear picture for managerial decision making, financial reporting and tax liability will be available 18. Exhibit 2 Comparison of Inventory Costing Methods FIFO Costing Method Managerial Decision Making Generally approximates physical flow. Tax Liability The oldest products, which generally have the lowest cost, must be used first. This leaves the company to pay higher taxes. Financial Reporting May distort gross profit somewhat since the newest sales are matched with the oldest inventory, costs aren't properly matched. Low level of manipulation. Low manipulation. Properly reflects ending inventory. Weighted Average Cost Preferred method for internal reporting due to its simplicity in application. Low level of manipulation of costs as all sales are lumped together throughout the period, giving management a fair representation of cost. No advantage or disadvantage. No manipulation. No clear picture of gross profit provided since sales and costs are not properly matched. Does not provide accurate representation of the actual flow of inventory and its related costs. 17 Fink et al. 34-39. 18 Fink et al. 34-39. Page 7 of 12

LIFO Gives the poorest estimation of the physical flow of inventory. Low level of manipulation. Greatest tax advantage since new inventory generally has a higher cost; LIFO will inflate cost of goods sold and therefore reduce a company's tax liability. Defers taxes. Provides better picture of gross profit by matching new revenues with new costs. Difference in LIFO's assumption of cost flow and the actual flow of goods understates ending inventory. Specific Identification (RFID) Reflects actual physical and cost flow. Provides for accurate representation of tax liability since no estimation of product flow is used. However, inventory may be used to reduce tax liability by distorting product flow and recognizing products with higher costs first to raise expenses and lower the tax liability. As a result, no real advantage or disadvantage. Provides optimal objective of financial reporting as each individual purchase is matched to a specific item cost. This allows for perfect matching and a clear representation of profit. Easily manipulated. Easily manipulated. Allows creation of cookie jar reserves. Sourced from Ross Fink et al. (2007) RFID s Impact on Auditors and Assurance Implications RFID deployment at an organization raises many new and different inventory issues for the auditor. In an effort to help businesses further understand the issues involved with RFID implementation, internal auditors can assist firms with risk evaluation, control assessment, and process improvements in significant areas related to RFID (Bean 2006). As for external auditors, auditing of companies who have implemented full scale (on an item-level basis) RFID systems will allow for more efficient testing, valuation and recognition of discrepancies in inventory. Accuracy of inventory valuation is enabled because RFID allows for specific identification of costing which, as mentioned earlier, allows for perfect matching of cost to inventory. Physical inventory counts will be made more efficient as all inventory will be tagged, allowing for ease of locating and tracking. However, the use of specific identification will provide management with the ability to manipulate product flow through use of cookie jar reserves. Cookie jar reserves allow an organization to adjust quarterly or yearly earnings (Fink et al. 2007). Similarly, with specific identification companies can purchase lower-priced inventory and hold them in reserve, and when sale is slow or extra revenue is needed, they can use these lower-priced inventory to Page 8 of 12

decrease cost of goods sold. 19 As a result, external auditors should be alerted to management manipulation when using the RFID-enabled specific identification costing method. Additional challenges faced by the auditor include data inconsistency due to varying tags and readers deployed across regions and business units, poor analytics due to lack of visibility and access to information, and productivity loss due to manual processes for information routing and communication. 20 In light of the improved costing information provided by RFID, auditors now face management of an exponential increase in data flow captured by RFID tags. As a result, auditors now hold the responsibility in ensuring that these electronic records are being adequately captured and managed in compliance with current audit standards. Case Study: University of Waterloo As the operations of a library are similar in many ways to that of a retail store, where books can be analogized to inventory, the University of Waterloo library was chosen as a case study to further assist practitioners in better understanding the many ways in which RFID can be applied. The University of Waterloo library was the first academic library in North America to utilize RFID technology in its facilities. 21 Over 300,000 items in the library were tagged to facilitate for ease and efficiency of checkouts. To further exploit the benefits that RFID has to offer, handheld sensors were employed to facilitate inventory tracking and to increase efficiency when handling library materials. In an article by Muir (2006), libraries have undertaken this technology in an effort to increase productivity and inventory management. RFIDs can also speed a number of processes for library staff through reduction in handling time, thus reducing queues at the front desk and increasing interaction with patrons (Yu 2007). For example, multiple books can be checked out simultaneously since the RFID reader does not have to be used within the line of sight of the tag (Muir 2006). While RFIDs offer many benefits to libraries in terms of time savings, productivity enhancements and better collection management 22, there still exists the pressing issue of privacy and security concerns. In a 2007 article, Yu (2007) reported that all patron activities such as 19 Fink et al. 34-39. 20 RFID Audit and Compliance 18 July 2008 <http://vandia.com/auditcompliance.html>. 21 3M Canada announces gift 18 July 2008 <http://www.lib.uwaterloo.ca/newsatlib/060529/3m_gift.html>. 22 Muir 95-107. Page 9 of 12

reading and action behavior can be detected by readers installed in the library. Possible scenarios of privacy invasion can involve someone walking by your bag of books with a RFID reader and being able to read all the books that you have checked out. Although one might question whether knowing what a person has checked out from the library is of any importance, a threshold must be set to effectively protect personal privacy. Conclusion Seeking a sustainable competitive advantage has become the priority for any company competing in the international marketplace. RFID is one such tool that has emerged in recent years which can provide organizations with this advantage. Although not widely accepted as of yet, RFID offers many benefits to businesses and has many areas of application. Benefits include increased supply chain and inventory visibility, greater operational efficiency, and substantial cost savings in the long run. In this report, we also evidenced the application of RFID in many areas, the most relevant being RFID s use in accounting for inventory and for auditing purposes. Specifically, RFID is generally used in inventory costing for accounting purposes, whereas its function in auditing lies in the performance of inventory counts and inventory valuation. In light of the many benefits provided by RFID, it is not without its challenges. Privacy, security and cost are among the top issues facing companies who are looking to deploy RFID systems. In today s technologically driven world, security plays an important role in ensuring operations can smoothly run without unauthorized outside interference. Consumer privacy must also be closely watched in situations where the technology is deployed on an item-level basis. Without measures in place to mitigate these issues, the potential opportunities that the technology has to offer cannot be fully exploited. By understanding the risks and opportunities associated with RFID, accounting practitioners should have a better understanding when approaching clients who have embraced this system. A clear understanding of RFID s many areas of application will also enable practitioners to assess potential risk areas when conducting assurance engagements. The intention of this paper was therefore to address the impact of RFID technology within a business setting and to provide an analysis of the risks, opportunities and areas of potential application for the use of accounting practitioners. This emerging technology was also addressed in regards to its impact on inventory costing and the ways in which it can assist auditors in the performance of inventory counts and inventory valuation. Page 10 of 12

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(2007): 54-64. Radio-frequency identification, Wikipedia. 18 July 2008 <http://en.wikipedia.org/wiki/rfid>. Saunders, Andrew, Can smart tags DELIVER? Managementtoday.com. 18 July 2008 <http://www.managementtoday.co.uk/search/article/461021/can-smart-tags-deliver/>. RFID Audit and Compliance. Vandia Security. 18 July 2008 <http://vandia.com/auditcompliance.html>. 3M Canada announces gift. University of Waterloo. 18 July 2008 <http://www.lib.uwaterloo.ca/newsatlib/060529/3m_gift.html>. Page 12 of 12