Inventory Audit Procedures
Inventory audit procedures are designed to validate a company’s reported inventory quantities and values, and to assess whether inventory is properly accounted for in accordance with applicable accounting standards.
Here are some common procedures that auditors might use to audit inventory:
- Physical Inventory Count: Auditors may attend the client’s physical inventory count at the year-end or another appropriate time. They will observe the counting process, check the accuracy of a sample of items counted by the client’s staff, and verify that the count is being conducted according to the company’s established policies and procedures.
- Inventory Valuation: Auditors review the methods used by the company to value inventory and check a sample of items to verify that they have been correctly valued. This could involve checking the costs assigned to inventory items against purchase invoices, and ensuring that the company’s method for allocating costs to inventory is consistent with applicable accounting standards.
- Inventory Ownership: Auditors need to confirm that all inventory reported on the balance sheet is actually owned by the company. This could involve reviewing purchase and sales agreements, checking for consignment inventory, and investigating any inventory held on behalf of others.
- Inventory Existence and Completeness: Auditors use inventory records and other documentation to verify that the reported inventory actually exists and that all inventory owned by the company has been included in the inventory count and properly reported.
- Inventory Obsolescence: Auditors assess whether any of the inventory is obsolete or has a market value lower than its cost. This could involve reviewing the company’s procedures for identifying obsolete inventory, checking sales data for slow-moving items, and considering whether any write-downs for obsolescence are appropriate.
- Cut-off Analysis: Auditors examine transactions that occurred near the inventory count date to ensure that they have been recorded in the correct accounting period. This helps ensure that the inventory quantities and values are accurately stated at the balance sheet date.
- Documentation and Internal Control Review: Auditors review the company’s internal controls related to inventory, such as procedures for receiving goods, moving inventory within the company, and shipping goods to customers. They also review documentation like purchase orders, receiving reports, and shipping documents to verify the accuracy of inventory transactions.
These procedures are designed to help the auditor obtain sufficient, reliable evidence about the quantity and value of the company’s inventory. However, the specific procedures used can vary depending on the nature of the company’s operations, the auditor’s assessment of the risk of material misstatement, and other factors.
Example of the Inventory Audit Procedures
- Physical Inventory Count: The auditor attends the physical inventory count at the end of the year. They observe the company’s employees counting the inventory, take note of the counting methods used, and randomly select some items to count independently for verification. For instance, the auditor might select a particular pallet of raw materials and count the number of units to check against the company’s count.
- Inventory Valuation: The auditor randomly selects some items from the inventory list and checks the costs assigned against purchase invoices. For example, the auditor could select a specific batch of raw materials and check the cost per unit recorded in the inventory records against the cost per unit on the supplier’s invoice.
- Inventory Ownership: The auditor reviews sales and purchase agreements to verify that the inventory is owned by the company. If they find goods in the warehouse that have been sold but not yet delivered (sales on consignment), they check that these are excluded from the inventory count.
- Inventory Existence and Completeness: The auditor selects some items from the inventory records and checks that these actually exist in the warehouse. They may also randomly select some items in the warehouse and check that these are included in the inventory records.
- Inventory Obsolescence: The auditor reviews the company’s sales records to identify slow-moving items. They discuss with management about the prospects for selling these items and consider whether a write-down for obsolescence might be necessary.
- Cut-off Analysis: The auditor checks transactions that occurred near the inventory count date to ensure these have been recorded in the correct accounting period. For instance, they might review the shipping documents for goods shipped just after the year-end to check that these sales have not been included in the year-end inventory count.
- Documentation and Internal Control Review: The auditor reviews the company’s internal controls for inventory management. They might follow the trail of a few transactions from the purchase order through to the receiving report and the recording in the inventory records, checking the approvals and documentation at each stage.
In this way, the auditor is able to gather sufficient evidence to assess the accuracy and completeness of the company’s reported inventory. Note that this is a simplified example, and real-world inventory audits can be more complex, involving various other procedures and considerations.