As per the requirements of
ISA 501, if inventory is material to the financial statements, the auditor
shall obtain sufficient appropriate audit evidence regarding the existence and
condition of inventory by: a) attendance at physical inventory
counting; b) performing audit procedures
over the entity’s final inventory records to determine whether they accurately
reflect actual inventory count results.
An Inventory count is carried out by
business either:
- to corroborate information contained in their books and records which is the product of a continuous accounting and control system, or
- to provide an inventory figure for inclusion in financial statement and to use in calculating profit where there is no system of continuous inventory accounting.
The purposes of the
physical inventory observation by auditor are to determine that
the inventory actually
exists,
- the methods of inventory taking are effective in obtaining accurate counts, and
- the inventory is in a usable and salable condition in the normal course of business (e.g., not damaged or obsolete).
It should be remembered
that while the auditor will himself carry out test counts and extract certain
cut-off information he is primarily there to observe that the client’s procedure
are satisfactory. Where the client has an efficient system for inventory
records, the physical inventory may be carried out on a continuous basis as
opposed to counting everything in one go at the year-end. In the case of a
client using the continuous basis, the auditor will still be required to
observe a part of this continuous inventory counting.
Recommendation
When conducting inventory
count at year end special attention needs to be paid by the auditor to apply
proper cut off procedures (testing last receiving and shipping transaction),
reconciling inventory count to the general ledger, testing high value items,
testing inventory in transit, testing the inventory at third party warehouses,
testing inventory cost including freight charges and testing for lower of cost
or net realizable value/market etc. The working paper should be prepared in
such a manner that the information can be easily followed up at the final audit
visit. Test counts for example should have been traced to the stock sheets to
confirm that they are a proper record of the results of the physical inventory.
