3/2

AUDIT OF INVENTORY
1 PERPETUAL INVENTORY COUNT (perpetual or continuous)
• Perpetual inventory where management has a programme of inventory-counting
throughout the year

• The inventory is divided into sections and different sections are counted at
different times throughout the year

• The book inventory records are amended for any differences identified during
each count and the final book inventory figure at the year-end is used for
preparing the financial statements for the year

PERPETUAL COUNT PROCEDURES

Before the count
• Confirm all inventory lines are counted at least once a year with higher value
and desirable lines being counted more frequently

• Confirm and review management has satisfactory procedures for inventory

counts and test-counting

• Confirm inventory records are kept up to date. Auditors may compare sales
and purchase transactions with inventory movements and carry out other tests
on the inventory records i.e checking casts and classification of inventory

• The counting of inventory is carried out by suitably experienced independent

individuals in a systematic and orderly manner

• Confirm any material discrepancies noted between inventory records and

physical quantities are investigated immediately and reported to management
for immediate further follow up as appropriate

• All corrections to inventory records are authorised by a responsible official of

the company independent of inventory count

• There are satisfactory procedures with regard to cut-off and receipt/issue

documentation at the time of inventory counts.

During & After the count

• Attend one of the inventory counts ( to observe and confirm instructions are being
adhered to)

• Follow-up the inventor counts attended to compare quantities counted by the

auditors with the inventory records, obtaining and verifying explanations for
any differences, and checking that the client has reconciled count records with

1
 book inventory records

• Review the year’s inventory counts to confirm the extent of counting, the
treatment of discrepancies and the overall accuracy of records (if matters are
not satisfactory, auditors will only be able to gain sufficient assurance by a full
count at the year-end)
(periodic)
• Assuming full count is not necessary at the year-end, compare the listing of
inventory with the detailed inventory records, and carry out other procedures
(cut-off, analytical review) to gain further comfort

BENEFITS OF PERPETUAL INVENTORY COUNTING

• There is no disruption caused by an annual inventory count (periodic)

• Enables errors, slow-moving and damaged inventory to be identified earlier as

there is more accurate and regular inventory counting

• Actual inventory balances are known at any time, thus allowing re-
ordering/replenishment of inventory to be done promptly and timely. Fewer
incidences of inventory reaching zero level causing unfulfilled orders. (no stock
out/ over-
stocking)
• Allows increased control over storekeeper as inventory is being reviewed
regularly, then reducing any pilferages (theft)

• Auditors can rely on the computerised inventory system, reducing substantive

testing of inventory during the year and at the year end

2 PERIODIC INVENTORY COUNT (annually)

• Attendance at an inventory count gives evidence of the Existence and
Ownership of inventory

Before the count

• Review the prior year audit files to identify whether there were any particular
warehouses where significant inventory issues arose last year

• Discuss with management whether any of the warehouse this year are new, or
have experienced significant control issues

• Decide which of the warehouse the audit team members will attend, basing
this on materiality and risk of each site (sample)

• Obtain a copy of the proposed inventory count instructions, review them to

identify any control deficiencies and if any are noted, discuss them with
management prior to the counts

2
 • Inquire from management inventory count arrangements and significant
changes
party (supplier) warehouse
• Arrange to obtain from any third parties external confirmation of inventory
they hold (Inventory Certificate)

• Consider the need for expert help.

During the count

• Observe the counting teams to confirm whether the inventory count
instructions are being followed correctly

• Confirm adequate supervisory controls with one individual assuming the

overall responsibility for the inventory count

• Counters to be organised into teams, usually in pairs, both independent

individual – to reduce the risks of error of fraud

• Inventory sheets should be standardized and pre-numbered; the numbers

issued to counting teams should be identified and controlled by the count
supervisor

• Select a sample of inventory and perform test counts from inventory sheets to
(shelf)
warehouse aisle(Existence)
and from warehouse aisle to inventory sheets (Completeness)
[PIC: Physical inventory to Inventory Count Sheet = C/ IPE]
(flagged)
• Items which have been counted should be marked or tagged as ‘counted’ to
avoid the possibility of double counting or omissions (miscounting)

• Inventory sheets should be completed in ink and signed by the relevant

individuals involved in the counting and recording process

• All inventory sheets issued, whether used or unused, should be returned to the
count supervisor upon completion of the count

• In order to minimise disruption to the production process, raw material

together with parts and finished goods inventories should be counted first
with WIP inventory being counted at the end of the working day

• Confirm the procedures for identifying and segregating damaged goods are
operating correctly, and assess inventory for evidence of nay damaged or slow-
moving items

3
 • Observe the procedures for movements of inventory during the count, to
confirm that all movements have ceased
(customer: bill & hold)
• Enquire as to the possibility of consignment or third-party inventories being
held by the company and record appropriate notes for subsequent follow up

• Identify and make a note of the last goods received notes and goods
despatched notes in order to perform cut-off procedures

• Obtain a photocopy of the completed sequentially numbered inventory sheets

for follow up testing on the final audit

After the count

• Ensure all inventory count sheets have been accounted for

• Ensure inventory count sheets are guarded to prevent any alterations i.e
inclusion of non-existent inventory, no relevant items have been omitted, no
inventory held for third party included all subsequent to the count

• Follow up all test counts trace test counts to final inventory sheets

• Ensure inclusions/exclusion of inventory is consistent with prior years

• Ensure exclusion of damaged or slow-moving inventories

• Perform cut off tests

• Reconciliation with inventory records, investigate and differences corrected

• Review replies from third parties about inventories held by them (Inventory
Certificate)

• Follow up queries and notify problems to management

3 INVENTORY HELD BY THRID PARTY

(Inventory Certificate)
• Send a letter requesting direct confirmation of inventory balances held at year
end from the third party warehouse providers regarding quantities and condition.
(supplier)
• Attend the third party warehouses inventory count (if one is to be performed) to
review the controls in operation to ensure the completeness and existence of
inventory.
(supplier)
• Inspect any reports produced by the third party warehouses auditors in relation
to the adequacy of controls over inventory.

4
 Review a sample of GRN both pre and post year end and follow these through to purchase invoices, in
the correct accounting period to ensure that cut-off has been correctly applied (purchase cut-off testing)

Review a sample of GDN both pre and post year end and follow these through to sales invoices, in the
correct accounting period to ensure that cut-off has been correctly applied (sales cut-off testing)

• Inspect any documentation in respect of third party inventory.(eg: warehouse receipts)

4 CUT-OFF PROCEDURES

Purchase Sales
Identify last GRN at cut-off point and a Identify last GDN at cut-off point and a
few before it few before it
Match the selected GRN with purchase Match the selected GDNs with sales
invoice in the current year invoices in the current year
Only goods received before the year-end Only goods dispatched before the year-
should be recorded as purchases end should be recorded as sales
Unmatched GRNs will be used to Unmatched GDNs will be used to update
accrued purchases and trade payables sales and trade receivables

5 INVENTORY VALUATION
• IAS 2 Inventories- inventory should be valued at the lower of cost and net
realizable value

NRV< COST (Audit risk)

NRV is likely to be less than cost when:
• An increase in costs or a fall in selling price
• Physical deterioration
• Obsolescence of products
• A marketing decision to manufacture and sell products at a loss
• Errors in production or purchasing

SUBSTANTIVE PROCEDURE INVENTORY VALUATION (IAS 2)

• * Select a sample of goods in inventory at the year end, agree the cost per the
records to a recent purchase invoice and ensure that the cost is correctly stated.

• * Select a sample of year end goods included in inventory and review post year-end
sales invoices to ascertain if NRV is above cost or if an adjustment is required.

• For a sample of manufactured items obtain cost sheets and confirm:

– raw material costs to recent purchase invoices
– labour costs to time sheets or wage records
– overheads allocated are of a production nature.

• Review aged inventory reports and identify any slow-moving goods, discuss with
management why these items have not been written down.

• Review the inventory records to identify the level of adjustments made

throughout the year for damaged/obsolete items.

• If significant consider whether the year end records require further adjustments
and discuss with management whether any further write downs/provision may
be required.

5
 • Follow up any damaged/obsolete items noted by the auditor at the inventory
counts attended, to ensure that the inventory records have been updated
correctly.

6 USE OF STANDARD COST FOR INVENTORY VALUATION (Auditor’s response)

• Discuss with management the basis of the standard costs applied to the
inventory valuation, and how often these are reviewed and updated.

• Review the level of variances between standard and actual costs and discuss with
management how these are treated.

• Obtain a breakdown of the standard costs and agree a sample of these costs to
actual invoices or wage records to assess their reasonableness
(FAULTY)
7 SUBSTANTIVE PROCEDURES FOR DAMAGED INVENTORIES
• Obtain a schedule of damaged inventories and cast to ensure accuracy

• During the inventory count identify the quantify of the damaged goods (auditor’s
list) and agree to the schedule

• Discuss with management their plans for disposing of these goods, whether they
believe these goods have a net realisable value at all or if they will need to be
scrapped

• If any of the goods have been sold post year end, agree to the sales invoice to
assess NRV

• Agree the cost of the inventory to supporting documentation to confirm the raw
material cost, labour cost and any overheads attributed to the cost

• Quantify the level of adjustment required to value inventory at the lower of cost
and NRV and discuss with management

8 SUBSTANTIVE PROCEDURES FOR WORK IN PROGRESS (WIP)

o Prior to attending the inventory count, discuss with management how the
percentage completions are attributed to the WIP

o During the count, observe the procedures carried out by staff in assessing the level
of WIP and consider the reasonableness of the assumptions used
Obtain , cast
o Cast the schedule of total WIP and agree to the trial balance and financial
statements to confirm A & C

o Agree for a sample that the percentage completions assessed during the count are
in accordance with co policies communicated prior to the count

6
 o Discuss with management the basis of the standard costs applied to the percentage
completion of WIP, and how often these are reviewed and updated

Standard
o Review the level of variances between standard and actual costs and discuss with
cost management how these are treated

o Obtain a breakdown of the standard costs and agree a sample of these costs to
actual invoices or payroll records to assess their reasonableness

o Agree sample of WIP assessed during the count to the WIP schedule, agree
percentage completion is correct and recalculate the inventory valuation