Inventory Auditing Lecture Notes

Introduction

• Inventory is a challenging area in audits, especially in manufacturing or retail companies.
• Inventory is material and subject to risks such as theft, obsolescence, and damage.

Key Audit Considerations

• Quantity and Location:

  • Accurately determining and locating all inventory can be difficult.
  • Challenges include mixed inventory types and scattered locations.

• Identification and Condition:

  • Auditors must identify and assess the condition of inventory.
  • Need to confirm whether inventory is still sellable and in good condition.

• Valuation and Ownership:

  • Inventory value should be the lower of cost or net realizable value.
  • Ownership must be confirmed; physical presence doesn’t always imply ownership.

Physical Stock Take

• Often conducted at year-end; provides strong evidence of inventory presence and condition.

• Auditor's Role:

  • Attend and observe the stock take, ensuring client conducts it properly.
  • Perform test counts, but not responsible for the entire count.

• Stock Take Planning:

  • Requires clear instructions and planning, especially if done annually.
  • Inventory should be organized and damaged or third-party stocks identified.

• Stock Sheet Process:

  • Shelves should have unique identifiers.
  • Inventory sheets should be pre-numbered and sequential to ensure completeness.

• Inventory Sheets:

  • Columns for location, product codes, quantity, condition, cost, and total value.
  • Sheets signed by counters for accountability.

Valuation and Cost Verification

• Valuation Methods:

  • FIFO (First-In, First-Out) and average cost methods.
  • Auditors may need to re-perform calculations to verify adherence.

• Net Realizable Value:

  • Assess the likelihood of selling inventory above cost.
  • Check for outdated or non-moving inventory.
  • Discuss with sales/marketing departments and review post-year-end sales.

Analytical Review

• Inventory Days:
  • Analyze changes in inventory days as a red flag for overstocking or poor sales.

Cut-off Procedures

• Consistency in Transactions:

  • Ensure purchases and sales are recorded in the correct period.

• Purchases Cut-off:

  • Goods received before year-end should be in closing stock and purchases.
  • Set up a purchase accrual if invoice is received after year-end.

• Sales Cut-off:

  • Goods dispatched before year-end should not be in closing stock.
  • Ensure sales and receivables are recorded.

Role of Auditor in Cut-off

• Verify the accuracy of cut-off by noting last goods received and dispatched numbers.
• Consistency and accuracy in recording transactions is crucial.

Conclusion

• Inventory auditing involves careful planning, accurate identification, and adherence to valuation policies.
• Cut-off procedures and stock takes are key components to ensure accurate and reliable financial statements.