Auditing &

Investigations II

Audit of Inventory
Key issues

 Introduction to audit inventory.

 Accounting for Inventory

 Audit Procedure for Inventory

 Physical Inventory count

 Cut-off testing

 Valuation
1. Introduction

 Inventory tend to be one of the large asset

in the statement of financial position.

 It is one of the items that carry inherent

risk because its valuation can be exposed to
judgement.

 The auditor must be diligent in his/her

audit approach and should be sensitive to
any issues that might cast doubt on the
reliability of management’s assertions in
relation to inventory.
Key inventory assertions

 Existence

 Completeness

 Rights and obligations

 Valuation

 Cut-off
 Assertions
Financial statement Audit objective
assertion

Existence and – Recorded purchases and sales represent

occurrence inventories bought and sold.

– Inventory on the statement of financial

position physically exists.
Completeness – All purchases and sales are recorded.

– All inventory at year end is included on

the statement of financial position.

Rights and – The entity has rights to inventory

obligations recorded in the period and at the year-
end.
 Assertions
Financial statement Audit objective
assertion
Accuracy, – Costs are accurately determined in
classification and accordance with accounting standards.
valuation
– Inventory is recorded at year end at
the lower of cost and net realisable
value (NRV).
Cut-off – All purchases and sales of inventories
are recorded in the correct period.

Presentation and – Inventory is properly classified in the

disclosure accounts.
– Disclosures relating to classification
and valuation are adequate and in
accordance with accounting standards.
2. Accounting for Inventory

 The valuation and disclosure rules

for inventory are laid down in IAS 2
Inventories.

 ‘Inventory should be valued at the

lower of cost and net realisable
value’.
Procurement Cycle
1. Internal requisition (IR)
2. Quotations
3. Purchase Order (PO)
4. Good/Services received
5. Quality Control
6. Good received note (GRN/GRV)
7. Invoices
8. Storage
9. Custody Management (Store Mgt)
10.Accounting processes
3. Audit Procedure
 Completeness
 Existence
 Rights and Obligations
 Valuation and Allocations
 Cut Off
 Accuracy
 Occurrence
 Classification
 Valuation
3.1.Completeness
Audit Procedures
 Complete the disclosure checklist to
ensure that all the disclosures relevant
to inventory have been made.
 Trace test counts to the detailed
inventory listing.
 Where inventory is held in third-party
locations, physically inspect this
inventory or review confirmations
received from the third party and
match to the general ledger.
 Compare the gross profit percentage
to the previous year or industry data.
 3.2. Existence

Audit Procedures

 Observe the physical inventory

count.

 Verifyselected items count

for availability.
3.3. Rights and obligations
Audit Procedures
 Verify that any inventory held for third
parties is not included in the year-end
inventory figure.
 For any 'bill and hold' inventory (ie
where the inventory has been sold but
is being held by the entity until the
customer requires it), identify such
inventory and ensure that it is
segregated during the inventory count.
 Confirm that any inventory held at
third-party locations is included in the
yearend inventory figure by reviewing
the inventory listing.
 3.4. Valuation and allocation

 Obtain a copy of the inventory

listing and agree the totals to
the general ledger.
 Castthe inventory listing to
ensure it is mathematically
correct.
 Vouch a sample of inventory
items to suppliers' invoices to
ensure it is correctly valued.
Continued………..
 Confirm that an appropriate basis of
valuation (eg FIFO) is being used by
discussing with management.
 Make enquiries of management to
ascertain any slow-moving or obsolete
inventory that should be written down.
 Examine prices at which finished goods
have been sold after the year end to
ascertain whether any finished goods need
to be written down.
Continued………..
 Compare the gross profit
percentage to the previous year or
industry data.
 Compare raw material, finished
goods and total inventory turnover
to the previous year and industry
averages.
 Compare inventory days to the
previous year and industry
average.
 3.5. Cut-off
Audit Procedures

 Note the numbers of the last

GDNs and GRNs before the year
end and the first GDNs and GRNs
after the year end, and

 check that these have been

included in the correct financial
year.
3.6. Accuracy
Audit Procedure

 Obtain a copy of the

inventory listing and cast it,
and test the mathematical
extensions of quantity
multiplied by price.
 Trace test counts back to the
inventory listing.
Continued….
 Ifthe entity has adjusted the
general ledger to agree with the
physical inventory count
amounts, agree the two
amounts.
 Where a continuous
(perpetual) inventory system is
maintained, agree the total on
the inventory listing to the
continuous inventory records,
using CAATs.
3.7. Occurrence and rights
and obligations
Audit Procedure

 Enquire of management and

review any loan agreements and
board minutes for evidence that
inventory has been pledged or
assigned.

 Enquire of management about

warranty obligation issues.
3.4. Classification

Audit Procedure

 Review the inventory listing to

ensure that inventory has been
properly classified between
raw materials, work-in-progress
and finished goods.
3.9. Accuracy and valuation

Audit Procedure

 Review the financial statements

to confirm whether the cost
method used to value inventory is
accurately disclosed.
 Read the notes to the accounts to
ensure that the information is
accurate and properly presented
at the appropriate amounts.
4. Physical Inventory count

 Physical inventory count procedures

are vital, as they provide evidence.

Key Assertions:

 Existence

 Condition
4.1. Audit Procedures
 Evaluate management's
instructions and
procedures for recording
and controlling the result
of the physical inventory
count
 Observe the performance
of the count procedures
 Inspect the inventory
 Perform test counts
5. Cut-off testing

 Auditors should test cut-off

by noting the serial
numbers of GDNs and GRNs
received and despatched
just before and after the
year end, and
 Subsequently test that they
have been included in the
correct period.
5.1. Audit Procedures

 The auditors should consider whether

management has implemented adequate
cut-off procedures.

 Check whether goods have been

recorded in the appropriate period.

 Check document process pre and post

yearend for cut off.

 Perform adjustment on any documents,

if any inappropriate periods.
6. Valuation
Auditing the valuation of
inventory includes:

 Testing the allocation of

overheads is appropriate

 Confirming inventory is carried

at the lower of cost and net
realisable value.
6.1. Assessment of cost and
net realisable value

Procedures

 Reviewing price changes near

the year end
 Ageing the inventory held
 Checking gross profit margins
to reliable management
accounts
6.2. Audit procedures
 Analytical
procedures may assist
comparisons

 Check the reasonableness of the

valuation

 Compare cost and NRV for each

item of inventory

 Ultimate selling price should be

compared with the carrying
value at the year end.
 End

Thank you for

your attention