For a manufacturer, a trader or a contractor, inventory is frequently the largest and least reliable figure in the accounts. An inventory audit tests whether the stock exists, whether the counting process can be relied on, and whether the valuation holds.
This describes the subject in general terms and is not advice; what applies depends on the facts, and the law changes.
Understanding the service
Verification has two sides. Existence is established by physical verification, through counts attended or observed by the auditor and reconciled to the records. Valuation is a question of accounting policy: inventory is generally carried at the lower of cost and net realisable value, with cost determined under the applicable standard.
Where goods are held by third parties, are in transit, or belong to someone else but sit on the premises, the cut-off and the ownership need separate attention.
Lenders often commission stock audits of their own where inventory is charged as security. That is a different engagement from verification for financial reporting.
When it becomes relevant
- A manufacturer or trader with significant stock holdings
- Inventory charged to a bank as security
- Recurring differences between physical stock and book records
- Slow-moving, obsolete or damaged stock that may not be worth its carrying value
- Stock lying with third parties, at sites or in transit
What the work usually covers
- Review of the counting instructions and the count process
- Attendance at, or observation of, physical verification
- Test counts and reconciliation of physical quantities to the records
- Review of the valuation basis, including the treatment of overheads where applicable
- Identification of slow-moving, damaged or obsolete items
- Cut-off testing around the period end
Framework and sources
The law and professional standards this work is carried out under. Links open the official site.
How the work runs
- Understand the stockIdentify locations, categories, third-party holdings and the records maintained.
- Review the count planAssess the instructions, cut-off arrangements and staffing of the count.
- Attend the countObserve the count and carry out test counts.
- ReconcileAgree physical quantities to records and investigate differences.
- Review valuationTest the basis of valuation and the treatment of slow-moving items.
- ReportReport differences, control weaknesses and valuation observations.
A general sequence. Engagements differ, and the scope of each is agreed in writing.
Common questions
Must the auditor count the stock?
The entity counts its stock. The auditor's role is to review the process, observe the count and carry out test counts.
What if stock lies with a third party?
Confirmation from the holder, and in some cases attendance at their premises, may be needed.