Management ordinarily establishes procedures under which inventory is physically counted at least once in a year to serve as a basis for the preparation of the financial statements or to ascertain the reliability of the perpetual inventory system.

When inventory is material to the financial statements, the auditor should obtain sufficient appropriate audit evidence regarding its existence and condition by attendance at physical inventory counting unless impracticable. The auditor’s attendance serves as a test of controls or substantive procedure over inventory approach. Such attendance enables the auditor to inspect the inventory, to observe compliance with the operation of management’s procedures for recording and controlling the results of the count and to provide audit evidence as to the reliability of management’s procedures.
If unable to attend the physical inventory count on the date planned due to unforeseen circumstances, the auditor should take or observe some physical counts on an alternative date and, when necessary, perform audit procedures on intervening transactions.

Where attendance is impracticable, due to factors such as the nature and location of the inventory, the auditor should consider whether alternative procedures provide sufficient appropriate audit evidence of existence and condition to conclude that the auditor need not make reference to a scope limitation. For example, documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory count may provide sufficient appropriate audit evidence.
In planning attendance at the physical inventory count or the alternative procedures, the auditor considers the following:

• The risks of material misstatements related to inventory
• The nature of the internal control related to inventory
• Whether adequate procedures are expected to be established and proper instructions issued for physical inventory counting.
• The timing of the count.
• The location at which inventory is held.
• Whether an expert’s assistance is needed.

When the quantities are to be determined by a physical inventory count and the auditor attends such a count one or more times during the year, the auditor would ordinarily observe count procedures and perform test counts.
If the entity uses procedure to estimate the physical quantity, such as estimating a coal pile, the auditor would need to be satisfied regarding the reasonableness of hose procedures.

When inventory is situated in several locations, the auditor would consider at which locations attendance is appropriate, taking into account the materiality of the inventory and risk of material misstatement at different locations.

The auditor would review management’s instructions regarding:

• The application of control activities, for example, collection of used stock sheets, accounting for unused stock sheets and count and re-count procedures;
• Accurate identification of the stage completion of work in progress, of slow moving ,obsolete or damaged items and of inventory owned by a third party, for example ,on consignment; and
• Whether appropriate arrangements are made regarding the movement of inventory between areas and the shipping and receipt of inventory before and after the cutoff date.

To obtain audit evidence that management’s control activities are adequately implemented, the auditor would observe employees’ procedures and perform test counts. When performing test counts, the auditor performs procedures over both the completeness and accuracy of the count records by tracing items selected from  those  records to the physical inventory and items selected from the physical inventory to the count records. The auditor considers the extent to which copies of such count records need to be retained for subsequent audit procedures and comparison.

The auditor also considers cutoff procedures including details of the movement of inventory just prior to, during and after the count so that the accounting for such movements can be checked at a later date.
For practical reasons, the physical inventory count may be conducted at a date other than period end. This will ordinarily be adequate for audit purposes only when the entity has designed and implemented controls over changes in inventory. The auditor would determine whether, through the performance of appropriate audit procedures, changes in inventory between the count date and period end are correctly recorded.

When the entity operates a perpetual inventory system which is used to determine the period end balance, the auditor would evaluate whether, through the performance of additional procedures, the reasons for any significant differences between the physical count and the perpetual inventory records are understood and the records are properly adjusted.
The auditor performs audit procedures over the final inventory listing to determine whether it accurately reflects actual inventory counts.
When inventory is under the custody and control of third party, the auditor would ordinarily obtain direct confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity.

Depending on materiality of this inventory the auditor would also consider the following:

• The integrity and independence of the third party.
• Observing, or arranging for another auditor to observe, the physical inventory count.
• Obtaining another auditors report on the adequacy of the third party’s internal control for ensuring that inventory is correctly counted and adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts, or obtaining confirmation from other parties when such inventory has been pledged as collateral.

Prepared By Alh. Y. O. Olajide
Managing Partner
Olajide And Associates
www.olajideassociates.com