Inventory Audit – Importance & Procedures

Stock is a vital asset in every company’s balance sheet. It is used as collateral for securing financial assistance. It also runs the risk of being inappropriate for fraudulent reports generation. Hence, inventory audit procedures are enforced to ascertain the correct levels of inventory.

What is the Inventory Audit?

Inventory Audit is the process of accounting the inventory levels of a company. The analytical tools used by the auditor to confirm the match of the book and actual levels of the stock is called inventory audit procedures.

What are the types of Inventory Audit?

Most companies place internal controls in place to keep an accurate track of inventory. This audit inventory is conducted periodically depending upon the firm’s inventory levels. It might be a:

  • Perpetual AnalysisWhere the inventory audit procedures are done in the year-end.
  • Periodic AnalysisWhere the inventory audit procedures are done at specified intervals continuously during the whole year.

Types of Inventory Audit

Checkpoints of Inventory Audit Procedures:

  • Does the business maintain complete and accurate records of inventory?
  • Is the manufacturing process monitored?
  • Is there a regular follow-up with the production department for out-of-stock and obsolete materials?
  • The manner of stock storage and proper personnel assigned to maintain the stock?
  • Do stocks carry adequate insurance against the risk of natural calamity, theft, pilferage, riots, and others?
  • Does the company maintain proper records of the insurance policy?
  • If insurance is not available, what are the steps by the senior management to protect their inventory?
  • Is the stock report review periodically and internal transfers are account for?
  • Are the records of perpetual stock maintained in proper condition?
  • Are there any internal norms in place for carrying minimum inventory stock levels?
  • Is the auditor carrying out their periodic review of the stock audit? And so on.

In conclusion, Auditors usually review these checkpoints before applying inventory audit procedures in a company.

Checkpoints of inventory audit procedures

Commonly Used Inventory Audit Procedures:

1. Cut-off Analysis:

The auditors typically test the last few incoming and outgoing transactions before the physical count. It also includes the following immediate transactions. This helps the auditors to check the authenticity of the books and the inventory levels.

2. Physical Inventory Count:

This is one of the commonly used inventory audit procedures where the auditors physically check the counts of the inventory. They test and observe the counts and compare their counts to the company’s record. If the company has multiple warehouses, the auditors will conduct a check at every location.

Physical Inventory Count

3. Finished Goods Cost Analysis:

This use of inventory valuation procedure is when the inventory comprises more of finish products. The auditors will use a combination of different inventory audit procedures to complete the analysis. They will review the bill of materials for a random product and then check whether they have the correct compilation of the materials used.

4. Test High-value Items:

If the inventory list contains high-priced stock, the auditors will review every factor of the inventory. They ensure that the articles are not over-value or under-value in the company’s financial statements.

Inventory Review by Auditors

5. Test Error-prone Items:

In case, the auditors noticed a problem in specific inventory items a few years back, then they are likely to recheck those items. This kind of inventory audit procedures have a few variations:

  • During transit
  • During calculating item cost
  • Reviewing freight costs and so on.

Related: 7 Realistic Ways to Reduce Inventory Costs

6. Overhead Analysis:

If the company is in the practice of applying overhead costs in inventory valuation, then they will be verified for consistency. The auditors ensure that the company is following the same principle when calculating overhead expenses. This method of inventory audit procedures also tests the validity and authenticity of the overheads.

Inventory Overhead Analysis

Companies and auditors use some of the inventory audit procedures for both internal and external stock auditing purposes. They help in ascertaining the accurate value and position of the firm’s inventory. It also helps the company find fraudulent practices and enforce a proper system of stock.

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