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Audit of Inventories

The document outlines critical audit assertions for inventory, including existence, completeness, rights & obligations, valuation, cut-off, and presentation. It also highlights risks in inventory auditing such as overstatement and improper valuation, along with key control activities and substantive audit procedures to mitigate these risks. Additionally, it discusses fraud considerations, audit strategy, and typical deliverables expected from an inventory audit.

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vanessa claire abad
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2 views5 pages

Audit of Inventories

The document outlines critical audit assertions for inventory, including existence, completeness, rights & obligations, valuation, cut-off, and presentation. It also highlights risks in inventory auditing such as overstatement and improper valuation, along with key control activities and substantive audit procedures to mitigate these risks. Additionally, it discusses fraud considerations, audit strategy, and typical deliverables expected from an inventory audit.

Uploaded by

vanessa claire abad
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.

📌 Audit Assertions for Inventory


Auditors typically examine these critical assertions:

●​ Existence: Physical inventory matches what's recorded—preventing overstatement or


phantom inventory slideteam.net+14reddit.com+14formsonfire.com+14shipbob.com.​

●​ Completeness: All inventory items and accounts are reflected in the financials
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●​ Rights & Obligations: The entity legally owns the inventory—verify for consigned,
pledged, or factored goods .​

●​ Valuation & Allocation: Inventory is properly valued at lower of cost or net realizable
value (LCNRV), including appropriate cost layering (FIFO, LIFO, weighted)
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●​ Cut‑off: Transactions around period-end are recorded in the correct reporting period
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●​ Presentation & Disclosure: Inventory classification, measurement methods, and


reserves are correctly disclosed .​

2. ⚠️ Risks in Inventory Auditing


Inventory is often the largest current asset and vulnerable to:

●​ Overstatement: Missing, damaged, or phantom inventory inflates balances


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●​ Improper valuation: Wrong cost allocation, obsolete goods, or failure to apply LCNRV
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●​ Cut‑off errors: Misdated shipments or receipts distort year-end balances


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●​ Rights misclassification: Inclusion of consignment or pledged stock .​


3. 🛡️ Key Control Activities
Important controls to evaluate include:

●​ Physical count procedures: Well-planned wall‑to‑wall counts; timing of operations


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●​ Cycle counting: Ongoing spot counts, especially for high‑value items using ABC
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●​ Segregation of duties: Recording, counting, and reconciliation performed by separate


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●​ Costing and valuation checks: Proper methods and inclusion/exclusion of overhead,


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●​ Cut-off controls: Shipping and receiving logs controlled around period-end


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●​ Inventory ownership verification: Review contracts to confirm legal title and


consignment arrangements collidu.com+13wikiaccounting.com+13deskera.com+13.​

4. 🧩 Substantive Audit Procedures


A. Observe Physical Counts

●​ Confirm that staff follow counting instructions and record damaged or obsolete items
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●​ Perform test‑counts: both record-to-floor and floor-to-record


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B. Cycle Counts & ABC Analysis

●​ Focus cycle counts on A‑class (high-value/high‑risk) items


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●​ Follow-up on discrepancies and assess control effectiveness netsuite.com.​

C. Cut‑off Testing

●​ Examine receiving and shipping documents around year-end to ensure correct period
recognition .​

D. Valuation & Cost Testing

●​ Review inventory cost layers, including direct costs and allocated overhead
corporatefinanceinstitute.com+1reddit.com+1.​

●​ Test LCNRV: compare recorded unit costs to market values and ensure lower value used
.​

●​ Verify freight, labor, and manufacturing costs are included or excluded appropriately .​

E. Analytical Procedures

●​ Compute ratios like inventory turnover, days on hand, and margin trends, comparing to
prior years or industry norms to identify anomalies
netsuite.com+15corporatefinanceinstitute.com+15deskera.com+15.​

F. Reconciliation & Invoice Matching

●​ Reconcile physical counts to general ledger balances


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●​ Match purchase orders, receipts, and invoices to validate quantities and costs
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G. Rights & Consignment Checks

●​ Confirm ownership via contracts, invoices, and warehouse agreements


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5. 🔍 Fraud Considerations & Red Flags
●​ Phantom inventory often arises from theft or poor recording
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●​ Obsolete or slow-moving items may be disguised or hidden—require proper identification


and write-downs .​

●​ Valuation manipulation through cost over-/under-allocation, or failure to apply LCNRV .​

6. 🔄 Audit Strategy & Risk Response


1.​ Assess inherent risk due to inventory materiality and manipulation potential.​

2.​ Evaluate control efficiency—if controls are weak, plan more rigorous substantive testing.​

3.​ Keep detection risk low—apply detailed substantive procedures: counts, valuations,
cut-off tests, and analytics.​

7. ✅ Typical Audit Deliverables


●​ Count observation notes and test-count schedules​

●​ Cut-off documentation and shipping/receiving cut-off logs​

●​ Costing worksheets, LCNRV calculations, and cost tracing memos​

●​ Reconciliation logs and discrepancy follow-up records​

●​ Analytical trend analysis outputs​

●​ Contracts/agreements confirming ownership​

●​ Inventory write‑off & obsolete reserve schedules​

●​

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