Year End Procedures

Physical Verification of Inventory

Rajat Kotharu
March 18, 2025
INVENTORY COUNT
 MEANING, SCOPE AND OBJECTIVE

Meaning of inventory audit?

An analytical procedure that cross-checks if financial records match inventory records or count of
physical goods.
•If inventory is material to the financial statements, auditors are required to attend the physical count.
Hence it is crucial for the audit team to be well prepared.

Objective What’s in the Scope of Inventory Count ?

To obtain evidence of the existence and condition ►Physical Verification of Stocks

of the inventory and the security of its storage. ►Review of current practices of client for
►To observe how the client company conducts the inventory management
inventory count
►To test the accuracy of the counting Our reason of performing stock count is not to
►To obtain information for checking at later count inventory but to satisfy ourselves as to the
stages, such as last goods received and dispatched effectiveness of the application of the client's
documents procedures
 Assertions – Physical Verification

Representations by management, explicit or otherwise, that are embodied in the financial statements,
as used by the auditor to consider the different types of potential misstatements that may occur.

Existence Completeness Accuracy

Priority
• The inventory actually
Definition
• The inventory has been • The inventory has been
exist as at the period end / completely recorded and completely recorded
year end date considered for physical and considered for
count in all aspects. physical count in all
aspects.

Low
Planning an Inventory Audit

PRELIMINARY UNDERSTANDINGS

➢ About Management process of verification , frequency and outcome of these verifications

➢Inquire about Segregation of duties -Store person and accounting person should be different

➢Process of issuing material for production -Issue on Request, Issue per schedule, etc.

➢Purchase / sale process

➢Understanding about type of inventory -RM, WIP FG, Buffer Inventory, Seasonal Inventory, etc.
Planning an Inventory Audit

PRELIMINARY UNDERSTANDINGS

➢ Understanding about location/s where inventory is lying -There could be multiple locations of
inventory warehouses.

➢Understanding about special category of inventory -Goods billed but not shipped, Goods received not
billed, Inventory owned by others etc.

➢Understanding about special classes of inventory- Obsolete, slow moving, special order, damaged etc.

➢Management instruction to conduct physical verification.

 Internal controls over physical count

Attributes to be considered Attributes to be considered during Attributes to be considered after

prior to physical verification physical verification physical verification

• Adequacy of Instructions • Whether the count sheets have been • Whether the book versus physical stock
• Whether the instructions have been complied, collated and signed off by the compilation sheet been signed off by the
signed by a person of requisite individual counting the inventories, finance team person after ascribing values
competency and authority for each reviewed and signed off by the reviewer to it
of the locations, and issued (control owner) who has requisite • Whether the above has been reviewed and
• Whether cost sheets/tags to be competency and authority approved by finance head and other
used in the count are pre-numbered • Whether book versus physical stock functional heads as may be designated for
• Whether separate series of discrepancies have been i) compiled for the purpose
sheets/tags have been used for re- each category of inventories, ii) for each • Whether the discrepancies have been
count location and reviewed and signed off by recorded in the books:
• Whether the format of the the reviewer (control owner) for • If it is a manual Journal entry, whether the
sheet/tag clearly identifies: i) the respective location entry has been approved as per
location, ii) item code, iii) item • Have damaged, slow moving and authorization in the normal course of
description, iv) unit of obsolete stocks been clearly identified in business
measurement and v) the count the count sheets, reviewed and signed • If quantities are adjusted in the inventory
off by the reviewer ledger in the system, test controls over
input and output
 Substantive Procedures for physical count

Observe Perform Compile & Collate Identify Obtain

•Tour all locations • Select samples • Compile all the •Identify slow moving •Obtain copies of
•Ensure stock samples counted stocks in your sample
from the floor, all count sheets
arrangement and agree with what is
count it and trace it by the auditors signed off by the
facilitate easy identified by the
back to the books. and obtain sign control owner.
counting. management.
off from the
• Select high value management. •Obtain cut off
•Scrutinize how •Goods physically
samples from the (especially for documents (Last
count is received but not
inventory ledger discrepancies) goods inward and
documented on recorded in the books. goods dispatch
sheets. and trace it to the
• Take note of documents)
floor. •Goods Invoiced but
•Ensure Locations count of sheets not dispatched.
are marked as • Document the used for re-count.
‘counted’ after count for all the
count. samples.
 Specific Considerations for Inventory Cout

Inventory verification verification Impracticable to attend

Inventory held by Inventory in transit /
not conducted by conducted other PV – Alternate
third party Cut off procedure
management than the date of FS procedures

• • Understand from the

Perform roll forward / • Obtain direct
• Understand the reason roll back procedures as management as to
• Using the work of internal confirmation on the
for not performing the applicable inventories that are in
auditor existence and the
physical verification • Understand if above transit and test for
• Engaging other chartered condition of the
approach may be contracts and other
accountant(s) to attend inventory with third
• Reassess the risk of appropriate in case of evidences regarding
physical verification parties
material misstatement certain industries where purchase / sales
• Use of technology in • Cut off procedures: inform
such an approach could inventory counting • Read and understand
• Perform test of controls be impracticable the entity to share the last
• If alternate procedures the contract with the
and other substantive • Understand if there is a documents (as applicable)
are impracticable, consider third party to
procedures (for perpetual / cyclical for cut off even if auditor is
modifications in audit understand their roles
example: validation of inventory count system not able to physically visit
report and responsibilities
purchases, subsequent and test controls and • When performing the
sales for all items) perform substantive audit, see evidence to test
procedures last transactions and trace
its actual movement with
[Link]

Rajat Kotharu
Rajat@[Link]