Audit of Inventory
- Finished goods held for sales in the ordinary course of business
- Work in progress
- Raw materials
Stock comprises a significant portion of the company’s assets and hence has a material effect on the presentation of the financial statements.
a. Ascertain the existence of stock.
b. Ascertain that stock is appropriately valued at lower of cost and net realizable value. Adequate provisions are created for dead and slow moving stock.
c. Verify the completeness and accuracy of the stock balance.
d. Verify that stock is appropriately presented and disclosed in the financial statements.
Problem encountered in the verification of stock
- The amounts involved are invariably material.
- Stock has a one for one impact on the reported profits i.e. an increase in stock increase the reported profit. It is therefore open to distortion by management.
- Stock does not derive from the normal double entry system; it is arrived at by stock taking carried out at the year-end.
- Stocks are portable and valuable opening themselves to pilferage and deterioration either intentional or accidental.
- The number of items involved is usually numerous creating verification problems as far as existence and condition is concerned.
- Although stocks are valued at the lower of cost and net realizable value, what constitutes cast can vary from one management to another and the basis of determining that cost can be subject to so many different methods all resulting in different values for the same items.
- It is an area that is susceptible to manipulation by management provision for obsolescence, slow moving and damaged stocks is a question of judgment therefore it vis easy for the auditor to disagree with management.
- stock is normally made up of different items e.g. work in progress, raw materials all these can be valued on a different basis and amalgamated and described as stocks.
- Stock may be overstated by inclusion of goods sold but not dispatched to customers.
Audit of stock
This involves determining the method adopted by the organization in costing stocks. The auditor should then check the acceptability and appropriateness of the adopted policies.
The rest of the exercise is to test that the adopted exercise if correctly applied.
Stock should be valued at lower of cost and net realizable value where net realizable value is defined as the amount that could be realized on the open market in the ordinary cause of business less the cost of putting them into a saleable condition and less the cost of sales.
It is up to the auditor to ensure that the net realizable value is properly calculated and is in accordance with the accounting standards.
Stocks should be reduced by a provision for obsolete or damaged and slow moving stock. This provision should not be excessive or inadequate. The auditor is guided by the factors such as age of stock, condition of stock, its turnover, technological advances in the industry, nature of stock (perishable or not), prevailing economic conditions etc. these guide him on judging the adequacy of provision for slow moving, obsolete or damaged stock.
The auditor must obtain adequate independent evidence that the stocks concerned are in existence. On several occasions auditors have certified accounts as giving a true and fair view when the stocks concerned were non- existent. The unfavorable decisions against the auditor have resulted in the profession making it obligatory that where stocks are of a significant figure in the accounts the auditor attending to observe the stock take.
It is not the auditor’s duty to take stock
He must however satisfy himself as to the validity of the amount attributed to stocks in the accounts that are the subject of his audit. The auditor should examine the internal control in order to determine the nature and extent of audit steps. Where stock is held at a number of locations the selection of the location to be visited should be planned so as to cover all significant locations over a period of years. When stock is based on records these must be substantiated by continuous or periodical physical stock takes. The records must be up to date. Stock Taking Exercise
It is the responsibility of management to ensure that the amount at which stocks are shown in the financial statements represents stocks physically in existence. The auditor should obtain evidence in order to enable him to draw conclusions about the validity of amounts attributable to stocks. Where stocks are material in the financial statements the auditor should attend the stock take. The auditor must be present during the stock take mot necessarily to count stock but to witness and observe the way stock taking is done to obtain assurance on the existence and value of stock in trade.
Reasons why procurement auditor need to attend a stock-take of the procurement entity that he audits
- Verify that the stock take exercise is carried out per the stock instructions. This will assure the auditor that the exercise can be relied upon to provide complete and accurate figures of the stock balance;
- To verify the physical existence of the stock;
- To inspect the general condition of the stock, this will assist in concluding whether the stock is correctly valued.
Note that the auditor does not attend the stock take to count stock but to observe how the exercise is being carried out.
The procedures to be followed during the count vary according to the size and circumstances of the business, nature of its stock and its stock records. Define instructions preferably in writing should be issued in all cases for the guidance of those who will be engaged in the actual stock taking. The instructions should contain:
i. Identification of the sock items and their ownership.
ii. Counting, weighing or measuring.
iii. Reporting of stocks which are damaged or defective.
The following issues should be addressed:
- Stock taking should be well planned and carried out systematically by persons who are fully informed of the duties involved.
- These persons should be familiar with the stock but supervisors should be from different departments. Counting should be done by at least two people, one to count and the other to check and record what has been counted.
- Stocks should be marked to facilitate counting. The whole stock taking area should be divided into sections for control purposes and avoids double counting.
- Ensure that properly qualified personnel are available where specialized knowledge is necessary to identify, quality and quantity of stock.
The procedures to be carried out by the auditor when attending stock taking are divided into:
- Duties before stock take.
- Duties during stock take.
- Duties after stock take. Duties before stocktaking The auditor should:
- Study of the client’s stock taking instructions and recommend for changes or improvements if the auditor consider them inadequate.
- Familiarization with the location of the stocks and the opportunity to plan for the work to be undertaken.
- Familiarization with the nature and volume of stocks and especially with high value items.
- Review of previous year’s working papers and discussions with the
managers of any significant changes from the previous year.
- Consideration of the location of stocks and likely points of difficulty e.g. cut off.
- Consideration of any involvement of the internal audit department and the extent of reliance to be placed upon their work.
- Arranging to obtain from third parties confirmation of stocks held by them.
- Establishing whether expert advice may be needed.
Duties during the stock take
- The main task is to ascertain whether the client’s employees are carrying out their instructions properly so as to provide reasonable assurance that the stock take was accurate and not necessarily to count stock. He will do this by testing efficiency of the counting by counting selected items.
- He should make notes for follow up purposes of items counted in his presence, details of damaged, obsolete or slow moving items.
- Details of items for cut off purposes should be noted.
- He should find out the methods of identifying slow moving, obsolete or damaged stock.
- Record fully the work done and his impression on the stock take exercise.
- He must form a conclusion as to whether the stock take can be relied on.
- Get photocopies of rough stock sheets.
- Get details of the sequence of the stock sheets.
- Pay special attention to high value items.
- If the auditor is not satisfied about the way stock taking was conducted, he should inform management and may request a recount.
Note that The auditor should conclude whether stock taking was properly carried out and can be relied upon for determining the existence of stock. He should also try to gain from his observations an overall impression of the levels and values of stocks held so as he may judge whether the value of stock appearing in the financial statements is reasonable.
Duties after the stock take
This is mainly a follow up exercise and it involves:
- Checking the cut off with the details of last numbers of stock movement forms and goods inwards and goods outward notes during the year and after the year end.
- Ensuring that the final stock checks have been properly prepared from the count records.
- He must particularly check that all the count sheets issued were returned.
- Check the final stock sheets for pricing, extensions, casting, summarization and the necessary improvement.
- The auditor should ensure that the stock records have been adjusted to amounts physically counted and that all reported differences have been investigated.
- Follow up any notes made in the attendance. Inform the management of any problems in the stock taking exercise so that they can act accordingly.
Non-attendance at stock takes
If the auditor is unable to attend a stock take either, because he has numerous clients with similar year ends or stock is located in remote locations, the auditor must still certify himself on the stock take. The auditor can in such cases:
i. Arrange for stock take to be done earlier.
ii. Appoint as agent.
iii. Examine perpetual inventory records more thoroughly.
Obtain representations from management on the existence, completeness and valuation of stock.
The audit tests that the procurement auditor would apply to establish the physical qualities of stock and their ownership
During the stocktaking, the main task is to ensure that the clients staff are carrying out their duties effectively. The auditor should:
- Make two-way test counts from stores floor to stock sheets, and from stock sheets to stores floor.
- Make notes of items counted, damaged stock, instances where the stock taking procedures are not being followed.
- Examine and test control over the stock sheets. The client should keep a stock sheet register.
- Examine cut off procedures. The auditor should examine the link between purchases records and stocks, and between sales records and stocks, to ensure that there is complete accord between stock and the financial records of purchases and sales, debtors and creditors. These are known as cut-off procedures. Procedures the auditor would carry out to ensure correct cut off include:
– During stock-take attendance note the serial numbers of the last sales invoice, dispatch note and goods received note generated before the stock-take.
– After the stock-take, check the year end dispatch notes to sales invoices and the sales day book and vice versa to ensure that dispatches and the related invoice both fall before year end.
– Similarly, for purchases, ensure year-end goods receipts notes and related purchase invoices are correctly treated in the current period.
– Take a sample of goods received and goods dispatched just after the year end and ensure that the related stock was not included in the count in the case of goods received, that it was included in the goods dispatched.
- Pay particular attention to goods held on behalf of third parties e.g. goods on consignment.
- Reach a conclusion as to whether or not the stock taking was satisfactory and hence provides reliable evidence supporting the final stock figure.
- To establish the physical quantities of stock, the auditor should attend the stock-take and observe how the clients’ employees are counting stocks particularly: –
– Are the client employees carrying out the work allotted to them properly and are they following the stock-take instructions?
– Does the stock appear to be recorded correctly on the stock sheets both as to description and quantity?
– Are all slow moving, obsolete and substandard stocks properly identified
How a procurement auditor satisfy himself that the procedures adopted by the management with regard to stocks have been applied throughout the financial period
In an attempt to satisfy himself that the management procedures as regards stocks have been properly applied throughout the period, the auditor will carry out tests of control which include: –
- Observe physical security of stocks and environment in which they are held.
- Test procedures for recording of stock movements in and out of stock.
- Test authorization for adjustments to stock records.
- Test authorization for write off or scrapping of stocks
- Test controls over recording of stock movements i.e. the use made of authorized goods received and dispatch notes.
- Inspect reconciliation of stock counts to stock records.
- Check sequences of dispatch notes and goods received notes for completeness.