Stock Audit or Inventory Audit Procedures

In order to conduct a stock audit in a professional manner, it is very important that proper procedures are followed. This will ensure whether a value of inventory has arrived in a reasonable manner. Some of the inventory audit procedures which are normally followed by a professional are as under:

  • Analysis of cut-offs

Here, auditor examines whether the company has a proper procedure for stopping receipt and issue of goods till actual physical verification of stock is taking place so that outside inventory are excluded. He may check status before the start of physical count and immediately after its completion to see whether proper accounting is done for the same or not.

  • Procedure for physical counting of inventory

Here, the procedures relating to physical stock verification is examined. The auditor discusses with management the procedure adopted by them for counting, make test checks of some items to verify whether the procedure followed by management is robust or require some improvement. In the case of multiple storage locations, He may test the inventory according to high quantity and high value.

  • Reconciliation of physical stock verification with accounting in general ledger

They will compare physically counted inventory with those mentioned in accounting records and ensure that both are reconciled and properly recorded in the company’s records.

  • Making ABC analysis while doing a counting

During a stock audit, an auditor will make an ABC analysis of inventory on the basis of high value to lower value items. Also, ensure that high-value items are checked 100% by spending extra time and ensuring its proper valuation and proper recording in books followed by items of comparatively less value.

  • Test of items prone to error

If an auditor has knowledge about any specific item of inventory which was subjected to some error in earlier years, those items should be tested again.

  • Test of items prone to error

There is a possibility that at time of physical count of inventory, some items are in transit from one storage location to another. Here, an auditor should check transfer documents to make a proper analysis of such items in transit.

  • Test basis of arriving at a cost

The auditor should verify how the purchase cost has been booked in accounting records. For same, He may check the supplier invoices and compare the cost with those recorded in books.

Further, freight cost treatment in the books shall be checked by Him to ensure there is consistency in booking such cost. Freight should either form part of the cost of stock or expense off in books but there should be consistency in its treatment.

  • Verifying lower of cost or market

As per accounting standard 2 issued by ICAI, the value of inventory shall be taken as lower of cost or market value. They should verify and ensure that the aforesaid rule is followed by the company.

  • Direct labor cost

In case of direct labor cost included in inventory, they should verify the working of such cost on basis of time cards, payroll records to ensure that direct labor cost has been accurately included in the cost of inventory.

Some other audit procedures during physical verification of stock may be as under:

  1. Analysis of overhead cost to a valuation of inventory.
  2. Testing of stocks which are under process or WIP. How the percentage of their completion are computed.
  3. Test whether allowances for scrap or obsolete stock are adequate and how it has been computed.
  4. Checking whether goods in accounting records are actually owned by the company or it is on a consignment basis or owned by customers.

Further, it may be noted that how extensive procedures need to be employed depending upon the fact that whether a proportion of stock in overall assets of the company is more or less.

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Author: Anil Agrawal
EZYBIZ India Consulting LLP, New Delhi. The firm is business and tax consultancy firm providing consultancy in Taxation, Regulatory, Transfer pricing, Valuation, Corporate funding and Business set up matters. He may be reached at 9899217778 or anil@ezybizindia.in.
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