Stock audits are to verify the existence, completeness and rights of an entity’s goods. Most of the times, Stock Audits are associated with physical verification of stock.
Table of contents
- What’s the testing approach for the Inventory Audit?
- Physical Verification of Stock:
- What’s the Purpose of Conducting Physical Verification of Stock?
- What are the Considerations in Performing Physical Verification of Stock?
- Improvements in Stock taking
- Conclusion for Physical Verification of Stock:
What’s the testing approach for the Inventory Audit?
The audit team performs substantive audit procedures like the test of details to confirm the rights of the entity associated with the goods disclosed in the financial statements and, Physical verification to test the existence and completeness of goods.
Depending on the terms of engagement, the auditor needs to test the valuation of Inventory as well. However, the stock audit is generally read as synonym of physical verification of inventory. But the former is a wide term in comparison to the latter.
Let’s focus on Physical verification of goods and then we will move on to the remaining testing approaches.
Physical Verification of Stock:
The Primary objective of Physical verification of Stock is to confirm the physical existence of goods. It also aids in understanding the Internal controls placed in the Inventory process.
Performing the Inventory’s physical verification requires the Audit team to visit the Go-down/Factory location of goods. The manual counts are replaced by the electronic manner due to the advancement of technology. For instance, business owners are tracking their inventory through bar codes. So, stock taking is done through scanning those bar codes. This electronic way is more efficient.
What’s the Purpose of Conducting Physical Verification of Stock?
The Context of Stock audit is crucial to advance into further details of this topic. Detail break down of the Stock Audits categories are below
1. Stock Audits performed as part of expressing audit opinion on financial statements:
Inventory is a Current Asset and is one of the significant account balances in the Financials. As such, any errors or misstatements in Inventory might impact the opinion expressed by auditors of Financial Statements. So, the Statutory Auditors perform the Stock Audits to test the Existence, Completeness, Rights and Valuation assertion of Goods.
Therefore, the Stock Audit here is a very Comprehensive term and does not involve just physical verification of Inventory. It also involves the testing of other assertions mentioned above.
2. Management Stock Audits:
Performing Stock Audits for the benefit of business, and the audit outcomes are for internal purposes such as detecting the Pilferage, Over Stocking of goods resulting in Working Capital Shortages, Identifying the Obsolete stocks etc. So, these stock audits are required by the management.
3. Audits carried out as per Lenders’:
Entities running a business requires funds. Mobilizing the Capital Investments can be either through the Public (Offering Shares) or Working Capital Loans such as Cash Credits, Revolving Credit facilities, Overdraft etc.
Banks or Lenders offer such Credit Facilities with the Hypothecation of Goods.
Therefore, Lenders appoint independent third parties to perform Stock Audits and provide a report to them with details of any errors and potential issues.
Irrespective of the above Category, all the below-listed essentials are applicable for any Stock Audits. Consider these as steps and prerequisites for those audits.
What are the Considerations in Performing Physical Verification of Stock?
1. Scope of Audit
Audit team shall understand the scope of the Audit from the appointing authority. Generally, Scope will be a Specific Percentage of Physical verification or Coverage of a particular value of goods.
How about an example here?
If the value of total goods is Rs.100,000 and quantity is 1,000, No’s
The scope requires physical verification of 60% of total number of goods irrespective of the value. Then audit team shall cover at least 600, No’s.
(or) The scope requires coverage of 70% of the value of goods. Then, the audit team shall perform physical verification of goods worth a minimum of Rs.70,000.
Statutory Audit does not have any Limitation of Scope. The audit team decides the testing approach and percentage of coverage of goods based on the risk associated with inventory balance and their professional judgement.
2) Obtaining Stock Statements
Obtain the List of inventories with the details such as quantity, value and location of goods. Said differently, this list is nothing but the inventory details per the entity’s financial records.
3) Sorting the Stock Statements
It’s not practically possible to physically verify all the goods unless the quantity of goods is very small in size. So, the Audit team shall sort the inventory listing based on monetary value. This helps auditors to focus on higher value items
Lets say the inventory audit relates to giving opinion on the Financial statements. Then, audit team is require reasonable assurance. So, sorting the goods by value will be good option to obtain more persuasive audit opinion.
4) Low Value Items
Auditor shall be very skeptical about the lower value of items and if the errors in all the lower value of items might be material when considered in aggregate. So, consider the Lower value items also while doing physical verification.
The Physical verification shall be a good mix of higher and lower value items.
Are you wondering how to identify higher-value vs lower value goods?
Here comes the concept of materiality. Materiality is a quantitative number calculated by the auditor to judge the audit significance of an account balance. Refer to this materiality article for detailed understanding.
5) Avoid Movement of Goods:
Audit team shall ensure that there is no movement of goods (Raw Materials/Work In Progress/Goods ready for sale) to Production or for sale. This helps avoid unnecessary differences between the audited goods and goods at the factory.
Lets take a scenario where there is a moment of goods during the physical verification. Assume that the Good A quantity per the Books of Accounts is 10 million (in No’s) and per Physical Verification is 9 million (No’s). The difference is due to 0.5 million being in Production and 0.5 million moving into Finished Goods. These reconciling items are not easy to figure out in the case of large warehouses where the goods are in huge quantities.
So, it’s always advisable to hold off on the movement of goods during the physical verification of Stock.
Improvements in Stock taking
Physical verification of Inventory has changed in recent times. Tracking of all the Stocks in the Factory or Go-down is through bar codes, and bar Codes help the audit team to track and will give a short summary of the nature of the goods through an easy scan.
How about an Practical Scenario here?
Let’s understand this with a practical scenario – Physical verification of a pharmaceutical company. Being auditors, we might not have good knowledge of the medicines or raw materials. I mean – we can’t figure out whether a raw material powder is Paracetamol or not on the face of it. The audit team will be relying on the name of the carton box and location from the Stock registers, or we might be taking the help of experts.
If there are no such indicators, it might not be easy to figure out the nature of a product. So, these barcodes might help in such scenarios.
Conclusion for Physical Verification of Stock:
Physical verification of Stock is verifying the existence and rights assertions of Stock by observing the inventory count. Sometimes, the audit team might do it by themselves.
The key points to be considered here are
- Ask for withholding the movement of Stock from further stages of Production
- Understanding the Industry in which the entity operates
- Be Aware of the scope and coverage of physical verification of Stock
- Determine the need for Industry experts’ involvement in the physical verification
Hope this guide provides a good start point for stock verification. Let us know your thoughts or questions through your comments