## Auditing Inventories: Rights and Obligations (Ownership Verification)

The entity must have valid legal ownership over inventories recorded in the balance sheet. This is especially complex when inventory is stored at third-party locations (warehouses, processors, consignees).

### Audit Procedures for Inventory Ownership

#### Document-Based Procedures

Procedure	Purpose
Vouch recorded purchases to underlying docs (requisition, PO, receiving report, vendor invoice, payment proof)	Confirm purchase actually occurred
Examine invoices — must be in the entity's name	Establishes legal title
Review consignment agreements	Identify consigned goods not owned by entity
Examine client correspondence and sales/receivable records	Identify goods sold but not removed from inventory
Determine existence of collateral/pledge agreements	Identify pledged inventory
Review material purchase commitment agreements	Identify future obligations

#### For Consigned Goods

Evaluate whether goods on consignment belong to the entity or are held on behalf of others
Goods sent on consignment to others = still owned by entity (include in inventory)
Goods received on consignment from others = NOT owned by entity (exclude from inventory)

#### For Inventory Held at Third-Party Locations

Insist on obtaining a written declaration from the third party on their official business letterhead
Declaration must be signed by an authorised person of the third party
Declaration should confirm: items belong to the entity and are held by the third party on the entity's behalf

#### Confirmation Procedures

Obtain confirmation for significant items of inventory held externally

Worked example

### Example 1

Q: Ginni Ltd. has ₹40 lakhs of raw material stored at a third-party warehouse. As statutory auditor, how do you verify ownership?

A: Since the inventory is at a third-party location, direct physical observation is not possible. The auditor should: (1) Obtain a written declaration from the warehouse operator on their official letterhead, signed by an authorised person, confirming the inventory belongs to Ginni Ltd. and is held on their behalf, (2) Vouch the original purchase invoices to confirm they are in Ginni Ltd.'s name, (3) Review the warehousing agreement/contract, (4) If material, consider arranging a physical count at the third-party location, (5) Obtain direct confirmation from the third party.

⚠️ Common exam mistakes

Not distinguishing between goods sent on consignment (still owned) vs goods received on consignment (not owned) — both affect inventory completeness differently
Forgetting that for third-party held inventory, a verbal confirmation is insufficient — it must be written, on letterhead, and signed by an authorised person
Overlooking the need to check for collateral/pledge agreements against inventory — pledged inventory is still owned but must be disclosed
Treating invoice verification as sufficient proof of ownership without reviewing consignment and pledge agreements

Reference:

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Auditing Inventories – Rights and Obligations (Ownership Verification)

Worked example

⚠️ Common exam mistakes