# Audit of Inventories
Inventory is often the single largest current asset and the most error-prone — counts can be wrong, ownership is unclear (consignment, goods-in-transit), and valuation involves significant judgement. The auditor must cover four assertions: Existence, Completeness, Rights & Ownership, and Valuation.
## 1. Existence — Test Counts by the Auditor
The auditor attends physical verification and performs test counts. Key activities:
- Observe employees comply with the agreed count plan.
- Ensure appropriate supervision of the count procedure.
- Verify all items are properly tagged.
- Observe that proper amounts are shown on tags.
- Determine that tags are controlled and reconciled (used/unused/voided).
- Reconcile test counts with tags; investigate discrepancies.
## 2. Completeness
- Analytical Procedures (AP):
- Compute inventory turnover ratio (COGS ÷ avg inventory).
- Vertical analysis: inventory as a % of total assets.
- Compare budget vs actual.
- Examine non-financial info related to inventory (e.g., production reports).
- Perform purchase and sales cut-off tests — critical at year-end to ensure goods received before YE are in inventory and goods sold before YE are excluded.
- Verify clerical and arithmetical accuracy of inventory listings.
- Reconcile physical counts with inventory records and with the general ledger control totals.
- Reconcile inventories owned by the client but held by third parties (e.g., warehouses, consignees).
## 3. Rights & Ownership
- Vouch recorded purchases to underlying documentation.
- Evaluate consigned goods — goods held on consignment for others are NOT the client's inventory.
- Examine client correspondence, sales records, receivables records.
- Review consignment agreements and purchase agreements.
- Examine invoices for evidence of ownership.
- Obtain confirmation from third parties for significant items held off-site.
## 4. Valuation
### (a) Raw Materials and Consumables
- Ascertain what elements of cost are included (purchase price, freight, duties).
- If standard costs are used, enquire into the basis of standards and variance treatment.
- Test check cost prices used with purchase invoices.
- Follow up valuation of all damaged inventories noted during physical counting.
### (b) Work in Progress (WIP)
- Ascertain how various stages of production are measured.
- Identify what elements of cost are included. If overheads are included, ascertain the basis of allocation.
- Ensure material costs exclude any abnormal wastage.
### (c) Finished Goods and Goods for Resale
- Enquire what costs are included and how they are established.
- Apply Lower of Cost or Net Realisable Value (NRV) — if NRV < cost, write down.
- Exclude from inventory cost:
- Costs not reasonably allocable to production (e.g., general & admin overheads).
- Abnormal wastage.
## 5. Obsolete, Damaged & Slow-Moving Inventory — Valuation
- Request inventory ageing split from the client.
- Follow up on damaged/obsolete inventory noted during the count.
- Compare recorded costs with replacement costs.
- Examine vendor price lists to check if recorded cost is less than current prices.
- Calculate inventory turnover ratio — low turnover signals obsolescence.
- Test overhead allocation rates — only direct labour, material, and production overhead are includible.
- Verify correct application of Lower-of-Cost-or-NRV principle.