Inventory Cycle Audits: Count Right, Value Fair & Report Clearly
Overview: The inventory cycle is critical because it impacts both the balance sheet and the income statement. This guide shows how auditors plan and perform inventory audits, observe counts, test valuation and disclosures, and ensure completeness and accuracy.
✅ Key Internal Controls
- Segregate duties: purchasing, receiving, warehouse custody, and shipping must be separate.
- Use serially numbered, approved purchase orders and receiving reports.
- Receiving should verify quantities and detect damage independently.
- Warehouse acts as custodian; shipping handles shipments only with approved sales orders.
✅ Physical Inventory Observation
- Observation of beginning and ending counts is a required procedure unless impractical.
- Auditor does not count everything but observes management’s process, inspects items for existence and condition, and performs test counts.
- For significant inventory in public warehouses or on consignment, observe on-site or confirm with third parties.
- If counts are at a date other than year-end, obtain evidence about transactions between count date and FS date.
✅ Testing Completeness & Accuracy
- Trace test counts to physical inventory reports to verify completeness.
- Select from prenumbered tags and trace to reports.
- Test mathematical accuracy of inventory reports and reconcile to the GL.
✅ Valuation, Allocation & Accuracy
- Review for obsolete, damaged, or slow-moving items during observation.
- Test vendor invoices, direct labor rates, standard overhead rates, and variance analyses.
- Ensure appropriate cost methods (FIFO, LIFO, weighted average) and NRV or lower of cost or market are applied correctly.
✅ Existence & Rights
- Verify consigned goods: exclude consigned-in items, include consigned-out goods.
- Check inventory in transit based on shipping terms.
- Vouch items from reports back to physical tags and test counts.
✅ Presentation & Disclosure
- Verify disclosures: cost method, valuation method, balances by category (raw, WIP, finished goods).
- Include pledged or assigned inventory, significant write-downs or commitments, and warranty obligations.
- Ensure clarity and classification between inventory categories.
🔗 Helpful References
👉 Count right, value fair, and present clearly — every time you audit inventory!
