Annual Audit Manual
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7061 Introduction
Jul-2017
In This Section
Overview
This topic explains:
- Content of OAG Audit 7060 to help navigate through this subsection
- The objective of the auditor with regards to inventory
- Situations where the prior period was audited by another auditor
CAS Objective
The objective of the auditor is to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory (CAS 501.3(a))
OAG Guidance
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Topic |
Title |
Content |
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Planning to Attend Physical Inventory Counting |
This topic explains planning to attend the entity’s annual physical inventory counting including considerations relating to staff members who will observe the physical inventory counting. In addition, this topic explains the evaluation of management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting and the importance of observing the performance of management’s count procedures. |
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Performing Test Counts at Annual Physical Inventory Counting |
This topic explains how to ascertain the existence of inventory through inspection and the process for performing test counts, including how to determine the number of test counts and how to evaluate count differences identified. |
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Cycle Counts |
This topic provides guidance on how to test cycle counts, including the procedures for planning cycle counts and items to be tested. |
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Testing Final Inventory Records |
This topic explains the procedures to trace test counts to the final inventory listing and how to use accept-reject testing to conduct tests of the final inventory listing. |
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Inventory Count Conducted Other than at the Date of the Financial Statements |
This topic provides guidance for situations where full physical inventory counting is conducted at a date other than the date of the financial statements. This topic also explains matters for consideration when designing audit procedures surrounding changes in inventory. |
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Unable/Impractical to Attend Physical Inventory Counting |
This topic provides guidance for situations where we are unable to attend physical inventory counting due to unforeseen circumstances and for situations where attending physical inventory counting is impractical, including alternative audit procedures. |
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Inventory under Custody and Control of a Third Party |
This topic provides guidance on procedures to perform for inventory under custody and control of a third party, including confirmation of the inventory with the third party and performance of inspection or other audit procedures over the inventory. |
OAG Guidance
The purpose of this section is to provide guidance for observing an entity’s physical inventory process. When inventory quantities are determined solely by means of a physical count, and all counts are made as of the date of the financial statements or as of a single date within a reasonable time before or after the date of the financial statements, it is ordinarily necessary for us to be present at the time of count and, by suitable inquiries, observation, test counts, and other audit procedures, satisfy ourselves as to the effectiveness of the methods of inventory taking and the measure of reliance which may be placed upon the entity’s assertions about the quantities and physical condition of the inventories.
We observe physical inventory counting to ascertain that the inventory exists and to observe whether the count and description of the inventory and its condition are accurate and properly recorded. While management is responsible for inventory quantities, our responsibility is to observe and evaluate the entity’s procedures and results on a real-time basis at the time the physical inventory counting is performed. One procedure among those we employ in achieving this objective is to make test counts, both to confirm the accuracy of the entity’s counting and descriptions and to obtain corroborative evidence of the existence and completeness of the inventory. These counts, or a portion thereof, are traced to the inventory summarization at a later date. See OAG Audit 7065.
During the observation or as a result of our audit procedures, we may find significant problems or testing differences in a number of areas (e.g., organization of inventory, inventory cut-off, tag or count sheet control, supervision, counting, observation that all areas have been counted, test counts, tests of tag or count sheet control, etc.). In such cases, we need to understand and document the nature and cause of the problem, determine an appropriate course of action, inform entity personnel, and evaluate and obtain evidence as to the adequacy of the entity’s remediation. See OAG Audit 7063.
Our aim is that at the conclusion of the physical inventory counting, both the entity and we have achieved our respective objectives. To help achieve these objectives, effective planning on our part and by the entity is essential. See OAG Audit 7062.
When well kept perpetual inventory records are checked by the entity periodically by comparisons with physical counts, our observation procedures generally can be performed either during or after the end of the period under audit. Some companies have developed inventory controls or methods of determining inventories, including statistical sampling, which are highly effective in determining inventory quantities and which are sufficiently reliable to make unnecessary an annual physical count of each item of inventory. In such circumstances, verify that the entity’s procedures or methods are sufficiently reliable to produce results substantially the same as those which would be obtained by a count of all items each year. We observe such counts as we deem necessary and satisfy ourselves as to the effectiveness of the counting procedures used. If statistical sampling methods are used by the entity in the taking of the physical inventory, we verify that the sampling plan is reasonable and statistically valid, that it has been properly applied, and that the results are reasonable in the circumstances. For guidance on cycle counts, see OAG Audit 7064.
OAG Guidance
Where the prior period was audited by another auditor, we may be asked to audit financial statements covering the current period and one or more periods for which we had not observed or made some physical counts of prior inventories. We may, nevertheless, be able to become satisfied as to such prior inventories through appropriate procedures, such as review of the predecessor auditor working papers, tests of prior transactions, reviews of the records of prior counts, and the application of gross profit and other analytical tests, provided that we have been able to become satisfied as to the current inventory. For guidance on initial audit engagements, see OAG Audit 3050.