Annual Audit Manual

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7068 Inventory under custody and control of a third party
Jun-2018

In This Section

Obtaining sufficient appropriate audit evidence regarding the existence and condition of inventory under the custody and control of a third party

Overview

This topic explains:

  • Confirmation of inventory under the custody and control of a third party
  • The performance of inspection or other audit procedures over inventory under the custody and control of a third party
Obtaining sufficient appropriate audit evidence regarding the existence and condition of inventory under the custody and control of a third party

CAS Requirement

If inventory under the custody and control of a third party is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following:

(a) Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity (CAS 501.8(a)).

(b) Perform inspection or other audit procedures appropriate in the circumstances (CAS 501.8(b)).

CAS Guidance

CAS 505, External Confirmations, establishes requirements and provides guidance for performing external confirmation procedures (CAS 501.A15).

Depending on the circumstances, for example where information is obtained that raises doubt about the integrity and objectivity of the third party, the auditor may consider it appropriate to perform other audit procedures instead of, or in addition to, confirmation with the third party. Examples of other audit procedures include:  (CAS 501.A16)

  • Attending, or arranging for another auditor to attend, the third party’s physical counting of inventory, if practicable.
  • Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of the third party’s internal control for ensuring that inventory is properly counted and adequately safeguarded.
  • Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts.
  • Requesting confirmation from other parties when inventory has been pledged as collateral.

OAG Guidance

Determine an appropriate approach to obtaining evidence over inventory held at a third party on a timely basis during the planning phase of the audit. As part of planning, obtain an understanding of the arrangement with the third party (e.g., by reading the underlying contract) and consider if obtaining a confirmation from the third party will provide us with sufficient appropriate evidence, or whether additional or other procedures may need to be performed.

An external confirmation for inventory under the custody and control of a third party as permitted by CAS 501.8(a) would generally provide us with sufficient evidence over the existence and condition of inventory, however when either of the following circumstances apply we may need to perform other procedures:

  • information is obtained that raises doubt about the integrity and objectivity of the third party,

  • inventory is material and the entity records information provided periodically by the third party and does not maintain perpetual inventory records or may not independently verify reports of inventory on hand at a third party.

There may be circumstances other than those listed above, where we may determine additional procedures (other than obtaining a third party confirmation) may be necessary. Apply professional judgment and consider engagement specific circumstances, including risk and materiality, when determining whether additional procedures may be necessary. For example, when we assess inherent risk for existence of inventory as significant and the inventory held at a third party exceeds multiples of performance materiality we may consider performing additional procedures; when inventory held at a third party approximates performance materiality, we may determine that additional procedures are not necessary.

Other procedures will be necessary if the third party does not respond to our confirmation or there are discrepancies between the third party confirmation and the entity’s records which cannot be reconciled.

CAS 501.A16 includes guidance on other procedures to consider when we determine that obtaining a confirmation from the third party would not alone provide sufficient appropriate evidence. Examples of procedures that we may perform in addition to third-party confirmation include attending the third party’s physical inventory count, inspection of warehouse receipts, review of a service auditor’s report on the third party’s controls over inventory and requesting confirmation from other parties when inventory has been pledged as collateral. If, as part of planning the audit, we determine that it would be appropriate to attend the third party’s count, consider whether obtaining a confirmation from the third party is necessary, as we would generally plan to obtain sufficient appropriate evidence from attending the count. In other words, if we plan to attend the third party’s count, we may not need to obtain a confirmation from the third party.

If we plan to attend the third party’s count (or have another auditor to attend the count), we apply the guidance in OAG Audit 7060 as appropriate. For example, if the third party performs an annual physical inventory count, we would generally apply guidance in OAG Audit 7063 and perform an appropriate number of test counts as part of our physical inventory observation. If the third party performs periodic cycle counts from which we intend to obtain audit evidence, apply the guidance in OAG Audit 7064.

When we determine that use of specialists or experts is appropriate to obtain audit evidence about the existence and/or condition of inventory held by a third party, refer to OAG Audit 3090 and OAG Audit 3100 for guidance.

Also, as part of audit planning consider if the third party in custody of the inventory represents a service organization as defined by CAS 402. For example, when the entity utilizes a third-party to maintain its perpetual inventory records and the third party services form part of the entity’s inventory process and controls, such third party may also be considered a service organization. If that is the case, apply the guidance in OAG Audit 6040.