What is Auditing Inventory?

Auditing inventory is the process of cross-checking financial records with

physical inventory and records. It can be completed by auditors and other
parties.

An inventory audit can be as simple as just taking a physical count of stock

and inventory to verify a match to the accounting records.

Auditing Explained

Auditing is the process of verifying that the financial records of an entity are
accurate and fairly represented. Transactions in financial records must fairly
represent the entity’s financial positioning and actual operating activities.

Since financial documentation and records are produced internally, there is

a high risk that records can be manipulated by inside parties. Insiders can
make mistakes or intentionally alter information while preparing financial
records, which is considered fraudulent behavior. Auditing ensures that
these mistakes are prevented.

Audits also ensure that entities are complying with relevant accounting
standards such as the International Financial Reporting Standards (IFRS),
Generally Accepted Accounting Principles (GAAP), and other relevant
accounting standards.

Evidence in Auditing

Evidence is needed to determine whether financial statements or records

have been prepared in accordance with standards and free from material
error. It is also required to promote the accuracy, transparency, and
independence of audit reports.
Evidence is required by auditors to verify the validity of financial records. It
can either verify or provide support for the financial information that is
presented. On the other hand, the evidence can contradict the financial
information, which indicates errors or fraudulent behavior.

Importance of Auditing Inventory

Observation of inventory is a generally accepted auditing procedure, where

an independent auditor issues an opinion on whether the financial records
of inventory accurately represent the physical inventory being carried.

Auditing inventory is an important aspect of gathering evidence, especially

for manufacturing or retail-based businesses. It can represent a large
balance of assets or capital.

Auditing inventory must verify not only the amount of inventory but also its
quality and condition to see whether the value of the inventory is fairly
represented in financial records and statements.

Inventory Audit Procedures

Some common inventory audit procedures are:

1. ABC analysis

An ABC analysis includes grouping different value and volume inventory.

For example, high-value inventory, mid-value, and low-value products can
be grouped separately. The items can be tracked and stored in their
separate value groups as well.

2. Analytical procedures
Analytical procedures include analyzing inventory based on financial
metrics such as gross margins, days inventory on hand, inventory turnover
ratio, and costs of inventory historically.

3. Cut-off analysis

The cut-off analysis includes pausing operations such as receiving and

shipping of inventory while making a physical count to avoid mistakes.

4. Finished goods cost analysis

Finished goods cost analysis applies to manufacturers and includes valuing

finished inventory during an accounting period.

5. Freight cost analysis

Freight cost analysis includes determining the shipping or freight costs for

transporting inventory to different locations. Generally, freight costs are
included in the value of inventory, so it is important to track the freight
costs as well.

6. Matching

Matching involves matching the number of items and the cost of inventory
shipped with financial records. Auditors may conduct matching to verify
that the right amounts were charged at the right time.

7. Overhead analysis

Overhead analysis includes analyzing the indirect costs of the business and
overhead costs that may be included in the costs of inventory. Rent,
utilities, and other costs can be recorded as part of inventory costs in some
cases.

8. Reconciliation

Reconciliation includes solving discrepancies that are found in an inventory

audit. Errors may be re-checked and reconciled on financial records.