Internal Audit

Stock Audit: Objective, Importance, and Best Procedure

Stocks are the most valuable asset for any business. The stock audit is a term that refers to the physical verification of a company or institution’s inventory assets. There are different types of stock audits depending on the purpose and require a different approach. Every business institution is required to perform a stock audit once a year to update and ensure that the physical stock matches the computed records. It helps to correct discrepancies between the physical stock and book stock can be corrected.

The objective is to ensure the existence, accuracy, and ownership rights and verify the realisable value of the items in the company’s Inventory.

Importance of Stock Audit

Some key reasons why there is a need to perform a stock audit include the following:

• Identification of slow-moving stock, deadstock, obsolete stock, and scrap
• Find discrepancies between recorded stocks and physical stock.
• Update the physical stock that matches the recorded stock.
• Proper preservation and handling of stocks.
• It is an important factor in determining the benefits offered to an organisation. These are the benefits:
• Reduced cost and bottom-line improvement.
• Prevention of pilferage and fraud.
• Accurate information on inventory value.
• Reduced gaps in the inventory management processes.
• Special arrangements for third-party opinion.
• The great control mechanism in running the business.

The procedure of stock- audit

To conduct an audit, some key stages and activities are similar to most audits:

Cut-off Analysis

The Auditors will inspect the procedures for halting into the warehouse or shipments at the time of physical inventory count so that any extraneous inventory items are excluded. Typically, they test the last few receiving and shipping transactions before the physical count, including the transactions immediately following it, to check the record.

Observe the physical inventory count.

The auditor needs to be comfortable with the inventory counting procedures. They will discuss the inventory counting procedure. Also, test counts some of the Inventory themselves and verify that all the inventory tags were accounted for. They might test the Inventory in those locations if one has multiple inventory storage locations. They can also ask the custodian of any public warehouse where the company stores Inventory for confirmation.

Reconcile with the inventory count in the general ledger

The Auditors will trace the valuation accumulated from the physical inventory count to the company’s ledger to check that the counted balance was carried forward into the company’s accounting records.

Test valued items

If there is an unimpressive-value inventory, the auditors are likely to spend extra time counting them in Inventory, ensuring they are valued correctly. They will also check the valuation report, and that carries forward into the Inventory in the general ledger.

Test error  items

The Auditors will test the items again for specific inventory items where they had noticed error trends in previous years.

Test Inventory in transit.

There is a possibility of risk if any inventory is in transit from one storage location to another while conducting the physical count. Auditors test this to review the transfer documentation.

Test item costs

The auditors must be informed regarding the purchase costs in the accounting records to compare the amounts in the recent supplier invoices to the costs listed in the inventory valuation.

Review freight costs

One can either include the freight costs in the Inventory or charge it as an expense in the period incurred so that it is accessible for the auditors to find freight invoices through the accounting system to see how they are handled.

Test for lower cost or market

The Auditors need to follow the lower cost or market value rule. So, they can do this by comparing the selected market prices to their reduced costs.

Finished goods cost analysis

If a significant portion of the inventory valuation comprises finished goods, the auditors will have to check the bill of materials for a selection of finished goods items. They must also test them to see the compilation accuracy of the components in the finished item and correct costs.

Direct labour analysis

If the inventory cost in a company includes direct labour, then the auditor needs to trace the labour charged during the time of production on the time cards or labour ratings to the inventory cost. They also need to investigate whether payroll records support the labour costs listed in the valuation.

Overhead analysis

 If to apply overhead costs to the inventory valuation^[1], the auditors need to verify the consistency of using the duplicate general ledger accounts to source for your overhead costs. It is to check whether overhead includes any abnormal costs and test the validity and consistency of the method applied to overhead costs for Inventory.

Work-in-process testing

 If one has a significant amount of work-in-process (WIP) inventory, the auditors, in this case, will test how to determine the completion percentage for work-in-process items.

Inventory allowances

The Auditors need to determine whether the amounts recorded as allowances for obsolete Inventory or scrap are adequate. It is based on the procedures for doing so, historical patterns, where-used reports, and inventory usage reports. If one has no such allowances, they will ask you to create them.

Inventory ownership

The Auditors may review the purchase orders to check the ownership of the Inventor warehouse.

Inventory layers

The Auditors will check the inventory layers for verification. The auditor can still use the physical count procedure if the organisation uses cycle counts instead of physical counts. They perform this during one or more cycle counts and also can do so at any time. Their tests evaluate the frequency of cycle counts and the quality of investigations conducted.

Conclusion

The stock audit is a vital process that includes different procedures per the company’s requirements. The process is tedious and requires much manual effort. Still, it plays a significant role in determining the accuracy and efficiency of the inventory management systems and other aspects of the inventories and thus completes the audit process.

Also Read: Effective Steps of Performing an Internal Audit Successfully