Timing and Extent of Inventory Observation
The timing and extent of inventory observation are determined by the client's inventory system and the effectiveness of its inventory controls. If the client maintains perpetual inventory records and the inventory controls are effective, the auditor may limit the extent of his or her observation and may observe the physical count at various times during the year.
If the client has a periodic inventory system, a physical inventory should be taken at least once during the year. No matter how many times during the year the client takes a physical inventory, the auditor should observe the count that occurs at or near year-end.
When quantities of inventory are determined solely by physical count and all counts are made as of the balance sheet date or within a reasonable time before or after the balance sheet date, the auditor should ordinarily be present when inventory is counted.
If the records are well kept and checked by the client periodically by comparisons with physical counts, the auditor may observe inventory either during or after the end of the period under audit.
Necessity to Observe Physical Count
The auditor should make or observe, some physical counts of the ending inventory. Tests of the accounting records alone are not sufficient for the auditor to become satisfied about inventory quantities at the balance sheet date.
Sometimes the auditor may not have observed the beginning inventory of a period he or she is being asked to report on. Ordinarily, this occurs in new engagement.
If the auditor is satisfied about the current year-end inventory, he or she may be able to satisfy himself or herself of prior period inventories by the following procedures :
- Tests of prior transactions;
- Reviews of records of prior counts;
- Tests of gross profit.
The two major steps in the observation of a physical inventory are as follows :
- Planning the physical inventory
- Taking the physical inventory
Planning the physical inventory before conducting the physical count is essential. The auditor should review or prepare the client instructions and should work closely with the client in the planning stage. The inventory should be taken at a time when operations are suspended or minimal.
The client has primary responsibility for planning and conducting the physical inventory. Because of the auditor's important role in the taking of the inventory, however, he or she should participate in the planning stage.
Before taking the inventory, the client should submit a plan containing the following :
- Date and time inventory is to be taken
- Locations of inventory
- Method of counting and recording
- Instructions to employees
- Provisions for the following : (a) receipts and shipments of inventory during the counts, (b) segregation of inventory not owned by client, (c) physical arrangement of inventory.
(Source : WILEY - Practitioner's Guide to GAAS 2010 - Steven M.Bragg)