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Existence. Does the inventory exist at date tested?

1. Observe inventory being counted and personally perform test counts to

verify counts.
2. When control risk is high and/or client uses periodic system - inventory
count should be at end of period.
3. If client uses perpetual system with good records, inventory may be
counted at interim dates. Statistical sampling procedures applied by client may be
acceptable. However, test counts are always required.

Observations of inventory should involve all significant inventory.


Review client's plan for performing inventory count.

a. Plan should include procedures relating to shipments and receipts

during count.

Consigned goods should be segregated.

c. Evidence of appropriate supervision for those performing count should

be examined.
d. Test counts by auditor should include:

observing employees are adhering to the plan.


assuring that all items are tagged


observing that proper amounts are shown on tags


determining that tags and summary sheets are controlled and

5. test counts are reconciled with tags and summary sheets discrepancies noted


watch for empty boxes, etc. and obsolete items

7. establish cut off by documenting last receiving report and shipping

document for the period

Confirm or investigate public warehouse inventory of client.

B. Completeness. Does the inventory account contain all inventory owned at

1. Perform analytical procedures (comparisons tests with industry averages,
budgets, prior years, trend analysis, etc.).

Inventory turnover ratio (cogs/average inventory)

b. Vertical analysis (inventory/total assets)


Budgetary expectations.

d. Examine nonfinancial information related to inventory, such as weights

and measures.
2. Perform purchase and sales cutoff tests. Trace shipping documents (bills
of lading and receiving reports, warehouse records, and inventory records) to
accounting records immediately before and after year-end.

Rights and Obligations. Is the inventory owned by the client?

1. Vouch recorded purchases to underlying documentation (purchase

requisition, purchase order, receiving report, vendor invoice, and cancelled check or
payment file).
2. Evaluate the consigned goods. Examine client correspondence, sales and
receivables records, purchase documents.
D. Valuation/Allocation. Is the inventory valued according to GAAP?
1. Compare recorded costs with replacement costs. Examine vendor price
lists to determine if recorded cost is less than current prices.

2. Calculate inventory turnover ratio. Obsolete inventory may be revealed if

ratio is very small.
3. In manufacturing environments, test overhead allocation rate and assure
that direct labor, direct materials and overhead are all accounted for in the inventory
E. Presentation/Disclosure. Is presentation of inventory and related accounts
appropriately presented and is the disclosure of valuation, cost flow assumptions, and
significant inventory transactions adequate?

Read financials.

2. Inquire of management about consignments, major purchases and current

commitments to purchase, and pledging/factoring arrangements.
3. Obtain and evaluate management representation letter for information
relevant to inventory.