INTERNAL CONTROLS PURHASE
INVENTORY CYCLE
COUNT
PHYSICAL INVENTORY COUNTS: PURPOSE AND RESPONSIBILITIES
Many organisations rely on a physical inventory count at the end of their financial year in order to
arrive at a figure for inventory in their financial statements. Even if an entity maintains
‘sophisticated’ inventory records, with continuous accounting records for inventory, the accuracy
of these records should be checked by means of regular physical counts of inventory
There are several reasons for physical counts of inventory:
Physical counts can be used by the entity to check the
accuracy of its inventory records, where it maintains
continuous inventory records.
Discrepancies between the physical count of inventory and
the entity’s inventory records may indicate weaknesses in
physical controls over inventory, and losses due to theft or
for losses from other causes.
INVENTORY
COUNT Where the entity does not have continuous inventory
records, a physical count of inventory is probably the only
way of establishing the quantity of inventory at the year-end.
A physical count of inventory can also be used to check the
physical condition of inventory, and whether there has been
any deterioration in condition.
INTERNAL CONTROLS PURHASE
INVENTORY CYCLE
COUNT
PHYSICAL INVENTORY COUNTS: PURPOSE AND RESPONSIBILITIES
It is important to appreciate the relative responsibilities of management and auditors with
respect to inventory counts.
It is the responsibility of
management to arrange for
It is the responsibility of the
physical counts to be made and
auditor to gather evidence from
to establish appropriate
which he can reach a conclusion
procedures for counting, to
on the figure for inventory in the
ensure that a complete and
financial statements. Observation
accurate count is taken. (It is the
and other audit
responsibility of the company’s
procedures performed by the
directors to ensure that the
auditor at the inventory count
valuation of inventory in the
will provide some of this audit
financial statements is reliable.)
evidence
INTERNAL CONTROLS PURHASE
INVENTORY CYCLE
COUNT
The auditor’s attendance at the physical inventory count is covered by ISA 501 Audit evidence
Additional considerations for specific items. The requirements of ISA 501 in respect of inventory
state that if inventory is material to the financial statements, the auditor should obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by attendance at
physical inventory counting unless impracticable. The purpose of such attendance is given as being to:
Evaluate management’s instructions and
procedures for recording and controlling the results of
the count.
Observe the performance of management’s count
procedures.
INVENTORY
COUNT Inspect the inventory.
Perform tests counts.
Perform audit procedures over the final inventory
records to determine whether they accurately reflect
the results of the count.
INTERNAL CONTROLS PURHASE
INVENTORY CYCLE
COUNT
POSSIBLE CONTROL WEAKNESSES IN AN INVENTORY COUNT
Control weaknesses in the client’s inventory counting procedures may be observed by the
auditor. These might include:
Failure to pre-number the count sheets. All count sheets should be
pre-numbered, so that they can all be accounted for at the end of the count
and none are ‘lost’ (and none are counted twice).
Entering the quantities counted on the count sheets in pencil. Entries in pencil
can be erased and altered later, fraudulently, without leaving trace of the
alteration.
Inventory may not be marked when it is counted. This gives rise to a risk that
items of inventory will be counted twice, and possibly that some items will not
be counted at all.
Lack of precise instructions to the counting team. The counting team must be
given precise and specific instructions about how to perform the count. If the
counting team is left to decide itself how the count should be conducted, this
will increase the risk of mistakes in counting – such as missing out some
items and double counting others.
INTERNAL CONTROLS PURHASE
INVENTORY CYCLE
COUNT
AUDIT WORK AFTER THE COUNT: FOLLOW UP
The audit work involved in verifying inventory quantities will include the following:
Obtaining the final Confirm that inventory
inventory sheets that were belonging to the client, but
prepared by the client’s staff held by third parties, is
during their inventory count. included on the inventory
sheets.
Check the numerical Confirm that inventory
sequence of the sheets and belonging to third parties,
the auditor’s record of the but on the client’s premises
last sheet number, to at the date of the count, is
confirm that no sheets are not included on the
missing. inventory sheets.
Check that cut-off is
Check the arithmetical correct. This is done by
accuracy of the calculations reference to the cut-off
on the sheets. information recorded at
the time of the count.