Inventory Audit – Importance, Procedure, Benefits

 

What is an Inventory Audit?

An inventory audit is defined as the process of checking a company’s actual inventory levels against their financial records to ensure accurate inventory accounting. Inventory audits can be performed by the company or an outside auditor to identify any problems with the inventory storage and accounting methods a company is using. 

They can be as simple as counting physical stock levels and cross checking against records, or as involved as hiring a third-party auditor to assess all of your inventory procedures.

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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.

 

How Does an Inventory Audit Occur? 

An inventory audit occurs when an auditor checks the existing processes a company uses to perform inventory counts and validates its system of record accurately reflects the inventory on hand. When auditing merchandise inventory at year-end, a snapshot is taken of the inventory record. The physical inventory is then counted and compared to the inventory record. The difference between the inventory record and the physical count is recorded as an inventory adjustment. The difference is investigated and usually attributed to either shortage or shrinkage. The two designations point to when in the inventory cycle the goods were lost. Shortage happens when the inventory received is less than what was expected. Shrinkage occurs after the goods have been received and recorded. 

Since any changes in inventory create confusion, the physical count usually occurs when there are no changes expected. Retail locations often count their merchandise in January, after the holiday rush has brought inventory level to a low point. The counting is usually done when the location is normally closed or can be closed for a short period of time.

Technology also plays an important role in the counting process. First, the warehouse or retail location is divided up into sections and marked with control numbers. To reduce the element of human error, the counting is done by scanning the barcodes for the various items with a handheld device into a database that compiles the information. The scanned items are tied to the location control number for that area to aid in secondary verification and research prior to making adjustments. 

 

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 cost 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.

 

Audit Checklist

To ensure you have all you need for your inventory audit, here’s a quick checklist:

• Conduct the audit around a time when business for your company is slow or not heavily productive

• If using an external auditor, ensure you have all of the required information needed to carry out the audit

• Have a good software that uses real-time asset management, facilitates scanning/tracking of inventory and generates reports

• Move forward with the appropriate procedures (i.e., cutoff analysis, physical inventory count, freight cost analysis, etc.)

• Record and report your findings

• Investigate item discrepancies if any are found in your audit

 

Key Benefits & Features

 

Reduce Preparation Time

Scheduled audits at the request of a third-party auditor require you to gather all of your paperwork. This can be time-consuming and tedious if your team has to sift through mountains of documents, and even worse if they’re stored in various places. This software lets you prepare accurate reports in minutes. As a result, you save time for yourself and the auditor.

Make Verified Data Accessible

Work orders have common qualities (i.e., asset stocking, ordering, tracking and inventory processes) that should be recorded and made easily accessible during the audit. With this software, these common qualities are stored and made available to auditors with just a few keystrokes, thus relieving unnecessary headaches.

Facilitate Scanning and Tracking of Assets

A built-in barcode scanning tool is a top priority. Scanning each item automatically records and stores data into the software. If there’s no built-in scanning feature, ponder how easy or difficult it would be to integrate this function into the software.

Generate Reports

Generating on-demand and scheduled reports during your audit is a must. You should also have the capability to create customized inventory reports that uniquely and accurately fit your business’ needs.

 

 

DISCLAIMER- These materials are public information and have been prepared solely for educational purposes. These materials reflect only the personal views of the author and are not individual legal advice.

It is understood that each case is fact specific and that the appropriate solution in any case will vary. Finally, the owner will not be accountable for any loses injuries or damages from the exposures or usage of this information.

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