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When auditors must take stock

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7th Mar 2011
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Due to the new Clarified auditing standards which are now beginning to bite for audits of accounts for periods ending on or after 15 December 2010, the Auditing Practices Board (APB) is starting to issue revised Practice Notes.

On 22 February 2011, the APB issued Practice Note 25 (revised) which covers the area relating to the auditor’s attendance at stocktake.

It is easy to forget the primary objective of why the auditor attends a stocktake and auditors may not note any fundamental changes. This article will take a brief look at the revised PN 25 and offer a brief refresher on why the audit firm attends the client’s stocktake, what to do beforehand and what types of procedure will gather evidence that will be both sufficient and appropriate.

Practice Note 25 (Revised) ‘Attendance at Stocktaking’

Auditors may not notice any differences to this practice note. However, what is often confusing (particularly to more junior audit staff) is the reason why auditors are required to attend stocktakes. 

The practice note confirms the assertions relating to stock which are:

  • Existence
  • Rights and obligations (i.e. ownership)
  • Completeness
  • Valuation.

Before the stocktake, PN 25 requires the auditor to undertake an element of planning, including:

  • Performing analytical procedures and discussing any significant variances with management
  • Discuss stocktaking arrangements and procedures with management
  • Familiarisation of the nature of stocks, volume, identification of high value items and the accounting method of stock valuation
  • Consideration of the location of stocks
  • Consideration of the quantity and nature of work in progress, quantity of stocks held by third parties and whether auditor’s experts may be required
  • Considering the internal controls relating to stocks to identify problem areas (e.g. problems relating to ‘cut offs’)
  • Whether any internal audit function exists and deciphering the extent to which reliance can be placed on internal audit
  • Considering the results of previous stocktakes
  • Reviewing the audit working papers for the previous year.

Paragraph 4 of ISA 501 (UK and Ireland) specifically requires the auditor to attend stocktake if the value of stock at the reporting date is (likely to be) material to the financial statements. Primarily the attendance at stocktake is that of an ‘observance’ test, i.e. to observe whether the procedures adopted by management insofar as the stock count is concerned would reduce the risk of material misstatement in the stock valuation. 

The revised practice note acknowledges that the UK & Ireland ISA 501 specifically requires the auditor to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory, in addition to other procedures, provided physical attendance at stocktake is impracticable. It is worth reminding auditors that auditors ‘shall’ perform audit procedures where ISA 501 (UK and Ireland) is applicable to them (remember, ‘should’ was changed to ‘shall’) to be more specific.

In addition to the usual test counts and observance of the stocktake being carried out, as well as evaluating the procedures management have adopted, auditors should also:

Observe the production process in relation to the completeness and valuation of stocks
Perform ‘cut off’ testing to ensure the client’s cut-offs are correct
Obtain evidence relating to the design and operation of the client’s controls in relation to stock

PN 25 (revised) contains various factors relating to the risk of material misstatement where stock is concerned which auditors need to be aware of, including the:

  • reliability of accounting and recording systems and related controls, particularly where estimates are used (such as work in progress)
  • the timing of the stocktake in relation to the year-end to determine whether additional procedures may be required (such as ‘roll-back’ procedures)
  • location of stocks, stock held by third parties, consignment stock and stock ‘in transit’
  • objectivity and experience of the stock counters
  • physical controls over the stock and the susceptibility of stock to theft or deterioration
  • degree of fluctuation in stock levels
  • nature of stocks, particularly where the use of auditor’s experts may be required or where degrees of estimation are used, such as in construction contracts
  • any difficulties which may be inherent where estimates are concerned

Sources of evidence relating to the existence of stocks are:

  • evidence from audit procedures relating to the reliability of accounting records upon which the stock value in the financial statements are based
  • evidence from tests of controls over stocks, including the counting procedures
  • substantive evidence from physical inspections at stocktake

If management retain detailed stock records and check these by way of regular stock counts, the auditor can perform audit procedures to determine whether management:

  • maintains adequate records of stocks which are kept up-to-date
  • has satisfactory procedures for stocktaking and test-counting
  • investigates and corrects all material differences between the book records of stocks and physical stocks

Where clients do not maintain detailed stock records, the quantification of stocks is likely to be based on a full, physical stocktake at the balance sheet date, or very close to the balance sheet date.  Evidence to satisfy the ‘existence’ assertion is therefore greater when the stocktake is carried out at the year-end (or a date very close to the year-end). This could well provide sufficient and appropriate audit evidence, however the auditor must also be satisfied that the records of stock movement are also reliable in the intervening periods.

ISA 501 (UK and Ireland) at paragraph 4 outlines specific procedures when the auditor attends a stocktake. The auditor is required to:

  • Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting
  • Observe the performance of management’s count procedures
  • Inspect the inventory
  • Perform test counts
  • Perform audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory results

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘The Interpretation and Application of International Standards on Auditing’ (Wiley March 2011).  Steve also lectures on financial reporting and auditing issues.

Replies (1)

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By pmolema
03rd Mar 2017 20:15

Hi,

There is a lot of information available about how to proceed as an auditor during the stocktake. The preparation of the warehouse, the cut-off times, the counting procedures, etc. I'm looking for the actual audit rules, meaning, once the count is finished, how are the audit rules applied. Do we take an x % of the total locations to check, out of this there needs to be a 99% accuracy to confirm the count. If the 99% isn't met, do we extend the sample with another 5% locations to check, etc, etc. Are there any guidelines available that you know of how to implement the actual audit procedure for verification of the counted result. When can we as an auditor give the "ok" stamp for approved audit?

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