by Verification and Valuation of stock in trade, also known as inventory, is a crucial aspect of the audit process to ensure that a company’s financial statements accurately reflect the value of its goods held for sale. The audit procedures involve confirming the existence, ownership, and valuation of stock in trade.
The verification and valuation of stock in trade involve a combination of physical inspections, documentation reviews, cut-off testing, and assessment of costing policies. Auditors play a crucial role in providing assurance that the values reported in the financial statements are accurate and in compliance with accounting standards. The choice of valuation method depends on the nature of the inventory and the specific circumstances surrounding each item.
Verification of Stock in Trade:
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Physical Inspection:
Auditors perform physical inspections of the stock to confirm its existence. This involves visiting the locations where the stock is stored and physically counting and verifying the items.
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Ownership Confirmation:
Auditors confirm ownership of the stock by reviewing purchase invoices, sales invoices, and other supporting documents. This ensures that the inventory belongs to the entity.
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Cut-Off Testing:
Cut-off testing is performed to ensure that transactions related to the movement of inventory are recorded in the correct accounting period. This includes reviewing shipping and receiving documents.
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Consignment Goods Verification:
For consignment goods, auditors verify the terms of the consignment agreement and confirm the ownership of the goods in the company’s possession.
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Third-Party Confirmations:
Auditors may obtain direct confirmations from third-party warehouses or logistic providers to verify the quantity and condition of the stock held off-site.
Valuation of Stock in Trade:
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Cost Calculation:
Auditors review the methods used by the company to calculate the cost of inventory. This may include the use of specific identification, FIFO (first-in, first-out), LIFO (last-in, first-out), or weighted average methods.
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Review of Costing Policies:
The auditor assesses whether the company’s costing policies are consistently applied and in compliance with accounting standards. Any changes in costing methods are scrutinized for appropriateness.
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Obsolete and Slow-Moving Inventory:
Auditors evaluate the company’s assessment of obsolete or slow-moving inventory. Provisions for potential declines in the value of certain items are reviewed to ensure they are adequately accounted for.
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Net Realizable Value Assessment:
Net realizable value is considered when the cost of inventory exceeds its market value. Auditors assess whether the company has appropriately considered factors that may affect the net realizable value of inventory.
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Lower of Cost or Market Rule:
The auditor verifies compliance with the lower of cost or market rule, ensuring that inventory is valued at the lower of its cost or its market value.
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Valuation of Work–in–Progress:
For manufacturing entities, auditors assess the valuation of work-in-progress by reviewing the allocation of direct and indirect costs and ensuring consistency with accounting policies.
Other Considerations:
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Disclosures:
Auditors review disclosures related to inventory in the financial statements, ensuring compliance with applicable accounting standards. This may include details about the valuation methods used, provisions for obsolete inventory, and any write-downs taken.
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Subsequent Events:
Any significant events occurring after the balance sheet date but before the financial statements are issued are considered to ensure that the values of stock in trade are still accurate.
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Management Representations:
Auditors obtain representations from management regarding the ownership, existence, and valuation of stock in trade. Management may be required to confirm the accuracy of inventory records and the adequacy of provisions.
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Review of Internal Controls:
Auditors assess the effectiveness of internal controls related to the counting, recording, and valuation of inventory. This includes controls over authorization, physical security, and reconciliation processes.
