Workshop on Stock in Trade –

Physical Stock Taking & Valuation

1
 Inventories

The following topics will be covered during the workshop:

• Definitions
• Financial statements assertion
• Methods of obtaining audit evidence
• Understanding of inventory system
• Physical inventories
• Valuation of inventories
• Presentation and disclosures
• Quiz and multiple choice questions

2
 Definitions

Inventories are assets

• Held for sale in the ordinary course of business;
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in
the production process in the rendering of services.
Net realizable value
Is the estimated selling price in the ordinary course of
business less the estimated costs of completion and
estimated costs necessary to make the sale.
Fair value
Is the amount for which an asset could be exchanged, or
a liability settled between knowledgeable, willing parties
in an arm length transaction. 3
 Financial statements assertion
Assertions about class of Assertions about
Assertions about account
transactions and events presentation and
balances at the period end
for the period under audit disclosure

•Occurrence—transactions and•Existence—assets, liabilities, and

equity interests exist •Occurrence and rights and
Events that have been recorded
Obligations—disclosed
have occurred and pertain •Rights and obligations—the entity
holds or controls the rights to events, transactions, and
to the entity
•Completeness—all transactions assets, and liabilities are the other matters have occurred
obligations of the entity and pertain to the entity.
and events that should have
•Completeness—all disclosures
been recorded have been •Completeness—all assets, liabilities
recorded and equity interests that shouldthat should have been included
•Accuracy—amounts and other data have been recorded have in the financial statements have
been recorded been included.
relating to recorded transactions
•Valuation and allocation—assets,•Classification and understandability
and events have been recorded
appropriately. liabilities, and equity interests are — financial information is
•Cutoff—transactions and eventsincluded in the financial statements appropriately presented
have been recorded in at appropriate amounts and and described, and disclosures
are clearly expressed
the correct accounting periodany resulting valuation or allocation
•
•Classification—transactions and adjustments are appropriatelyAccuracy and valuation—financial
and other information
events have been recorded recorded are disclosed fairly and at
4
in the proper accounts
appropriate amounts
Audit procedures of obtaining audit evidence
Audit procedures of obtaining audit evidence

Objective

The auditor obtains audit evidence to draw reasonable conclusions

on which to base the audit opinion by performing audit procedures:

Methods
– Inspection of records or documents
– Inspection of tangible assets
– Observation
– Inquiry
– Confirmation
– Recalculation
– Re performance
– Analytical procedures

5
 INVENTORY SYSTEM

Purchase Requisition

Store Department Yes Approval

Approval
Purchase Order Finance / Store
Copy to

Quality Control Report to Finance / Store

Goods Receipt Note Prepared at store for issuance to next

department

Goods Issued to relevant

department (process)

Additions
Process Labor and overheads

Goods issued to finished goods

Packing
department

Warehouse

Sale Order Description - Date of delivery - Quality

Delivery Note Finance / warehouse

Invoice
6
 Physical inventories
• Objective of physical attendance
• Need for physical stock taking
• General audit procedures for stock take
• Audit procedures for physical stock taking
• Specific areas

7
 Objective of physical attendance
• The attendance at the client’s physical inventory
is now regarded as a compulsory procedure.

• The purpose of observing inventory is to

determine that the client’s procedure result in
accurate count.

• The auditor will himself observe test count.

• The auditor will extract certain cut-off

information.
8
 Need for physical stock taking

When inventory is material to the financial statements,

the auditor should obtain sufficient appropriate audit
evidence regarding its existence and condition by
attendance at physical inventory counting unless
impracticable.

If unable to attend the physical inventory count on

the date planned, take or observe some physical counts
on an alternative date and, when necessary, perform
audit procedures on intervening transactions.

Where attendance is impracticable, due to factors

such as the nature and location of the inventory, the
auditor should consider alternative procedures.
9
General Considerations for Stock Taking
In planning attendance at the physical inventory count or
the alternative procedures, the auditor considers the
following:
– The risks of material misstatement related to
inventory.
– The nature of the internal control related to inventory.
– Whether adequate procedures are expected to be
established and proper instructions issued for
physical inventory counting.
– The timing of the count.
– The locations at which inventory is held.
– Whether an expert’s assistance is needed.
10
Audit procedures for physical stock
taking

After stock
take

During the stock take

Before stock take

11
 Audit Procedures Before Stock Take

Responsibility

The client has primary responsibility for planning and conducting the
physical inventory. The presence of Auditor during this phase is important
because of participation in the physical count.

The auditor may carry out the following procedures before the stock take:
– Date and time of inventory in consultation with client
– Locations of inventory in consultation with client
– Stocks held in bonded ware houses
– Methods of counting and recording
– Instructions to employees
– Determine materiality
– Need for expert
– Provisions for the following:
• Receipts and dispatch of inventory during the count
• Segregation of inventory held for third party
• Physical arrangement of inventory

12
Audit procedures during stock take

13
 Audit Procedures During Stock Take
The main task is to ensure that the client’s staff are carrying out
their duties effectively. The auditor should:

• obtain cutoff numbers (last receiving number and last dispatch

number)
• determine extent to which client counts would be tested.
• make two-way test counts from floor to sheet, and from stock sheets
to floor.
• compare count with appears on inventory tag, sheet, bin cards, and
also compare serial number and description, of the tags, sheets, bin
cards.
• Make notes of all tags, sheets, bin cards that represents damaged
stocks and slow moving items.
• examine source of stock sheet generation
• for work in process discuss with knowledgeable employee to review
the estimated cost to complete related to labor and factory
overheads.
• Make sure that inventory not owned by the client is not included in
the stock sheets.
• If experts are used than observe the procedures performed by him.
14
 Audit procedures after stock take
Following are the procedures

• The sheets shall be signed by all persons who were involved in the physical
stock taking
• Ensure all inventory sheets are accounted for
• Ensure rough inventory sheets are retained
• Cut off testing of receiving and dispatch of documents
• Prepare reconciliations in order to reach at year end stock, if the physical
stock tacking is performed before or after year end
• Document/ Inquire the observations/ discrepancies between physical and
sheets provided noted during the course of physical stock take

15
 Specific Areas
Stocks held at third party

1. Obtain direct confirmation

• As to the quantities.
• As to the condition of inventory.

2. Depending on materiality of this inventory the auditor would also consider

the following:

• The integrity and independence of the third party.

• Observing, or arranging for another auditor to observe, the physical
inventory count.
• Obtaining another auditor’s report on the adequacy of the third party’s
internal control for ensuring that inventory is correctly counted and
adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties, for
example, warehouse receipts, or obtaining confirmation from other
parties when such inventory has been pledged as collateral.

16
 Specific areas
Stock in transit
– The auditor should verify through reviewing purchase invoices
and subsequent status.
– Considerations to quarantine inventories

Stock in bonded ware houses

1. Auditor obtain direct confirmation in writing, from custodian.
2. The auditor should also apply one or more of the following
additional procedures:
– Review and test client’s procedures for investigating the
warehouseman and evaluating his or her performance.
– observe physical counts of goods, if applicable.
– if warehouse receipts have been pledge as collateral, confirm
details of pledged receipts with lenders.

17
 Audit of Inventory valuation
Topics to Cover:
- Definition of Inventories (Detailed)
- Initial Recognition of Inventories
- Implications of ISA-500 (Audit Evidence) on audit of
Inventories
- Subsequent Measurement of Inventories including different
methods of Inventory Valuation
- Other Matters which include Retail and Standard Cost Method
of Inventory Valuation and special considerations related to
Joint and By Product Costs.

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 Definition of Inventory
Inventory includes:
Inventories of Manufacturing Concern
- Assets held for sale in the ordinary course of business
(finished goods);
- Assets in the production process for sale in the ordinary
course of business (work in process); and
- Materials and supplies to be consumed in the production
process (raw materials) or rendering of services. [IAS 2.6].
Inventories of Service Provider
In the case of service provider, inventories include the costs of the
services which consist primarily of the labor and other costs of
personnel directly engaged in providing of the service, including
supervisory personnel and attributable overheads for which the entity
has not yet recognized the related revenue (see IAS 18 Revenue)

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 Initial Recognition

Cost should include all: [IAS 2.10]

- Costs of purchase (including taxes, transport, and handling) net of trade
discounts received;
- Costs of conversion (including fixed and variable manufacturing
overheads); and
- Other costs incurred in bringing the inventories to their present location
and condition.

Inventory cost should not include: [IAS 2.16-2.18]

- Abnormal waste;
- Storage costs;
- Administrative overheads unrelated to production;
- Selling costs;
- Foreign exchange differences; and
- Interest cost.

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 Cost Formulae

- For inventory items that are not interchangeable, specific costs are
attributed to the specific individual items of inventory. [IAS 2.23]

- For items that are interchangeable, IAS 2 allows the FIFO or

weighted average cost formulas. [IAS 2.25]. The same cost formula
should be used for all inventories with similar characteristics as to
their nature and use to the enterprise. For groups of inventories that
have different characteristics, different cost formulae may be
justified. [IAS 2.25]

- The standard cost and retail methods (For Commercial Importers

and Traders) may be used for the measurement of cost, provided
that the results approximate actual cost. [IAS 2.21-22]

21
 Subsequent Measurement

• Any write-down to NRV should be recognized as an expense in the period in

which the write-down occurs.
• Any reversal should be recognized in the income statement in the period in
which the reversal occurs. [IAS 2.34]

What is NRV:
NRV is the estimated selling price in the ordinary course of business, less
the estimated cost of completion and the estimated costs necessary to
make the sale. [IAS 2.6].

NRV = Estimated (selling price–cost to complete– cost necessary to

make sale)

22
 Activity Based Costing Limited
Finished Goods Physical Stock Sheet
As at June 30 2005
Audit Tick Slow Moving/ Audit Tick
Particulars Location Quantity Physical Damage/ Slow Moving/
of Item Held Count Obsolete Damage/ obsolete

Item - A W1-A 10,232 P 205 S

Item - B 7,685 P 154 S
Item - C 567 P 11 D
Item - D 7,898 P 158 O
Item - E 3,455 P 69 D
Item - F 5,692 P 114 S
Item - G 9,843 P 197 O
Item - H 15,468 P 309 D
Item - I 8,756 P 175 S
Item - J 1,938 P 39 O
Item - K 8,762 P 175 D
Item - L 1,450 P 29 S
Item - M 617 P 12 O
82,363 1,647

Audit Tick for Physical Verification P

Audit Tick for Slow Moving Stock S
Audit Tick for Demaged Stock D
Audit Tick for Obsolete Stock O
23
 Activity Based Costing Limited
Finished Goods Stock Valuation Sheet
As at June 30 2005
Estimated Estimated Estimated Net Lower of
Particulars Quantity Average Total Selling Completion Selling Realizable Total Cost/
Held Cost Cost Price Cost Cost Value NRV NRV

Item - A 10,232 102.5 1,048,780.00 117.88 - 2.36 115.52 1,181,975.06 1,048,780.00

Item - B 7,685 345.32 2,653,784.20 397.12 - 7.94 389.18 2,990,814.79 2,653,784.20
Item - C 567 85.47 48,461.49 98.29 - 1.97 96.32 54,616.10 48,461.49
Item - D 7,898 1257.63 9,932,761.74 1,265.70 - 25.31 1,240.39 9,796,568.63 9,796,568.63
Item - E 3,455 628.82 2,172,555.83 723.14 - 14.46 708.67 2,448,470.41 2,172,555.83
Item - F 5,692 419.21 2,386,143.32 482.09 - 9.64 472.45 2,689,183.52 2,386,143.32
Item - G 9,843 314.41 3,094,713.02 361.57 - 7.23 354.34 3,487,741.58 3,094,713.02
Item - H 15,468 251.53 3,890,604.17 245.35 - 4.91 240.44 3,719,172.32 3,719,172.32
Item - I 8,756 209.605 1,835,301.38 241.05 - 4.82 236.22 2,068,384.66 1,835,301.38
Item - J 1,938 179.66 348,183.85 206.61 - 4.13 202.48 392,403.20 348,183.85
Item - K 8,762 104.80 918,279.51 120.52 - 2.41 118.11 1,034,901.00 918,279.51
Item - L 1,450 69.87 101,309.08 80.35 - 1.61 78.74 114,175.34 101,309.08
Item - M 617 52.40 32,331.57 60.26 - 1.21 59.06 36,437.68 32,331.57
82,363 28,463,209.15 30,014,844.29 28,155,584.20

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 Activity Based Costing Limited
Provision for slow moving/ demaged/ obsolete stock
As at June 30 2005
Slow Moving/ Amount
Particulars Demage/ Average of
Obselence Cost Provision

Item - A 205 102.5 20,975.60

Item - B 154 345.32 53,075.68
Item - C 11 85.47 969.23
Item - D 158 1257.63 198,655.23
Item - E 69 628.82 43,451.12
Item - F 114 419.21 47,722.87
Item - G 197 314.41 61,894.26
Item - H 309 251.53 77,812.08
Item - I 175 209.605 36,706.03
Item - J 39 179.66 6,963.68
Item - K 175 104.80 18,365.59
Item - L 29 69.87 2,026.18
Item - M 12 52.40 646.63
1,647 569,264

25
 Activity Based Costing Limited
Raw Material Physical Stock Sheet
As at June 30 2005
Slow Moving/ Audit Tick
Particulars Location Quantity Physical Demage/ Slow Moving/
of Item Held Count Obselence Damage/ obsolete

Item - RM - A W1-A 5,116 P 102 S

Item - RM - B 3,467 P 69 S
Item - RM - C 635 P 13 D
Item - RM - D 7,475 P 150 O
Item - RM - E 3,258 P 65 D
Item - RM - F 5,936 P 119 S
Item - RM - G 9,254 P 185 O
Item - RM - H 12,655 P 253 D
Item - RM - I 7,536 P 151 S
Item - RM - J 1,675 P 34 O
Item - RM - K 8,265 P 165 D
Item - RM - L 1,923 P 38 S
Item - RM - M 715 P 14 O
67,910 1,358

Audit Tick for Physical Verification P

Audit Tick for Slow Moving Stock S
Audit Tick for Demaged Stock D
Audit Tick for Obsolete Stock O

26
 Activity Based Costing Limited
Raw Material Valuation
As at June 30 2005
Amount
Particulars Quantity Average of
Held Cost Valuation

Item - RM - A 5,116 51.25 262,195.00

Item - RM - B 3,467 172.66 598,612.22
Item - RM - C 635 42.74 27,136.73
Item - RM - D 7,475 628.82 4,700,392.13
Item - RM - E 3,258 314.41 1,024,339.64
Item - RM - F 5,936 209.61 1,244,215.28
Item - RM - G 9,254 157.20 1,454,763.50
Item - RM - H 12,655 125.76 1,591,530.77
Item - RM - I 7,536 104.80 789,791.64
Item - RM - J 1,675 89.83 150,466.45
Item - RM - K 8,265 52.40 433,096.33
Item - RM - L 1,923 34.93 67,178.40
Item - RM - M 715 26.20 18,733.45
67,910 12,362,451.52

27
 Activity Based Costing Limited
Provision for slow moving/ demaged/ obsolete stock
As at June 30 2005
Slow Moving/ Amount
Particulars Demage/ Average of
Obselence Cost Provision

Item - RM - A 102 51.25 5,243.90

Item - RM - B 69 172.66 11,972.24
Item - RM - C 13 42.74 542.73
Item - RM - D 150 628.82 94,007.84
Item - RM - E 65 314.41 20,486.79
Item - RM - F 119 209.61 24,884.31
Item - RM - G 185 157.20 29,095.27
Item - RM - H 253 125.76 31,830.62
Item - RM - I 151 104.80 15,795.83
Item - RM - J 34 89.83 3,009.33
Item - RM - K 165 52.40 8,661.93
Item - RM - L 38 34.93 1,343.57
Item - RM - M 14 26.20 374.67
1,358 247,249.03

28
Activity Based Costing Limited
As at June 30 2005

Stock in Trade: 2005 2004

Finished goods 28,155,584 26,344,876

Work in progress 14,556,654 16,765,489
Raw material 12,362,452 10,982,345
55,074,690 54,092,710
Less: Provision 569,264 -
54,505,426 54,092,710

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 Presentation and Disclosure of Inventories
under Fourth Schedule and IAS-2
IFRS Fourth Schedule
- Accounting policy for inventories. - Stock in trade distinguished between
- Carrying amount, generally classified appropriate classifications.
as merchandise, supplies, materials, - Provision, if any, made for diminution
work in progress, and finished goods in the value of or loss shall be shown
- Carrying amount of any inventories as a deduction from the gross amount.
carried at fair value less costs to sell
- Amount of any write-down of
inventories recognized as an expense
in the period
- Amount of any reversal of a write-
down to NRV and the circumstances
that led to such reversal
- Carrying amount of inventories
pledged as security for liabilities
- Cost of inventories recognized as
expense (cost of goods sold)

30
Multiple Choice Questions

31
 Multiple Choice Questions
Which of the following analytical procedures is
most applicable to inventory?
a. Comparison of sales of current and prior years.
b. Comparison of gross profit ratios of current and
prior years.
c. Comparison of marketing expense with budget.
d. Comparison of ratios of sales to accounts
receivable of current and prior years.
Solution
b
Reason
Because the amount shown for inventory affects
cost of sale and the gross profit ratio, fluctuations in
this ratio are investigated in connection with the
32
audit inventory.
 Multiple Choice Questions

The inventory observation provides least

evidence of
a. Presentation c. Valuation
b. Existence d. Rights
Solution
A
Reason
Observation of inventory on hand provides little
evidence about the classification of inventory.

33
 Multiple Choice Questions
The observation of inventories is a(n)
a. Generally accepted auditing standard.
b. Generally accepted auditing procedure
c. Alternative auditing procedure.
d. Optional auditing procedure.
Solution
b
Reason
Observation of inventories is a procedure, i.e.,
an act to be performed.
34
 Multiple Choice Questions
During an inventory observation auditors normally
record certain of their test counts to
a. Be used in compiling the client’s inventory.
b. Check the accuracy of the client’s account.
c. Compare with the final inventory listing.
d. Test the client’s counting procedure.
Solution
c
Reason
Recorded test counts are compared with the client’s
final inventory listing to provide assurance that the
client’s counts were not changed between the time
they were made and the time the final inventory listing
was prepared.
35
 Multiple Choice Questions
During an inventory observation an auditor
may detect absolute items by all of following
except
a. Observing unusual amounts of rust or dust.
b. Observing items with prior year inventory tags.
c. Computing gross profit ratios.
d. Inquiry of plants personnel.
Solution
C
Reason
The gross profit ratio will not detect absolute goods
in inventory although other ratios such as inventory
turnover will.
36
 Multiple Choice Questions
To test the receiving cut off auditors record the
last several numbers of documents used prior
to the taking of the inventory. These
documents are
a. Vendor invoices.
b. Purchase orders.
c. Receiving reports.
d. Purchase requisition
Solution
c
Reason
Receiving reports are used to test the receiving cut off.
37
 Multiple Choice Questions
In performing an inventory receiving cut off test, an
auditor determines that an item was received and
counted on 12/31/X3 (the audit date), but the purchase
was not recorded until 1/4/X4. The effect of this to
a. Overstate inventory and accounts payable.
b. Understate inventory and accounts payable.
c. Overstate inventory and understate accounts payable.
d. Overstate net income and understate accounts payable.
Solution
d
Reason
The inventory count generated an entry debiting inventory
(because inventory was physically on hand but not recorded
on the books) and crediting cost of sales (inventory overage).
The credit to cost of sales should have been to accounts
payable.

38
 Multiple Choice Questions
In which of the following types of inventories
would an auditor be least likely to need the
assistance of a specialist to determine
existence?
a. Baked goods
b. Coal Pile
c. Precious gems
d. Art work
Solution
a
Reason
The auditor could evaluate baked goods, but would
need a surveyor for the coal pile and appraisers for
the gems and art work.

39
 Multiple Choice Questions
The most important objective in the audit
of current liabilities is
a. Existence
b. Completeness
c. Valuation
d. Presentation and disclosure.
Solution
c
Reason
Unrecorded items constitute the auditor’s
man risk when auditing current liabilities.
40
 Multiple Choice Questions
In determining which accounts payable to select for
confirmation, an auditor is most likely to pick
a. Accounts with the largest balances to obtain dollar coverage.
b. Major vendors and suppliers regardless of the amount of the
balances.
c. Accounts with debit balances.
d. Any account with zero balance.
Solution
b
Reason
Because the auditor is primarily concerned with the
completeness assertion, he or she sends confirmations to
vendors that should have large balances (the major vendors).

41
Multiple Choice Questions
The review of subsequent disbursements covers
the period ending on the
a. Audit Date
b. Bank cut off statement.
c. Last day of field work.
d. Day of delivery of audit report
Solution
c
Reason
The auditors are in the client’s office through the last
day of field work, and this is the date trough which the
review of subsequent disbursements is performed.

42
Multiple Choice Questions
In the audit of accrued liabilities an auditor finds
that the only recorded accrual is for payroll. This
suggests that another accrual is needed for
a. Vacation pay
b. Profit sharing
c. Executive salaries
d. Payroll taxes
Solution
d
Reason
The client should have accrued payroll taxes
applicable to the accrued payroll.

43
Multiple Choice Questions
An auditor testing pricing of inventory for a client
that uses a job-order cost system would review
a. Categories of cost flowing through the control
accounts.
b. Accumulations of cost by cost centre.
c. Standard cost buildups.
d. Variation between actual and projected cost.
Solution
a
Reason
The auditor would review costs in the direct labor,
material, and overhead control accounts.

44
Multiple Choice Questions
Goods were received on December 29 and
counted during December 31 physical inventory.
The transaction to record the purchase was
recorded January 3. Which of the following
entries will the auditor purpose?
a. Debit inventory and credit accounts payable.
b. Debit inventory and credit purchases.
c. Debit cost of sales and credit accounts payable.
d. Debit cost of sales and credit inventory.
Solution
c
Reason
Cost of sales was credited in the entry to record the
physical inventory counts, but the entry should
have been to accounts payable.

45
True and False

46
 True and False
• The taking of an accurate physical inventory is a generally accepted auditing
procedure.
F
The observation of the physical inventory is a generally accepted auditing
procedure.

• Before the start of the inventory, the auditor should review the client’s inventory
instructions.
T

• The auditor tests a client’s inventory cut off to determine that physical items and
their related costs are treated in a consistent manner.
T

• The objective of a receiving cut off test is to determine whether items that are
received near the end of the year and included in inventory also are recorded as
purchases and accounts payable.
T

• The test of inventory pricing in a job-order cost system usually involves a review of
the flow and accumulation of costs by cost centre for the major products.
F
The review of costs by cost centre is performed when auditing a process cost
system
47
 True and False
• If a product is counted quarts and priced in gallon, inventory will be understated.
F Inventory will be overstated, not understated.

• The auditor would perform more extensive inventory cut off procedures where there is a separate receiving
department and renumbered receiving reports are used ten where such controls do not exist.
F
The auditor would perform less extensive inventory cut off procedure in this case.

• The auditor seldom finds amounts recorded as liabilities that are not liabilities, but unrecorded liabilities are not
unusual.
T

• Confirmation of accounts payable is a generally accepted auditing procedure.

F
Although confirmation of accounts payable is common practice, it has not been designated as a generally
accepted auditing procedure

• An account payable confirmation may shown an amount different from the client’s books, but both may be correct.
T

• An advantage of using the review of subsequent disbursements in the audit of accounts payable is that provides
much broader account coverage than would be practicable with confirmations.
T

• A good starting point in a search for unrecorded accrued liabilities is the client’s expense accounts
T

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