Attendance at Physical Inventory Counting (Ref: Para. 4(a))

Management ordinarily establishes procedures under which inventory is physically counted at least once a year to serve as a basis for the preparation of the financial report and, if applicable, to ascertain the reliability of the entity’s perpetual inventory system.

Attendance at physical inventory counting involves:

• Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
• Observing compliance with management’s instructions and the performance of procedures for recording and controlling the results of the physical inventory count; and
• Obtaining audit evidence as to the reliability of management’s count procedures.

These procedures may serve as test of controls or substantive procedures depending on the auditor’s risk assessment, planned approach and the specific procedures carried out.

Matters relevant in planning attendance at physical inventory counting (or in designing and performing audit procedures pursuant to paragraphs 4-8 of this Auditing Standard) include, for example:

• 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 physical inventory counting.
• Whether the entity maintains a perpetual inventory system.
• The locations at which inventory is held, including the materiality of the inventory and the risks of material misstatement at different locations, in deciding at which locations attendance is appropriate. 
• Whether the assistance of an auditor’s expert is needed. ASA 620^[4] deals with the use of an auditor’s expert to assist the auditor to obtain sufficient appropriate audit evidence.

Evaluate Management’s Instructions and Procedures (Ref: Para. 4(a)(i))

Matters relevant in evaluating management’s instructions and procedures for recording and controlling the physical inventory counting include whether they address, for example:

• The application of appropriate controls, for example, collection of used physical inventory count records, accounting for unused physical inventory count records, and count and re-count procedures.
• The accurate identification of the stage of completion of work in progress, of slow moving, obsolete or damaged items and of inventory owned by a third party, for example, on consignment.
• The procedures used to estimate physical quantities, where applicable, such as may be needed in estimating the physical quantity of a coal pile.
• Control over the movement of inventory between areas and the shipping and receipt of inventory before and after the cut-off date.

Observe the Performance of Management’s Count Procedures
(Ref: Para. 4(a)(ii))

Observing the performance of management’s count procedures, for example those relating to control over the movement of inventory before, during and after the count, assists the auditor in obtaining audit evidence that management’s instructions and count procedures are adequately designed and implemented.  In addition, the auditor may obtain copies of cut-off information, such as details of the movement of inventory, to assist the auditor in performing audit procedures over the accounting for such movements at a later date.

Inspect the Inventory (Ref: Para. 4(a)(iii))

Inspecting inventory when attending physical inventory counting assists the auditor in ascertaining the existence of the inventory (though not necessarily its ownership), and in identifying, for example, obsolete, damaged or ageing inventory.

Perform Test Counts (Ref: Para. 4(a)(iv))

Performing test counts, for example by tracing items selected from management’s count records to the physical inventory and tracing items selected from the physical inventory to management’s count records, provides audit evidence about the completeness and the accuracy of those records.

In addition to recording the auditor’s test counts, obtaining copies of management’s completed physical inventory count records assists the auditor in performing subsequent audit procedures to determine whether the entity’s final inventory records accurately reflect actual inventory count results.

Physical Inventory Counting Conducted Other than At the Date of the Financial Report (Ref: Para. 5)

For practical reasons, the physical inventory counting may be conducted at a date, or dates, other than the date of the financial report.  This may be done irrespective of whether management determines inventory quantities by an annual physical inventory counting or maintains a perpetual inventory system.  In either case, the effectiveness of the design, implementation and maintenance of controls over changes in inventory determines whether the conduct of physical inventory counting at a date, or dates, other than the date of the financial report is appropriate for audit purposes.  ASA 330 establishes requirements and provides guidance on substantive procedures performed at an interim date.^[5]

Where a perpetual inventory system is maintained, management may perform physical counts or other tests to ascertain the reliability of inventory quantity information included in the entity’s perpetual inventory records.  In some cases, management or the auditor may identify differences between the perpetual inventory records and actual physical inventory quantities on hand; this may indicate that the controls over changes in inventory are not operating effectively.

Relevant matters for consideration when designing audit procedures to obtain audit evidence about whether changes in inventory amounts between the count date, or dates, and the final inventory records are properly recorded include:

• Whether the perpetual inventory records are properly adjusted.
• Reliability of the entity’s perpetual inventory records.
• Reasons for significant differences between the information obtained during the physical count and the perpetual inventory records.

Attendance at Physical Inventory Counting Is Impracticable (Ref: Para. 7)

In some cases, attendance at physical inventory counting may be impracticable.  This may be due to factors such as the nature and location of the inventory, for example, where inventory is held in a location that may pose threats to the safety of the auditor.  The matter of general inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that attendance is impracticable.  Further, as explained in ASA 200,^[6] the matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive.

In some cases where attendance is impracticable, alternative audit procedures, for example inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting, may provide sufficient appropriate audit evidence about the existence and condition of inventory.

In other cases, however, it may not be possible to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by performing alternative audit procedures.  In such cases, ASA 705 requires the auditor to modify the opinion in the auditor’s report as a result of the scope limitation.^[7]

Inventory under the Custody and Control of a Third Party

Confirmation (Ref: Para. 8(a))

ASA 505^[8] establishes requirements and provides guidance for performing external confirmation procedures.

Other Audit Procedures (Ref: Para. 8(b))

Depending on the circumstances, for example where information is obtained that raises doubt about the integrity and objectivity of the third party, the auditor may consider it appropriate to perform other audit procedures instead of, or in addition to, confirmation with the third party.  Examples of other audit procedures include:

• Attending, or arranging for another auditor to attend, the third party’s physical counting of inventory, if practicable.
• Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of the third party’s internal control for ensuring that inventory is properly counted and adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts.
• Requesting confirmation from other parties when inventory has been pledged as collateral.

[Deleted by the AUASB.  Refer ASA 502 Audit Evidence—Specific Considerations for Litigation and Claims]

(Ref: Para. 13)

Depending on the applicable financial reporting framework, the entity may be required or permitted to disclose segment information in the financial report.  The auditor’s responsibility regarding the presentation and disclosure of segment information is in relation to the financial report taken as a whole.  Accordingly, the auditor is not required to perform audit procedures that would be necessary to express an opinion on the segment information presented on a stand-alone basis.

Understanding of the Methods Used by Management (Ref: Para. 13(a))

Depending on the circumstances, example of matters that may be relevant when obtaining an understanding of the methods used by management in determining segment information and whether such methods are likely to result in disclosure in accordance with the applicable financial reporting framework include:

• Sales, transfers and charges between segments, and elimination of inter-segment amounts.
• Comparisons with budgets and other expected results, for example, operating profits as a percentage of sales.
• The allocation of assets and costs among segments.
• Consistency with prior periods, and the adequacy of the disclosures with respect to inconsistencies.