Auditing Inventory

The process of cross-checking financial records with physical inventory and records

Written by CFI Team

Published July 9, 2020

Updated December 5, 2022

What is Auditing Inventory?

Auditing inventory is the process of cross-checking financial records with physical inventory and
records. It can be completed by auditors and other parties.

Auditing Inventory

An inventory audit can be as simple as just taking a physical count of stock and inventory to verify a
match to the accounting records.

Auditing Explained

Auditing is the process of verifying that the financial records of an entity are accurate and fairly
represented. Transactions in financial records must fairly represent the entity’s financial positioning
and actual operating activities.

Since financial documentation and records are produced internally, there is a high risk that records
can be manipulated by inside parties. Insiders can make mistakes or intentionally alter information
while preparing financial records, which is considered fraudulent behavior. Auditing ensures that
these mistakes are prevented.

Audits also ensure that entities are complying with relevant accounting standards such as the
International Financial Reporting Standards (IFRS), Generally Accepted Accounting Principles (GAAP),
and other relevant accounting standards.

Evidence in Auditing

Evidence is needed to determine whether financial statements or records have been prepared in
accordance with standards and free from material error. It is also required to promote the accuracy,
transparency, and independence of audit reports.
Evidence is required by auditors to verify the validity of financial records. It can either verify or
provide support for the financial information that is presented. On the other hand, the evidence can
contradict the financial information, which indicates errors or fraudulent behavior.

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.

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 costs 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.

Related Readings

Thank you for reading CFI’s guide to Auditing Inventory. To keep learning and developing your
knowledge base, please explore the additional relevant resources below:

Accounting Policies

Audited Financial Statements

IFRS vs. US GAAP

Inventory Valuation

See all accounting resources