Stock audit, also known as inventory check, is a crucial process that involves the physical verification and valuation of inventory items. It serves the purpose of independently assessing the existing stock and identifying any discrepancies. In legal terms, stock audit is a mandatory procedure that every business entity must perform at least once in a financial year. The process entails counting the physical stock present in specified premises and comparing it with the computed stock maintained by the company. The objective is to rectify any disparities between the recorded stock and the physical stock by making necessary adjustments.
What is Included in Stock?
Inventory typically includes various items such as stores, spare parts, maintenance supplies, raw materials, work-in-progress, finished products, and waste or by-products.
Purpose of Stock Audit
Stock audits serve several purposes, including:
1. Identifying slow-moving stock, obsolete stock, dead stock, and scrap.
2. Preventing pilferage and fraud.
3. Obtaining instant information about the value of inventory.
4. Reducing costs and improving the bottom line.
5. Facilitating third-party opinions, particularly for agent warehouses.
6. Addressing gaps in inventory management processes.
Key Aspects of Stock Audit
According to the Guidance Note of the Institute of Chartered Accountants of India (ICAI) on Stock Audit, the following aspects are essential:
1. Evaluation of Internal Control:
This involves separating inappropriate or conflicting functions and adopting standard methods to record stock movement. It also includes cross-checking data generated by various departments. The auditor examines specific controls over issues, receipts, physical stock, and recorded inventory.
2. Verification:
Physical verification of stocks is the responsibility of management. The auditor is responsible for acquiring sufficient and reliable audit evidence to validate the declarations made by management regarding the existence, ownership, and valuation of stock.
- Existence: Confirming the availability of recorded stock at the end of the year.
- Ownership: Ensuring that recorded stock is owned by the entity.
- Valuation: Validating the correct application of stock valuation methods and assessing the condition of the stock based on its valuation.
Appointment of Stock Auditor
The stock auditor is appointed by the bank from which the auditee has taken a working capital loan. The auditor should have at least three years of post-qualification experience, with a minimum of two years of experience in stock audits across different industries. In the case of firms, the experience of the partners is considered as the firm's experience. Stock audits are conducted quarterly, and the auditor examines various aspects, including physical verification of stock, outstanding amounts of debtors and creditors, submission of stock statements to the bank, purchase and sale records, drawing power, insurance coverage, and other mandatory information.
Performing Stock Audit
The stock audit process involves several steps:
1. Cut-off Analysis:
Reviewing the company's procedures for the last few receiving and shipping transactions before conducting the physical count. This ensures that all transactions are accounted for.
2. Physical Inventory Counting:
Physically counting each item of inventory using techniques such as barcode scanning for accuracy.
3. Inventory Layers:
Analyzing inventory layers when the company follows methods like FIFO (first-in, first-out) or LIFO (last-in, first-out) to validate the recorded inventory.
4. High-Value Item Inventory Analysis:
Using ABC Analysis to group products based on their value, prioritizing management efforts and improving stockroom management.
5. Inventory-in-Transit Analysis:
Tracking the time between shipment and receipt of materials to ensure items are not lost or damaged during transit.
6. Freight Cost Analysis:
Determining shipping costs and expenses associated with transporting products.
7. Finished-Goods Cost Analysis:
Analyzing the value of completed inventory ready for sale during the accounting period.
Role of the Auditor and Stock Audit Process
During the stock audit process, the auditor performs the following tasks:
1. Physical verification of stocks and examination of relevant records such as goods received notes, material issue notes, inspection reports, and bin cards.
2. Taking attendance during stock-taking, especially when a significant portion of the stock is held by third parties, and confirming their presence.
3. Ensuring that stock valuation follows the standard accounting principles issued by the ICAI (Accounting Standard 2 - Valuation of Inventories).
4. Conducting an analytical review process to gather audit evidence related to inventory assertions discussed earlier. This includes analyzing work-in-progress to validate its valuation.
5. Obtaining a written statement from the management team of the entity, detailing inventory information, methods and procedures of physical verification, and stock valuation.
Based on the gathered evidence, the stock auditor provides an audit opinion that reflects a true and fair assessment of the stock.
In summary, stock audit plays a vital role in assessing and managing inventory. By conducting regular audits, businesses can ensure the accuracy of their stock records, identify inefficiencies, prevent fraud, and make informed decisions regarding inventory management.