Inventory Observation (Objective and Explanation)

Overview:

Auditors generally observe the inventory count performed by the client at the end of the year or accounting period.

Most of the accounting book is closing at the end of the calendar year, and normally entity performs a full inventory count to assess the actual quantity and calculate the exact amount of inventory closing balance.

An entity might want to assess the internal control system on inventory and whether it is running correctly through an annual inventory count.

If a significant variance is found between balances per record and actual, the inventory internal system might need to review, and an investigation might need to perform.

The objective of inventory observation:

Normally, inventory count is performed by the entity’s staff and observed by auditors.  Auditors are not involved in the counting process.

This is to ensure that there is no conflict of interest involved. However, during the counting process, the auditor might request to recount certain items that are noted as unusual by them.

Auditors perform an inventory observation for many reasons. For example, the auditor wants to confirm does the client performs annual inventory counts and wants to assess the appropriateness of inventory counts.

This is important for auditors. If the counting process is not proper, then the inventory balance in the financial statements might have some problems.

Auditors might also want to assess the inventory’s condition and its existence. In financial statements, inventory amounts are normally material. Therefore, auditors should ensure that the inventories exist.

Related article  What Are the Purposes of Audit on Financial Statements?