Inventories observation is the procedure that normally use by auditors to observe the inventory count that perform 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 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 whether it is running properly or not through annual inventory count.
If a significant variance is found between balances per records and actual, the inventory internal system might need to review and investigation might need to perform.
Objective of inventory observation:
Normally, inventory count is performed by the entity’s staff and observe 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.
Auditor performance an inventory observation for many reasons. For example, the auditor wants to confirm does the client really performs annual inventory counts and wants to assess the appropriateness of inventory count.
This is really 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 condition of inventory as well as the existence. In financial statements, inventory amounts normally material. Therefore, auditors should ensure that the inventories really exist.