Process and Importance of Stock Audit for Manufacturing & Trading Concerns

Process and Importance of Stock Audit for Manufacturing

An inventory audit or Stock Audit can be as simple as just taking a physical count of stock and inventory to verify a match to the accounting records. 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. During the Stock Audit Procedure the independent auditor observes the inventory and gives an opinion on whether the financial records of inventory accurately represent the physical inventory being carried. 

In the course of stock audit the auditor 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. Stock audits are also undertaken for banks and other financial institutions which have extended credit to businesses against physical goods and assets. We have big enough network throughout India for quick and simultaneous audits at multiple locations.

Purpose of Stock Audit:

There are several key reasons why an institution needs to perform a stock audit, including:

  • Identification of the slow-moving stock, dead stock, obsolete stock, and scrap.
  • Identification of the discrepancy between stock records and physical stock.
  • Updation in the book stock to match physical stock levels.
  • Ensure proper preservation and handling of stocks.

Benefits of Stock Audit:

Stock Audit offers many benefits to the organization including following:

  • Cost Reduction by preventing excess investment in carrying cost of inventory;
  • Prevention of fraud and theft of stocks;
  • Appropriate Valuation of Inventory resulting in true and fair view of financial records;
  • Reduction in gaps in the inventory management process;
  • Unbiased and profession opinion about inventory management;
  • Implementation of effective internal control for inventory management.

List of Documents required For Stock Audit:

  • Stock Register;
  • Stock Statements as on date of verification;
  • Invoices of Purchases, Sales, Delivery Notes, Receipt Notes etc.;
  • Stock list of non-moving, obsolete, dead stock;
  • Method of valuation of closing stock;
  • Provisional balance Sheet, Trial balance as on date of verification;
  • Latest Audited Financials Statements;
  • Stock Insurance policy, if any;
  • Debtors and Creditors list for latest 6 months.

Stock Auditor’s Checklist:

Apart from regular checking of physical stocks, a stock auditor can verify following details in particulars:

  • The adequacy of internal controls regarding purchase, sales and storage of materials.
  • System of Assignment of Unique Number to the physical stock (Stock Number) for stock identification.
  • Whether or not the high value items has been given due consideration.
  • Analysis of the Standard Operating Procedures defined for the storage and movement of stock.
  • Check whether the staff responsible for stock handling is qualified and possesses necessary skill set for the purpose.
  • Seek clarification for the deviation between physical stock and book stock.
  • Whether the stock records are verified by staff members from time to time and if so, the frequency of such verification. Also, check the appropriateness of the method adopted for such verification process.
  • Verify accuracy of the MIS software installed for stock keeping and also check the correctness of the reports generated by the same.
  • Verify the provision of physical security controls of stock including security guard, CCTV cameras, Firefighting equipments, entry and exist procedures, biometric door locks etc.

Methods of Stock Valuation and Recording:

First-In-First-Out (FIFO):

  • According to the first-in-first-out (FIFO) inventory valuation method, it’s assumed that inventory items are sold in the order in which they’re manufactured or purchased. In other words, the oldest inventory items are sold first.
  • The FIFO method is widely used because companies typically sell products in the order in which they’re purchased, so it best represents the actual flow of goods in a business.

Last-In-First-Out (LIFO):

  • The last-in-first-out (LIFO) inventory valuation method assumes that the most recently purchased or manufactured items are sold first – so the exact opposite of the FIFO method.
  • When the prices of goods increase, Cost of Goods Sold in the LIFO method is relatively higher and ending inventory balance is relatively lower.

Weighted Average Method:

  • The Weighted Average Method uses the item’s average cost throughout the year.
  • The average cost per unit is calculated by dividing the total cost by the total number of units purchased during the year.
  • This method is appropriate when a business doesn’t have much variation in its inventory.

ABC Analysis:

  • An ABC analysis includes grouping of different inventory items in categories A, B and C.
  • Such grouping is based on the consumption value and volume of the concerned inventory.
  • Consumption value is the total value of an item consumed over a specified time period, for example a year.
  1. Class ‘A’ Items:
  • Inventory items categorized as ‘A’ items are goods whose annual consumption value is the highest.
  • They comprise a relatively small number of items but have a relatively high consumption value.
  • Every aspect of such inventory items must be analyzed and inquired thoroughly by the auditor including controls in place, storage conditions, transportation methods etc.
  • Due to high value, such inventory items offer the greatest potential to reduce costs or losses.
  1. Class ‘B’ Items:
  • ‘B’ items fall somewhere between ‘A’ and ‘C’ items. Their consumption values are lower than ‘A’ items but higher than ‘C’ items.
  • The auditor should check whether the potential value derived from such items justify the cost incurred on storage and transport on such items.
  1. Class ‘C’ Items:
  • The inventory items falling under this class are consumed in highest number as compared to the other classes. However, these items cumulatively represent the lowest consumption value in the production cost.
  • So, t’s not usually cost-effective to deploy tight inventory controls, as the value at risk of due to loss is relatively low.
  • The auditor should ensure that the carrying cost of such items does not exceed the value of contributed by these items into the final product.

Note: The above classification of the inventory is not based on any pre-defined and strict standards. They vary from industry to industry depending on the nature of business.

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.
  • Auditor should thoroughly check for the appropriateness of the method and basis of allocation of overheads to the items of inventory.

Inventory-in-Transit Analysis:

  • The auditor must conduct an analysis to check the average time for which the inventory remains in transit.
  • This is an analysis to track the time between the date of shipment and the date of receipt when materials are moving between two locations or more.
  • This audit helps to make sure that all the items are not lost and safe while in transit.
  • Also, the auditor should try to determine the proportion of transport cost and whether the cost is justified or not.

Finished-Goods Cycle Analysis:

  • The auditor should analyze the time taken in conversion from raw material to finished goods.
  • He must also analyze the value addition into the inventory from raw material to finished goods and also the proportion and value of wastage in the production process.


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Financial Management