Separate management’s count from the auditor’s attendance
Management conducts and records physical verification. Where inventory is material, SA 501 paragraph 4 requires the auditor to obtain sufficient appropriate evidence of its existence and condition through attendance at physical counting unless impracticable, and through procedures over final inventory records. At attendance, evaluate management’s instructions, observe the count procedures, inspect inventory and perform test counts. Attendance supports existence and condition; it does not establish ownership, cut-off or valuation by itself.
| Stage | Work to document |
|---|---|
| Before the count | Assess material locations and risks, count controls, third-party and consignment goods, and how movements are controlled and recorded. |
| During attendance | Observe counting, inspect condition and use test counts from records to floor and floor to records as appropriate. These directions support existence and completeness respectively. |
| After the count | Trace test counts and count tags to the final compilation, reconcile differences and test the relevant cutoff and valuation. |
Paragraph 5 requires work on intervening movements when the count occurs on another date. Use a quantity bridge by item where practical and a consistent cost bridge. Add receipts or production and deduct issues and dispatches to roll forward; reverse those movements to roll back. Include returns, transfers, scrap and adjustments and avoid counting internal transfers twice. The standard does not require testing 100% of intervening transactions in every case.
If unforeseen circumstances prevent attendance on the planned date, paragraph 6 requires making or observing some physical counts at an alternative date and testing intervening transactions. If attendance is impracticable, paragraph 7 requires suitable alternatives; if sufficient evidence still cannot be obtained, evaluate the opinion under SA 705 (Revised). Inconvenience alone does not establish impracticability. For material inventory in third-party custody and control, paragraph 8 requires confirmation, inspection or other appropriate procedures, singly or in combination as circumstances warrant.
Apply CARO’s class-level rule where the Order applies
CARO paragraph 3(ii)(a) addresses management verification at reasonable intervals, appropriate coverage and procedure, and discrepancies of at least 10% in aggregate for each class and whether they were properly dealt with in the books. The ICAI guidance applies the value test on a net basis after offsetting excesses and shortages within the same class. Do not net between classes. Use the class value at physical verification and document the inputs and calculation. The 10% reporting test does not replace financial statement materiality or automatically modify the main audit opinion.
Verify valuation independently
Apply the relevant framework, including the lower of cost and net realisable value (NRV) under Ind AS 2 or AS 2 as applicable. NRV is expected ordinary-course selling price less estimated costs of completion and costs necessary to sell. Aging is a risk indicator, not a fixed write-down rule. Assess post-period sales for what they indicate about conditions at the reporting date. For WIP, verify actual cost components and overhead absorption; a physical completion percentage is not necessarily the same as cost incurred. Under Ind AS 2, reverse a write-down when supported by changed circumstances or clear evidence of higher NRV, limited to the original write-down.
Seven worked cases
1. Trace count tags in both directions
A forging plant holds 650 bins valued at ₹32 crore. The team traces 40 selected register items worth ₹14.50 crore to physical stock and 35 selected bins, estimated at ₹6.20 crore, to count records. One physical tag for 120 shafts at ₹18.50 lakh is omitted. Investigate duplicate tags, ownership, cutoff and unit cost before correcting the compilation. The selections can overlap; do not add their values to claim distinct coverage.
2. Roll forward from 26 to 31 March
Use five days of movements, from 27 to 31 March. Amounts are in ₹ lakh. Assume there are no relevant additional classes or net WIP balances at the dates shown.
| Movement | Raw materials | Finished goods | Total |
|---|---|---|---|
| 26 March count value | 840.00 | 620.00 | 1,460.00 |
| External receipts | 68.50 | 0 | 68.50 |
| Issued to production | −42.00 | 0 | −42.00 |
| Completed production at cost | 0 | 54.20 | 54.20 |
| Dispatches recognised out at cost | 0 | −88.40 | −88.40 |
| 31 March bridge | 866.50 | 585.80 | 1,452.30 |
Verify receipt, issue, production and dispatch records and compare the bridge with the final ledger. Matching totals alone does not prove the cutoff was correct.
3. Roll back from 6 April
On 6 April a distributor has ₹24.50 crore at cost. Over 1–6 April it records ₹2.80 crore qualifying receipts and ₹3.65 crore qualifying dispatches at cost. With no other movements, year-end inventory is ₹24.50 − ₹2.80 + ₹3.65 = ₹25.35 crore. Verify the timing and ownership of both streams.
4. Quantify a raw cotton shortage for CARO
Book inventory of 15,000 bales valued at ₹18 crore implies ₹12,000 per bale if uniform. A count of 13,200 means 1,800 short, worth ₹2.16 crore. With no offsetting excesses within the class, the net value discrepancy is 12%. If CARO applies, report the threshold finding and whether the books deal with it appropriately. Assuming the shortage is confirmed and no separate adjustment applies, recognise ₹2.16 crore of shortage loss and reduce inventory by the same amount. Investigate the cause rather than assuming theft.
5. Reassess costs of part-built machines
Forty-five machines are valued at ₹8.40 crore based on a uniform 75% stage. Inspection indicates 22 are at 25% and 23 at 75%. If all machines have equal expected cost, the percentages also measure cost incurred and there are no other adjustments, multiply ₹8.40 crore by (22 × 25% + 23 × 75%) ÷ (45 × 75%). The illustrative revised amount is ₹5.6622 crore, a reduction of ₹2.7378 crore. In an audit replace these assumptions with evidence from bills of materials, actual stages, labour and overhead records.
6. Estimate NRV from supported clearance prices
Of a retailer’s ₹45 crore of inventory, 54,166 aged garments cost ₹1,200 each, or ₹6,49,99,200. Assume subsequent sales support a reporting-date expected net selling price of ₹445 per garment after discounts and excluding GST, rather than deriving it from the ₹499 ticket price without evidence. At ₹45 costs necessary to sell, NRV is ₹400 and the shortfall ₹800 per unit. If the sample is representative and NRV applies to all these units, the write-down is ₹4,33,32,800 and the revised carrying amount is ₹2,16,66,400.
7. Test third-party warehouse stock
A processor records 12,000 tonnes worth ₹48 crore across eight warehouses. The three largest hold 82% by quantity, or 9,840 tonnes, leaving 2,160 tonnes elsewhere. Obtain direct confirmations where appropriate and consider inspecting inventory, receipts and moisture or quality evidence. Plan procedures for the other locations and verify title, pledges and stock held for others. A percentage of stock covered or assets held offsite does not by itself determine sufficient evidence.
Close the inventory workpaper
Retain the instructions, site and selection rationale, count evidence, discrepancies, movements and cutoff tests, ledger reconciliation, valuation support and CARO conclusion. For dispersed inventory, select locations based on risk and materiality rather than a fixed number of visits. Document what evidence supports unvisited locations and why it is sufficient. A digital count register can help organise evidence but cannot substitute for professional evaluation.
Sources
- ICAI: SA 501, inventory paragraphs 4–8 and application material
- Companies (Auditor’s Report) Order, 2020, paragraph 3(ii)(a)
- ICAI Guidance Note on CARO 2020 (Revised 2022), inventory discrepancy guidance
- MCA: Ind AS 2, Inventories
- Companies (Accounting Standards) Rules, 2021, including AS 2
- ICAI: SA 505, External Confirmations
- ICAI: SA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report