## Learning Outcomes

After reading this article, you will be able to explain why inventory counts are necessary, outline correct procedures for attending and observing inventory counts, identify auditor responsibilities for inventory count and cut-off, and apply IAS 2 rules for inventory valuation, including cost components, net realisable value, and required disclosures. You will also recognise common audit risks and deficiencies in inventory controls and provide relevant substantive procedures and responses.

## ACCA Audit and Assurance (AA) Syllabus

For ACCA Audit and Assurance (AA), you are required to understand the audit procedures and accounting rules for inventory and non-current assets. The following syllabus areas are directly relevant to this topic:

- The auditor’s objectives and responsibilities regarding inventory counts, attendance, and cut-off testing.
- Audit evidence requirements and substantive procedures over inventory and non-current assets.
- Audit risks and control procedures for inventory, including deficiencies and recommendations.
- The principles of inventory valuation under IAS 2: cost determination, net realisable value, and cut-off.
- Reporting implications if sufficient appropriate evidence over inventory or non-current assets is not obtained.

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. Why must auditors attend inventory counts, and what are they required to do while in attendance?
2. According to IAS 2, how should finished goods inventory be valued on the statement of financial position?
3. A client holds inventory at a third-party warehouse. What procedures should the auditor perform to obtain sufficient appropriate evidence over existence and valuation?
4. State two risks of material misstatement that may arise in relation to inventory at the year end and recommend one audit response for each.

## Introduction

Inventory is frequently material to the financial statements. Auditors are required by ISA 501 to obtain sufficient and appropriate evidence regarding the existence and condition of inventory. As inventory is typically counted at the period end, auditors need to attend the count, observe control procedures, perform test counts, and evaluate cut-off. Additionally, IAS 2 requires inventory be valued at the lower of cost and net realisable value (NRV), with strict rules on components of cost and proper write-down for obsolete or slow-moving items.

> **Key Term: Inventory count**
> The process through which the quantity and condition of physical inventory held by an entity at a specific point in time is established.

### Inventory count procedures and auditor attendance

Auditors must assess whether management’s inventory count procedures are adequate to ensure completeness and existence. Attendance enables the auditor to observe the effectiveness of controls, identify potential errors or fraud, and perform test counts to verify the client’s records.

### Inventory cut-off and completeness

Cut-off refers to recording transactions in the correct reporting period. Mistakes can result in material overstatements or understatements of both inventory and cost of sales. Auditors must verify goods in transit, goods received, and dispatched near the period end are correctly included or excluded.

> **Key Term: Cut-off**
> The process of ensuring transactions are recorded in the correct accounting period, especially around the period end, to prevent misstatement of closing inventory and related accounts.

### Inventory valuation under IAS 2

Inventory should be measured at the lower of cost and net realisable value. The cost includes all direct purchase costs, direct production costs, and appropriate production overheads, while NRV is the estimated selling price less costs to complete and sell. Items that are obsolete, slow-moving, or damaged must be written down.

> **Key Term: Lower of cost and NRV**
> The required basis under IAS 2 for carrying inventory: the lower amount between actual cost of acquisition/production and the net amount the item can be sold for after selling costs.

### Components of cost under IAS 2

Cost of inventory includes purchase price, import duties, transport and handling, direct labour, direct expenses, subcontracted work, and production overheads allocated based on normal activity. Abnormal waste, storage costs, indirect administration, and selling costs are excluded.

### Valuation challenges and audit responses

Audit risk increases when clients use standard costing, have a mix of old and new inventory, or experience frequent price changes. Auditors must challenge management’s calculations, test for accuracy, and ensure any necessary write-downs are made.

### Inventory held by third parties and rights

When inventory is stored externally, auditors must seek direct confirmation from the third party and, if material, arrange to visit the site. In all cases, rights and obligations must be confirmed.

> **Key Term: Rights and obligations**
> The assertion that assets and liabilities included in the financial statements belong to the entity.

### Non-current assets: Existence, valuation, and audit evidence

Non-current assets must actually exist, be fully recorded, valued accurately, and be owned by the entity. Standard audit procedures include physical inspection, vouching additions, reviewing disposals, recalculating depreciation, and confirming title deeds or registration documents.

> **Key Term: Depreciation**
> The systematic allocation of the cost of a tangible non-current asset over its estimated useful life, reflecting the pattern in which the asset’s economic benefits are consumed.
> **Key Term: Impairment**
> A reduction in the recoverable value of an asset below its carrying amount, requiring a write-down in accordance with accounting standards.

### Worked Example 1.1

**Scenario:** You attend ABC Ltd’s year-end inventory count at the main warehouse. A delivery of goods arrives during the count and is registered in the system. The goods were dispatched by the supplier two days ago and physically received today.

**Question:** Should these goods be included in year-end inventory? What audit procedure should you perform?

> **Answer:**
> Inclusion depends on who has rights to the inventory at year end (as per supplier terms). If risks and rewards passed to ABC Ltd before year-end, they should be included. Review delivery notes and purchase orders to determine correct cut-off and observe how the client records them.

### Worked Example 1.2

**Scenario:** DEF Co manufactures custom furniture. At year end, 25% of inventory is stored at a logistics company. The client provides only a written note stating "all goods intact."

**Question:** Is this sufficient evidence? What further steps should you take?

> **Answer:**
> A client note is not sufficient. Obtain direct written confirmation from the third party specifying quantities and condition. If material, consider attending a third-party count or reviewing third-party controls.
>
> **Revision Tip:**
> Practise writing clear, action-based audit procedures for inventory and asset balances. Focus on the assertion tested, action taken, and required evidence.
>
> **Exam Warning:**
> It's a common mistake to think that simply attending the count, or relying on client-prepared lists, is sufficient. You must actively observe, question, and test cut-off and condition. Always corroborate the client’s records with independent or third-party documentation where possible.

### Inventory audit risks and deficiencies

Audit risk is especially high for inventory due to susceptibility to fraud, error, obsolescence, and significant estimation. Common deficiencies include lack of supervision during counts, incomplete documentation, failure to perform reconciliations, weak controls when goods move between locations, and omission of obsolete or damaged stock.

Auditors should identify and report control deficiencies, recommend periodic independent counts, clear documentation procedures, and regular review of differences between physical and recorded inventory.

### Attendance at inventory counts

Prior to the count, obtain and review the client’s inventory instructions, clarify the count process, identify the locations and times, and assess the need for expert assistance (e.g., valuing precious metals, wines, or art).

On the day:

- Observe procedures for preventing movement during count.
- Ensure teams performing the count include independent staff.
- Check all areas are covered; sections should be marked after counting.
- Test count by selecting from inventory sheets to physical (completeness) and from warehouse to sheets (existence).
- Identify and record damaged or obsolete items.
- Review how inventory held on behalf of others is separated and labeled.

After the count, compare count sheets with final inventory listings. Investigate and resolve any discrepancies.

### Inventory cut-off and analytical procedures

To test cut-off, examine goods received notes (GRNs) and goods dispatched notes (GDNs) immediately before and after the year end. Trace selected items to ensure recording in the correct period.

Analytical procedures can help identify slow-moving, obsolete, or overvalued stock. Calculate inventory holding period and compare to prior periods, investigate large variances, and perform reasonableness checks for valuation.

### Valuation procedures—lower of cost and NRV

Obtain inventory listing and select samples. For each:

![Inventory valuation under IAS 2 using lower of cost and net realisable value, including cost components, exclusions, NRV calculation, and carrying amount.](https://static.pastpaperhero.com/images/acca-aa-inventory-and-non-current-assets-inventory-counts-and-valuation-ias-2_00.png)

_IAS 2 measurement compares inventory cost with net realisable value after permitted cost attribution, excluded expenditures, and completion and selling costs._

- Agree cost to supplier invoice, job cost records, or standard cost breakdown, checking for recent review/update if standard costing is used.
- For NRV, compare with recent sales prices, less costs to complete and sell. For unsold or slow-moving items, examine post-year-end sales or management's disposal plans.
- For obsolete or damaged items, inspect physical condition or obtain expert valuation as required.

### Work-in-progress and manufacturing inventory

For work in progress (WIP), review client calculations for stage of completion, costs incurred, and allocation of overheads. Agree the percentage of completion with production records and compare cost plus estimated completion costs to expected selling price for NRV.

### Audit procedures for non-current assets

- Physically inspect a sample of assets recorded in the fixed asset register.
- Verify additions to invoices and authorisations.
- Review disposals for supporting documentation and correct accounting for any gain or loss.
- Recalculate depreciation in accordance with the entity’s policy and useful life evaluations.
- Where impairment indicators exist, obtain and review management calculations, external valuation reports, or other objective evidence.

### Common reporting implications

If the auditor cannot obtain sufficient appropriate evidence over inventory counts, valuation, or existence (for example, if inventory was not counted at the end of the year and no alternative procedures are possible), this constitutes a limitation of scope and may require a modified opinion in the auditor’s report.

## Summary

Inventory and non-current assets require specific auditor attention due to their significance and risk of error. Attending inventory counts, verifying cut-off, and performing thorough valuation procedures per IAS 2 are essential. For non-current assets, existence, rights, depreciation, and impairment tests must be applied. Always document findings and deficiencies, recommend improvements, and communicate reporting implications if evidence is insufficient.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Reasons for inventory count attendance, key audit procedures, and observation during counts.
- Audit tests for cut-off, completeness, and valuation of inventory.
- Rules under IAS 2 for inventory valuation: cost components and net realisable value.
- Testing procedures for inventory held by third parties and confirmation of rights.
- Audit procedures for non-current assets: existence, rights, additions, disposals, depreciation, and impairment.
- Common inventory deficiencies and appropriate control recommendations.
- Reporting consequences where sufficient appropriate evidence is not available.

## Key Terms and Concepts

- Inventory count
- Cut-off
- Lower of cost and NRV
- Rights and obligations
- Depreciation
- Impairment


Inventory and non-current assets - Inventory counts and valuation (IAS 2)