Physical verification of inventory is the responsibility of management of the entity. Management is required to establish procedures under which inventory is physically counted at least once a year to ensure existence, condition and support valuation of inventory.
The Companies (Auditor’s Report) Order, 2016 (CARO 2016) also requires auditors to comment on “Whether physical verification of inventory has been conducted at reasonable intervals by the management and whether any material discrepancies were noticed and if so, whether they have been properly dealt with in the books of account”. SA 500, “Audit Evidence” prescribes that the objective of the auditor is to design and perform audit
procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion. When inventory is material to the financial statements, SA 501, “Audit Evidence – Specific Considerations for Selected Items” requires
that the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by:
(a) Attendance at physical inventory counting, unless impracticable to:
i. Evaluate management’s instructions and procedures for recording and controlling the results
of the entity’s physical inventory counting;
ii. Observe the performance of management’s count procedures;
iii. Inspect the inventory; and
iv. Perform test counts; and
(b) Performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.
The term “impracticable” has been explained in paragraph A12 of SA 501 as below:
“A12 In some cases, attendance at physical inventory counting may be impracticable. This may be due to factors such as the nature and location of the inventory, for example, where inventory is held in a location that may pose threats to the safety of the auditor. The matter of general inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that attendance is impracticable. Further, as explained in SA 200, the matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive.”
AUDITOR’S CONSIDERATIONS IN VARIOUS SCENARIOS
The COVID-19 outbreak could create several potential challenges for management of an entity to conduct physical inventory counting and for the auditors to attend these counts. With scenarios like lockdown, travel restrictions etc. as imposed by Government of India, physical inventory counting
would be challenging and in some cases it would be impracticable. Possible challenges in this regard are discussed below.
B.1 Management unable to conduct physical inventory counting as on the date of financial statements Due to Government imposed restrictions, there could be situations where management is unable to conduct physical inventory counting as on the date of financial statements for example, inventory is held in locations which are closed due to Government imposed lockdown. In such a scenario, management should inform the auditors and those charged with governance the reasons of not conducting the inventory counting.
B.2 Physical inventory counting conducted by management at a date other than the date of financial statements
• Where an auditor decides to observe the physical inventory counting at a date other than the date of the financial statements, the auditor would need to comply with the procedures given in paragraphs 5 and 6 of SA 501 read with paragraphs A9 to A11 of SA 501.
• Attending inventory counting at an alternative date may involve attending inventory counting at a later date from the date of the financial statements with performing roll-back procedures to the balance sheet date, or, if an inventory counting was conducted by the entity and attended by the auditor at an interim date before the date of the financial statements, it may be possible
to use those findings and perform roll-forward procedures to the balance sheet date.
• Roll-forward or roll-back procedures may also be a viable option where the entity has a continuous inventory counting system. Auditors should also consider whether the time
between the balance sheet date and the date of the inventory counting being performed reflects the appropriate assessment of the physical condition of inventory.
• It should be noted that auditors should not take a blanket approach to all their audit clients as there may be some industries in which business has not been adversely affected, and thus
above mentioned approach may not be appropriate in such circumstances.
• Any approach to the audit of inventory involves the consideration of the quality of the entity’s inventory records and internal controls over inventory movements and records. Auditors
should exercise professional skepticism and consider whether inventory records and internal controls have deteriorated as a result of current events, including assessing any additional
actions taken by the entity regarding its security. Accordingly, auditors should appropriately consider the impact of the aforesaid on their opinion on internal financial controls under section 143(3)(i) of the Companies Act, 2013.
• Reference may also be made to paragraphs 2.47 to 2.62 of the “Implementation Guide to SA 501” issued by the Auditing and Assurance Standards Board of ICAI.