Inventory verification is one of the most important and difficult verification problems with which the auditor is faced. It is commonly the single greatest current asset and is often the largest asset in the entire Balance Sheet.
An error in inventory affects the net income directly. This makes inventory verification a crucial exercise for both the company and the auditor.
Inventory verification process
Cutoff analysis: The auditors will examine your procedures for halting any further receiving into the warehouse or shipments from it at the time of the physical inventory count, so that extraneous inventory items are excluded.
Observe the physical inventory count: The auditors want to be comfortable with the procedures you use to count the inventory. This means that they will discuss the counting procedure with you, observe counts as they are being done, test count some of the inventory themselves and trace their counts to the amounts recorded by the company's counters, and verify that all inventory count tags were accounted for.
Reconcile the inventory count to the general ledger. They will trace the valuation compiled from the physical inventory count to the company's general ledger.
Test error-prone items. If the auditors have noticed an error trend in prior years for specific inventory items, they will be more likely to test these items again.
Finished goods cost analysis. If a significant proportion of the inventory valuation is comprised of finished goods, then the auditors will want to review the bill of materials for a selection of finished goods items, and test them to see if they show an accurate compilation of the components in the finished goods items, as well as correct costs.
Work-in-process testing. If you have a significant amount of work-in-process (WIP) inventory, the auditors will test how you determine a percentage of completion for WIP items.
Inventory ownership. The auditors will review purchase records to ensure that the inventory in your warehouse is actually owned by the company (as opposed to customer-owned inventory or inventory on consignment from suppliers).
How to conduct inventory verification?
It will be very difficult for a company to manage and control the inventory verification process unless the company has the proper system in place for managing it. So a company can better manage it inventory and meet the compliance by adopting a well management system in their organisation. So it recommended adopting the practise of tagging the inventory with appropriate systems.