Auditors attendance at stock take in the UK & Ireland

The ‘clarified’ (UK and Ireland) International Standards on Auditing have now been with us for a while and since then the Auditing Practices Board (APB) started to issue revised Practice Notes.  On 22 February 2011, the APB issued Practice Note 25 (revised) which covers the area relating to the auditor’s attendance at stocktake.

It is easy to forget the primary objective of why the auditor attends a stocktake and auditors may not note any fundamental changes.  This article will take a brief look at the revised PN 25 and offer a brief ‘refresher’ as to the reasons why the audit firm attends the client’s stocktake, what to do before attendance and which types of procedure will gather evidence that will be both sufficient and appropriate.

Practice Note 25  (Revised) ‘Attendance at Stocktaking’

Auditors may not notice many differences to this practice note.  However, what is often confusing (particularly to more junior audit staff) is the reason why auditors are required to attend stocktakes.  The practice note confirms the assertions relating to stock which are:

• Existence;
• Rights and obligations (i.e. ownership);
• Completeness; and
• Valuation.

Before the stocktake, PN 25 requires the auditor to undertake an element of planning, including:

• Performing analytical procedures and discussing any significant variances with management.
• Discuss stocktaking arrangements and procedures with management.
• Familiarisation of the nature of stocks, volume, identification of high value items and the accounting method of stock valuation.
• Consideration of the location of stocks.
• Consideration of the quantity and nature of work in progress, quantity of stocks held by third parties and whether auditor’s experts may be required.
• Considering the internal controls relating to stocks to identify problem areas (e.g. problems relating to ‘cut offs’).
• Whether any internal audit function exists and deciphering the extent to which reliance can be placed on internal audit.
• Considering the results of previous stocktakes.
• Reviewing the audit working papers for the previous year.

Paragraph 4 of ISA (UK and Ireland) 501 Audit Evidence – Specific Considerations for Selected Items requires the auditor to attend the stocktake if the value of stock at the reporting date is (likely to be) material to the financial statements.  Primarily the attendance at stocktake is that of an ‘observance’ test i.e. to observe whether the procedures adopted by management would reduce the risk of material misstatement in the final stock valuation.

The revised practice note acknowledges that the ISA (UK & Ireland) 501 specifically requires the auditor to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory, in addition to other procedures, provided physical attendance at stocktake is impracticable.  It is worth reminding auditors that auditors ‘shall’ perform audit procedures where ISA (UK and Ireland) 501 is applicable to them (remember, ‘should’ was changed to ‘shall’ in the clarity ISAs) to be more specific.

In addition to the usual test counts and observance of the stocktake being carried out, as well as evaluating the procedures management have adopted, auditors should also:

• Observe the production process in relation to the completeness and valuation of stocks.
• Perform ‘cut-off’ testing to ensure the client’s cut-offs are correct.
• Obtain evidence relating to the design and operation of the client’s controls in relation to stock.

PN 25 (revised) contains various factors relating to the risk of material misstatement where stock is concerned which auditors need to be aware of, including the:

• reliability of accounting and recording systems and related controls, particularly where estimates are used (such as work in progress);
• the timing of the stocktake in relation to the year-end to determine whether additional procedures may be required (such as ‘roll-back’ procedures);
• location of stocks, stock held by third parties, consignment stock and stock ‘in transit’;
• objectivity and experience of the stock counters;
• physical controls over the stock and the susceptibility of stock to theft or deterioration;
• degree of fluctuation in stock levels;
• nature of stocks, particularly where the use of auditor’s experts may be required or where degrees of estimation are used, such as in construction contracts; and
• any difficulties which may be inherent where estimates are concerned.

Sources of evidence relating to the existence of stocks are:

• evidence from audit procedures relating to the reliability of accounting records upon which the stock value in the financial statements are based;
• evidence from tests of controls over stocks, including the counting procedures; and
• substantive evidence from physical inspections at stocktake.

If management retain detailed stock records and check these by way of regular stock counts, the auditor can perform audit procedures to determine whether management:

• maintains adequate records of stocks which are kept up-to-date;
• has satisfactory procedures for stocktaking and test-counting; and
• investigates and corrects all material differences between the book records of stocks and physical stocks.

Where clients do not maintain detailed stock records, the quantification of stocks is likely to be based on a full, physical stocktake at the balance sheet date, or very close to the balance sheet date.  Evidence to satisfy the ‘existence’ assertion is therefore greater when the stocktake is carried out at the year-end (or a date very close to the year-end).  This could well provide sufficient and appropriate audit evidence, however the auditor must also be satisfied that the records of stock movement are also reliable in the intervening periods.

ISA (UK and Ireland) 501 at paragraph 4 outlines specific procedures when the auditor attends a stocktake.  The auditor is required to:

(a)          Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting.

(b)          Observe the performance of management’s count procedures.

(c)           Inspect the inventory.

(d)          Perform test counts.

(e)          Perform audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory results.

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