finance
Effective inventory management is crucial for ensuring the accuracy of financial statements in both manufacturing and trading companies. The provisions outlined in AS 2 and IND AS 2 highlight the importance of inventory accounting, while auditing inventory, as instructed by SA 501, demands meticulous consideration.
Inventory represents goods produced or purchased that remain unsold and is classified as a current asset on the balance sheet. Inventory accounting aligns with the guidelines established by AS 2 and IND AS 2. When it comes to auditing, inventory assessments conform to SA 501, which emphasizes the necessity of audit evidence and specific considerations for selected items.
Managing inventory for trading entities is relatively straightforward, primarily because there are no complex valuation or classification issues to navigate. Purchased goods are recorded as inventory and recognized as revenue upon sale. The valuation method typically involves only the purchase price and any incidental expenses.
Physical Count: Confirm whether management conducts periodic physical counts of inventory, appropriate for the entity's size and operations. Auditors may participate in these counts if feasible.
Valuation Workings: Examine valuation reports outlining costs and net realizable value (NRV). Cost verification can be completed through sampling of purchase invoices, while NRV can be assessed through subsequent sales data.
Physical Verification: Conduct an additional physical verification of inventory as of the audit date for assurance.
Inventory management in manufacturing entities is more complex due to its categorization into:
The valuation of stores and spares is straightforward, as it encompasses the purchase cost and related incidental costs. This same methodology is applicable to raw materials, allowing for similar audit procedures as those used for trading entities.
Valuating WIP is intricate and must account for:
Direct overheads should be recorded in accordance with AS 2 or IND AS 2 guidelines. It is important to note that AS 2 and IND AS 2 do not apply to certain inventories, including work in progress linked to construction contracts, financial instruments, and biological assets related to agriculture.
Auditors must ensure that WIP valuations accurately reflect all incurred costs up to the current date. Obtaining a cost auditor's report to certify the valuation can be especially beneficial. This documentation is vital, as the assessing officer under Income Tax laws may request inventory valuation reports.
Additionally, auditors should:
SA 501 mandates auditors to attend at least one physical count per year when inventory is material, unless impracticable, and permits alternative procedures if the count does not occur at year-end.
The valuation of finished goods is determined by the lower of cost or NRV. The same valuation principles applicable to raw materials also apply here, ensuring that recorded quantities match the actual physical inventory on hand.
Auditing inventory may seem straightforward initially, yet it can complicate in larger, process-oriented entities. Industries with diverse production processes, such as plywood manufacturing or casting, present unique challenges. A deep understanding of AS 2, IND AS 2, and SA 501 is vital for auditors managing the complexities associated with inventory audits across various business environments.