Corporate Accounting and Auditing · Audit of Various Items of Financial Statements

Audit of Inventories: Stock Verification and Valuation

Updated 10 October 2026 · Fact-checked

Audit of inventories means obtaining sufficient appropriate evidence that closing stock exists, is owned by the company, is complete and is valued correctly. Under SA 501 you attend the physical count where inventory is material, test the count, check cost and net realisable value, and then reconcile the count to the books.

Understand Audit of Inventories

Inventory is often the largest and riskiest current asset. It is held at many places, it moves daily, it can be damaged or obsolete, and its valuation needs judgement. An error in closing stock flows straight into profit. That is why auditors treat it as a high-risk area.

The auditor has two main questions. First, existence and completeness: is the stock really there, and is all of it recorded? Second, valuation: is it carried at the lower of cost and net realisable value (NRV), as Ind AS 2 / AS 2 requires? Rights and obligations also matter. Goods held for others must be excluded, and goods owned but lying elsewhere must be included.

Management is responsible for counting stock and for the records. The auditor does not take the count. The auditor observes it. Under SA 501, if inventory is material, you must attend the physical count unless it is impracticable. You observe management's instructions being followed, inspect the stock, and perform test counts. You test from the list to the floor (checks existence) and from the floor to the list (checks completeness).

If the count happens on a date other than the balance sheet date, SA 501 requires you to perform procedures to obtain evidence that changes in inventory between the count date and the final inventory records are properly recorded. In common audit practice, you do this by testing the movements between the two dates. When the count is before year end, you test the receipts and issues after the count date up to the balance sheet date. When the count is after year end, you test the receipts and issues between the balance sheet date and the count date. If you cannot attend, you perform alternative procedures. If these do not give enough evidence, the matter leads to a modified opinion (SA 705).

For valuation you check cost build-up, the cost formula used (FIFO or weighted average), consistency, slow-moving and obsolete items, and NRV against post-year-end selling prices. Where stock is held by third parties, you ask for confirmation or attend their count. Where the work of a management's expert is used (for example a valuer of specialised stock), SA 500 applies. You assess the expert's competence, capability and objectivity. If you use an auditor's expert, SA 620 applies.

Key rules to remember

Valuation rule: Closing stock = Lower of (Cost, Net Realisable Value), item by item or group by group; Ind AS 2 / AS 2. NRV = Estimated selling price − Estimated cost of completion − Estimated selling costs.
SA 501 attendance rule: If inventory is material → attend physical count (unless impracticable) and do alternative procedures if you cannot; If sufficient appropriate evidence is still not obtained, modify the opinion.
Movement test when count is before year end (common practice): Stock at BS date = Stock at count date + Purchases (or receipts) after count − Sales (or issues) after count; This is an illustrative reconciliation used in audit practice, not an SA 501 formula. SA 501 only requires you to test that changes in inventory between the count date and the final inventory records are properly recorded. Test the movements between the count date and the balance sheet date.
Movement test when count is after year end (common practice): Stock at BS date = Stock at count date + Sales (or issues) between BS date and count date − Purchases (or receipts) between BS date and count date; This is an illustrative reconciliation used in audit practice, not an SA 501 formula. Test the movements between the balance sheet date and the count date against supporting documents. Then compare the stock you arrive at with the stock in the books at the balance sheet date, and with management's count records if management counted on that date, and investigate differences.
Two-way test count: List → Floor (existence) and Floor → List (completeness); State both directions in written answers.

How to solve Audit of Inventories questions

Use this order for any question on audit of inventories, whether it asks for procedures, a scenario or a reporting decision.

1Identify the assertion at risk: existence, completeness, rights and obligations, or valuation.
2Plan before the count: study the nature of stock, locations, past errors, management's count instructions and the control environment.
3At the count: observe instructions being followed, do test counts in both directions, note damaged or slow-moving items, and record cut-off details of last goods received and dispatched.
4Handle special cases: third-party stock (confirm or attend), count on another date (test the movements between the count date and the balance sheet date; in common audit practice this is called roll-forward if the count is before year end and roll-back if after, and these are practice terms, not SA 501 wording), or no attendance possible (alternative procedures).
5Check valuation: cost build-up, consistent formula, NRV against subsequent sales, and provision for obsolete stock. Evaluate any expert's work.
6Reconcile the count results to the stock records and to the general ledger, and examine differences.
7Conclude: sufficient appropriate evidence or not, and state the effect on the audit report (SA 705) if not.

Quickest way: Count, Cut-off, Cost, NRV

When to use it: Use for short-note or 'list the procedures' questions when time is limited.

Write four headings: Count, Cut-off, Cost, NRV.
Under Count, put attendance, instructions, two-way test counts and third-party stock.
Under Cut-off, put last receipt and dispatch documents and the test of count date movements (called roll-forward or roll-back in common audit practice, not SA 501 wording).
Under Cost, put cost formula, consistency, overheads and standard cost variances.
Under NRV, put post-year-end sales, obsolete items and expert use, then end with the SA 705 consequence.

Common mistakes in Audit of Inventories

Writing that the auditor takes the physical stock count.
The words 'physical verification' suggest the auditor does the counting.
Fix: State that management counts and the auditor observes and test-counts. Verification is management's responsibility.
Testing only from the stock list to the floor.
Students think checking listed items is enough.
Fix: Add floor to list to prove completeness. Mention both directions every time.
Valuing stock at cost only, or at selling price.
The lower of cost and NRV rule is forgotten under time pressure.
Fix: Always state the lower of cost and NRV and show NRV after completion and selling costs.
Ignoring the count date being different from the balance sheet date.
Problems mention the dates in passing.
Fix: Check the dates. If they differ, add the test of movements and cut-off. In common audit practice, this is called roll-forward for a count before year end and roll-back for a count after year end. SA 501 itself does not use these terms.
Relying fully on management's expert or on stock records without evaluation.
Students assume a certificate is final evidence.
Fix: Evaluate the expert's competence, capability and objectivity, and the appropriateness of the work. Rely on records only to the extent that controls are evaluated and found effective, or when substantive procedures give sufficient appropriate evidence.
Missing the reporting consequence when attendance was not possible.
Students stop at procedures.
Fix: End with the conclusion: if alternative procedures give no sufficient appropriate evidence, a qualified opinion or disclaimer follows as per SA 705, depending on pervasiveness.

Worked examples

Example 1

Mehta Textiles Ltd. has stock of ₹6,40,00,000 at three warehouses. The auditor was appointed after the year end. Management counted the stock on 31 March, the balance sheet date, and that count is already over, so the auditor cannot attend it. Management's records show a perpetual inventory system. What should the auditor do?

Show the solution

Stock is material, so SA 501 expects attendance at the count. Appointment of the auditor after the year end is a recognised situation where attendance at the count could not occur. The 31 March count is already over, so SA 501 requires the auditor to perform alternative procedures.
Review the count instructions and count records that management used, and check whether the count was properly documented.
Perform a test count at a later date. Then test the movements between 31 March and that count date by reconciling them to supporting documents. In common audit practice the rolled-back figure is: Expected stock at 31 March = Stock counted later + Issues/sales between 31 March and the count date − Receipts/purchases between 31 March and the count date.
Compare the rolled-back stock at 31 March with management's 31 March count records and with the perpetual records. Investigate any differences and decide whether the book figure can be accepted.
Check purchases and sales documents around the year end for cut-off.
Test perpetual records and controls, and confirm any stock held with third parties.
Check valuation: cost records and NRV against later selling prices.
Judge whether the evidence is sufficient and appropriate. If it is not, consider the effect on the opinion under SA 705.

Answer: The auditor was appointed after the year end and cannot attend the 31 March count, so SA 501 requires alternative procedures: review of management's count records, a test count at a later date with the movements since 31 March tested by reconciliation, comparison of the rolled-back 31 March stock with management's count records and the perpetual records (investigating differences), cut-off tests, tests of perpetual records and third-party stock, and valuation checks. If the evidence is still not sufficient and appropriate, the opinion is modified under SA 705.

Example 2

At the year end, Sharma Chemicals Ltd. holds an item costing ₹180 per unit for 5,000 units. Estimated selling price is ₹210 per unit, with ₹15 per unit selling costs and ₹20 per unit to complete it. What value should the auditor accept for this item?

Show the solution

Cost = ₹180 per unit.
NRV = 210 − 20 − 15 = ₹175 per unit.
Lower of cost and NRV = ₹175 per unit.
Value = 5,000 × 175 = ₹8,75,000.
Cost value would have been 5,000 × 180 = ₹9,00,000, so a write-down of ₹25,000 is needed.

Answer: The item should be valued at ₹8,75,000. If the company shows ₹9,00,000, stock is overstated by ₹25,000 and the auditor should ask for the write-down.

Exam tips

Begin with the SA 501 attendance rule, then give procedures in the order: before, at and after the count.
In written answers, use headings such as Existence, Completeness and Valuation. They earn step marks.
For MCQs, remember that attendance is required when inventory is material, and that the auditor observes rather than counts.
In numerical problems, compute NRV first and then compare it with cost item by item.
Close scenario answers with the report impact under SA 705 when evidence is insufficient.

Practice questions from Audit of Various Items of Financial Statements

Audit of Inventories in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Audit of Inventories: frequently asked questions

Is attendance at physical inventory count compulsory for the auditor?

Where inventory is material, SA 501 requires you to attend the count unless it is impracticable. If you cannot attend, you perform alternative procedures to get sufficient appropriate evidence.

Who is responsible for stock verification, management or the auditor?

Management is responsible for counting stock and keeping proper records. The auditor observes the count, performs test counts and forms an opinion on the figures.

How does an auditor check the valuation of closing stock?

Check that stock is at the lower of cost and NRV. Test cost build-up, the consistency of the cost formula, post-year-end selling prices and provisions for slow-moving or obsolete items.

What if the auditor cannot get enough evidence on inventories?

Consider the effect under SA 705. A qualified opinion or a disclaimer follows, depending on how material and pervasive the possible misstatement is.