Internal and Forensic Audit · Internal Audit of Specific Functions

Internal Audit of Inventory and Stores

Updated 11 October 2026 · Fact-checked

Internal audit of inventory and stores is a review of how an entity orders, receives, stores, issues, counts and values its stock. You assess controls, test records against physical stock, check valuation at the lower of cost and net realisable value, and report on obsolete or slow-moving items with recommendations.

Understand Internal Audit of Inventory and Stores

Inventory is often the largest current asset of a manufacturing or trading entity. It is also easy to misstate, steal or let decay. That is why internal audit gives it close attention.

The audit follows the stock cycle: purchase requisition, receipt and inspection, storage, issue to production or sale, return, and disposal. At each stage you ask three things. Is the movement authorised? Is it recorded fully and on time? Is the physical stock safe?

Stores controls are the first line of defence. They include segregation of duties between storekeeper, purchase staff and accounts staff. They also include a goods received note for every receipt, issue only against a signed requisition, restricted access, and regular reconciliation of bin cards with the stock ledger.

Physical verification proves that the books match reality. It may be a full count at year end or perpetual (cycle) counting through the year. You check that count instructions exist, counters are independent of storekeepers, tags are controlled, cut-off is fixed, and differences are investigated and approved before adjustment.

Valuation follows Ind AS 2 or AS 2 as applicable to the entity: inventory is measured at the lower of cost and net realisable value. Cost uses a consistent method such as FIFO or weighted average. Obsolete and slow-moving stock needs ageing analysis, a clear provision policy, and management approval for write-down or disposal.

Key rules to remember

Inventory measurement rule: Carrying value = Lower of (Cost, Net Realisable Value); Applied item by item or to groups of similar items, as the accounting standard permits.
Net realisable value: NRV = Estimated selling price − Estimated cost of completion − Estimated cost to make the sale; For raw materials held for use, replacement cost may be the best evidence of NRV where the finished goods will sell above cost.
Inventory turnover: Inventory turnover = Cost of goods sold ÷ Average inventory; A falling ratio can signal slow-moving or obsolete stock.
Days inventory held: Days inventory = 365 ÷ Inventory turnover; Compare with past periods and industry norms.
Stock reconciliation: Closing stock = Opening stock + Receipts − Issues; Use it to reconcile bin card, stores ledger and physical count.
Book-to-physical difference: Difference = Physical quantity − Book quantity; Value it at cost. Investigate before any adjustment is approved.

How to solve Internal Audit of Inventory and Stores questions

Use this order for any case question on inventory or stores. It keeps your answer in the expected form: provision, analysis of facts, conclusion.

1Identify the entity type and the stock cycle stage the facts point to: purchase, receipt, storage, issue, count, valuation or disposal.
2List the control objectives at that stage: authorisation, completeness, accuracy, existence, safeguarding and valuation.
3Pick out each weakness in the facts and name the risk it creates, such as theft, misstatement, overstocking or unrecorded receipts.
4State the audit procedure: inspect documents, observe the count, recompute, trace and vouch, confirm third-party stock, review ageing.
5Apply the valuation rule where figures are given: compare cost with NRV item by item and compute any write-down.
6Conclude with a clear finding, its impact in rupees if possible, and a practical recommendation.
7Add a follow-up point: who acts, by when, and how internal audit will verify closure.

Quickest way: Cycle-Risk-Test-Recommend

When to use it: Use it when time is short and the question asks you to list weaknesses, audit steps or recommendations for a stores or stock scenario.

Write the cycle stage in one line.
List each fact as a weakness with its risk in a short bullet.
Give one test for each weakness.
If numbers are given, compute NRV comparison or book-versus-physical difference first.
Close with two or three recommendations and a follow-up line.

Common mistakes in Internal Audit of Inventory and Stores

Valuing inventory at cost without checking net realisable value
Students focus on the costing method and forget the lower-of rule.
Fix: Always compare cost with NRV for each item and write down only the shortfall on items where NRV is lower.
Adjusting book stock to physical stock straight away
It seems the quickest way to clear a difference.
Fix: Investigate the cause first, check cut-off and unrecorded movements, and adjust only after approval by an authorised person.
Suggesting that the internal auditor takes the physical count
Students confuse observing the count with doing it.
Fix: Management staff count and internal audit observes, test-counts and checks the count procedures. Auditors must stay independent.
Ignoring cut-off at the count date
Students think only of what is on the shelves.
Fix: Note the last goods received and issued numbers at count time and trace them to the records of the correct period.
Treating all slow-moving stock as obsolete
Both terms sound alike.
Fix: Slow-moving stock still has expected use. Obsolete stock has little or no use or sale. Use ageing and usage data, then judge the provision for each.
Giving generic recommendations like strengthen controls
Students rush to the conclusion.
Fix: Tie each recommendation to a specific finding, such as independent gate check of goods received against the purchase order.

Worked examples

Example 1

Sharma Components Ltd has three items in closing stock. Item A: cost ₹2,40,000, estimated selling price ₹2,80,000, selling costs ₹15,000. Item B: cost ₹3,10,000, estimated selling price ₹3,00,000, selling costs ₹20,000. Item C: cost ₹1,50,000, estimated selling price ₹1,45,000, selling costs ₹5,000. The internal auditor must test valuation item by item. What value should be carried, and what write-down is needed?

Show the solution

Item A: NRV = 2,80,000 − 15,000 = ₹2,65,000. Cost is ₹2,40,000, which is lower. Carry at ₹2,40,000.
Item B: NRV = 3,00,000 − 20,000 = ₹2,80,000. Cost is ₹3,10,000, so NRV is lower. Carry at ₹2,80,000. Write-down = ₹30,000.
Item C: NRV = 1,45,000 − 5,000 = ₹1,40,000. Cost is ₹1,50,000, so NRV is lower. Carry at ₹1,40,000. Write-down = ₹10,000.
Total carrying value = 2,40,000 + 2,80,000 + 1,40,000 = ₹6,60,000.
Total cost = 2,40,000 + 3,10,000 + 1,50,000 = ₹7,00,000. Total write-down = 7,00,000 − 6,60,000 = ₹40,000.

Answer: Carry inventory at ₹6,60,000. A write-down of ₹40,000 is needed (₹30,000 on Item B and ₹10,000 on Item C). Item A is not written up above cost.

Example 2

During a stores audit at Kaveri Foods Pvt Ltd, you find that the storekeeper also posts the stock ledger, issues are made on verbal requests, and no physical count has been done for 18 months. Identify the weaknesses and state your audit procedures and recommendations.

Show the solution

Weakness 1: the storekeeper both holds stock and posts the ledger. Risk: theft can be hidden by changing records. This is a failure of segregation of duties.
Weakness 2: issues on verbal requests. Risk: unauthorised issues and wrong cost charged to production or departments.
Weakness 3: no count for 18 months. Risk: book stock may not exist, and shortages, damage or obsolete items go unnoticed.
Procedures: compare a sample of issues with signed requisitions, test-count selected items against bin cards and ledger, trace differences, review ageing of items with no movement, and check who has system or ledger access.
Recommendations: separate custody from recordkeeping, allow issues only on numbered, authorised requisitions, start a perpetual count programme with a full count at year end, and have differences investigated and approved before adjustment.
Follow-up: report to management and the audit committee with a timeline, then re-test samples after implementation.

Answer: The main weaknesses are no segregation of duties, unauthorised issues and no periodic verification. Test counts, requisition checks and ageing review give the evidence. Recommend separation of duties, written authorised issues and regular counts, with follow-up testing.

Exam tips

Write answers in the order of weakness, risk, procedure and recommendation. Examiners reward this structure in case questions.
If figures are given, compute NRV or the stock difference first and show each line. Marks are given for method.
Always name the standard rule for valuation (lower of cost and NRV) and say that the method must be applied consistently.
Keep observing the count and conducting the count separate in your answer. Independence is a frequent point.
End with a practical recommendation and a follow-up step. Do not stop at listing faults.

Practice questions from Internal Audit of Specific Functions

Internal Audit of Inventory and Stores in other exams

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

Internal Audit of Inventory and Stores: frequently asked questions

What is the main objective of internal audit of inventory?

It is to give assurance that stock exists, is safeguarded, is completely and accurately recorded, and is valued properly. It also checks that stores processes are efficient and authorised.

Does the internal auditor count the stock?

No. Management staff conduct the count. The internal auditor observes it, performs test counts, and reviews instructions and reconciliations. This keeps the auditor independent.

How do you audit obsolete and slow-moving stock?

Obtain an ageing report and usage data, inspect items physically, and discuss with stores and production. Then check that the provision policy is applied and approved, and that NRV is compared with cost.

What is the difference between perpetual and periodic inventory counting?

Periodic counting is a full count at one date, usually year end. Perpetual counting checks different items on a rolling basis through the year. The auditor tests whether differences are investigated and corrected in either case.