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CA Intermediate · Auditing and Ethics · Audit of Items of Financial Statements

While auditing Kaveri Textiles Ltd, the auditor observes that the company's year-end inventory of yarn is stored in a public warehouse operated by an independent third party and forms a material part of total inventory. The auditor could not attend the physical count at that location. Which is the most appropriate audit response to obtain sufficient appropriate evidence about existence of this inventory?

The auditor should obtain direct confirmation from the third-party warehouse or attend or arrange observation of the count there. Under SA 501, material inventory held by others needs sufficient appropriate evidence of existence, and management representations or internally held receipts alone do not provide that.

  1. ARely only on the management representation letter confirming the quantity held
  2. BObtain direct confirmation from the warehouse keeper about quantities held, or arrange to attend or observe the count at the warehouseCorrect
  3. CAccept the warehouse receipts held by the company as conclusive evidence of existence
  4. DSkip testing existence since the stock is not in the company's own premises

Explanation

When material inventory is held by a third party, SA 501 requires the auditor to obtain sufficient appropriate evidence of its existence, by direct confirmation from the third party or by attending or arranging for attendance at the count. A management representation alone is not sufficient evidence. Documents held by the company are internal and weaker than external confirmation, so they cannot be treated as conclusive.

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