An inventory audit occurs when an auditor checks the existing processes a company uses to perform inventory counts and validates its system of record accurately reflects the inventory on hand. The most common type of inventory audit occurs in warehouses, distribution centers, and retail and grocery chains, but inventory audits are also performed in any business scenario where there is a physical inventory of products, such as IT inventory or sales inventory.
Traditional Inventory Auditing Process
For the traditional inventory audit, the levels involved are: store or floor inventory count, third party count, and internal audit’s validation of both processes.
The initial inventory is when a store or floor employee performs a physical count of inventory, the goods or items received into the location, and checks inventory daily for shrinkage, goods that have been damaged, lost or stolen.
Third Party Counts
Public companies will also hire a third party to perform complete inventory audits on a rotational basis for each location. Internal audit is responsible for providing assurance on both processes. This is typically achieved through inventory cycle counts and surprise audits.
Inventory Cycle Counts & Surprise Audits
Inventory cycle counts involve counting portions of the entire inventory in a location over a period of time. Internal audit will use the inventory system of record to generate a listing of the inventory on hand in a spreadsheet; this is the inventory count sheet that testers assigned to the audit will use to test the inventory. There are two types of tests that occur: sheet to floor and floor to sheet.
- Sheet to floor: the auditor will validate everything on the count sheet is on the floor. Used to find what is missing.
- Floor to sheet: the auditor counts everything on the floor and marks it off on the sheet. Used to find what is extra.
Surprise audits are when internal audit double checks the inventory count sheets of third party counters on days they perform audits.
Internal Audit Procedures for Inventory
Following the actual counts, internal audit will perform followup to determine why there were missing or extra products, and note any controls that are not operating effectively. Auditors will then assign remediation action plans and follow up with issue owners throughout the remediation process. The results of these audits are documented in an audit report document. In this way, internal audit helps the business uncover issues and fix them before external audit performs the year-end audit.
4 Ways to Optimize Internal Audit of Inventory Management Process
Inventory audits encompass high risk, high value areas that are important for organizations to have coverage over. Below are best practices you can leverage for your 2020 audit program to maximize the efficiency and effectiveness of your inventory audits.
- Understand where the value is in the warehouse. Prior to stepping into the warehouse, study its accounting. Spend time learning what the inventory is comprised of, what the outliers are, and identify where the value and risk is. Look at items that are different from the rest of the population. Reviewing reconciliations and roll-forwards for reconciling items can show what management is having difficulty with and indicate where you want to spend most of your time. This information can help you optimize your inventory audit to spend more time on high value items with the greatest risk to your financial statements.
- Take a Socratic approach. The most effective way to learn the inventory system is to ask as many questions as possible and not make any assumptions. Sit down with management and warehouse teams to learn how they receive inventory and process it in the system of record (SAP, Oracle, etc), as well as how they process and run reports. Be specific and ask if there are any issues they are experiencing in the system and steps that have been taken to address them. These conversations will better position you to spend your time where management is spending its time and experiencing issues, setting you up for a more effective audit.
- Look at the results of cycle counts. Variances in cycle counts provide insights into issues. These should not be used to identify root causes, but should be seen as symptoms to take into account with your other research, helping to paint the full picture of the inventory system.
- Build and improve on relationships. Understand the limited perception audit clients often have of auditors. Turn your audit clients into allies by explaining internal audit’s goal is to understand how they do their jobs in order to help make improvements that make their lives easier. Once audit clients understand internal audit’s goal is to help the company, rather than to find errors, they are more likely to be helpful collaborators.
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