What is the responsibility of the auditor during an inventory count?

Amendments: Amending releases and related SEC approval orders

.01 Observation of inventories is a generally accepted auditing procedure. The independent auditor who issues an opinion when he has not employed them must bear in mind that he has the burden of justifying the opinion expressed.

.02 The purpose of this section is to provide guidelines for the independent auditor in observing inventories. This section relates only to observation of inventories and does not deal with other important auditing procedures which generally are required for the independent auditor to satisfy himself as to these assets.

Receivables

[.03-.08] [Paragraphs deleted.]

Inventories

.09 When inventory quantities are determined solely by means of a physical count, and all counts are made as of the balance-sheet date or as of a single date within a reasonable time before or after the balance-sheet date, it is ordinarily necessary for the independent auditor to be present at the time of count and, by suitable observation, tests, and inquiries, satisfy himself respecting the effectiveness of the methods of inventory-taking and the measure of reliance which may be placed upon the client's representations about the quantities and physical condition of the inventories.

.10 When the well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts, the auditor's observation procedures usually can be performed either during or after the end of the period under audit.

.11 In recent years, some companies have developed inventory controls or methods of determining inventories, including statistical sampling, which are highly effective in determining inventory quantities and which are sufficiently reliable to make unnecessary an annual physical count of each item of inventory. In such circumstances, the independent auditor must satisfy himself that the client's procedures or methods are sufficiently reliable to produce results substantially the same as those which would be obtained by a count of all items each year. The auditor must be present to observe such counts as he deems necessary and must satisfy himself as to the effectiveness of the counting procedures used. If statistical sampling methods are used by the client in the taking of the physical inventory, the auditor must be satisfied that the sampling plan is reasonable and statistically valid, that it has been properly applied, and that the results are reasonable in the circumstances.

.12 When the independent auditor has not satisfied himself as to inventories in the possession of the client through the procedures described in paragraphs .09 through .11, tests of the accounting records alone will not be sufficient for him to become satisfied as to quantities; it will always be necessary for the auditor to make, or observe, some physical counts of the inventory and apply appropriate tests of intervening transactions. This should be coupled with inspection of the records of any client's counts and procedures relating to the physical inventory on which the balance-sheet inventory is based.

.13 The independent auditor may be asked to audit financial statements covering the current period and one or more periods for which he had not observed or made some physical counts of prior inventories. He may, nevertheless, be able to become satisfied as to such prior inventories through appropriate procedures, such as tests of prior transactions, reviews of the records of prior counts, and the application of gross profit tests, provided that he has been able to become satisfied as to the current inventory.

Inventories Held in Public Warehouses

.14 If inventories are in the hands of public warehouses or other outside custodians, the auditor ordinarily would obtain direct confirmation in writing from the custodian. If such inventories represent a significant proportion of current or total assets, to obtain reasonable assurance with respect to their existence, the auditor should apply one or more of the following procedures as he considers necessary in the circumstances.

Test the owner's procedures for investigating the warehouseman and evaluating the warehouseman's performance.
Obtain an independent accountant's report on the warehouseman's control procedures relevant to custody of goods and, if applicable, pledging of receipts, or apply alternative procedures at the warehouse to gain reasonable assurance that information received from the warehouseman is reliable.
Observe physical counts of the goods, if practicable and reasonable.
If warehouse receipts have been pledged as collateral, confirm with lenders pertinent details of the pledged receipts (on a test basis, if appropriate).

Effect on the Auditor's Report

.15 For a discussion of the circumstances relating to receivables and inventories affecting the independent auditor's report, see paragraphs .07 and .51 of AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances.

Audits of any kind are time-consuming and require manual work, but they provide an insightful deep dive into a business’s different accounts and/or financial situation.

When it comes to selling goods, ecommerce businesses may audit their inventory — whether it’s for tax purposes annually or to simply verify units on hand.

Inventory audits can be done in-house or by a third party and represent one point in time. Let’s dive into auditing one of your most valuable assets — your inventory!

What is an inventory audit?

An inventory audit is defined as the process of checking a company’s actual inventory levels against their financial records to ensure accurate inventory accounting. Inventory audits can be performed by the company or an outside auditor to identify any problems with the inventory storage and accounting methods a company is using.

They can be as simple as counting physical stock levels and cross checking against records, or as involved as hiring a third party auditor to assess all of your inventory procedures.

9 common inventory audit procedures

To audit your inventory, you’ll need to choose the method that makes the most sense for the purpose it serves and who is performing the audit. Here are a few of the most common inventory audit analyses and procedures used.

1. Cutoff analysis

This is when you pause operations such as receiving and shipping at the time of the physical count to ensure nothing is being handled and goes unaccounted for.

2. Physical inventory count

This is to make sure that the system’s numbers match up with your physical stock, counting each unit. The use of product barcodes and devices like inventory barcode scanners can help keep track electronically.

3. Analytical procedures

This involves comparing gross margins, inventory turnover ratio, and/or unit costs of inventory with previous years.

4. ABC analysis

This is when you group items of different value and volume together, such as high-value items ( or “A” products), mid-tier “B” products, and low-value “C” products. You may even choose to store these items accordingly this way (which can make it easier for an auditor who pays attention to mainly the high-value inventory items).

5. Freight cost analysis

This determines the costs of getting things from one place to another, such as freight shipping costs and tracking the time between the date of shipment and the date of receipt. This documentation accounts for any units that are in transit and also in case anything is lost or damaged in transit.

6. Finished goods cost analysis

This is ideal if you create your own products as it demonstrates when product is ready to be sold so an auditor can immediately value the inventory for the current accounting period. Auditors may test this inventory to ensure financial statements are accurate. Learn more about finished goods inventory here.

Knowing your indirect costs of doing business will help with budgeting. Outside of direct materials and labor, this looks at “hidden” expenses such as rent, utilities, and other costs of doing business — if you record overhead as part of your inventory costs.

8. Reconciling items

If there are discrepancies found in your inventory audit, you may wish to do a reconciling items investigation to determine the root cause. You’ll want to track if there are certain error-prone SKUs and keep an eye on them in the future.

9. Match invoices to shipping log

Verify that invoices match the amount of items and cost of inventory shipped from your ecommerce warehouse. This may be done at random by an auditor to verify that the right amount was charged to the right customer at the right time.

Why inventory auditing is important for ecommerce businesses

An efficient inventory management process can reduce the frequency, length, and complexity of audits. Ecommerce inventory is different from physical retail stores, as sales can take place anywhere across the globe and are thus more unpredictable.

In a digital world, your inventory audit methods must match. Using technology that keeps inventory counts synced in real-time rather than using something static like Excel helps with the following.

1. Calculate profit

Inventory audits can help you calculate accurate profits, as the accuracy of your inventory accounting informs your bottom line. Tracking and accounting for changes in the value of inventory over time as it relates to manufacturing and costs of goods sold can drastically impact your accounting records. Inventory audits can prevent inventory shrinkage (or when the actual inventory levels are less than accounting has them recorded as) and identify costly slow-moving products.

2. Budget with accuracy

If you don’t have an accurate method for keeping track of your inventory’s value, you can’t budget for the next batch of inventory you need to purchase. Inventory audits can help you budget better and more accurately when you know the exact inventory count you’re running through, and how much safety stock you should keep.

3. Find inefficiencies

Audits can help you find inefficiencies, including inventory that’s not selling quickly (or much at all), SKUs that are selling out quickly and causing frequent stockouts, inaccuracies with storage or inventory tracking techniques, and other operational errors.

You can use this information to improve the financial health of your business by discontinuing unsuccessful products, doubling down on what’s working, and optimizing other areas of your supply chain — from manufacturers to warehouse locations.

4. Optimize your inventory holding

Holding costs are the sum of all costs related to carrying inventory including warehousing, labor, insurance, and rent, combined with the value of damaged, expired, and out-of-date products. The longer you hold inventory and the more unusable inventory you have, the more money you pay. Inventory audits can help you limit these factors.

3 challenges of performing an inventory audit

Inventory audits can be an incredibly challenging task to perform. And the bigger the business, the more complex it becomes. Here’s what you may encounter.

1. It’s time-consuming

Auditing physical inventory is very tedious. Think about it: If you sell 500 SKUs and you check actual inventory levels against the amount of inventory you have listed on hand electronically or in an inventory sheet, that can take you days, if not weeks, to complete.

Even if you have one SKU and 3,000 units, you’re going to spend a while on a manual task. Going electronic with inventory reports is key to saving time, with access to the most up-to-date information across locations. 3PLs like ShipBob help with this.

“We have access to live inventory management, knowing exactly how many units we have in each location. It not only helps with our overall process in managing and making sure our inventory levels are balanced but also for tax purposes at the end of the year. ShipBob simplified the entire process for our accountants and us.”
Matt Dryfhout, Founder & CEO of BAKblade

2. It’s difficult to scale

The bigger you get, the more strategic you’ll need to be with inventory solutions. Spot checking can be a more manageable way to keep inventory audits under control in between full physical inventory audits. This means choosing a specific product, counting the number of units on hand, and comparing it to the number of units listed in the system.

“I felt like I couldn’t grow until I moved to ShipBob. Our old 3PL was slowing us down. Now I am encouraged to sell more with them. My CPA even said to me, ‘Thank God you switched to ShipBob. ShipBob provides me clarity and insight to help me make business decisions when I need it, along with responsive customer support.”
Courtney Lee, founder of Prymal

Inventory management technology can help simplify inventory methods by prompting a spot check when the system marks the product stock as zero to confirm there are no more units on hand.

3. It can halt operations

If you pause everything to conduct an inventory audit, you halt operations, which includes order fulfillment and getting items shipped to customers. In the age of Amazon, meeting customer expectations around timely delivery can influence their experience and impression of your product and brand.

How to improve inventory efficiency with software

Stock control is difficult, but the use of tools can help streamline it. Small to midsize ecommerce businesses can outsource fulfillment to ShipBob to receive the fulfillment services, warehouses, and technology needed to compete today.

1. Forecast demand

Auditing inventory helps you understand current counts, but it’s another thing entirely to use data to make future business decisions. Demand forecasting is predicting future orders by using historical data. This enables a business to make better decisions around inventory planning, product storage, and marketing promotions while meeting customer expectations.

ShipBob’s analytics provides the following distribution metrics and data visually:

Which items are slow-moving
How many days of inventory you have until you are expected to run out (based on SKU velocity)
How your current demand compares to previous time periods
How your sales are affected by different seasons and months
How much inventory you were holding at any ShipBob fulfillment centers at any point in the past
Your best-selling items and the percentage of your business they account for
And much more

“ShipBob’s inventory management functionality lets us track inventory change and velocity over time. Being able to monitor which styles are selling quickly helps us to always keep our best sellers in stock. We’ve been able to get through our heaviest seasons while staying ahead of production using ShipBob’s forecasting tools — even as our order volume more than quadrupled in less than a year.”

Ryan Casas, COO of iloveplum

2. Store product in the “right” location(s)

Part of making inventory management more efficient includes optimizing your inventory storage system. This means both within a warehouse and by zooming out to understand where in the world you should keep inventory. Thus, good inventory management software should not only help you review all of your SKUs but also connect your shipping data to close the loop.

For example, ShipBob’s software helps you understand where to distribute your inventory across its network of fulfillment centers by analyzing your past order history.

This is so you can keep inventory closer to your customers, reducing the shipping zones, transit times, and shipping costs. When an order is placed, ShipBob’s algorithm automatically matches the order to the warehouse that has the available inventory and is closest to the customer.

“ShipBob has fulfillment centers all over, so we can spread out our inventory across the country and leverage ground shipping as an inexpensive alternative to expedited air shipping.”
Founder of My Calm Blanket

3. Stay accurate and reorder on time

With software like ShipBob’s, you can view the status of your inventory and know when to proactively replenish inventory. Using your store’s order history, ShipBob can help project when you should send more inventory to prevent stockouts — no need to do manual reorder point calculations each time. You will be alerted to restock at the SKU level.

Additionally, you can manage how SKUs are grouped to bundle products, merge the same SKU across stores, and add new SKUs with ease.

“We roll out new products and designs on our website 1-3 times a month and send new inventory to ShipBob each week. It’s really easy to create new SKUs and restock existing ones using ShipBob’s technology, which is especially important with high inventory turnover.”
Carl Protsch, Co-Founder of FLEO Shorts

Conclusion

It’s important to conduct inventory audits to maintain inventory accuracy, identify shrinkage, and ensure that you always have enough (but not too much) stock at any time. Outsourcing inventory management and fulfillment to a 3PL can help. They will take measures to keep your inventory safe and secure, without you having to do any of the time-consuming work yourself.

If you’re in the market to partner with an ecommerce fulfillment company that has inventory management tools and technology, check out ShipBob today. Get pricing and see if we’d be a mutual fit by clicking the button below.

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