This involves determining the method adopted by the organization in costing stocks. The auditor should then check the acceptability and appropriateness of the adopted policies.
The rest of the exercise is to test that the adopted exercise if correctly applied.
Stock should be valued at lower of cost and net realizable value where net realizable value is defined as the amount that could be realized on the open market in the ordinary cause of business less the cost of putting them into a saleable condition and less the cost of sales.
It is up to the auditor to ensure that the net realizable value is properly calculated and is in accordance with the accounting standards.
Stocks should be reduced by a provision for obsolete or damaged and slow moving stock. This provision should not be excessive or inadequate. The auditor is guided by the factors such as age of stock, condition of stock, its turnover, technological advances in the industry, nature of stock (perishable or not), prevailing economic conditions etc. these guide him on judging the adequacy of provision for slow moving, obsolete or damaged stock.
The auditor must obtain adequate independent evidence that the stocks concerned are in existence. On several occasions auditors have certified accounts as giving a true and fair view when the stocks concerned were non- existent. The unfavorable decisions against the auditor have resulted in the profession making it obligatory that where stocks are of a significant figure in the accounts the auditor attending to observe the stock take.
It is not the auditor’s duty to take stock
He must however satisfy himself as to the validity of the amount attributed to stocks in the accounts that are the subject of his audit. The auditor should examine the internal control in order to determine the nature and extent of audit steps. Where stock is held at a number of locations the selection of the location to be visited should be planned so as to cover all significant locations over a period of years. When stock is based on records these must be substantiated by continuous or periodical physical stock takes. The records must be up to date.
Stock Taking Exercise
It is the responsibility of management to ensure that the amount at which stocks are shown in the financial statements represents stocks physically in existence. The auditor should obtain evidence in order to enable him to draw conclusions about the validity of amounts attributable to stocks. Where stocks are material in the financial statements the auditor should attend the stock take. The auditor must be present during the stock take mot necessarily to count stock but to witness and observe the way stock taking is done to obtain assurance on the existence and value of stock in trade.