Practice

2004
Note 25

January
ATTENDANCE AT STOCKTAKING

Further copies, 5.00, post-free, can be obtained from:

Wolters Kluwer (UK) Limited,

145 London Road, Kingston upon Thames
Surrey
KT2 6SR

Telephone: 0870 777 2906

Fax: 020 8247 1124
E-mail: customerservices@cch.co.uk
Website: www.cch.co.uk
 PRACTICE NOTES

The Auditing Practices Board Limited is responsible for the establishment of standards
and guidance for auditing in the United Kingdom and Republic of Ireland with the
objective of enhancing public condence in the audit process and the quality and
relevance of audit services in the public interest.

The Auditing Practices Board Limited discharges its responsibilities through a Board
(the APB) comprising individuals who are not eligible for appointment as company
auditors, as well as those who are so eligible. Those who are eligible for appointment
as company auditors may not exceed 40% of the APB by number.

Neither the Auditing Practices Board Limited nor the APB accepts any liability to any
party for any loss, damage or costs howsoever arising, whether directly or indirectly,
whether in contract, tort or otherwise from any action or decision taken (or not taken) as
a result of any person relying on or otherwise using this document or arising from any
omission from it.

The purpose of Practice Notes issued by the APB is to assist auditors in applying
Auditing Standards of general application to particular circumstances and industries.

They are persuasive rather than prescriptive. However, they are indicative of good
practice, even though they may be developed without the full process of consultation
and exposure used for Statements of Auditing Standards.

This Practice Note replaces Auditing Guideline 405 which was issued by the Auditing
Practices Committee in October 1983.

# APB Limited 2004

ISBN 1-84140-466-7
 Practice Note 25 January 2004

PRACTICE NOTE 25

ATTENDANCE AT STOCKTAKING

Contents Paragraphs

Introduction 1-6

Assessment of risks and internal controls 7-9

Audit evidence 10-15

Procedures
Before the stocktake 17-18
During the stocktake 19-25
After the stocktake 26-28

Work in progress 29

The use of expert valuers and stocktakers 30-31

Stocks held by third parties or in public warehouses 32

THE AUDITING
1
PRACTICES BOARD
Practice Note 25 January 2004

INTRODUCTION

1. Practice Note 25 contains guidance on how the requirements of Statement of Auditing

Standards (SAS) 300: Accounting and Internal Control Systems and Audit Risk
Assessments and SAS 400: Audit Evidence may be applied in relation to attendance at
stocktaking. The Practice Note also comments briey on the application of SAS 480:
Service organisations and SAS 520: Using the work of an expert. The guidance is
supplementary to, and should be read in conjunction with, the SASs which apply to all
audits undertaken in the United Kingdom and the Republic of Ireland.

2. The main assertions1 relating to stock and work in progress (stocks) are existence,
ownership, completeness and valuation. Practice Note 25 is primarily concerned with
audit evidence relating to the existence assertion.

3. When stocks are material to an entitys nancial statements, or where the risk of mis-
statement of stocks is so great as to give rise to the risk of material mis-statement in the
nancial statements, it will normally be necessary for auditors to attend stocktakes to
obtain evidence of the existence of stocks2.

4. While the principal reason for attendance at a stocktake is to obtain evidence to

substantiate the existence of the stocks, attendance can also enhance the auditors
understanding of the business by providing an opportunity to observe the production
process and/or business locations at rst hand and providing evidence in relation to the:

 completeness and valuation of stocks,

 cut-off for recording stocks inwards and outwards, and the resultant impact on the
measurement of revenues and costs, and
 design and operation of an entitys accounting and control systems.

5. It is the responsibility of the directors of an entity to ensure that the amount at which stocks
are recorded in the nancial statements represents stocks physically in existence and
includes all stocks owned by the entity. To achieve this entities may maintain detailed
stock records and check these by regular test counts. In some entities where the
accounting records are less detailed, the amount of stock may be determined by way of a
full physical count of all stocks held at a date close to the entitys balance sheet date.

1 Assertions are the representations of the directors that are embodied in the nancial statements and
are more fully described in SAS 400 Audit evidence.
2 International Standard on Auditing 501 Audit evidence-additional considerations for specic items
includes a bold letter requirement which states When inventory is material to the nancial
statements, the auditor should obtain sufcient appropriate audit evidence regarding its existence and
condition by attendance at physical inventory counting unless impracticable.

THE AUDITING
2
PRACTICES BOARD
 Practice Note 25 January 2004

6. In the case of a company incorporated under the Companies Acts, management also has
responsibilities to maintain proper accounting records and to include any statements of
stocktakings in those records3.

ASSESSMENT OF RISKS AND INTERNAL CONTROLS

7. SAS 300: Accounting and Internal Control Systems and Audit Risk Assessments
requires that auditors should obtain an understanding of the accounting and internal
control systems sufcient to plan the audit and develop an effective audit approach. The
SAS requires that auditors should use their professional judgment to assess the
components of audit risk and to design audit procedures to reduce this to an acceptably
low level.

8. In accordance with SAS 300 auditors should use professional judgment to assess the
components of audit risk4. Risk factors relating to the existence assertion in the context of
the audit of stocks include the:

 reliability of accounting and stock recording systems including, in relation to work in

progress, the systems that track location, quantities and stages of completion;
 timing of stocktakes relative to the year-end date, and the reliability of records used in
any roll-forward of balances;
 location of stocks, including stocks on consignment and those held at third-party
warehouses;
 physical controls over the stocks, and their susceptibility to theft or deterioration;
 objectivity, experience and reliability of the stock counters and of those monitoring
their work;
 degree of uctuation in stock levels;
 nature of the stocks, for example whether specialist knowledge is needed to identify
the quantity, quality and/or identity of stock items; and
 difculty in carrying out the assessment of quantity, for example whether a signicant
degree of estimation is involved.

9. When planning the audit, auditors also assess the risk that fraud may cause the nancial
statements to contain material mis-statements. Based on this risk assessment, the
auditors design audit procedures so as to have a reasonable expectation of detecting

3 In the United Kingdom Section 221 of the Companies Act 1985; in the Republic of Ireland Section
230.3(c) of the Companies Act 1990.
4 SAS 300.2.

THE AUDITING
3
PRACTICES BOARD
Practice Note 25 January 2004

material mis-statements arising from fraud. Fraudulent activities which can occur in
relation to stocks include:

 false sales involving the movement of stocks still owned by the entity to a location not
normally used for storing stocks;
 movement of stocks between entity sites with stocktakes at different dates;
 the appearance of stocks and work in progress being misrepresented so that they
seem to be of a higher value/greater quantity;
 the application of inappropriate estimation techniques;
 stock count records prepared during stock counts deliberately being incorrectly
completed or altered after the event; and
 additional (false) stock count records being added to those prepared during the
count.

AUDIT EVIDENCE

10. SAS 400: Audit Evidence requires that auditors should obtain sufcient appropriate
audit evidence to be able to draw reasonable conclusions on which to base their audit
opinion. The SAS also requires that, in seeking to obtain audit evidence from substantive
procedures, auditors should consider the extent to which that evidence together with any
evidence from tests of controls, supports the relevant nancial statement assertions.

11. Where stocks are material to an entitys nancial statements, or where the risk of mis-
statement of stocks is so great as to give rise to the risk of material mis-statement in the
nancial statements, it will normally be necessary for auditors to attend a stocktake to
obtain evidence of the existence of stocks. Such attendance might also provide evidence
to the auditors in respect of completeness and valuation assertions (including
consideration of possible obsolescence and deterioration). The extent and nature of
evidence required will depend upon the auditors assessment of risk.

12. The principal sources of evidence relating to the existence of stocks are:

 evidence from audit procedures which conrm the reliability of the accounting records
upon which the amount in the nancial statements is based;
 evidence from tests of the operation of internal controls over stocks, including the
reliability of stock-counting procedures applied by the entity; and
 substantive evidence from the physical inspection tests undertaken by the auditors.

13. The nature of the auditors procedures during their attendance at a stocktake will depend
upon the results of the risk assessment carried out in accordance with SAS 300. In cases

THE AUDITING
4
PRACTICES BOARD
 Practice Note 25 January 2004

where the auditors decide to place reliance on accounting systems and internal controls,
the auditors attend a stocktake primarily to obtain evidence regarding the design and
operating effectiveness of management procedures for conrming stock quantities.

14. Where entities maintain detailed stock records and check these by regular test counts
auditors perform tests designed to conrm whether management:

 maintains adequate stock records that are kept up-to-date;

 has satisfactory procedures for stocktaking and test-counting; and
 investigates and corrects all material differences between the book stock records and
the physical counts.

Auditors attend a stocktake to gain assurance that the stock-checking as a whole is

effective in conrming that accurate stock records are maintained. If the entitys stock
records are not reliable the auditors may need to request management to perform
alternative procedures which may include a full count at the year end.

15. In entities that do not maintain detailed stock records the quantication of stocks for
nancial statement purposes is likely to be based on a full physical count of all stocks held
at a date close to the companys year end. In such circumstances auditors will consider
the date of the stocktake recognising that the evidence of the existence of stocks provided
by the stocktake is greater when the stocktake is carried out at the end of the nancial
year. Stocktaking carried out before or after the year end may also be acceptable for audit
purposes provided the auditors are satised that the records of stock movements in the
intervening period are reliable.

PROCEDURES

16. The following paragraphs set out the principal procedures which may be carried out by
auditors when attending a stocktake, but are not intended to provide a comprehensive list
of the audit procedures which the auditors may nd it necessary to perform during their
attendance.

Before the stocktake

17. The effectiveness of the auditors attendance at stocktaking is increased by the use of
audit staff who are familiar with the entitys business and where advance planning has
been undertaken. Planning procedures include:

 performing analytical procedures, and discussing with management any signicant

changes in stocks over the year and any problems with stocks that have recently
occurred, for example unexpected stock-out reports and negative stock balances;
 discussing stocktaking arrangements and instructions with management;

THE AUDITING
5
PRACTICES BOARD
Practice Note 25 January 2004

 familiarising themselves with the nature and volume of the stocks, the identication of
high value items, the method of accounting for stocks and the conditions giving rise to
obsolescence;
 considering the location of the stock and assessing the implications of this for stock
control and recording;
 considering the quantity and nature of work in progress, the quantity of stocks held by
third parties, and whether expert valuers or stocktakers will be engaged (further
guidance on these issues is set out in paragraphs 29-32 below);
 reviewing the systems of internal control and accounting relating to stocks, so as to
identify potential areas of difculty (for example cut-off);
 considering any internal audit involvement, with a view to deciding the reliance which
can be placed on it;
 considering the results of previous stock counts made by the entity; and
 reviewing their working papers for the previous year.

18. The auditors examine the way the stocktake is organised and evaluate the adequacy of
the clients stocktaking instructions. Such instructions, preferably in writing, should cover
all phases of the stocktaking procedures, be issued in good time and be discussed with
the person responsible for the stocktake to check that the procedures are understood and
that potential difculties are anticipated. If the instructions are found to be inadequate, the
auditors seek improvements to them.

During the stocktake

19. During the stocktake, the auditors ascertain whether the clients staff are carrying out their
instructions properly so as to provide reasonable assurance that the stocktake will be
accurate. They make test counts to satisfy themselves that procedures and internal
controls relating to the stocktake are working properly. If the manner of carrying out the
stocktake or the results of the test-counts are not satisfactory, the auditors immediately
draw the matter to the attention of the management supervising the stocktake and they
may have to request a recount of part, or all of the stocks.

20. When carrying out test-counts, the auditors select items both from count records and from
the physical stocks and check one to the other to gain assurance as to the completeness
and accuracy of the count records. In this context, they give particular consideration to
those stocks which they believe to have a high value either individually or as a category of
stock. The auditors record in their working papers items for any subsequent testing
considered necessary, such as copies of (or extracts from) stock count records and
details of the sequence of those records, and any differences noted between the records
and the physical stocks counted.

THE AUDITING
6
PRACTICES BOARD
 Practice Note 25 January 2004

21. The auditors determine whether the procedures for identifying damaged, obsolete and
slow moving stock operate properly. They obtain (from their observations and by
discussion, for example with storekeepers and stock counters) information about the
stocks condition, age, usage and, in the case of work in progress, its stage of completion.
Further, they ascertain that stock held on behalf of third parties is separately identied and
accounted for.

22. The auditors consider whether management has instituted adequate cut-off procedures,
i.e. procedures intended to ensure that movements into, within and out of stocks are
properly identied and reected in the accounting records in the correct period. The
auditors procedures during the stocktake will depend on the manner in which the year
end stock value is to be determined. For example, where stocks are determined by a full
count and evaluation at the year end, the auditors test the arrangements made to identify
stocks that correspond to sales made before the cut-off point and they identify goods
movement documents for reconciliation with nancial records of purchases and sales.
Alternatively, where the full count and evaluation is at an interim date and year end stocks
are determined by updating such an amount by the cost of subsequent purchases and
sales, the auditors perform appropriate procedures during their attendance at the
stocktaking and in addition they test the nancial cut-off (involving the matching of costs
with revenues) at the year end.

23. The auditors working papers include details of their observations and tests (for example,
of physical quantity, cut-off date and controls over stock count records), the manner in
which points that are relevant and material to the stocks being counted or measured have
been dealt with by the entity, instances where the entitys procedures have not been
satisfactorily carried out and the auditors conclusions.

24. Although the principal reason for attendance at a stocktake is usually to obtain evidence to
substantiate the existence of the stocks, as noted in paragraph 4 above attendance can
also enhance the auditors understanding of the business by providing an opportunity to
observe the production process and/or business locations at rst hand and providing
evidence regarding the completeness and valuation of stocks and the entitys accounting
and control systems. Matters that the auditors may wish to observe whilst attending a
stocktake include:

Understanding the business

 the production process;

 evidence of signicant pollution and environmental damage;
 unused buildings and machinery.

THE AUDITING
7
PRACTICES BOARD
Practice Note 25 January 2004

Completeness and valuation of stocks

 physical controls;
 obsolete stock (for example goods beyond their sale date);
 scrap, and goods marked for re-work;
 returned goods.

Accounting and control systems

 exceptions identied by the production process (for example missing work tickets);
and
 the operation of shop-oor disciplines regarding the inputting of data such as stock
movements into the computer systems.

25. Some entities use computer-assisted techniques to perform stocktakes; for example hand
held scanners can be used to record stock items which update computerised records. In
some situations there are no stock-sheets, no physical count records, and no paper
records available at the time of the count. In these circumstances the auditors consider the
IT environment surrounding the stocktake and consider the need for specialist assistance
when evaluating the techniques used and the controls over them. Relevant issues involve
systems interfaces, and the controls over ensuring that the computerised stock records
are properly updated for the stock count information.

The auditors consider the following aspects of the stock count:

how the test counts (and double counts where two people are checking) are recorded,

how differences are investigated before the computerised stock records are updated
for the counts, and

how the computerised stock records are updated, and how stocktake differences are
recorded.

After the stocktake

26. After the stocktake, the matters recorded in the auditors working papers at the time of the
count or measurement, including apparent instances of obsolete or deteriorating stocks,
are followed up. For example, details of the last serial numbers of goods inwards and
outwards records and of movements during the stocktake may be used in order to check
cut-off. Further, copies of (or extracts from) the stock count records and details of test
counts, and of the sequence of stock count records may be used to check that the results
of the count have been properly reected in the accounting records of the entity.

THE AUDITING
8
PRACTICES BOARD
 Practice Note 25 January 2004

27. The auditors review whether continuous stock records have been adjusted to the amounts
physically counted or measured and that differences have been investigated. Where
appropriate, they consider whether management has instituted procedures to ensure that
all stock movements between the observed stock count and the period end have been
adjusted in the accounting records, and they test these procedures to the extent
considered necessary to address the assessed risk. In addition, they follow up queries
and notify senior management of serious problems encountered during the stocktake.

28. In conclusion, the auditors consider whether attendance at the stocktake has provided
sufcient reliable audit evidence in relation to relevant assertions (principally existence)
and, if not, the other procedures that should be performed.

Work in progress
29. Management may place substantial reliance on accounting systems and internal controls
designed to ensure the completeness and accuracy of records of work in progress. In
such circumstances there may not be a stocktake which can be attended by the auditors.
Nevertheless, inspection of the work in progress may assist the auditors in understanding
the entitys control systems and processes. It will also assist them in planning their other
audit procedures, and it may also help on such matters as the determination of the stage
of completion of construction or engineering work in progress. For this purpose, auditors
identify the accounting records that will be used by management to produce the work in
progress gure in the year-end accounts and, where unnished items are uniquely
identiable (for example by reference to work tickets or labels), they physically examine
items to obtain evidence that supports the recorded stage of completion. In some cases,
for example in connection with building projects, photographic evidence can also be
useful evidence as to the state of work in progress, particularly if provided by independent
third parties or the auditors themselves.

The use of expert valuers and stocktakers

30. Prior to attending a stocktake, the auditors establish whether expert help, such as that
provided by a quantity surveyor, needs to be obtained by management to substantiate
quantities, or to identify the nature and condition of the stocks, where they are very
specialised. In cases where the entity engages a third party expert auditors assess, in
accordance with SAS 520: Using the work of an expert, the objectivity and professional
qualications, experience and resources of the expert engaged to carry out this work, and
also the instructions given to the expert.

31. Management may from time to time appoint stocktakers from outside the entity, a practice
common for stocks at, for example, farms, petrol stations and public houses. The use of
independent stocktakers does not eliminate the need for auditors to obtain audit evidence
as to the existence of stocks. In addition, as well as satisfying themselves as to the
competence and objectivity of the independent stocktakers, the auditors consider how to
obtain evidence as to the procedures followed by them to ensure that the stocktaking

THE AUDITING
9
PRACTICES BOARD
Practice Note 25 January 2004

records have been properly prepared. In this connection, auditors have regard to the
relevant guidance set out in SAS 480: Service organisations.

Stocks held by third parties or in public warehouses

32. If stocks (including those on consignment) are located in public warehouses or with other
third parties, the auditors normally obtain direct conrmation relating to quantities and
ownership in writing from the custodian. If such stocks are material, auditors have regard
to the relevant guidance set out in SAS 480 and consider one or more of the following
procedures:

 testing the owners procedures for investigating the custodian and evaluating the
custodians performance;
 obtaining an independent report on the custodians control procedures relevant to
custody of goods; and
 observing physical counts of the goods, or arranging for the third partys auditors to
do so.

THE AUDITING
10
PRACTICES BOARD
 NOTICE TO READERS
The Accountancy Foundation Limited

This document has been obtained from the website of The Accountancy Foundation Limited
and its subsidiary companies (The Review Board Limited, The Auditing Practices Board
Limited, The Ethics Standards Board Limited, The Investigation and Discipline Board
Limited). Use of the website is subject to the WEBSITE TERMS OF USE, which may be
viewed at http://www.accountancyfoundation.com/terms. Readers should be aware
that, although The Accountancy Foundation Limited and its subsidiary companies seek to
ensure the accuracy of information on the website, no guarantee or warranty is given or
implied that such information is free from error or suitable for any given purpose: the
published hard copy of the document alone constitutes the definitive text.