CA Inter Audit & Ethics Notes

Chapter 5 – Audit of Items of Financial Statements

Part 4 – Audit of Inventory, Property, Plant & Equipment (PPE) & Investments

3.6 AUDIT OF INVENTORY

Meaning

Inventory refers to assets:

Held for sale in the ordinary course of business.
In the process of production for sale.
In the form of raw materials, stores and consumables.

Examples:

Raw Materials
Work-in-Progress (WIP)
Finished Goods
Stores & Spares
Packing Material

Audit Objectives

The auditor should ensure that inventory:

Exists physically.
Is owned by the entity.
Is completely recorded.
Is correctly valued.
Is properly disclosed.

Assertions

Existence
Completeness
Rights & Obligations
Valuation
Presentation & Disclosure

A. EXISTENCE

Physical Verification (Most Important)

The auditor should:

✔ Attend physical stock count.

✔ Observe inventory counting procedures.

✔ Evaluate whether management’s counting instructions are adequate.

✔ Perform test counts.

✔ Compare physical count with inventory records.

Auditor should observe:

Proper tagging of inventory.
Identification of damaged goods.
Segregation of obsolete items.
Separate identification of goods belonging to others.

Test Counts

Auditor should:

Select inventory from warehouse → trace to stock sheets.
Select stock sheets → trace back to physical inventory.

This ensures both:

Existence
Completeness

SA 501

SA 501 – Audit Evidence – Specific Considerations for Selected Items

Physical attendance at inventory count provides audit evidence regarding:

Existence
Condition of inventory

Inventory at Third Party

Examples:

Goods lying with transporter
Warehouse
Consignment Agent

Auditor should obtain:

Direct confirmation
Warehouse certificate
Goods receipt records

Goods in Transit

Verify:

Purchase documents
LR/RR
Shipping documents
Ownership

B. COMPLETENESS

Ensure:

✔ All inventory owned by company is recorded.

✔ Goods held at branches included.

✔ Goods with third parties included.

✔ Goods sold before year-end excluded.

Cut-off Testing

Very important.

Verify:

Purchases and sales immediately before and after Balance Sheet date.

Purchases

Goods received before year-end

→ Included.

Goods received after year-end

→ Excluded.

Sales

Goods dispatched before year-end

→ Removed from inventory.

Goods dispatched after year-end

→ Continue in inventory.

Goods on Approval

If ownership has not transferred,

Inventory should continue to be included.

Goods on Consignment

Goods sent to agent

Still belong to company.

Must remain in inventory.

Goods received on Consignment

Do NOT include.

Ownership belongs to consignor.

C. RIGHTS & OBLIGATIONS

Auditor verifies ownership.

Verify

Purchase invoices
GRN
Delivery challans
Title documents
Import documents

Inventory pledged with banks

Verify:

Loan agreement
Charge documents

Disclosure required.

D. VALUATION

Inventory should be valued according to:

AS 2

Inventory =

Lower of

Cost
OR
Net Realisable Value (NRV)

Components of Cost

Includes

✔ Purchase Cost

✔ Conversion Cost

✔ Other Costs

Excludes

❌ Abnormal Waste

❌ Selling Cost

❌ Administrative Overheads

❌ Storage Cost (unless necessary)

Auditor verifies

Cost formula used
FIFO/Weighted Average
NRV calculation
Obsolete inventory
Slow-moving stock
Damaged goods

Obsolete Inventory

Ensure adequate provision.

Slow-moving Inventory

Review ageing analysis.

Compare with previous year.

Analytical Procedures

Compare:

Gross Profit Ratio
Inventory Turnover Ratio
Closing Stock %
Previous Year’s Inventory

Investigate unusual variations.

E. PRESENTATION & DISCLOSURE

Schedule III requires disclosure of:

Raw Material
WIP
Finished Goods
Stock-in-Trade
Stores & Spares

One-Day Revision

Inventory Audit

✔ Physical Verification

✔ SA 501

✔ Test Count

✔ Cut-off

✔ Goods in Transit

✔ Consignment

✔ Goods on Approval

✔ AS 2

✔ Lower of Cost or NRV

3.7 AUDIT OF PROPERTY, PLANT & EQUIPMENT (PPE)

Meaning

PPE are tangible assets used for:

Production
Supply of goods/services
Administration
Rental

Expected to be used for more than one accounting period.

Examples

Land
Building
Plant
Machinery
Furniture
Vehicles
Computers

Assertions

Existence
Completeness
Rights
Valuation
Disclosure

A. EXISTENCE

Verify through:

✔ Physical inspection.

✔ Fixed Asset Register (FAR).

✔ Asset Identification Number.

Auditor should compare

Fixed Asset Register

↓

General Ledger

↓

Financial Statements

Additions during the Year

Verify:

Purchase Invoice
Vendor Invoice
GRN
Installation Cost
Capitalisation Date
Board Approval

Capital Work-in-Progress

Verify:

Supporting bills
Engineer Certificates
Stage of completion

Disposal of Assets

Verify:

Sale Invoice
Board Resolution
Asset removed from FAR
Profit/Loss on Sale

B. COMPLETENESS

Ensure

All capital assets purchased have been capitalised.

Repairs should not be wrongly capitalised.

C. RIGHTS & OBLIGATIONS

Verify:

Title Deeds
Registration Documents
Lease Agreements

Land & Building

Important Point

Title deeds should be in the company’s name.

If not,

Obtain explanation and examine disclosure.

Assets under Mortgage

Verify

Charge registration
Bank documents
Proper disclosure

D. VALUATION

Verify:

Depreciation calculated correctly.

Depreciation

Companies Act, 2013

Schedule II

Verify

Useful Life
Residual Value
Method
Change in Method

Impairment

Where indication exists,

verify compliance with

AS 28 / Ind AS 36

Revaluation

Verify:

Valuation Report
Independent Valuer
Revaluation Reserve

Repairs vs Capital Expenditure

Capital Expenditure

✔ Increases useful life.

✔ Increases capacity.

✔ Creates new asset.

Revenue Expenditure

✔ Routine maintenance.

✔ Day-to-day repairs.

E. DISCLOSURE

Verify disclosure of:

Gross Block
Additions
Deductions
Depreciation
Net Block
CWIP

As per Schedule III.

3.8 AUDIT OF INVESTMENTS

Meaning

Investments are assets held for:

Earning income
Capital appreciation
Strategic control

Types

Current Investments

Held for short term.

Non-current Investments

Held for long term.

Assertions

Existence
Rights
Valuation
Completeness
Disclosure

A. EXISTENCE

Verify:

Share Certificates
Demat Statements
Mutual Fund Statements
Bond Certificates

Investments with Custodian

Obtain direct confirmation.

B. RIGHTS

Verify ownership through:

Demat Account
Contract Notes
Purchase Deeds
Transfer Documents

C. VALUATION

Current Investments

Valued at

Lower of

Cost
Fair Value

(Category-wise)

Long-term Investments

Carried at Cost.

Provide for permanent diminution.

Auditor verifies

Market Value
Cost
Dividend received
Interest accrued
Impairment

D. INCOME FROM INVESTMENTS

Verify:

Dividend
Interest
Bonus Shares
Rights Issue

E. DISCLOSURE

Ensure proper disclosure of:

Quoted Investments
Unquoted Investments
Current
Non-current
Market Value
Carrying Value

One-Day Revision

Inventory

✔ SA 501

✔ Physical Count

✔ Test Count

✔ Cut-off

✔ AS 2

✔ Lower of Cost & NRV

PPE

✔ FAR

✔ Physical Verification

✔ Title Deeds

✔ Depreciation

✔ Schedule II

✔ CWIP

✔ Capital vs Revenue

Investments

✔ Demat Statement

✔ Confirmation

✔ Cost

✔ Fair Value

✔ Permanent Diminution

✔ Dividend & Interest

Important Standards

Standard	Topic
SA 501	Inventory Physical Verification
AS 2	Inventory Valuation
Schedule II (Companies Act, 2013)	Depreciation on PPE
AS 28 / Ind AS 36	Impairment of Assets
AS 13 / Ind AS 109	Accounting for Investments

Exam Memory Mnemonics

Inventory: P-C-V-D

P – Physical Verification
C – Cut-off
V – Valuation (Lower of Cost or NRV)
D – Disclosure

PPE: F-T-D-R

F – Fixed Asset Register
T – Title Deeds
D – Depreciation
R – Repairs vs Capital Expenditure

Investments: E-R-V-D

E – Existence
R – Rights
V – Valuation
D – Disclosure

Part 4 covers the audit of Inventory, Property, Plant & Equipment, and Investments. The next part will cover Loans & Advances, Current Liabilities, Provisions, Revenue, Expenses, and other remaining audit areas to complete the chapter.