Auditing Inventory
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Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Inventory is one of the most misstatement-prone assets on a balance sheet — vulnerable to theft, obsolescence, and clerical error — which makes it a frequent audit focus and a well-tested topic on the AUD section of the CPA exam. Three procedures do most of the work: physical inventory count, obsolescence review, and cut-off testing.
What is a physical inventory count?
Auditors physically count inventory items and reconcile them to the client's records — the most direct way to verify the existence assertion. This is usually done at or near the balance sheet date, either as one full count or through cycle counting spread across the year.
Example: You're auditing a clothing retailer whose ledger shows 500 units of a particular shirt in stock. The physical count finds only 475 units — a 25-unit discrepancy that needs investigating for theft, misplacement, or a record-keeping error.
What is an obsolescence review?
An obsolescence review evaluates whether inventory has lost value due to age, changing demand, or wear and tear — targeting the valuation assertion. Obsolete inventory may need to be written down, affecting both the balance sheet and the income statement.
Example: Still at the clothing retailer, you find a pile of jackets that haven't sold in two seasons. After reviewing market trends with management, you conclude they're obsolete. The jackets are on the books for $10,000 but are now worth only $3,000, requiring a write-down of $7,000.
What is cut-off testing?
Cut-off testing confirms that inventory transactions near the balance sheet date land in the correct accounting period — targeting the cut-off assertion. Getting this wrong distorts both current and future financial statements.
Example: The retailer's year-end is December 31. A shipment of 100 shirts arrived on December 30 but wasn't recorded as inventory until January 2 — understating the current year's ending inventory and overstating next year's starting inventory.
Each procedure targets a different way inventory can be misstated. Physical count asks "is it really there?" Obsolescence review asks "is it still worth what the books say?" Cut-off testing asks "is it in the right period?"
I walk through count night, including which direction to trace and what each direction tests, in inventory count observation.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 90 on AUD. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.
