Inventory Audit | Audit Procedures for Inventory Processes

Are you overwhelmed by the idea of performing an inventory audit?

You won’t be after reading this article.

Inventory auditing is one of the most important tools an inventory control manager can use to maintain inventory and uncover issues. It's a critical skill to consider when awarding someone an inventory manager salary, too. Once you have the know-how and the right tools you can become an auditing master and earn that warehouse manager salary.

Here's how inventory audit procedures works, the best practices on how to calculate ending inventory, and additional procedures, such as using the inventory days formula, to ensure you make the most out of your audits. It's an important part of our inventory control guide.

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What Is Inventory Audit?

An inventory audit is a process where a business cross-checks its financial records against its inventory records. It is a vital part of inventory management process. It is done to ensure all records are accurate and uncover any discrepancies in inventory count or financial records. These audits can also help with inventory forecasting.

How to Conduct Inventory Audit

Conducting an inventory audit requires accurate and current data from a variety of sources. This may include inventory counts, backorders, sales records, shipping manifests, or other records. Inventory tracking is key in ensuring audits can be done with complete and accurate information.

Though there are many forms of inventory auditing, the workflow is mostly the same. You must acquire two records that should reflect the same inventory numbers. Then check them against each other to discover if they do match. If not, flag the areas with issues and look into any problems that arise like missing inventory, damaged product, or inaccurate sales figures.

There are also many smaller inventory audit procedures that may be a part of the workflow.

10 Inventory Audit Procedures

Inventory audits can be completed by using a variety of audit procedures.

Here are ten of the most common inventory audit procedures:

1. Physical inventory count. This is the most common way to perform an inventory audit. It involves physically counting every item in your inventory and comparing the numbers against the numbers in your system. This is easier for businesses that use a just in time inventory method or regularly calculate their economic order quantity.
2. Inventory cycle count. Similar to physical counting, cycle counting involves manually counting a number of products and comparing them against your system. However, cycle counts are performed regularly on only a select number of products. This means you can audit your most valuable products much more often and avoid issues like inventory shrinkage.
3. ABC inventory analysis. ABC analysis is a process where you group different items by their value. This allows you to store and audit only the particular groups you want.
4. Cutoff analysis. With this analysis, you halt all operations at the time of the physical inventory count. This ensures there can be no mistakes of uncontrolled variables.
5. Analytical procedures. Here, you compare your inventory turnover ratio using the inventory turnover formula, gross margins, or unit costs with the data from previous years. This lets you catch any sudden increases or volatility.
6. Overhead analysis. An overhead analysis is an audit of all non-material expenses. This includes rent, utilities, salaries, and other "hidden" costs associated with inventory.
7. Finished goods cost analysis. This method is ideal for manufacturers and producers. All products are accounted for and values upon completion to ensure financial statements are accurate.
8. Freight cost analysis. This analysis evaluates the amount you spend on shipping costs and the lead time (lead time definition) involved. It also accounts for losses and damage incurred during transit.
9. Shipping invoice matching. Auditors often perform this inventory audit at random. It involves matching the cost of inventory shipped with the number of products shipped. It verifies that no products are shipped for the incorrect amount of money.
10. Product reconciliation. If you discover issues during your inventory count, you need to investigate to reconcile products. This will let you track any SKU number that's likely to have errors in the future.

Frequency of Inventory Audits

There’s no general rule on how often to do audits. Most companies have inventory audit procedures that schedule checks. For some businesses, the period between two inventory audits might be six months. However, some companies might even do daily inventory audits. Here are the factors that can help establish the frequency of inventory audit procedures.

1. Automation and inventory systems. One of the benefits of investing in inventory automation systems is that it can reduce the need of audits. These systems help reduce human error and can improve efficiency.
2. Company size. Smaller companies might go through an inventory audit procedure less frequently compared to large ones. That’s because the inventory turnover of smaller businesses is usually less compared to the turnover of large ones.
3. Level of risk. A higher risk of inventory loss or damage is a reason to schedule more frequent inventory audit procedures. Furthermore, businesses that have high-risk items in their inventory should also follow more strict procedures. ‍
4. The average price of goods. Inventory errors when buying or selling expensive items can have a bigger negative impact on the business. That’s why companies that trade high-value items might have an incentive to do audits more often.

Inventory Auditing Standards

Inventory audits are only as good as the standards applied to them. On the financial side, standards are set by the IRS and SEC. If you are not accurately reporting the value of your inventory or sales, you can be fined or worse.

On the warehouse side, standards must be established by the business itself. There is no legal punishment for failed inventory audits, but they can have a negative impact on your business. If you have no standards, you cannot expect to achieve the results you want.

There are two rules that make inventory audits easier and more accurate.

Here they are:

• Pick the audit types you'll use and do them regularly. From the list of ten above, pick one or two and make them a part of your monthly or weekly business process flow. This way you can discover problems sooner and avoid having to train employees on new audits as you perform them.
• Practice proper inventory control. Inventory audits are useless if you're not actively tracking and recording the movement of your products. Make sure all warehouse management process flow and activities are being tracked so that you can easily access and compare numbers.

Inventory Checklist

Inventory auditing is best done by using an inventory checklist. You can use the checklist as you take a full physical inventory count or for smaller cycle counts.

To help make things easier for you, we've put together a simple inventory checklist. Just download our inventory checklist excel sheet, change the sample data to your own, and start tracking your own products!

Physical Counts of Inventory

Physical counts of inventory are necessary to measure and adjust for inventory shrinkage. If you are using auditing measures that are focused on other data or have a perpetual inventory system, you may uncover some discrepancies.

Physical inventory counts are the only way to guarantee to verify these numbers and ensure that shrinkage is accounted for. It will also let you know if it's time to perform some inventory reduction to eliminate extra products. Inventory management can also be done through ERP software which is why it's ideal to understand the benefits of ERP.

Frequently Asked Questions About Inventory Audit

Inventory audit can help you limit wastage and manage inventory better. Let's answer a few questions about inventory audit.

How Do You Audit Inventory and Verify Inventory?

Inventory can be audited and verified in the following ways:

• Freight cost analysis
• ABC analysis
• Cut-off analysis
• Finished goods cost analysis
• Matching
• Overhead analysis
• Reconciliation

What are the Types of Inventory Control?

The four types of inventory control are:

• ABC control
• Aggregate control
• Safety stock

What is MRO Inventory?

MRO inventory includes consumable materials, such as restaurant supplies, bakery equipment, and other wholesale supplies needed for repair, maintenance, and operational activities. Items referred to as MRO inventory are used in the production process.

Are Inventory Audits Required?

If the company is made public, an inventory audit is a requirement. If the inventory is considered material. The audit must be done by an independent and external auditor with the proper certifications. The audit is conducted at least once a year, as a part of the financial statement audit. It serves to verify the inventory part of the book value of the specific company.

Audit and a Bag of Chips

Now that you have a better grasp of the different ways you can audit your inventory, you can start working on limiting waste. Your audits can uncover shrinkage, issues with your reorder point, dead stock (see what is dead stock), and more.

One way to make inventory auditing easier for you is to invest in inventory management software. These programs can be integrated into your POS system and provide a perpetual inventory count. This way, you can perform audits whenever you want without needing to take a full physical inventory and continue to sell products on a DTC or online marketplace with confidence.