Audit of inventories explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Inventory is where existence, completeness and valuation risks meet. Stock can be miscounted, counted twice, pushed across the year-end, held at a godown owned by someone else or carried at a value nobody will realise. This article explains how an auditor tests inventory and what an accountant should prepare. If you want an independent stock verification for a lender, see our stock audit service.
This article is based on the Standards on Auditing issued by ICAI as in force on 4 October 2026; ICAI may revise standards, so check the current text on icai.org. The standards are explained in our linked posts; here they are applied to one balance.
When inventory is material, the auditor must attend the physical count unless that is impracticable (SA 501, paragraph 4). If the count is on another date, the auditor tests movements between the count date and year end (paragraph 5). If attendance is impracticable, the auditor performs alternative procedures, and where none can give enough evidence modifies the opinion (paragraph 7). For stock held by third parties, the auditor confirms or inspects (paragraph 8). Valuation and cut-off are tested separately.
What SA 501 requires for inventory
When inventory is material, the auditor must obtain sufficient appropriate evidence of its existence and condition by attending the count and by testing the final inventory records (paragraph 4). Attendance has four parts: evaluating management's instructions and procedures for recording and controlling count results, observing management's count procedures, inspecting the inventory and performing test counts. The final inventory records are then tested to see whether they accurately reflect the actual count results (paragraph 4(b)). Our post on SA 501 covers the whole standard, including litigation and segment information.
Application paragraph A2 adds that attendance gives evidence on the reliability of management's count procedures, and these procedures may serve as tests of controls or substantive procedures depending on the auditor's approach. A3 lists factors for planning attendance: the nature of the inventory, stages of completion of work in progress, risks of misstatement, controls, whether a perpetual system exists, timing, locations, and whether an expert is needed.
Before the count: instructions and planning
Management's count instructions are the auditor's first test. Paragraph A4 gives the matters the auditor looks for: control activities such as collecting used and accounting for unused count sheets and re-count procedures, accurate identification of work in progress stage, slow-moving, obsolete, damaged and third-party stock, estimating quantities where counting is not practical, and control over movements and shipping and receipt around the cut-off.
| Count control | Why it matters | Auditor's check |
|---|---|---|
| Numbered count sheets or tags | Prevents omission and double counting | Account for all issued and unused sheets |
| Freezing movements | Avoids stock being counted in two places | Observe whether movements stop or are recorded |
| Separate identification of third-party, damaged and obsolete stock | Existence is not ownership; value depends on condition | Inspect and note on the auditor's own sheets |
| Independent re-counts | Catch careless counting | Observe, and do own test counts |
| Cut-off records | Anchor for later testing | Collect last receipt and dispatch numbers |
At the count
The auditor inspects the inventory, which helps ascertain existence (though not necessarily ownership) and spots obsolete, damaged or ageing items (A6). Test counts run in both directions: items picked from management's count records are traced to the physical stock, and items picked from the stock are traced to the records. The first shows that recorded items exist; the second shows that the records are complete (A7). Copies of the completed count records are retained so that the final inventory listing can be tested later (A8).
Count on a date other than year end
Where the count is on another date, the auditor must also test whether changes between the count date and the balance sheet date are properly recorded (paragraph 5). The reliability of perpetual records, the reasons for significant differences found at the count and whether those records were properly adjusted all matter (A11). A9 notes that the effectiveness of controls over changes in inventory decides whether counting on another date is appropriate. If the auditor cannot attend because of unforeseen circumstances, the auditor makes or observes some counts on an alternative date and tests intervening transactions (paragraph 6).
When attendance is impracticable
Paragraph 7 requires alternative procedures; if sufficient evidence cannot be obtained, the opinion is modified under SA 705 (Revised). A12 says inconvenience, difficulty, time or cost is not a valid ground to call attendance impracticable. An example of an alternative in A13 is examining documents of the subsequent sale of items purchased before the count. See our post on SA 705 for the modification.
Stock held by third parties
Where inventory in the custody and control of a third party is material, the auditor must obtain evidence by requesting confirmation of quantities and condition from the third party, by inspection or other appropriate procedures, or both (paragraph 8). Confirmation is governed by SA 505; where the third party's integrity or objectivity is in doubt, A16 points to alternatives such as attending the third party's count or obtaining a service auditor's report on its controls. Our post on SA 505 covers the confirmation process.
Valuation, cut-off and analytics
Valuation is tested against the accounting standard: the cost build-up, the basis of costing and the comparison of cost with net realisable value for slow-moving, damaged and obsolete items; see AS 2. Cut-off is tested by tracing the last goods received and dispatched documents before year end to the ledger, and the first after year end to the next period. Analytics under SA 520, such as stock days, gross margin and ageing against prior periods, point to areas for further work; see SA 520. Stock-related reporting by companies is covered in our post on CARO 2020 clause 3(ii). For stock audits done for lenders, see our stock audit process and checklist.
Worked example (illustrative)
Mahima Steel Traders Pvt Ltd, an invented trader, closes its year on 31 March, and its stock of Rs 18 crore is the largest asset. Management counts on 28 March. The auditor attends, reviews instructions, and makes test counts of 40 lines in each direction. Two lines in the stock to records direction are missing from the records; both are positive differences of an illustrative Rs 3 lakh in total, recorded after the count. For the period from 28 to 31 March, the auditor traces dispatch notes and goods received notes to the ledger and finds a dispatch of Rs 40 lakh on 30 March booked as sale in April, with stock reduced in March. This is a cut-off error: sales are understated by Rs 40 lakh and stock is understated by its cost. Management corrects it. Steel lying at a processing contractor is confirmed in writing, and the auditor inspects a sample on a later visit because the contractor's replies had inconsistencies.
Documents to keep ready
- Count instructions, circulated before the count.
- Numbered count sheets or tags, with reconciliations of issued, used and unused.
- Stock ledgers and perpetual records, with roll-forward from count date to year end.
- Last goods received and dispatch numbers at the cut-off.
- Third-party stock statements, confirmations and agreements.
- Costing sheets, net realisable value and obsolescence working.
Common lapses
- No written count instructions, or instructions that were not followed.
- Goods at the godown that belong to others, or goods in transit, treated as the entity's stock.
- Cut-off errors around the count and year end.
- Obsolete stock carried at cost.
- Inventory held with job workers or agents ignored in the count plan.
Need help with stock verification and records?
Clean stock records, a written count procedure and a documented roll-forward make the audit of inventory shorter and the result more reliable. If you also need independent verification for a lender, we handle stock audits and the supporting records; see our stock audit service.
Key takeaways
- Attending the count is required when inventory is material, unless impracticable (SA 501, paragraph 4).
- A count on another date needs testing of movements to year end (paragraph 5).
- Inconvenience or cost does not make attendance impracticable (A12).
- Third-party stock is confirmed or inspected (paragraph 8).
- Valuation and cut-off are tested separately from the count.
Read next
- Audit of property, plant and equipment
- Audit of revenue and trade receivables
- SA 501, inventory count, litigation and segments
- Internal audit of procurement and inventory
Disclaimer: Based on the Standards on Auditing, the review, assurance and related services standards, the Compendium of Standards on Internal Audit (as on 1 October 2022) and the Compendium of Forensic Accounting and Investigation Standards (as on September 2025) issued by the Institute of Chartered Accountants of India, in the versions named in the article, as consulted on 4 October 2026. ICAI revises standards from time to time; check the current text and effective dates on icai.org and the Companies Act provisions referred to. This article is general information, not legal advice; check the official text before acting.