The Inventory Cut-Off That Nobody Owned
You are the audit senior on the December year-end audit of Fenwick Components Ltd, a manufacturer with £18m revenue. Inventory of £2.4m is material (10% of total assets) and the client's count is scheduled for 31 December at a single warehouse. Two weeks before the count, the warehouse manager resigns and is not replaced. The financial controller tells you the count will proceed with two junior stores clerks and that 'the system report will do the cut-off for us'. Last year's file records a £140k prior-year adjustment for goods received but not invoiced. You have not yet tested the perpetual inventory system's controls, and the client has a £600k bank covenant tested on year-end inventory. The engagement partner asks you to finalise the count attendance plan by Friday.
1. Assess the risks arising and recommend how the audit team should respond to the count arrangements, justifying your attendance decision.
Read the worked answer
Risk assessment. Inventory is material (£2.4m, 10% of total assets) and the covenant creates pressure to overstate it, which raises inherent risk. The loss of the warehouse manager removes the person with custody knowledge and weakens the segregation of duties: the same two clerks will likely count and record. The controller's reliance on 'the system report' assumes the perpetual system is accurate, but you have not tested it, so control risk cannot be assessed as low. The prior-year £140k cut-off adjustment signals a recurring cut-off weakness rather than a one-off.
Response. Attendance is not optional here: the risk is significant and the count is the primary source of evidence. The team should attend, and because of the control vacuum, observe rather than merely inspect. Practical steps:
- Obtain and review the client's written count instructions before the count; if none exist, ask the controller to issue them and confirm the two clerks understand the two-person count-and-record rule.
- Test the count on a sample basis, recording the last goods-received numbers and last despatch numbers either side of the cut-off.
- Inspect the receiving and despatch records around 31 December and trace to inventory records and purchase/sales ledgers.
- Because the system is untested, perform substantive tests of the perpetual records, including a roll-forward from the count date to year-end if the count is not at year-end.
- Document the control deficiency and communicate it to those charged with governance in the management letter.
The partner should also consider whether the covenant pressure requires heightened professional scepticism and a review of any post-year-end returns or credit notes.
2. The controller proposes to move the count to 15 December to 'avoid the holiday period'. What are the audit implications and what would you recommend?
Read the worked answer
A count before year-end means the year-end inventory balance depends on the accuracy of the roll-forward of transactions between the count date and 31 December. That roll-forward is only reliable if purchases, sales, returns and write-offs are completely and accurately recorded, and you have not yet tested those controls.
The risks are:
- Cut-off errors in the intervening 16 days, especially given the prior-year cut-off adjustment.
- Unrecorded movements, for example goods received but not invoiced or goods despatched but not invoiced.
- Window dressing, where inventory is deliberately overstated at year-end after the count has been taken.
Recommendation. Prefer a year-end count. If the client insists, accept only if you can obtain sufficient appropriate evidence over the roll-forward: test the completeness and accuracy of the perpetual records for the period, reconcile the count to the ledger at 15 December, and review large or unusual movements. You may also need to attend a second, smaller count or perform a year-end physical observation of high-risk lines. Document the rationale and discuss with the partner; if evidence remains insufficient, consider a modified opinion on inventory.