The Rotterdam count: three findings on the last day of the year
You are the senior auditor on the statutory audit of Nordwind Logistics SA, a listed group with consolidated revenue of €310m. Overall materiality is €450,000. On 28 December you observe the year-end inventory count at the Rotterdam warehouse, where three matters arise. First, 40 pallets of electronic components with a book value of €1.2m stand in a fenced area labelled 'customer returns - pending inspection'; the warehouse manager says the goods belong to a customer, but no agreement or credit note is produced. Second, a consignment invoiced on 22 December for €680,000 is still on the loading dock; the contract states that title and risk pass on delivery to the customer's site, scheduled for 6 January. Third, the client's cycle-count sheet shows a 3.1% variance on the bin locations counted, which the controller describes as 'immaterial counting noise' and has not posted. Your group auditor in Warsaw requires clearance by 20 January and the engagement partner signs on 24 January.
1. Assess each of the three findings as an audit risk, quantify where possible, and state the response you would design for each, given overall materiality of €450,000.
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Finding 1 - pallets, €1.2m (2.7× materiality). Assertions at stake: existence and rights and obligations of inventory, and possibly occurrence of a prior sale. A verbal claim of customer ownership is not evidence. Response: obtain the customer agreement and the returns policy; inspect the pallets' condition and any customer labels; confirm directly with the customer; trace subsequent January shipments and credit notes to see whether these goods were ever derecognised. If ownership cannot be evidenced, treat them as Nordwind inventory and test net realisable value (electronic components are exposed to obsolescence). Unresolved, this is a material misstatement, not a disclosure matter.
Finding 2 - €680k invoiced 22 December. This is a cut-off issue and, at €680k, individually material. Response: read the delivery clause and any Incoterms, obtain January proof of delivery, check the accounting period in which the revenue and the related cost of sales were booked, and propose derecognition of revenue and receivable with reinstatement of inventory if risk has not passed. Because a recurring December pattern is a fraud-risk indicator under ISA 240, extend the test to all December shipments near the year-end.
Finding 3 - 3.1% variance. Convert it to money by applying 3.1% to the value of the locations counted; on, say, €6m of stock that is about €186k. Below materiality alone, but the refusal to post is a control deficiency and a management-bias indicator. Response: reperform a sample of the counting, evaluate the client's posting threshold, and aggregate with the other findings.
2. The controller refuses to post the cycle-count variance and says the 3.1% is 'normal' for a warehouse of this size. How do you proceed, and what do you communicate to the group auditor before 20 January?
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The controller's refusal is not itself a misstatement, but it removes the evidential basis for relying on the client's count and it signals possible bias. Document the request made, the refusal and the reasons given, because the file must show both.
Steps: (i) convert the variance into a monetary amount so the discussion is about materiality, not percentages; (ii) obtain the count sheets, the client's historical variance trend and the posting threshold applied in prior years - a threshold set just above the observed variance level is itself a finding; (iii) reperform counts on a sample of the locations with the largest variance and extend the sample if errors are found; (iv) assess whether the variance affects the inventory figure as a whole or is offset elsewhere.
Communication to the group auditor: send an interim memorandum now, not on 20 January, listing the three findings, their monetary size, the evidence obtained and the open items with the dates by which answers are needed. Flag the cut-off item as potentially material at group level and state that the inventory population may require an adjustment. If the controller still refuses and the aggregate effect is material, escalate to those charged with governance and record the matter as an uncorrected misstatement in the management letter. Silence until the deadline transfers the risk to you.
3. Assume the customer confirms in writing that the 40 pallets are its property but asks Nordwind to hold them free of charge until March. What changes in your audit approach?
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Written third-party confirmation of the customer's ownership is good evidence for rights and obligations, but it does not close the matter. Three consequences follow.
First, the goods must be excluded from Nordwind's inventory and any prior revenue must be examined: if they were sold earlier and returned, the credit note and the revenue reversal must appear in the correct period; if they were never sold, only the custody note is needed. Trace the €1.2m to the stock ledger and to the sales and returns accounts.
Second, free storage creates a separate obligation. Check whether a liability or a provision is needed for the storage cost, whether an onerous or service contract exists, and whether the arrangement is disclosed. Immaterial in amount, perhaps, but it shows whether the arrangement is really as described.
Third, the confirmation changes the risk from existence to classification and presentation. Update the risk assessment, reduce the inventory testing on this population, but keep the January cut-off work because the same warehouse handled the €680k consignment. Note in the file that the confirmation was obtained directly by the auditor rather than through the client.