Attending a stock count is one of the most visible audit procedures, but the auditor's job is not to watch staff count boxes. When inventory is material to the financial statements, SA 501, Audit Evidence: Specific Considerations for Selected Items, requires the auditor to obtain sufficient appropriate audit evidence about the existence and condition of inventory by attending physical inventory counting, unless that is impracticable. For company audits, the same count also feeds the auditor's reporting on physical verification under CARO 2020. This guide covers what SA 501 requires, how to plan and run count-day procedures, how to handle cut-off and counts on another date, and two worked examples you can adapt for your file.
What SA 501 requires on inventory
The inventory requirements sit in paragraphs 4 to 8 of SA 501.
| Paragraph | Situation | What the auditor shall do |
|---|---|---|
| 4 | Inventory is material | Attend physical inventory counting, unless impracticable, to evaluate management's instructions and procedures for recording and controlling the count, observe management's count procedures, inspect the inventory and perform test counts |
| 5 | Count is held on a date other than the date of the financial statements | In addition to paragraph 4, perform procedures to obtain evidence on whether changes in inventory between the count date and the balance sheet date are properly recorded |
| 6 | Auditor cannot attend because of unforeseen circumstances | Make or observe some physical counts on an alternative date and perform procedures on intervening transactions |
| 7 | Attendance is impracticable | Perform alternative audit procedures; if sufficient appropriate evidence still cannot be obtained, modify the opinion under SA 705 |
| 8 | Material inventory is held by a third party | Request confirmation from the third party of quantities and condition, or perform inspection or other appropriate procedures |
Management performs the count and remains responsible for the financial statements. The auditor observes and tests the process. Seeing goods in a warehouse gives evidence of existence and condition; it does not by itself establish ownership or the value at which the goods should be carried.
Planning the attendance
The application guidance to SA 501 lists matters relevant to planning attendance. They include the nature of inventory, the stages of completion of work in progress, the risks of material misstatement related to inventory, the nature of internal control over inventory, the timing of the count, whether a perpetual inventory system is maintained, and the locations at which inventory is held, including the materiality and risks at each location.
Read management's count instructions before the count. The application guidance expects them to address the application of control activities, accurate identification of the stage of completion of work in progress and of damaged items, the procedures used to estimate quantities where needed, and control over movement of inventory between areas and over shipping and receipt before and after the cut-off date.
The ICAI's Guidance Note on Audit of Inventories covers the same ground from the practitioner's side: the need for attendance at stock taking, the methods and procedures for stock taking, factors in assessing its adequacy, movement of stocks during counting and cut-off procedures, along with confirmations from third parties holding inventory.
On count day: observe, inspect, test
A sound attendance programme has three strands.
- Observe whether counting teams follow the instructions: areas are sealed or marked once counted, tags are issued and returned in sequence, and goods do not move during the count without documentation.
- Inspect the inventory for existence and condition. Note damaged, expired, slow-moving and obsolete items for the later valuation review.
- Test count independently and record enough detail (location, item code, tag number, quantity) to trace each test count to the final listing later.
Test counts in both directions
SA 501's application guidance explains that tracing items selected from management's count records to the physical inventory, and tracing items selected from the physical inventory to management's count records, provides evidence about the completeness and accuracy of those records. In practice, sheet-to-floor tests address existence (is the item really there?) and floor-to-sheet tests address completeness (was everything on the floor recorded?). Weight the mix according to the risk you are addressing.
After the count, trace your test counts to the final inventory listing and investigate differences and count adjustments. A good count is of little use if the priced listing that reaches the ledger differs from what was counted.
Cut-off: a correct count can still give a wrong balance
A physically accurate count still misstates year-end inventory if purchases, sales and transfers fall in the wrong period. Record the last and first goods receipt notes, delivery challans or dispatch notes and inter-location transfers around the count and the reporting date. Goods dispatched before year-end but still in the inventory records overstate inventory if ownership has passed to the customer; goods received before year-end but left out of the count and the purchase records understate both inventory and liabilities. The accounting answer depends on the contract terms and the applicable framework, not only on where the goods physically sit.
Worked example 1: tracing a count difference to the final listing
Product RM-17 is counted at the close of 31 March. The ledger shows 1,000 units. Management's count and the auditor's recount both show 980 units. Cost is Rs 200 per unit, supported separately by the costing records.
| Workpaper item | Units | Evidence or result |
|---|---|---|
| Ledger before count adjustments | 1,000 | Dated product ledger retained |
| Physical quantity | 980 | Count sheet C-42 and independent recount |
| Difference | 20 | 1,000 less 980; investigate before proposing an entry |
| Dispatch omitted from ledger | 20 | Dispatch note D-318 dated 31 March, agreed to delivery evidence and contract terms |
| Corrected closing quantity | 980 | Agrees to count and final listing |
Here the contract and delivery evidence show that the goods should no longer be in the seller's inventory. Inventory was overstated by 20 x Rs 200 = Rs 4,000, and the corrected amount for this item is 980 x Rs 200 = Rs 1,96,000 before any valuation adjustment. Trace the Rs 4,000 correction to the final listing and the general ledger, and check the related sales and cost entries separately.
If 10 of the 980 units are damaged, they remain part of the physical quantity. Flag them for valuation; do not deduct them from the count. And without evidence for a difference, do not label it a dispatch error to make the working balance. This is one tested item, not a conclusion on the whole warehouse.
Counts on another date and missed counts
Under paragraph 5, a count held before or after the balance sheet date is acceptable only with procedures on the movement in between. The application guidance links this to the effectiveness of controls over changes in inventory and to the reliability of perpetual records, including the reasons for significant differences between the count and those records.
Worked example 2: rolling forward a 15 March count
A company counts finished goods item FG-4 on 15 March and closes its books on 31 March. The count shows 1,200 units. Between 16 and 31 March the perpetual records show receipts from production of 300 units and dispatches of 450 units. The expected year-end quantity is 1,200 + 300 less 450 = 1,050 units. The auditor tests a sample of the production receipts and dispatches to source documents and cut-off, then agrees 1,050 units to the year-end listing. The longer the gap and the weaker the controls, the more testing the roll-forward needs.
Paragraph 6 and paragraph 7 deal with different situations. If an unforeseen event stops the auditor attending on the planned date, the auditor must make or observe some counts on another date and test the intervening transactions. Impracticability under paragraph 7 is a different matter. General inconvenience, travel cost or a scheduling clash does not make attendance impracticable. If alternative procedures cannot give sufficient appropriate evidence, SA 705 applies.
Inventory held by third parties
Stock with a warehouse keeper, job worker, processor or consignee is covered by paragraph 8: request confirmation from the third party of quantities and condition, or perform inspection or other suitable procedures. Consider the third party's independence and reliability, whether the confirmation reply can be trusted, and whether documents support the entity's ownership. Where the balance is large or the custodian's integrity is in doubt, inspect as well as confirm.
CARO 2020: reporting on physical verification
For companies covered by the Companies (Auditor's Report) Order, 2020 (S.O. 849(E) dated 25 February 2020), clause 3(ii)(a), as explained in the ICAI's Guidance Note on CARO 2020, requires the auditor to report whether management conducted physical verification of inventory at reasonable intervals, whether the coverage and procedure of verification is appropriate, whether discrepancies of 10% or more in the aggregate for each class of inventory were noticed, and whether they were properly dealt with in the books.
The 10% test is applied class by class, not item by item. Suppose book raw material stock is Rs 45,00,000 and the physical count values it at Rs 40,20,000. The discrepancy is Rs 4,80,000, which is 10.67% of the book amount, so it must be reported with how it was dealt with. Finished goods of Rs 26,00,000 in the books against Rs 24,80,000 counted gives a discrepancy of Rs 1,20,000, or 4.62%, below the reporting threshold, though it still needs investigation and correction. Your SA 501 attendance papers are the main evidence for these comments.
Inventory count audit file checklist
- Understand the inventory: locations, categories, material balances, high-value items, obsolete stock and goods held by or for third parties.
- Review count instructions: tag control, movement control, identification of damaged and obsolete items, recounts and cut-off.
- Plan test counts covering both existence and completeness, with enough detail to reperform the trace.
- Observe the count and note departures from instructions, uncontrolled movements, and missing or duplicate tags.
- Inspect condition and list items needing valuation attention.
- Capture cut-off documents: last and first receipt, dispatch and transfer documents.
- Test roll-forward or roll-back movements if the count date differs from the balance sheet date.
- Confirm or inspect third-party stock based on materiality and risk.
- Trace test counts to the final listing and the ledger, and investigate adjustments.
- Compute class-wise discrepancies for CARO clause 3(ii)(a) and check their treatment in the books.
- Document conclusions: locations attended, procedures performed, exceptions and how sufficient appropriate evidence was obtained, or why the opinion needs modification.
Updated on 27 September 2026: retitled, merged the stock verification checklist duplicate, added the paragraph-by-paragraph SA 501 table, planning and instruction points from its application guidance, a roll-forward example and CARO 2020 clause 3(ii)(a) reporting with a class-wise 10% example.
