Background

Work patterns have changed in recent years, with many auditors - and staff at audited entities - working remotely and spending less time in the office. Environmental and economic factors continue to impact local and international travel and other decisions. Consequently, some auditors may need to conduct inventory counts remotely. It is important, however, to ensure that audit work performed remotely still achieves the same robustness of testing and audit evidence.

ISA requirements

ISA 501 requires auditors to attend inventory counts where inventory is material, unless impractical, to provide audit evidence relating to existence and condition. Where a count is conducted at a date other than the year end, additional procedures are required to cover the intervening period.

Where inventory counts are performed by management and auditors are not able, willing or permitted to attend, auditors should seek to perform alternative audit procedures. Alternative procedures, such as gathering evidence through remote means, may be possible. The Audit and Assurance Faculty's guides Remote auditing in practice and Remote auditing FAQs discuss some of the issues around this. In some cases, it may be possible to verify without physical verification, although materiality needs to be considered.

Where alternative audit procedures cannot be performed then there may be no alternative to a limitation of scope in the audit opinion. In some cases, a disclaimer of the audit opinion may be necessary if the impact is both material and pervasive. Qualifications arising from a limitation of scope of the audit are more likely to be issued than disclaimers of opinion, which are relatively rare.

This guide explores these issues further and answers some common questions raised by auditors in the UK and elsewhere on alternative audit procedures for testing inventory.

Common questions

Management has cancelled the inventory count and intends to use a book value or estimate instead. What should I do?

If management has cancelled the inventory count, you should consider the impact on your risk assessment, your audit approach, and the balance of substantive procedures and tests of controls. The inventory count represents an important control in many cases. The risk of theft remaining undetected, for example, might increase in such cases. All of the alternative procedures set out elsewhere in this document may be considered in such cases. Enhanced basic procedures such as analytical procedures and testing after the year end may also be appropriate, but it may be difficult to obtain sufficient appropriate audit evidence relating to the existence and condition of inventory at the balance sheet date.

This is the second year the inventory count has required alternative procedures, what should I do?

It may be helpful to consider the following questions:

• What was your audit opinion last year? If you were able to obtain sufficient, appropriate audit evidence last year, consider whether any circumstances have changed in the past year that may impact you this year.
• If you were unable to obtain sufficient, appropriate audit evidence last year, consider the impact on opening balances, and whether there may need to be a restatement in the accounts.
• Where your opinion was modified previously, what will you be able to do differently this year?
• Are there any lessons to take from other audits and/or different procedures that can be implemented? Have you been able to do any interim work?
• Has management potentially installed additional inventory controls and/or inventory management and monitoring systems?

Where possible, it will be helpful to engage early with management to discuss potential problem areas, as well as alternative procedures.

Can management change the entity's year end to move their inventory count?

Yes, it is possible for management to change the entity's year end to facilitate an inventory count, however, it could have tax, filing and other implications, which management will need to consider when making this decision. Other factors to consider might include whether any challenging macro conditions, such as supply chain disruption, high energy prices, and other logistical limitations might still be present at the revised year end and in future periods.

There may also be restrictions on changing the year end and/or eligibility requirements which may need to be met. For example, in the UK, there are restrictions in relation to lengthening accounting periods if entities have done so before in the past five years. Entities are permitted to shorten accounting periods in the UK as many times as desired.

I don't feel comfortable sending my staff to do an overseas inventory audit, given current UK Foreign Office advice. Should I suggest that management delays the inventory count for a number of months?

Auditors should review UK Foreign Office advice and any restrictions in the applicable jurisdiction prior to any inventory audit. When guidelines warn against travel and/or restrictions apply, you may need to consider cancelling or delaying attendance at inventory counts to safeguard the wellbeing of your staff.

If conditions worsen, or restrictions remain in place, delaying inventory counts may not improve the ability of management or auditors to perform appropriate procedures. You may need to ultimately limit the scope of your audit opinion in any case.

If management does decide to perform a count after the year end, and you are able, willing and permitted to attend, you may be able to perform roll-back testing procedures after the year end. This would involve auditing management's reconciliation of the inventory counted with the year end inventory. A long time lag may provide an opportunity for conditions to improve, but the longer the delay, the less likely it is that a reconciliation will be possible. This, however, will depend on the extent of inventory movements, which may be affected by supply chain issues in certain industries.

You should consider whether inventory will be accessible during the intervening period ie, whether warehouses and other relevant premises are likely to remain open. You should plan how you will reconcile movements in the light of the accounting system, type of inventory and volume of transactions, and how you will assess the condition of inventory at the year end, which will depend on the typical life of the inventory. You may need to consider how often inventory turns over - a high volume of transactions may make a roll-back difficult and the reconciliation may be more complicated for manufacturers with raw materials and WIP, as well as finished goods.

Management has closed its warehouse over the year end; what issues should I consider when it reopens?

If the warehouse was closed prior to the year end and remained closed over that year end, management might decide to perform a physical inventory count before trading begins for the next year. The extent to which this provides sufficient appropriate audit evidence relating to inventory held at the year end depends on whether, for example, evidence exists to demonstrate that no inventory has been removed or added over the period. This would include physical controls, such as security systems to prevent theft of inventory, and CCTV footage.

As with a roll-back or roll-forward, evidence will be needed relating to the condition of the inventory at the year end.

As with a roll-back or roll-forward, it may not be possible to obtain sufficient appropriate audit evidence in these cases.

Management only performs inventory counts once a year, but has asked me not to attend due to health and safety concerns. What should I do?

You may want to consider counting at an alternative date, performing a roll-back or roll-forward, or consider alternative procedures.

Arranging to visit the site to conduct your tests when the relevant premises are closed and no staff are present will not provide audit evidence relating to inventory counting procedures, and the substantive evidence based on sampling procedures it would provide relating to the existence and condition of inventory would be very limited. You may need to limit the scope of your audit opinion in such cases.

Can I use technology, such as video conferencing or use of robotics, to attend the inventory count remotely?

New technology, such as drones or remotely controlled robotics, might help with your inventory testing in some cases, but you should consider legal restrictions on the use of such technology in close proximity to people. If you do decide to use such technology, you should consider the following limitations:

• Who will be controlling the device(s), and how and where are the cameras directed? If you are not in control, there is a risk that the video footage may be manipulated.
• How will you obtain evidence regarding completeness? Do cameras allow you to see all of the inventory at any point in time? There is a risk that things are hidden out of frame or that items are moved in and out of frame.
• Can the condition of the inventory be assessed? If videos lack resolution, you may not be able to see indications of damage. Video footage may not be appropriate for assessing the condition of all inventory.
• Does the technology rely on a strong wi-fi connection and is that stable across the entire site? If wi-fi drops out within certain areas of the location this may impede the auditor's testing.
• How will you select samples for testing, and will you increase their size to reflect the increased risk? If communicated prior to the count, this could allow for manipulation. Unpredictability, and only selecting on the call items to be counted, from both floor to sheet, and sheet to floor, will help to reduce this risk.
• Do you need to adjust your sample sizes, given these issues?
• How experienced are your staff who are involved with the count? Given the technology limitations, you will likely want to use staff with prior experience of inventory counts. You may also find it helpful to have more than one member of staff involved or to take recordings which can be reviewed by multiple members of the team.

Depending on the nature of the inventory, virtual reviews may be inappropriate or unreliable. If alternative procedures cannot be performed, you may need to limit the scope of your opinion.

If certain types of inventory are more easily reviewed - such as finished goods rather than raw materials or WIP - comfort might be obtained in some cases on part of the inventory balance, with other procedures undertaken to test the remaining items.

This is unlikely to constitute sufficient appropriate audit evidence in its own right and therefore, will most likely need to form part of a package of alternative procedures. You should inform management that the remote review may not be sufficient by itself. If possible, consider doing a count at a later date.

You should understand and assess the risks of conducting inventory tests remotely. Processes should be documented clearly on the audit file.

Management are limiting non-employee visits to their sites. Could I ask the internal auditors to attend on my behalf?

ISA 610 Using the Work of Internal Auditors sets out requirements and guidance for external auditors where local laws or regulation allow them to use the work of internal auditors. UK auditors should note that the FRC prohibits the use of internal auditors by external auditors for audits conducted in accordance with ISAs (UK). However, it may be permitted elsewhere. You should check local requirements before proceeding.

When considering relying on internal auditors, you should consider:

• Are there any threats to the independence of the internal auditors, actual or perceived?
• Are the internal auditors competent to do this work? It is possible that staff absences will reduce their resources?
• How systematic and disciplined has their work been in the past? It may not be appropriate to rely on internal auditors in certain cases.

You should also consider the safety of those you ask to work on your behalf. If management are not already planning on sending internal audit staff to attend, it would not be appropriate for you to ask them to attend in your absence.

The entity's inventories are held by a third party who sends confirmations. Do I need to do anything more on this?

You should consider whether third party confirmations remain reliable. For example, you may have concerns over the reliability of manual controls at such organisations. If controls are less reliable, you may need to consider whether any of the additional alternative procedures mentioned previously are suitable for third party confirmations.

The entity has a perpetual inventory counting system – what does that mean for my testing?

Some businesses count their inventory on a rolling basis throughout the year. All inventory is counted at least once a year and records are kept up to date at all times ('perpetual counting and recording systems'). Where such systems are in place, they represent important controls over inventory and inventory records. A year end count may or may not be performed in conjunction with this type of system. Other businesses may count all or part of their inventory on a periodic or cyclical basis but do not maintain perpetual records.

If you and management have tested the operation of perpetual counting and recording systems during the year, controls are found to be effective, and substantive tests have also been performed, only a limited level of testing may be required at the year end. The inability to attend a full or partial year end count will be less of an obstacle to obtaining sufficient appropriate audit evidence than would be the case were such a system not in place. However, you should consider whether controls have been operating effectively and if controls reliance is appropriate. It is possible that staff absences or warehouse closures will have impacted how controls operate, making it inappropriate to rely on controls.

Assessing the results of alternative procedures

There may be other relevant considerations. Each individual engagement will need to be assessed on a case-by-case basis to determine what more, if anything, may be appropriate.

You should consider whether alternative procedures have fulfilled the requirements of ISA 501 and in particular whether sufficient appropriate evidence has been obtained. If, despite using alternative procedures, the requirements of ISA 501 are not met, you will need to modify the audit opinion under ISA 705.

This guide may also be relevant to auditors outside the UK performing audits under local ISA variants.

The Audit and Assurance Faculty has prepared guides which provide advice when preparing modified audit opinions. ICAEW members can also contact the Technical Advisory Service on +44 (0)1908 248 250 or e-mail technicalenquiries@icaew.com.