Inventory Audit Procedure for Manufacturers
Last updated: 16 October 2026
Quick Answer: An inventory audit procedure for a manufacturer has six stages, from stores floor to stock register: plan, count, cut-off, reconcile, value and report. Together they test existence, ownership, cut-off and valuation at the lower of cost and net realisable value. Where CARO 2020 applies, the auditor reports a net difference of 10% or more in any class.
Many stock differences at a mid-size plant come from paperwork, not theft: a receipt posted late, scrap never booked, material at a job worker, or work in progress counted at the wrong stage. A written inventory audit procedure finds them before the year-end audit or the lender does.
What Does an Inventory Audit Test in a Factory?
Whether booked stock exists, belongs to the company, sits in the correct period and carries the right value. Stock verification, the physical count compared with the records, is one part of it; the audit adds cut-off, reconciliation and valuation.
| Assertion | The question it answers | Main test |
|---|---|---|
| Existence | Is the booked stock physically there? | Test counts from count sheets to the floor |
| Completeness | Is everything on the floor in the books? | Test counts from the floor to the sheets |
| Ownership | Does the company own it? | Owner flags; confirmations for stock held outside |
| Cut-off | Is each movement in the right period? | Documents just before and after the count |
| Valuation | Is it at the lower of cost and net realisable value? | Cost build-up, ageing, item-wise value tests |
The audit runs class by class, and AS 2 names seven common classes, from raw materials and components through work-in-progress, finished goods and stock-in-trade to stores and spares, loose tools and others.
Inventory Audit Procedure in Six Steps
- Plan: fix the scope by class and location, the count date, the instructions and the team.
- Count: observe the count, run test counts both ways and control every count sheet.
- Cut-off: freeze or log movements, then test documents on either side of the count.
- Reconcile: match physical to book stock, recount large differences and post approved adjustments.
- Value: test the cost build-up, then age the stock against net realisable value.
- Report: set out differences by class, root causes, adjustments and control fixes.
How Should a Manufacturer Plan the Inventory Audit Procedure?
Planning puts four things in writing before anyone counts: scope, method, instructions and people.
Scope by class, location and value
List every place stock sits, including job workers, depots and goods in transit. ICAI guidance on CARO 2020 expects every material item to be verified at least once a year and suggests counting A items more often than B, and B more often than C. Compare inventory days and consumption per unit of output by class with last year; an unexplained shift earns extra test counts.
Periodic count or continuous verification
A periodic count covers every item on one date, at or near the year-end. Continuous verification spreads counts through the year so each material item is covered at least once a year.
Written count instructions
Under SA 501 the auditor evaluates management's count instructions and procedures. They cover pre-numbered sheets and the return of unused ones, recount rules, recording the stage of work-in-progress, tagging damaged, slow-moving and third-party stock, and the movement freeze.
Count Observation: What Happens on the Count Day?
The team counts, weighs or measures each item while an independent observer checks that the instructions are followed.
Attendance at physical inventory counting under SA 501 means evaluating instructions, observing procedures, inspecting the stock and performing test counts.
Weigh bulk material such as cotton bales, castings or steel scrap. Tag damaged, rusted or expired items, and list the slow-moving or non-moving items found at the count for the valuation stage.
Stock at warehouses, job workers and other sites
Material outside the plant is still company inventory. Count it on the same date, or obtain the holder's written confirmation and reconcile it to delivery challans and returns; SA 501 accepts confirmation, inspection or other suitable procedures, alone or together. For receiving, storage and dispatch controls at those sites, use the warehouse audit checklist.
How Does Cut-Off Testing for Inventory Work?
Cut-off testing checks that each receipt, issue and dispatch near the count date falls on the correct side of it. ICAI guidance suggests examining documents from shortly before and after the cut-off date.
| Document | What to check | Typical error |
|---|---|---|
| Goods receipt note | Received before the count: in both count and books | Bill booked while the lorry waits at the gate |
| Sales invoice and delivery challan | Invoiced before the count: off the floor | Invoice dated 31 March, goods dispatched in April |
| Material issue slip | Issues posted before work-in-progress is counted | Counted in stores and again on the floor |
| Job work challan | Lots at the job worker on the count date counted once, by confirmation | Returned lots received, never posted |
| Inter-plant transfer | In-transit stock counted once, under its class | Counted at both plants or neither |
If the count is not held on the balance sheet date, SA 501 also requires evidence that movements between the two dates were recorded properly. A count a week before 31 March therefore needs a roll-forward of that week.
Reconciling Count Results to the Stock Ledger
Item by item, then class by class, then to the general ledger. CARO 2020 does not cover every company, so confirm first that the Order applies to yours. Recount any item whose difference crosses a threshold set for its ABC class, then classify each difference: unposted document, wrong item code or unit, cut-off error, unbooked process loss, or actual loss. Post adjustments only after finance approves them.
At class level, paragraph 3(ii)(a) of CARO 2020 asks whether discrepancies of 10% or more in the aggregate for each class were noticed and properly dealt with in the books. ICAI guidance applies the test on value, net of excesses and shortages within the class, and a net excess is reportable too.
| Class (illustrative) | Book value | Physical value | Net difference |
|---|---|---|---|
| Raw materials and components | ₹3.40 crore | ₹3.31 crore | ₹9 lakh short |
| Stores and spares | ₹48 lakh | ₹42 lakh | ₹6 lakh short |
| Finished goods | ₹2.10 crore | ₹2.13 crore | ₹3 lakh excess |
Here stores and spares are 12.5% short against book, while raw materials differ by 2.6% and finished goods by 1.4%. A small class can cross 10% while the plant total looks clean. Where working capital limits above ₹5 crore in aggregate are sanctioned against current assets, paragraph 3(ii)(b) also checks that the quarterly returns or statements filed with the banks or financial institutions agree with the books.
How Should Inventory Valuation and Slow-Moving Stock Be Checked?
Test the cost build-up first and net realisable value second, because AS 2 values inventories at the lower of cost and net realisable value.
Cost build-up: materials, freight, labour and overheads
Purchase cost covers the price, non-recoverable duties and taxes, freight inwards and other direct acquisition costs, less trade discounts and rebates, so GST input tax credit the company claims stays out. Conversion cost adds direct labour and a systematic share of production overheads, with fixed overheads spread on normal capacity. Abnormal wastage, most storage, unrelated administration and selling costs stay out. Then check the cost formula: AS 2 assigns cost by FIFO or weighted average, and by specific identification only for items that are not ordinarily interchangeable or are segregated for specific projects. Confirm the formula used is the one stated in the accounting policy.
Net realisable value and slow-moving stock
Age the stock by its last issue, consumption or sale date, then test net realisable value item by item, or for groups of similar or related items, never for a whole class, wherever stock is damaged, obsolete or idle beyond the company's cut-off.
Inventory Audit Report Format: Five Parts
The report has five parts: scope and method, differences by class with root causes, adjustments posted, valuation findings, and control actions with owners and dates. Keep in one evidence file the records ICAI guidance lets an auditor examine: written instructions, count sheets signed by field staff and responsible officials, summary sheets, notes on issues raised and coverage by value.
Inventory Audit Checklist for the Count
Use this inventory audit checklist to sign off the count; any "no" needs a note and an owner.
Before the count:
- All locations listed, including job workers and goods in transit
- Racks labelled; customer-owned and consignment stock kept apart
- Movements frozen, or logged for the cut-off test
- Counting pairs briefed; none counts an area it manages
- Scales calibrated; units of measure match the ERP
During the count:
- Pre-numbered blind sheets issued and all returned
- Damaged, obsolete and idle items tagged in place
- Test counts by someone outside the stores team
After the count:
- Large differences recounted before adjustment
- Root cause and approval logged for each adjustment
- Class-wise net difference compared with the 10% trigger
- Report issued with control actions, owners and dates
Inventory Audit Programme: Test Steps, Evidence and Red Flags
These rows are illustrative; add your own plants and locations.
| Stage | Test step | Evidence to keep | Red flag |
|---|---|---|---|
| Plan | List every location and class with its book value | Location and class list approved by the CFO | Job-worker or depot stock missing |
| Count | Test counts from sheet to floor and floor to sheet | Test-count list showing both directions | Test items chosen by the stores team |
| Count | Record the stage of each work-in-progress lot | Route card or operation number on the sheet | Work-in-progress valued as finished goods |
| Cut-off | Trace documents dated around the count | List of GRNs, challans and issue slips | Receipts posted after the count but dated before it |
| Reconcile | Recount items above the agreed threshold | Recount sheets and root-cause log | Differences adjusted with no reason recorded |
| Reconcile | Compute the net difference by class on value | Class-wise working against 10% | Shortages in one class netted against another |
| Valuation | Recompute cost for sample items | Invoices, bill of materials, overhead working | Abnormal scrap or idle-time cost in closing stock |
| Valuation | Age the stock and test value item by item | Ageing report and recent selling prices | Old stock carried at full cost |
| Report | Agree physical value to the ledger and the quarterly returns or statements filed with the bank | Reconciliation signed by finance | Quarterly statement filed with the bank differs from the books |
Count sheet columns
- Sheet number, location and bin
- Item code, description and unit of measure
- Counted and recount quantities
- Condition and work-in-progress stage
- Owner flag: own, customer-owned or consignment
- Counter and checker signatures and time
Who Should Run the Inventory Audit: Your Team or an Outside Firm?
Either can run the inventory audit procedure, provided the people counting and testing do not keep the stock ledger they check. An in-house team knows the items; an outside team brings independence and crew for overnight counts across plants. When inventory is material, your auditor normally attends and test-counts for its own audit, yet the count stays management's responsibility.
Astral Business Consulting LLP, a Coimbatore-based management consulting and audit firm, offers stock counts and verification through its Cycle Count division, covering overnight counts, work-in-progress audits, third-party locations, cycle count verification and pan-India counts.
Where inventory is one cycle in a wider review, its process-based internal audit covers inventory management alongside indent-to-pay and order-to-cash for textile, engineering, dairy and other manufacturers.
Scoping an Inventory Audit for Your Plants?
If book and physical stock no longer agree, or the year-end count must stand up to your auditor, talk to the Cycle Count division of Astral Business Consulting LLP about scoping the count for your plants.