The Inventory problem
Many a times, not once, the inventory section gets a bigger share of queries than most sections in an audit. Does it deserve it? In my opinion, yes. The inventory section of the balance sheet is or can be much more problematic than it can appear, sometimes, it can be a cause for qualification of an audit report.
Inventory is a special item in financial statements. Unlike other sections, its balance affects both the credit and debit side of the balance sheet hence, it’s double edged effec is not something to dispense with so easily.
To an auditor, credit balances are prone to understatement (incompleteness) while debit balances are prone to overstatement (non-existence). On the other hand closing inventory balances appears both on credit (in the profit and loss account) and debit (in the balance sheet). What’s the risk? Understatement and overstatement. Both!
The above, is the auditor’s problem, who else cares? Or, at least, who else understands the grave risk in this area?
The auditor’s problem above is also not what I would like us to look into at the moment. The real issue is the inventory systems in businesses and how most times, businesses loose a lot due to inadequate inventory management systems and controls.
In my previous queries on the section, I have and I can reasonably estimate with high accuracy that many auditors have and will receive responses such as:
“Only the boss can resolve this issue, I really cant help much,” -by the Accountant.
“I am sure in your examination, you already know that we have never had any inventory records in place. The store key is only with Mr. Y, the director’s nephew and how much stock is in there, none of us knows” – the Senior Accountant.
“What I can say is that, we have had this inventory issue each year, we are trying hard to make things right, we need your assistance but the decision making on allocating time, resources and investing in the inventory systems, lies with the directors. I have presented this a number of times, hopefully, we will by next year.” – The Financial Controller. (You check the Management letter for the last 3 years, you find ML issues on inventory with the same “intelligent response.” So what do we do this year?
“I have had this same issue even with previous auditors, and I must say we really want to take it seriously and look into it. In the mean time . . . . . . . . . .(anything suitable can be said in view of getting a good report. Unknown, it’s the businesses that suffer more when they feel they are doing their best to impress the auditor.”
And many more . . . . .
And there, the problem lies.
It clear then that, the management trivializes the inventory issue, hence, they do not have time to ensure proper systems in place or;
The management does not understand the importance of having a proper inventory system in place to be able to invest into having a proper one in place or;
The key management are comfortable with the old order of doing things and are not ready to have any otherwise recommendations or;
Due to the nature of inventory, the management actually leaves the inventory gap unattended so that it can be tailored to suit their objective or;
The company grew too fast, the directors did not observe the change, and are stuck and do not actually know how best to go about overhauling the inventory system or automate to suit the growth.
What goes wrong without adequate Inventory Control Systems?