Inventory observation definition
/What is an Inventory Observation?
An inventory observation is the oversight of a client's inventory counting process by an outside auditor. This oversight work includes a number of tasks, including the following:
Verifying that all inventory was counted
Physically inspecting inventory items. This is an examination of their condition, to see if any items have been damaged or are obsolete. This could be grounds for creating a larger reserve for obsolete inventory.
Testing a sample of the counts made by client employees
Reviewing the client's counting policies and procedures
Reviewing the extended cost calculations made by employees
Advantages of Conducting an Inventory Observation
There are several advantages associated with conducting an inventory observation, which are as follows:
Improved record accuracy. Observing an inventory helps to ensure that recorded quantities of inventory match the actual amounts on hand. This can reduce discrepancies that may arise due to errors, fraud, or outdated records.
Identification of obsolete inventory. Someone conducting an inventory observation is in a good position to identify items that may be damaged, expired, or obsolete, which may not be apparent through records alone
Improved financial reporting. Since inventory can be one of the largest assets on the balance sheet, inventory observations can lead to a more accurate asset valuation, which in turn improves the accuracy of an entity’s balance sheet.
Enhanced fraud detection. By observing inventory in person, auditors and managers can detect unusual patterns, such as excessive shrinkage, which might indicate theft or fraud.