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VALUATION
OF INVENTORIES
JUNE 2011
not be recoverable if the estimated costs of completion or
INTRODUCTION the estimated costs to be incurred to make the sale have
increased. The practice of writing inventories down below
1. For companies whose principal activities are mainly cost to net realisable value is consistent with the view that
trading, import and export of goods and assets should not be carried in excess of amounts
manufacturing, the inventory balance is usually a expected to be realised from their sale or use (FRS 2,
material item on the balance sheet. Coupled with paragraph 28).
the fact that some inventories may be more
susceptible to the risk of obsolescence, it is 7. In each financial period, a new assessment is made by
important for auditors to perform adequate audit management to determine the carrying value of
procedures to obtain audit evidence on the valuation inventories to ensure that inventories are stated at
assertion of inventory balances. lower of cost and net realisable value. When the
circumstances that previously caused inventories to
2. Clarified Singapore Standard of Auditing (SSA) 315 be written down below cost no longer exist or when
states that the assertions about account balances at there is clear evidence of an increase in net realisable
the period end include Valuation and allocation value because of changed economic circumstances,
assets, liabilities, and equity interests are included in the amount of the write-down is reversed (i.e. the
the financial statements at appropriate amounts and reversal is limited to the amount of the original write-
any resulting valuation or allocation adjustments are down) so that the new carrying amount is the lower of
appropriately recorded *Paragraph A111(b)(iv)+. the cost and the revised net realisable value. This
occurs, for example, when an item of inventory that is
carried at net realisable value, because its selling price
3. This Practical Guidance focuses on valuation of
has declined, is still on hand in a subsequent period
inventories (excluding construction or project work-
and its selling price has increased (FRS 2, paragraph
in-progress) and is intended to provide some
33).
practical guidance to auditors when performing audit
procedures in the following areas:
8. FRS 21 The Effects of Changes in Foreign Exchange
(a) Unit cost test under the first-in, first-out
Rates states that non-monetary items that are
(FIFO) and weighted average cost formulas;
measured in terms of historical cost in a foreign
(b) Net realisable value test; and
currency shall be translated using the exchange rate at
(c) Translation of inventories denominated in foreign
the date of the transaction (FRS 21, paragraph 23b).
currencies.
In the application of FRS 21, inventories are non-
monetary items.
For a more detailed discussion on the issue of
inventory obsolescence, please refer to Practical
Guidance No. 1 on Inventory Obsolescence.
PERFORMING UNIT COST TEST
11. If there are discrepancies in the samples tested for unit 14. Often, companies rely on their inventory systems to
cost test, the auditor needs to consider the calculate the weighted average costing of inventories.
requirements of Clarified SSA 530 Audit Sampling. Unless the integrity of the inventory systems has
Specifically, paragraph A18, A19 and A22 of Clarified been tested and verified, the auditor should not rely
SSA 530 requires the auditor to project misstatements solely on the weighted average costing generated by
for the population to obtain a broad view of the scale of the inventory systems and deem it to be appropriate.
misstatement (paragraph A18). When a misstatement The auditor should request for the detailed
has been established as an anomaly, it may be excluded movements of inventories, verify to the relevant
when projecting misstatements to the population. supporting documents such as supplier invoices (for
However, the effect of any such misstatement, if purchases) and sales invoices (for sales) and test
uncorrected, still needs to be considered in addition to check the accuracy of the weighted average costing.
the projection of the non-anomalous misstatements
(paragraph A19). In the case of tests of details, the 15. The auditor may face a situation where the
projected misstatement plus anomalous misstatement, companys inventory system cannot generate the
if any, is the auditors best estimate of misstatement in detailed movements of inventories during the
the population. When the projected misstatement plus financial year. In such instances, the auditor can
anomalous misstatement, if any, exceeds tolerable consider assessing the inventory turnover of the
misstatement, the sample does not provide a selected inventory item. If the inventory turnover of
reasonable basis for conclusions about the population that selected item is fast, vouching to the most recent
that has been tested. The closer the projected supplier invoices may be an acceptable alternative to
misstatement plus anomalous misstatement is to testing the weighted average costing assuming that
tolerable misstatement, the more likely that actual the auditor has verified the sales and purchases
misstatement in the population may exceed tolerable transactions with no exceptions noted and therefore
misstatement (paragraph A22). can be relied upon to compute the inventory
turnover of that selected item. The appropriateness
12. Furthermore, it is not uncommon for inventories to be of the alternative audit procedure is a matter of
purchased from overseas suppliers. In such instances, professional judgment.
the auditor needs to ensure that the related inward
freight charges, if material, have been taken into 16. However, in the event that inventory turnover is very
account in the cost of inventories in accordance with slow, the auditor may have to test the individual
paragraph 10 of FRS 2. Some companies may not have inventory movements to ascertain that the weighted
capitalised such inward freight costs. The auditor can average costing is applied correctly. By virtue of
consider estimating the amount of inward freight costs having a slow inventory turnover, this probably
to be capitalised by assessing the inventory turnover for indicates that inventory movements are minimal
each category of inventory and applying the inward during the financial year and it may not be too
freight costs associated with that category of inventory. difficult for the company to produce the information
For example, if the inventory turnover is, say, 60 days, for the auditor to perform the testing.
this indicates that the inward freight costs for the last 2
months of the financial year may need to be capitalised
PERFORMING NET REALISABLE VALUE TEST adjusted for. This approach may be applied on the
assumption that the company does not have many
17. In performing net realisable value test, the auditor should product lines and each product line have similar
inspect the sales invoices subsequent to year end as this turnover period. In addition, the use of average
is more reflective of the realisable value of the exchange rates should only be used when there are
inventories as at that date. If there are no subsequent no major fluctuations noted in the exchange rates
year end sales, the auditor should consider if sales over the relevant period, and that the purchase
completed close to year end can be used as an patterns do not vary significantly from batch to batch.
alternative. If not, the auditor should consider replacing
the samples without subsequent year end sales to CONCLUSION
complete the testing. Paragraph 10 of Clarified SSA 530
states that if the audit procedure is not applicable to the 22. The requirement for inventories to be stated at the
selected item, the auditor shall perform the procedure on lower of cost and net realisable value is stipulated in
a replacement item. Paragraph A14 of Clarified SSA 530 FRS 2. As inventory is a common significant balance
further states that the auditor must be satisfied that the sheet item, the auditor will need to be vigilant in
original selected item is not applicable for the audit performing the audit procedures to ensure they are
procedure such that it does not constitute a deviation not materially misstated.
and an appropriately chosen replacement is examined.
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