Inventory Price Testing: Vouching Cost, Testing Overhead and Checking Net Realizable Value

Counting inventory proves quantity. Price testing proves value. A count can be flawless and the balance still wrong if unit costs are stale, overhead is mis-absorbed or the stock is worth less than it cost. This post covers the three steps of the valuation test: cost, the extension and total, and the lower of cost and net realizable value. The accounting is in inventory costing, FIFO, average and NRV. For manufacturers, see also standard costing and overhead absorption.

Step 1: Get the priced listing and tie it out

Obtain the final priced inventory listing at the balance sheet date, with item number, description, location, quantity, unit cost, extended cost and cost category (raw materials, work in process, finished goods). Test:

• The listing's total ties to the ledger and the trial balance.
• Footing and cross-footing on the listing.
• Quantities agree to the count results, adjusted for the interval if the count was not at year end. See interim count roll-forward.
• Items counted are on the listing, and items on the listing were counted or explained.

A listing that does not tie to the ledger is not a reliable population for selection.

Step 2: Select items

Use monetary unit sampling or stratified selection so that high-value items have a higher chance of selection. See monetary unit sampling. Add targeted items: slow-moving stock, items with large cost changes, items with negative or zero quantities, and items with unit costs far from similar items. Select from every cost category and every location with material balances.

Step 3: Vouch purchased inventory cost

For raw materials and purchased finished goods:

1. Find the cost method. FIFO, weighted average, specific identification, or standard cost approximating actual. Confirm the client applies it consistently.
2. Agree the unit cost to a recent vendor invoice, for items bought in the period. For FIFO, find the most recent invoices that make up the quantity on hand. For average cost, test the computation of the average.
3. Include only costs that belong in inventory: purchase price, freight in, duties and handling to bring it to location. Exclude storage, selling and general costs.
4. Reduce for discounts and rebates the client is entitled to.
5. Check units of measure. An invoice per case and a listing per unit is a common source of error.
6. Recompute the extension: quantity times unit cost.

Step 4: Test manufactured inventory

For work in process and finished goods the cost includes materials, direct labor and absorbed overhead.

• Materials: agree to the bill of materials and vendor costs.
• Labor: agree labor rates to the payroll register and hours to routings or time records.
• Overhead: obtain the overhead pool, the allocation base and the rate. Test the pool for items that should not be included (selling, general and administrative costs, unallocated idle capacity), and the denominator for normal capacity.
• Standard costs: if standards are used, test how and when they were last updated, and the variance accounts. Large unabsorbed variances sitting in the ledger mean standards do not approximate actual cost, and inventory may need a variance allocation.
• Work in process: test stage of completion to production records and recompute the equivalent units.

Step 5: Apply lower of cost and net realizable value

For inventory measured under FIFO or average cost, the carrying amount must not exceed net realizable value: the estimated selling price in the ordinary course, less reasonably predictable costs of completion, disposal and transportation. Test:

1. Sales after year end. For finished goods, agree selling prices of sales after year end to the invoice. Compare to the carrying cost.
2. Price lists and market data for items with no recent sales.
3. Slow-moving and obsolete analysis. Obtain the client's aging by last-movement date. Test the reserve method and its application to the listing. Challenge reserves that have not changed despite a changed aging.
4. Specific known issues: damaged, expired or discontinued stock, lower-priced competitor products, returned goods.
5. Costs to complete and sell for work in process and goods needing rework.

Worked example

A distributor reports inventory of $3.09 million. The auditor selects 41 items by monetary unit sampling with a sampling interval of $75,000 (tolerable misstatement $225,000, confidence factor 3.00; $3.09 million divided by $75,000 is about 41). Results:

Projection with tainting: B-203, 6,150 / 61,500 = 10 percent × 75,000 = 7,500; D-312, 5,640 / 28,200 = 20 percent × 75,000 = 15,000; E-050, 7,600 / 19,000 = 40 percent × 75,000 = 30,000. Items A-114 and others are zero. Projected misstatement 52,500. That is not the end of the evaluation. Basic precision at 95 percent confidence is 3.00 × 75,000 = 225,000, which already equals tolerable misstatement, so any error pushes the upper limit past it. Using the standard Poisson reliability factors (3.00, 4.75, 6.30, 7.76) and ranking the taintings 40, 20 and 10 percent, the upper limit is 225,000 + 52,500 + (22,500 + 8,250 + 3,450) = 311,700. The sample does not support the balance as is. The auditor proposes an adjustment for the known errors and extends testing, and two causes drive the errors: a stale cost file and unit-of-measure mapping. The auditor tests the cost file update procedure for the vendors with price changes in the fourth quarter, and extends the NRV test to all items with sales after year end below cost. The projected amount goes to the uncorrected misstatements schedule.

Common problems

• Costs not updated after price changes.
• Overhead rates that include selling expense.
• Unused capacity costs capitalized.
• Obsolete stock carried at full cost with no reserve.
• Standard costs not updated for years.
• Items priced at replacement cost instead of cost.
• Intercompany profit in inventory.

Documentation

Selection method and population tie-out, cost method, vouching for each item with invoice references, manufactured cost tests, NRV evidence, misstatements and projection, conclusions on the reserve and cause analysis.

CORAA prepares ready-to-review audit files for US CPA firms; the firm keeps the client, the review and the signature. See /us.

Sources

• AICPA, AU-C Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained; AU-C Section 530, Audit Sampling
• FASB, Accounting Standards Codification Topic 330, Inventory
• U.S. Government Accountability Office, Financial Audit Manual, Volume 1 (GAO-26-108577), June 2026, section 480 (monetary unit sampling and projected misstatement): gao.gov

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error