CHAPTER SEVEN 7
Taking a Physical Inventory
A CRITICAL ELEMENT IN any system of internal control is verification that what the control totals say actually represents the underlying reality. Are receivables really owed to the company? Send out a confirmation. Does the company really have the finished goods inventory as per the balance sheet? An annual physical inventory, priced out and then reviewed by the external auditors is considered to provide positive evidence that the books of account properly reflect the current inventory situation.
As discussed earlier in the book, a periodic physical inventory of Property, Plant, and Equipment (PP&E) is essential, albeit not directly or explicitly required by generally accepted auditing standards (GAAS) or the Public Company Accounting Oversight Board’s (PCAOB’s) Statement 5, “An Audit of Internal Control Over Financial Reporting That Is Integrated with an Audit of Financial Statements.” It seems to be only a matter of time, however, before internal control over fixed assets does require a periodic inventory and reconciliation.
There are two major potential problems that an inventory will uncover. The first is the existence, actually the nonexistence, of assets on the books. By popular reckoning these are usually referred to as “Ghost Assets,” as in they should be there but we cannot find them. For the second, the author coined the term “Zombie Assets,” which describes those assets actually present physically, but that do not appear on ...