How Is an Inventory Audit Conducted in the UAE and What Does It Examine?

What an Inventory Audit Is and Why UAE Businesses Need One

An inventory audit is a structured examination of a business’s stock of goods to verify that the quantities and values recorded in the accounting system accurately reflect the physical inventory on hand, and that inventory is accounted for in accordance with the applicable accounting standards. For UAE businesses, inventory audits serve both operational and regulatory purposes. They verify the accuracy of the balance sheet figure for inventories , one of the most significant assets on the books of a trading, manufacturing, or distribution business , and support the accuracy of the income statement through the cost of goods sold calculation.

Under IAS 2, Inventories , the IFRS standard governing inventory accounting for UAE businesses , inventories must be measured at the lower of cost and net realisable value. An inventory audit verifies that this measurement basis has been correctly applied, that the cost formula used (FIFO or weighted average) is applied consistently, and that obsolete or slow-moving items have been written down to their net realisable value where appropriate.

The Key Inventory Audit Procedures

1. Physical Count and System Reconciliation

The foundation of any inventory audit is a physical count: the auditor or audit team physically counts inventory items at the warehouse or storage location and compares the counted quantities to the quantities recorded in the inventory management system and financial records. Where discrepancies are identified , quantities in the system exceed physical counts, or vice versa , the auditor investigates the cause. Common causes include unrecorded sales, theft, damage not yet written off, or receiving errors where goods arrived without the system being updated.

The physical count is typically performed with warehouse operations paused or cut off to prevent goods moving in or out during the count period, ensuring that the counts reflect a fixed point in time that can be reconciled to the accounting records.

2. Cutoff Analysis

The cutoff analysis verifies that inventory transactions , purchases, sales, and transfers , are recorded in the correct accounting period. The auditor reviews goods received notes, delivery notes, and supplier invoices around the period end date to confirm that: goods received before the period end are included in closing inventory and the corresponding payable is recorded; goods received after the period end are excluded from closing inventory; and sales completed before the period end are excluded from inventory and the revenue is recognised in the correct period.

Cutoff errors are among the most common inventory audit findings. An incorrect cutoff produces either an overstatement or understatement of closing inventory and a corresponding error in the income statement through cost of goods sold.

3. Valuation Testing

Valuation testing verifies that the unit costs applied to inventory items are accurate and that the overall inventory balance is correctly stated under IAS 2. The auditor examines:

• Cost accuracy: whether the cost recorded per unit reflects actual purchase cost, including freight, customs duties, and import costs, with reference to supplier invoices and import documentation
• Cost formula consistency: whether the business applies its stated cost formula (FIFO or weighted average) consistently across all inventory categories
• Net realisable value: whether items whose selling price has fallen below cost have been written down to net realisable value. The auditor reviews selling prices, aged inventory reports, and any damaged or obsolete items identified during the physical count

4. ABC Analysis

Where inventory comprises a large number of different items, audit resources are allocated using ABC analysis: high-value items (Group A) receive the most detailed audit attention, including full physical counts and detailed valuation testing; medium-value items (Group B) receive targeted testing; and low-value items (Group C) are tested on a sample basis or through analytical procedures. This approach ensures that audit effort is proportionate to risk, with the highest-value items receiving the most rigorous verification.

5. Analytical Procedures

Analytical procedures use financial ratios and trends to identify areas where inventory figures appear inconsistent with expectations. Common analytical procedures in an inventory audit include:

• Inventory turnover ratio: the number of times inventory is sold or used in a period. A significant unexplained change in inventory turnover compared to prior periods or industry benchmarks may indicate misstatement
• Gross margin analysis: comparing the gross margin percentage to prior periods. A decline may indicate inventory write-offs that should have been recognised, cost overruns, or theft
• Days inventory outstanding: how many days of sales the current inventory balance represents. An unexpected increase may indicate slow-moving or obsolete inventory

6. Freight and Landed Cost Analysis

For businesses that import goods, the audit verifies that all costs of bringing inventory to its current location and condition are included in the carrying value. This includes the purchase price, freight costs, customs duties, and any other directly attributable import costs. Under IAS 2, these costs must be included in inventory cost, not expensed separately. The auditor traces a sample of inventory receipts through the freight documentation, import declarations, and cost records to confirm that landed costs are correctly captured.

7. Matching Invoices to Receiving Records

The auditor selects a sample of supplier invoices and traces them to the corresponding goods received notes and inventory system entries to verify that goods were actually received, in the quantities invoiced, at the prices agreed. This procedure identifies phantom inventory purchases, duplicate invoices, and pricing discrepancies between purchase orders and invoices.

8. Write-Off and Shrinkage Review

Inventory write-offs and shrinkage (unexplained stock losses) require specific attention. The auditor reviews all inventory write-offs during the period for appropriate authorisation, documentation, and accounting treatment. Where shrinkage is identified through the physical count reconciliation, the auditor investigates whether it represents theft, waste, breakage, or a recording error, and whether the write-off has been correctly reflected in the financial statements.

Inventory Audit in the UAE Regulatory Context

For UAE businesses subject to Corporate Tax under Federal Decree-Law No. 47 of 2022, the inventory valuation directly affects taxable income. Cost of goods sold is a deductible expense, and the basis on which closing inventory is valued determines the COGS figure. An inventory overstatement reduces COGS and inflates taxable profit; an understatement inflates COGS and reduces taxable profit. Accurate inventory accounting is therefore a Corporate Tax compliance matter as well as an IFRS reporting matter.

For VAT-registered businesses, inventory write-offs require consideration of input VAT previously recovered on the goods being written off. Where inventory is destroyed, lost, or written off as unsaleable, the VAT previously recovered as input tax on those goods may need to be adjusted or repaid to the FTA, depending on the circumstances and whether the write-off constitutes a deemed supply under UAE VAT law.

For free zone businesses, a number of UAE free zones , including JAFZA, DMCC, and DAFZA , require annual audited financial statements as a condition of licence renewal. The inventory balance is a material item on the balance sheet of any trading or manufacturing business, and the auditor must obtain sufficient evidence that inventory is correctly stated before issuing an audit opinion.

Frequently Asked Questions (FAQs)

How Farahat & Co. Can Help

Farahat & Co. provides inventory audit services to UAE businesses across the trading, manufacturing, and distribution sectors, covering physical count attendance, valuation testing under IAS 2, cutoff analysis, and reconciliation of inventory records to financial statements. Our team also assists businesses with inventory write-off documentation for Corporate Tax and VAT purposes.

Contact Farahat & Co. today to discuss your inventory audit requirements.