1.17     Query

Norms for the frequency of physical verification of stores and spare parts for

the purpose of Section 227 (4A) of theCompanies Act, 1956.

1. Out of the total inventory of Rs. 14,12,683 the break-up of stores and spares appeared in the balance sheet of a company as follows:

                        Stores and Spares (at cost)

2. Pursuant to the provisions of section 227(4A) of the Companies Act, 1956, the auditors’ report included the following statement:

“As explained to us, physical verification of stocks of finished goods, raw materials and packing materials have been conducted by the management at reasonable periods during the year and no significant discrepancies have been noticed on such verification as compared to book stocks. We were informed that physical verification of stores and spares was conducted only on 31^st March 1981. In our opinion, the frequency of physical verification of stores and spare parts was not reasonable.”

3. In reply to the above comments of the auditors, the following statement appeared in

the Addendum to the Directors’ Report:

“The Company has conducted physical verification at reasonable intervals for major items like furnace oil, leco, packing materials, raw materials and finished goods and it was only in respect of stores and spare parts that the physical verification was done at the end of the year. The Management felt that physical verification on yearly basis would suffice for stores and spare parts since the total purchases during the year under this head amounted to Rs. 2,10,457 only and the quantum of inventory holding was also very low.”

4. The querist sought the opinion of the Expert Advisory Committee on whether the physical verification conducted by the Management at the end of the year was in accordance with the requirements of Section 227(4A) of the Companies Act, Keeping in view the fact that the value of stores and spare parts was merely Rs. 95,061 out of the total value of inventories (stores and spares, raw materials and finished goods) of Rs. 14,12,683.

                                                         Opinion                                                            August 13,1982

1.The Committee notes that according to paragraph 24(b) of the ‘Statement on the

Manufacturing and Other Companies (Auditor’s Report) Order, 1975’ published by the Research Committee of the Institute of Chartered Accountants of India, “Inventories must be verified at least once in a year and more often in several cases. Where a “perpetual inventory system” is in operation, it would be advisable for the auditor to insist on an A-B-C analysis of the inventory, ‘A’ category items being verified more frequently than ‘B’ category and the latter more frequently than the ‘C’ category items.”

  2. It is also pointed out in paragraph 24(b) of the Statement that “the auditor’s duties with regard to the physical verification of inventories by the management are similar to his duties as regards the physical verification of fixed assets and the comments made in paragraph 22 would be equally applicable.” In the context of frequency of physical verification of fixed assets it is stated in para 22(p) of the Statement that “the order does not specify the frequency of verification, which must therefore be reasonable in the circumstances of each case.”

  3. It is apparent from the above that the reasonableness of the frequency of physical verification of inventories has also to be determined from the circumstances of each case. Value of a particular inventory item in relation to the value of other inventory items and value of inventories taken as a whole, are important factors but nevertheless not the only factors, e.g., one of the other factors may be the degree of control at the time of issuance, consumption etc. of stores, spare parts and tools. Thus, the auditor has to satisfy himself, keeping in view the circumstances of each case, that the frequency of physical verification of inventories is reasonable. The auditor is justified in qualifying his report if he is not satisfied.

  4. The Committee is, therefore, of the opinion that, in the present case even though the value of the inventory of stores and spare parts is not very significant, yet the auditors are justified, if the other relevant circumstances so warrant, in expressing their opinion that frequency of physical verification of these is not reasonable.

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