The valuation of stock is frequently the main factor in determining the result shown the accounts. Apart from the effect on the Balance Sheet, incorrect treatment of stock would affect the profits of the year that has closed as well as that of the next following. The valuation of the closing stock, therefore, is an important step essential for the determination of the profits of the year and also for truly disclosing the financial position of the concern at the close of the year. An auditor being intimately concerned with these aspects of financial statements, it is his duty to verify the existence of the stock-in-trade possessed the concern at the end of the year and to ascertain that the same has been valued correctly on a consistent basis. The precise duties in regard to verification of stock-in-trade are nowhere defined. Under the circumstances, these have to be deduced from an interpretation of the general responsibility of auditors in regard to the statements of accounts verified them, especially in regard to stock-in-trade. These have been considered in a few English decisions. Justice Lindsay, while delivering the famous judgement in the case of Kingston Cotton Mills Co. Ltd. (1896) observed : It is no part of the auditor’s duty to take stock. No one contends that it is so; he must rely on other people for details of the stock-in-trade in hand. In the case of a cotton mill, he must rely on some skilled person for the material necessary to enable him to enter the stock-in-trade as its proper
value in the Balance Sheet.
In the same case, Justice Lopes observed as follows: “An auditor is not bound to be a detective, or as was said to approach his work with a foregone conclusion that there is something wrong. He is watchdog, but not a blood hound. He is justified in believing tried servants of the company in whom confidence is placed the company. He is entitled to assume that they are honest to rely upon their representations, provided he takes reasonable care.”
In the case of the Westminster Road Construction & Engineering Co. Ltd. (1932), it was held that an auditor must make the fullest use of all materials available to him and although he is neither a stocktaker and nor a valuer of work-in-progress, he will be guilty of negligence if he fails to take notice of all available evidence from which it could be reasonably deducted that the work-in-progress was overvalued. The decision thus appear to have settled the following three principles for the general guidance of the auditor :
- That it is no part of auditor’s duty to take stock.
- That for the purpose he can rely upon statements and reports made available to him in regard to the valuation of stocks so long as there is no circumstance which may arouse his suspicion and he is satisfied that the procedures in the matter of stock taking and management are such as
would enable it to give such a certificate and that these have been followed.
- That an auditor would be failing in his duty if he does not take reasonable care in verifying the statements of stock which are put up to him according to the information in his possession and the expert knowledge expected of him in regard to methods of verification and stock control.
The above view was almost accepted universally accountants until as a result of the disclosures in the case of McKesson and Robbins, the auditors in the U.S.A decided to make physical contact with the inventories presented to them. In United Kingdom, the situation also underwent a change in 1967 since the decision of the famous case in Thomas Gerrard & Sons Limited. The liquidator of Thomas Gerrard & Sons Limited succeeded in an action against the company’s auditors. The Managing Director of the company manipulated cut-off procedures and included non-existent stocks in the accounts in order to pay huge dividends, which in fact were paid out of the capital. The auditors relied on the Kingston Cotton Mill unsuccessfully; because the learned judge pointed out that this decision also made reference to the absence of suspicious circumstances. In the instant case such circumstances were in plenty as many sales and purchase invoices at the year end had been deliberately altered. The Judge further observed that in these circumstances the auditors should reasonably have attended the stock taking.
Following this in 1968, the Institute of Chartered Accountants in England & Wales issued Auditing Statement U-9 advising positively that auditors should attend at stock taking for the purpose of observing the client’s procedures and ensuring that they were likely to result in a reliable count. In this context it is also necessary to consider that during the last fifty years, there has been a great advancement in the techniques and methods of stock control. With the aid of modern methods of costing, accounting ratios and budgetary control, it is now possible to obtain more accurate information in regard to quantities and value of stock. Besides, now-a-days greater attention is being paid businessmen to stock control and, as a result, the stock records maintained are more amenable to tests and checks. The provisions in the Companies Act, 1956 have also considerably advanced the responsibilities of auditors in this regard. Section 209 of the Act requires a company to maintain proper books of account. Such books of account must, it is believed, include books kept to record transactions in stock-in-trade. The Act empowers the Central Government to require companies engaged in production processing, manufacturing or mining to maintain books as would furnish particulars in relation to utilisation of materials or labour or other items of cost as may be prescribed. Furthermore, section 541(2) ‘proper books of account’ have been defined to include statements of annual stocktaking and (except in case of goods sold way of ordinary retail trade) of all goods sold and purchased. Part II of Schedule VI to the Act prescribes that the figures of opening and closing balances, of stock and work-in-progress be disclosed in the Profit and Loss account. Part I of the same Schedule requires that the mode of valuation of stock be shown on the Balance Sheet. Schedule VI requiring particulars or quantities of materials purchased, opening and closing stock and turnover is also of particular significance in this respect.