CARO's clause 3(ii) requires the auditor to report whether physical verification of inventory has been conducted by management at reasonable intervals, and whether, in the auditor's opinion, the coverage and procedure of such verification is appropriate. It further requires reporting whether any discrepancies of 10% or more in the aggregate for each class of inventory were noticed, and if so, whether they have been properly dealt with in the books of account. The 10% test is calculated by class of inventory (raw material, work-in-progress, finished goods, each separately) and in aggregate across all count differences within that class — not item by item, and not as a single combined percentage across all inventory types together.
What "reasonable intervals" actually means
The standard doesn't fix a specific frequency — what counts as reasonable depends on the nature of the inventory, its value, and how susceptible it is to loss or deterioration. Fast-moving, high-value inventory in a manufacturing operation typically warrants more frequent counts (cycle counts through the year, in addition to a year-end count) than slow-moving, low-risk stock. A company that performs only an annual count, for inventory that's materially susceptible to shrinkage or obsolescence between counts, may not meet the "reasonable interval" bar even though an annual count technically happened.
How the 10% aggregate test actually works
| Item | Book quantity | Physical count | Difference |
|---|---|---|---|
| Raw material A | 1,000 units | 960 units | -40 (-4%) |
| Raw material B | 500 units | 530 units | +30 (+6%) |
| Raw material C | 2,000 units | 1,750 units | -250 (-12.5%) |
Common practice, not a requirement
The aggregate discrepancy for the raw material class in this example has to be computed across all raw material items together, in value terms, not just averaged as a simple percentage across items of different unit values — a small-quantity, high-value item's discrepancy can dominate the aggregate even if its unit-count variance looks modest on its own.
What the auditor actually does once the threshold is crossed
- 01Confirm the discrepancy was actually recorded in the booksA write-up or write-down to the physical count result, not left as an unreconciled difference between the system and the floor.
- 02Investigate the cause, not just the amountA pattern concentrated in one class or location points at a process issue worth separately flagging in the management letter, distinct from the CARO disclosure itself.
- 03State the finding specifically in the clause responseNaming the class, the aggregate percentage, and confirming the books were adjusted — a vague "minor discrepancies were noted and adjusted" doesn't give a reader the specific information the clause is asking for.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- CARO & Companies ActCARO fixed asset and inventory clauses: what auditors testWhat the fixed asset and inventory points under CARO actually require in evidence: physical verification, title deeds, revaluation, and count discrepancies.
- Inventory & stockPhysical stock count: audit observation procedurePlanning the count date and cut-off instructions, test counts and sampling, covering multiple locations at once, and reconciling count to book quantities.
- Inventory & stockThe stock count that didn't match the ledger, and whyThe physical count came in 6% below the system quantity for one product line. Six percent is too large to be counting error.
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