Overview
The Public Company Accounting Oversight Board (PCAOB) published its Staff Update on 2024 Inspection Activities in March 2025. In 2024, the PCAOB inspected 171 registered firms and reviewed portions of over 800 issuer audits. Inventory remained among the top financial statement area deficiency categories, together with revenue and other recurring areas.
The findings underscore a persistent gap between PCAOB AS 2510 requirements and actual audit execution. Because inventory misstatement is a common path to financial reporting fraud, these deficiencies represent more than regulatory non-compliance—they signal systemic risk in financial reporting.
For what an inventory audit covers and what you receive, see inventory audit services scope and deliverables.
Source: PCAOB Staff Update on 2024 Inspection Activities (March 2025)
Key Findings
In 2024, the PCAOB inspected 171 registered firms and reviewed portions of over 800 issuer audits. The staff's March 2025 update lists inventory among the top financial statement area deficiency categories. Common inventory deficiencies included failures to test period-end inventory listings, to test inventory movement from an interim count date to period end, to test valuation at the lower of cost or net realizable value, and to obtain sufficient evidence that cycle-count procedures were reliable.
Most Common Deficiencies:
- Inadequate testing of inventory listings and counts: Auditors did not test the accuracy and completeness of period-end inventory listings, or did not obtain sufficient evidence that cycle-count procedures were reliable
- Insufficient testing of inventory valuation: Auditors did not test whether inventory was recorded at the lower of cost or net realizable value, or did not test the pricing of old inventory
- Inadequate testing of movement to period end: When the physical observation was at an interim date, auditors did not adequately test inventory movement between that date and period end
- Insufficient work on inventory held elsewhere: Auditors limited procedures on subsidiary or third-party inventory, for example by reviewing a reconciliation without sufficient substantive testing
Source: PCAOB Staff Update on 2024 Inspection Activities (March 2025)
Firm-by-Firm Analysis
PCAOB inspection reports name the registered firm. The 2024 U.S. Big Four reports show the number of audits in which inventory was selected for review, and how many of those audits had a Part I.A inventory deficiency:
| Firm (2024 inspection report) | Inventory audits reviewed | Audits with Part I.A inventory deficiencies |
|---|---|---|
| Deloitte & Touche LLP (104-2025-036) | 12 | 1 |
| Ernst & Young LLP (104-2025-037) | 19 | 3 |
| KPMG LLP (104-2025-039) | 12 | 0 |
| PricewaterhouseCoopers LLP (104-2025-040) | 15 | 0 |
Note: These figures come from each firm's public 2024 inspection report, dated February 26, 2025. The reports name the firm. They anonymize the issuer, not the firm. A zero in the last column means the report did not identify a Part I.A inventory deficiency in the inventory audits reviewed for 2024.
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Learn MoreDeficiency Patterns
Analysis of the 2024 findings reveals several recurring patterns that transcend firm size and industry specialization:
Multi-Location Sampling
Auditors consistently failed to visit enough locations to achieve sufficient coverage, particularly when inventory was dispersed across numerous sites.
Roll-Forward Gaps
When observation occurred before year-end, auditors often performed inadequate testing of intervening transactions, particularly for high-volume or high-value movements.
Valuation Testing
Insufficient skepticism when testing management's obsolescence reserves, net realizable value calculations, and lower-of-cost-or-market adjustments.
Third-Party Inventory
Inadequate procedures for inventory held by third-party logistics providers, consignees, or in-transit inventory, particularly in complex supply chains.
Root Causes
The PCAOB's inspection reports, combined with post-inspection remediation discussions, point to several underlying causes for the persistent inventory deficiencies:
1. Resource Constraints and Timing Pressures
Inventory observation often occurs during peak busy season when audit teams are stretched thin. Firms frequently assign less experienced staff to observation procedures, and senior reviewers may not adequately supervise or review the work performed.
Impact: Inadequate sample sizes, missed high-risk items, and insufficient documentation of procedures performed.
2. Overreliance on Client-Prepared Information
Auditors increasingly rely on client-generated reports, cycle count results, and perpetual inventory systems without performing sufficient independent verification. This is particularly problematic when internal controls are weak or untested.
Impact: Failure to detect material misstatements in inventory quantities, valuation, or existence.
3. Inadequate Training on AS 2510 Requirements
Despite the inventory observation standard being in effect as a PCAOB interim standard since April 2003 (later reorganized as AS 2510), many audit staff lack comprehensive training on its requirements, particularly regarding alternative procedures, roll-forward testing, and third-party confirmations.
Impact: Non-compliance with fundamental observation requirements, leading to Part I.A deficiencies.
4. Complex Supply Chains and Inventory Systems
Modern supply chains involve multiple locations, third-party logistics providers, just-in-time inventory, and complex valuation methodologies. Audit procedures have not always kept pace with this complexity.
Impact: Incomplete coverage of inventory populations, particularly for high-risk or non-standard inventory items.
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Get the ChecklistImplications for 2026 Audits
The 2024 inspection findings have immediate implications for audits currently in progress and those planned for 2026:
Heightened PCAOB Scrutiny
The PCAOB staff's 2024 inspection update lists inventory among the top financial statement area deficiency categories. In its 2025 inspection priorities, the staff also noted that supply-chain or logistics changes can increase the risk associated with the valuation of inventory. Firms should expect:
- Increased selection of audits with significant inventory balances
- More detailed review of observation workpapers and documentation
- Greater scrutiny of roll-forward procedures and alternative procedures
- Enhanced focus on multi-location inventory and third-party holdings
Audit Committee Expectations
Audit committees are increasingly aware of PCAOB findings and are asking more pointed questions about inventory observation procedures. Auditors should be prepared to discuss:
- How observation procedures address identified risks
- Rationale for location selection and sample sizes
- Use of specialists or third-party observation services
- Quality control procedures over observation work
Reputational and Regulatory Risk
Repeated Part I.A deficiencies can lead to enhanced monitoring by the PCAOB, potential enforcement actions, and reputational damage. Firms with multiple inventory deficiencies across inspection cycles face increased regulatory scrutiny and potential client concerns about audit quality.
Recommendations for Audit Firms
Based on the 2024 findings and discussions with audit quality leaders, CPCON recommends the following actions for audit firms:
Enhance Training and Supervision
Implement mandatory AS 2510 training for all staff involved in inventory observation, with annual refreshers. Ensure senior reviewers are actively involved in planning and reviewing observation procedures.
Action: Develop firm-specific observation checklists and require partner-level review of all observation workpapers before audit completion.
Improve Location Selection Methodology
Develop a risk-based approach to location selection that considers inventory value, risk of material misstatement, control environment, and historical accuracy. Document the rationale for locations selected and not selected.
Action: Create a standardized location selection template that requires quantitative analysis and partner approval.
Strengthen Roll-Forward Procedures
When observation occurs before year-end, perform comprehensive testing of intervening transactions, including detailed review of high-value movements, cycle count results, and reconciliations.
Action: Require detailed roll-forward workpapers with specific testing of material transactions and reconciliation to year-end balances.
Consider Third-Party Specialists
For complex, multi-location, or high-risk inventory populations, consider engaging independent inventory observation specialists who can provide additional coverage and expertise.
Action: Evaluate the cost-benefit of third-party observation services versus internal resource allocation and potential inspection risk.
Enhance Documentation Standards
Ensure workpapers clearly document the procedures performed, items tested, results obtained, and conclusions reached. Include photographs, detailed item descriptions, and evidence of testing performed.
Action: Implement standardized observation workpaper templates with required fields and evidence attachments.
Frequently Asked Questions
Why are inventory deficiencies so common in PCAOB inspections?
Inventory observation is inherently complex, requiring significant resources, coordination, and professional judgment. The combination of timing pressures, resource constraints, complex supply chains, and inadequate training creates conditions where deficiencies are more likely to occur. Additionally, the PCAOB has made inventory a focus area, leading to increased scrutiny and detection of deficiencies.
What is the difference between a Part I.A and Part I.B deficiency?
Part I.A findings are deficiencies of such significance that it appeared the firm had not obtained sufficient appropriate audit evidence to support its opinion on the financial statements and/or internal control over financial reporting. Part I.B findings are instances of non-compliance with PCAOB standards or rules other than those where the firm had not obtained sufficient appropriate audit evidence to support its opinion. Criticisms of a firm's system of quality control appear in Part II of the inspection report, which is often nonpublic when the report is first issued. Inventory findings that affect the sufficiency of audit evidence are typically presented in Part I.A.
How many locations should an auditor visit for inventory observation?
There is no fixed coverage percentage in AS 2510. When inventory quantities are determined by a physical count, the standard requires the auditor to be present at the time of count and, by observation, tests, and inquiries, to be satisfied as to the count methods and the quantities and condition of the inventories. The work should follow a risk-based approach that considers the locations, the significance of the inventory, the risk of material misstatement, and the effectiveness of internal controls.
Can auditors rely on client cycle counts instead of performing observation?
AS 2510 allows auditors to observe cycle counts instead of a full physical inventory count, but only if the cycle count program is well-designed, properly controlled, and provides sufficient coverage. The auditor must still observe some cycle counts during the year, test the effectiveness of the program, and perform roll-forward procedures to year-end. Simply relying on client-reported cycle count results without observation is insufficient.
What should auditors do if they cannot attend the physical inventory count?
AS 2510 requires auditors to perform alternative procedures if they cannot attend the count due to unforeseen circumstances or if attendance is impracticable. Alternative procedures might include observing a subsequent count, testing intervening transactions, and obtaining confirmations from third parties. However, these alternatives must provide sufficient appropriate evidence, and the auditor must document why attendance was impracticable.
How can audit firms prevent inventory deficiencies in future inspections?
Prevention requires a multi-faceted approach: enhanced training on AS 2510 requirements, improved supervision and review of observation work, risk-based location selection methodologies, adequate resource allocation, use of specialists when appropriate, and robust documentation standards. Firms should also conduct internal inspections focused on inventory observation procedures to identify and remediate issues before PCAOB inspection.
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