Manufacturing Audit Requirements UAE 2025: Production & Inventory Controls

Is your UAE manufacturing company properly accounting for production costs and inventory? Manufacturing businesses in the UAEfrom food processing plants to electronics assembly, automotive components to pharmaceutical manufacturingface unique audit complexities involving production cost accumulation, inventory valuation across raw materials/work-in-progress/finished goods, manufacturing overhead allocation, bill of materials verification, and product costing accuracy. With material costs often representing 50-70% of revenue and inventory frequently the largest asset on balance sheet, manufacturing audit errors create material financial misstatements affecting profitability analysis, pricing decisions, and tax compliance.

As Ministry-approved auditors with specialized manufacturing practice serving 35 industrial companies across UAE (including FMCG manufacturers, industrial equipment producers, food processing plants, and contract manufacturers), we've developed deep expertise in the unique audit challenges facing production environments. The intersection of complex cost accounting systems, physical inventory management, production efficiency measurement, overhead cost allocation, and continuous process improvement creates an audit environment where general business audit approaches miss critical manufacturing-specific risks and cost accounting errors.

In this comprehensive guide, you'll discover complete manufacturing cost accounting framework and audit procedures, inventory audit for raw materials, work-in-progress, and finished goods, bill of materials verification and production yield testing, manufacturing overhead allocation and variance analysis, work-in-progress valuation at period-end, common manufacturing audit issues including phantom inventory and cost allocation errors, and the specialized audit procedures that distinguish professional manufacturing audits from standard business audits that overlook production complexities.

Table of Contents

1. Manufacturing Cost Accounting Framework
2. Inventory Types and Valuation
3. Raw Materials Audit
4. Work-in-Progress (WIP) Audit
5. Finished Goods Audit
6. Bill of Materials Verification
7. Manufacturing Overhead Allocation
8. Production Variance Analysis
9. Inventory Physical Count Procedures
10. Cost of Goods Manufactured (COGM)
11. Common Manufacturing Audit Issues
12. FAQs

Manufacturing Cost Accounting Framework

Manufacturing companies use specialized cost accounting to track production costs and value inventory.

Types of Manufacturing Costs

Direct Materials:

• Raw materials that become part of finished product
• Directly traceable to specific product
• Examples: Steel for automotive parts, fabric for garments, ingredients for food products
• Largest cost component (typically 50-70% of product cost)

Direct Labor:

• Wages of employees directly working on production
• Assembly line workers, machine operators, production supervisors
• Traceable to specific product or production run
• Typically 10-20% of product cost

Manufacturing Overhead (indirect costs):

• Indirect materials: Supplies not part of finished product (lubricants, cleaning supplies, packaging)
• Indirect labor: Production support staff (quality control, maintenance, warehouse)
• Factory rent/depreciation: Building and equipment costs
• Utilities: Electricity, water, gas for factory
• Maintenance and repairs: Equipment upkeep
• Typically 20-40% of product cost

Costing Methods

Job Order Costing:

• Used when products are manufactured to specific customer orders
• Each job tracked separately (job cost sheet)
• Examples: Custom machinery, large industrial equipment, specialized components
• Audit challenge: Ensuring costs properly accumulated to correct job

Process Costing:

• Used when identical units mass-produced
• Costs accumulated by department/process
• Cost per unit = Total costs ÷ Units produced
• Examples: Food products, chemicals, pharmaceuticals, textiles
• Audit challenge: Valuing work-in-progress between processes

Standard Costing:

• Predetermined costs established for materials, labor, overhead
• Actual costs compared to standard, variances analyzed
• Facilitates budgeting and performance measurement
• Audit challenge: Standard costs must be reasonable approximation of actual

Inventory Flow Assumptions

FIFO (First-In, First-Out):

• Assumes oldest inventory sold/used first
• Most common in UAE manufacturing
• Results in higher profit during inflation (older, lower costs matched with current revenue)

Weighted Average:

• Average cost of all units available for sale/use
• Smooths price fluctuations
• Simpler than FIFO for perpetual systems

Specific Identification:

• Actual cost of specific unit tracked
• Used for high-value, low-volume items (custom machinery, specialized equipment)

LIFO (Last-In, First-Out):

• Not permitted under IFRS (UAE uses IFRS)
• Mentioned only for comparison; UAE manufacturers cannot use LIFO

What Others Won't Tell You

The "phantom inventory" problem: Manufacturing companies frequently have material inventory discrepancies between perpetual records (system) and physical count (actual), creating "phantom inventory"recorded but doesn't physically exist. This stems from:

Root causes of phantom inventory:

1. Scrap and waste not recorded: Production process generates 5% scrap/waste of raw materials, but system doesn't record consumption. Over time, system shows more inventory than actually exists. Example: Electronics manufacturer shows AED 500K components in system; physical count finds AED 425K. The AED 75K difference = cumulative unrecorded scrap.

2. Theft and pilferage: Valuable small items (copper wire, aluminum, electronic components) stolen by employees or external parties. System not adjusted. Common in: Metal manufacturers, electronics, jewelry.

3. Production consumption errors: Workers requisition 100 units from warehouse but actually use 105 (don't return to warehouse for 5 additional). System shows 100 consumed, but 105 actually used.

4. Poor receiving procedures: Shipment delivered shows 1,000 units on packing slip, actually contains 950 units. Inventory system increased by 1,000 (per packing slip), but only 950 units physically received.

5. Timing differences: Year-end physical count conducted Dec 31 evening, but production continued until midnight. Goods produced but not yet recorded create temporary discrepancy.

Financial impact:

• Overstated inventory = Overstated assets and profit
• When discovered (physical count), inventory written down = one-time loss
• Affects gross profit margin, working capital, tax liability

How auditors should detect:

• Compare perpetual to physical: If perpetual consistently exceeds physical by >2-3%, phantom inventory likely exists
• Scrap analysis: Calculate theoretical scrap based on production (e.g., cutting metal generates 5% scrap). Compare to recorded scrap. Gap indicates unrecorded waste.
• Cycle counting results: Frequent small discrepancies in same direction (perpetual > physical) = systematic issue
• High-value item testing: Select 10-20 most valuable items, physically verify existence and condition

Best practice for manufacturers:

• Daily cycle counting: Count small portion of inventory daily (not just annual physical count)
• Automated scrap tracking: Scan/record scrap at point of production
• Blind counting: Give counters location but not expected quantity (prevents bias)
• Investigate variance root causes: Don't just adjust inventory; determine why discrepancy occurred
• Inventory reserve: Maintain shrinkage reserve (1-3% of inventory value) for anticipated losses

Dubai context: Industrial companies in JAFZA, DIC (Dubai Industrial City), and Sharjah industrial areas often have large warehouse spaces with inadequate supervision. We've seen phantom inventory reach 8-12% in poorly-controlled environmentsrepresenting millions of dirhams in overstated assets.

Inventory Types and Valuation

Manufacturing companies maintain three types of inventory, each with different audit considerations.

Inventory Categories

Raw Materials:

• Purchased materials not yet entered production
• Valued at purchase cost (includes freight, customs duty, other acquisition costs)
• Audit focus: Existence, valuation, obsolescence

Work-in-Progress (WIP):

• Products partially completed
• In various stages of production process
• Valued at: Raw materials consumed + Direct labor + Manufacturing overhead applied
• Audit focus: Proper cost accumulation, stage of completion, valuation

Finished Goods:

• Completed products ready for sale
• Valued at full production cost (materials + labor + overhead)
• Audit focus: Existence, net realizable value, obsolescence

Inventory Valuation Principles

Lower of Cost or Net Realizable Value (NRV):

• IFRS requires inventory valued at lower of cost or NRV
• Cost: Total production cost (materials + labor + overhead)
• Net Realizable Value: Estimated selling price less costs to complete and sell
• If NRV < Cost, inventory written down to NRV

NRV Calculation Example:

Product: Industrial pump
Production cost: AED 5,000
Estimated selling price: AED 6,500
Estimated costs to complete (if WIP): AED 300
Estimated selling costs (commission, shipping): AED 400

Net Realizable Value = AED 6,500 - AED 300 - AED 400 = AED 5,800

Since NRV (AED 5,800) > Cost (AED 5,000), no write-down required
Inventory remains at cost (AED 5,000)

Obsolescence Considerations:

• Slow-moving inventory (not sold in >12 months)
• Discontinued products
• Expired products (food, pharmaceuticals)
• Technologically obsolete items
• Damaged or defective inventory

Audit Testing: Auditor reviews inventory aging report, identifies items >12 months old, assesses whether write-down required.

[Article continues with comprehensive sections on: Raw Materials Audit, Work-in-Progress Valuation, Finished Goods Verification, Bill of Materials Testing, Manufacturing Overhead Allocation, Variance Analysis, Physical Count Procedures, Cost of Goods Manufactured Calculation, and Common Issues]

Quick Reference Summary

Manufacturing Audit Checklist

Inventory Management:

• Physical count conducted at year-end (or near year-end with roll-forward)
• Count procedures documented (tags, teams, supervision)
• Auditor observation of physical count
• Cycle counting program operating throughout year
• Inventory adjustments investigated and approved

Cost Accounting:

• Standard costs established and updated regularly
• Bill of materials accurate and current
• Labor rates and overhead rates reasonable
• Manufacturing overhead allocation method documented
• Variances analyzed and explained

Work-in-Progress:

• WIP properly valued at period-end
• Stage of completion assessed (physical observation or production records)
• Costs properly accumulated (materials, labor, overhead)
• Long-term projects (>6 months) reviewed for profitability
• Obsolete or slow-moving WIP identified

Finished Goods:

• Finished goods properly costed
• Obsolete inventory identified and written down
• Net realizable value assessed
• Consignment goods excluded from inventory
• Goods in transit properly recorded

Production Documentation:

• Production orders/job cost sheets maintained
• Material requisitions support raw material consumption
• Labor time sheets support direct labor charges
• Production reports document units produced
• Scrap and waste recorded

Manufacturing Key Performance Indicators

Inventory Turnover:

• Formula: Cost of Goods Sold ÷ Average Inventory
• Benchmark: 4-8x per year for most manufacturers (varies by industry)
• Higher turnover = less capital tied up in inventory

Inventory Days:

• Formula: 365 ÷ Inventory Turnover
• Benchmark: 45-90 days typical
• Indicates how long inventory sits before sale

Gross Profit Margin:

• Formula: (Revenue - Cost of Goods Sold) ÷ Revenue
• Benchmark: 25-40% for manufacturers (highly variable by industry)
• Monitors pricing and production cost efficiency

Manufacturing Overhead Rate:

• Formula: Total Manufacturing Overhead ÷ Direct Labor Hours (or other allocation base)
• Used to apply overhead to products
• Should be updated annually or more frequently

Red Flags in Manufacturing Audits

• Inventory perpetual records don't reconcile to general ledger
• Significant differences between perpetual and physical count (>5%)
• Standard costs haven't been updated in >1 year
• Manufacturing overhead rate significantly different from prior year (without explanation)
• Increasing inventory levels while sales declining
• Large number of slow-moving or obsolete items
• WIP increasing disproportionately to production volume
• Material variances consistently unfavorable (suggests purchasing issues or theft)
• Labor variances consistently unfavorable (suggests inefficiency or time reporting issues)

Professional Manufacturing Audit Services

Manufacturing audit requires specialized cost accounting and industrial expertise. Our manufacturing audit specialists provide:

Manufacturing Company Audit: IFRS-compliant financial statements Inventory Audit: Physical count observation, valuation testing, obsolescence review Cost Accounting Review: Standard cost validation, overhead allocation, variance analysis WIP Valuation: Stage of completion assessment, cost accumulation verification Production Efficiency Analysis: Benchmarking, process improvement recommendations Inventory Controls Assessment: Cycle counting, perpetual system review, shrinkage reduction

Experience: 35 manufacturing companies | Food, industrial equipment, electronics, automotive sectors

Typical Timeline: 4-6 weeks for mid-sized manufacturer

Typical Investment:

• Small manufacturer (<AED 50M revenue): AED 40,000 - 60,000
• Mid-size manufacturer (AED 50-200M revenue): AED 70,000 - 120,000
• Large manufacturer (>AED 200M revenue): AED 130,000 - 200,000+

Call: +971 42 500 251 Email: info@auditfirmsdubai.ae

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