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Audit of the Inventoryand Warehousing

CycleChapter 20

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Learning Objective 1

Describe the business functions

and the related documents and

records in the inventory

and warehousing cycle.

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Raw Materials Work in Process

ManufacturingOverhead

Flow of Inventory and Costs

Actual Applied

ManufacturingDirect Labor

Actual Applied

Beginninginventory

RawmaterialsusedPurchases

Endinginventory

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Work in Process Finished Goods

Flow of Inventory and Costs

Beginninginventory

Endinginventory

Cost of Goods Sold

Cost of goodsmanufactured

Beginninginventory

Endinginventory

Cost ofgoods sold

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Functions in the Inventory and Warehousing Cycle

Processpurchase

orders

Processpurchase

ordersReceive raw

materialsReceive raw

materials

Storeraw

materials

Storeraw

materialsProcess the materialsProcess the materials

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Functions in the Inventory and Warehousing Cycle

Perpetual inventorymaster file

Perpetual inventorymaster file

Storefinishedgoods

Storefinishedgoods

Shipfinishedgoods

Shipfinishedgoods

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Learning Objective 2

Describe how e-commerce

affects inventory management.

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How E-Commerce Affects Inventory Management

The Internet enables clients to provide expandeddescriptions of their inventory on a real-time basis.

The use of the Internet and other e-commerceapplications may lead to financial reportingrisks if access to inventory databases and

systems is not adequately controlled.

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Learning Objective 3

Explain the five parts of

the audit of the inventory

and warehouse cycle.

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Audit of Inventory

Acquire and recordraw materials, labor,

and overhead.

Internally transferassets and costs.

Part of audit Cycle in which tested

Acquisition andpayment plus

payroll and personnel

Inventory andwarehousing

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Audit of Inventory

Ship goods and recordrevenue and costs.

Physically observeinventory.

Price and compileinventory.

Cycle in which testedPart of audit

Sales andcollection

Inventory andwarehousing

Inventory andwarehousing

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Learning Objective 4

Design and perform audit

tests of cost accounting.

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Cost Accounting Controls

2. Controls over the related costs

1. Physical Controls

Raw materials WIP Finished goods

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Methodology for Designing Controls and Substantive Tests

Understand internal control –cost accounting system.

Assess planned control risk –cost accounting system.

Evaluate cost-benefitof testing controls.

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Methodology for Designing Controls and Substantive Tests

Design tests of controlsand substantive tests oftransactions for the cost

accounting system to meettransaction-relatedaudit objectives.

Audit procedures

Sample size

Items to select

Timing

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Tests of Cost Accounting

Physical Controls

Documents and records fortransferring inventory

Perpetual inventory master files

Unit cost records

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Learning Objective 5

Apply analytical procedures to

the accounts in the inventory

and warehousing cycle.

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Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare gross margin Overstatement orpercentage with that of understatement ofprevious years. inventory and cost

of goods soldCompare inventory turnover Obsolete inventory(cost of goods sold divided Overstatement or by average inventory) with understatement ofthat of previous years. inventory

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Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare unit costs of Overstatement orinventory with those of understatement ofprevious years. unit costs

Compare extended Misstatements ininventory value with that compilation, unitof previous years. costs, or extensions

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Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare current year Misstatement of unitmanufacturing costs with costs of inventory,those of previous years especially direct(variable costs should be labor andadjusted for changes in manufacturingvolume). overhead

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Methodology for Designing Tests of

Balances – Other Accounts

Identify client business risks affectingthe inventory and warehousing cycles.

Set tolerable misstatement andassess inherent risk for the

inventory and warehousing cycles.

Assess control risk for several cycles.

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Methodology for Designing Tests of

Balances – Other Accounts

Design and perform tests ofcontrols and substantive tests

of transactions for theseveral cycles.

Design and perform analyticalprocedures for the inventory

and warehousing cycle.

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Methodology for Designing Tests of

Balances – Other Accounts

Design tests of detailsof inventory to satisfy

balance-relatedaudit objectives.

Audit proceduresSample size

Items to selectTiming

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Learning Objective 6

Design and perform

physical observation

audit tests for inventory.

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Controls

Proper instructions for the physical count

Supervision by responsible personnel

Independent interval verification of the counts

Independent reconciliations of the physicalcounts with perpetual inventory master files

Adequate control over count sheets or tags

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Selection of items

Sample size

Timing

Audit Decisions

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Physical Observation Tests

The most important part of the observationof inventory is determining whether the

physical count is being taken in accordancewith the client’s instructions.

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Balance-Related Objectives: Physical Inventory Observation

Existence

Completeness

Accuracy

Inventory as recorded on tags exist.

Existing inventory iscounted and tagged.

Inventory is countedaccurately.

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Classification

Cutoff

Realizable Value

Inventory is classified correctly on the tags.

Transactions are recorded in the proper period.

Obsolete and unusableinventory items areexcluded or noted.

Balance-Related Objectives: Physical Inventory Observation

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Balance-Related Objectives: Physical Inventory Observation

Rights The client has rights

to inventory recorded on tags

Realizable Value

Obsolete and unusableinventory items areexcluded or noted.

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Learning Objective 7

Design and perform audit

tests of pricing and

compilation for inventory.

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Audit of Pricing and Compilation

Inventory compilation tests

Inventory price tests

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Valuationof inventory

Pricing andcompilationprocedures

Pricing andcompilation

controls

Audit of Pricing and Compilation

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Balance-Related Objectives: Inventory

Pricing and Compilation

Detailtie-in

Existence

Completeness Accuracy

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Balance-Related Objectives: Inventory

Pricing and Compilation

ClassificationRealizable

value

RightsPresentation

and disclosure

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Valuation (Pricing)of Inventory

Pricing Purchased Inventory

Pricing Manufactured Inventory

Cost or Market

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Learning Objective 8

Integrate the various parts of

the audit of the inventory

and warehousing cycle.

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Interrelationship ofVarious Audit Tests

Tests of acquisitionand payment cycle

Raw materialsAcquisitions ofraw materials

Work in processOther manufacturing

overhead

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Interrelationship ofVarious Audit Tests

Tests of payrolland personnel cycle

Work in processDirect labor

Work in processIndirect labor

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Interrelationship ofVarious Audit Tests

Inventory tests

Raw materialsEnding inventory

Work in processEnding inventory

Finished goodsEnding inventory

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Interrelationship ofVarious Audit Tests

Tests of sales andcollection cycle

Finished goodsCost of goods sold

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Integration of the Tests

Acquisition and Payment Cycle

Payroll and Personnel Cycle

Sales and Collection Cycle

Cost Accounting

Physical Inventory, Pricing, and Compilation

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End of Chapter 20