2d - 1 audit of the inventory and warehousing cycle chapter 2d

2D - 1

Audit of the Inventoryand Warehousing

CycleChapter 2D

2D - 2

OVERVIEW OF THE INVENTORY

MANAGEMENT PROCESS

Figure 13-1 shows how other processes interact with the inventory management process.

Figure 13-2 presents a flowchart for a reasonably complex inventory management process.

2D - 3

DOCUMENTS AND RECORDS

Production schedule. Receiving report. Material requisition. Inventory master file. Production data information. Cost accumulation and variance report. Inventory status report. Shipping order.

2D - 4

Raw Materials Work in Process

ManufacturingOverhead

Flow of Inventory and Costs

Actual Applied

ManufacturingDirect Labor

Actual Applied

Beginninginventory

RawmaterialsusedPurchases

Endinginventory

2D - 5

Work in Process Finished Goods

Flow of Inventory and Costs

Beginninginventory

Endinginventory

Cost of Goods Sold

Cost of goodsmanufactured

Beginninginventory

Endinginventory

Cost ofgoods sold

2D - 6

Functions in the Inventory and Warehousing Cycle

Processpurchase

orders

Processpurchase

ordersReceive raw

materialsReceive raw

materials

Storeraw

materials

Storeraw

materialsProcess the materialsProcess the materials

2D - 7

Functions in the Inventory and Warehousing Cycle

Perpetual inventorymaster file

Perpetual inventorymaster file

Storefinishedgoods

Storefinishedgoods

Shipfinishedgoods

Shipfinishedgoods

2D - 8

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

2D - 9

Audit of Inventory

Ship goods and recordrevenue and costs.

Physically observeinventory.

Price and compileinventory.

Cycle in which testedPart of audit

Sales andcollection



2D - 10

SEGREGATION OF DUTIES

The inventory management function should be segregated from the cost accounting function.

The inventory stores function should be segregated from the cost-accounting function.

The cost-accounting function should be segregated from the general ledger function.

The responsibility of supervising physical inventory taking should be separated from the inventory management and inventory stores functions.

2D - 11

INHERENT RISK ASSESSMENT

Industry-related factors Competition Inventory valuation issues Rapid technology changes

Engagement and Operating Characteristics Types of product Valuation can lead to disagreements with client Possible related-parties transactions

2D - 12

CONTROL RISK ASSESSMENT

Planning and performing tests of controlson inventory transactions

Understanding and documenting the inventory management process based

on the planned level of control risk

Assessing and documenting thecontrol risk for the

inventory management process

2D - 13

AUDITING INVENTORY

Substantive tests of transactions Analytical procedures Tests of account balances

2D - 14

SUBSTANTIVE TESTS OF TRANSACTIONS

Because the inventory management process interacts with the revenue, purchasing, and payroll processes, control procedures over the receipt of raw materials, shipment of goods, and assignment of labor costs are normally tested as part of those processes.

If the auditor intends to obtain substantive evidence on the perpetual inventory records, the tests of receipt and shipment of goods can be extended by tracing the transactions into the perpetual inventory records.

2D - 15

ANALYTICAL PROCEDURES

Compare raw material, finished goods, and total inventory turnover to previous years’ and industry averages.

Compare days outstanding in inventory to previous years’ and industry averages.

Compare gross profit percentage by product line with previous years and industry data.

Compare actual cost of goods sold to budgeted amounts.

2D - 16

ANALYTICAL PROCEDURE (continued)

Compare current year standard costs with prior years’ after considering current conditions.

Compare actual manufacturing overhead costs with budgeted or standard manufacturing overhead costs.

2D - 17

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

2D - 18

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

2D - 19

Cost Accounting Controls

2. Controls over the related costs

1. Physical Controls

Raw materials WIP Finished goods

2D - 20

Tests of Cost Accounting

Physical Controls

Documents and records fortransferring inventory

Perpetual inventory master files

Unit cost records

2D - 21

OBSERVATION OF PHYSICAL INVENTORY

The auditor's observation of inventory is a generally accepted auditing procedure.

The observation of the physical inventory provides evidence primarily on the validity audit objective (also ownership and valuation).

2D - 22

OBSERVATION PROCEDURES

Insure that no production is scheduled. Ensure that there is no movement of goods during the

inventory count. Make sure that the client's count teams are following the

inventory count instructions. Ensure that inventory tags are issued sequentially to

individual departments. Perform test counts and record a sample of counts in the

working papers.

2D - 23

OBSERVATION PROCEDURES

(continued) Obtain tag control information for testing the client's

inventory compilation. Obtain cutoff information. Observe the condition of the inventory for items that

may be obsolete, slow moving, or in excess quantities.

Inquiry about goods held on consignment for others or held on a "bill and hold" basis.

2D - 24

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

2D - 25

Audit of Pricing and Compilation

Inventory compilation tests

Inventory price tests

2D - 26

Valuationof inventory

Pricing andcompilationprocedures

Pricing andcompilation

controls

Audit of Pricing and Compilation

2D - 27

Valuation (Pricing)of Inventory

Pricing Purchased Inventory

Pricing Manufactured Inventory

Cost or Market

2D - 28

TESTS OF ACCOUNT BALANCES

Table 13-8 summarizes the tests of the inventory account balance for each audit objective.

2D - 29

POSSIBLE CAUSES OF BOOK-TO-PHYSICAL

DIFFERENCES Inventory cutoff errors. Unreported scrap or spoilage. Pilferage or theft.

2D - 30

SAMPLE DISCLOSURE ITEMS FOR INVENTORY AND RELATED ACCOUNTS

Cost method (FIFO, LIFO, retail method). Components of inventory. Long-term purchase contracts. Consigned inventory. Purchases from related parties. LIFO liquidations. Pledged or assigned inventory. Disclosure of unusual losses from writedowns of

inventory or losses on long-term purchase commitments.

Warranty obligations.

2D - 31

Interrelationship ofVarious Audit Tests

Tests of acquisitionand payment cycle

Raw materialsAcquisitions ofraw materials

Work in processOther manufacturing

overhead

2D - 32


Tests of payrolland personnel cycle

Work in processDirect labor

Work in processIndirect labor

2D - 33


Inventory tests

Raw materialsEnding inventory

Work in processEnding inventory

Finished goodsEnding inventory

2D - 34


Tests of sales andcollection cycle

Finished goodsCost of goods sold