ch19-70-360

Copyright © 2007 Pearson Education Canada

1

Chapter 19: Audit of the Inventory and Warehousing

Cycle


19-2

Chapter 19 objectives

Identify the five different parts of the inventory and warehousing cycle that are audited

Describe the process used to audit the inventory and warehousing cycle

Discuss the role of specific tests in the audit of inventory

Describe how the relationship between the tests of different cycles affects the audit of inventory

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19-3

Auditing inventory can be complex

Reasons include:– It may be a major item on the balance sheet– Inventory items could be at different locations– Very diverse items are included (jewels,

chemicals, electronic parts)– Valuation needs to consider obsolescence– One client may use several methods for

valuing inventory



19-4

Functions in the inventory and warehousing cycle

Process purchase orders Receive new materials Store materials Process goods Store finished goods Ship finished goods



19-5

Five parts of the audit of inventory, and the cycle in which tested



19-6

Audit of cost accounting

Cost accounting systems vary more than the other transaction cycle areas due to the wide variety of types of inventory and the differences in level of sophistication required by management



19-7

Cost accounting controls

These are controls that are related to the physical inventory and the compilation of the costs of that inventory from raw material requisition through to finished product

Broken into two categories:– Physical control over inventory movement– Controls over related costs



19-8

Methodology for designing tests of controls for cost accounting



19-9

Analytical procedures for the inventory and warehousing cycle

Analytical procedure Possible misstatement

Compare gross margin percentage with previous years

Overstatement or understatement of inventory and cost of goods sold

Compare inventory turnover with previous years

Obsolete inventory

Compare unit costs of inventory with previous years

Over/understatement of inventory. Over/understatement of unit costs



19-10

Analytical procedures for the inventory and warehousing cycle

(cont’d)Analytical procedure Possible misstatement

Compare extended inventory value with previous years

Misstatements in compilation, unit costs, or extensions that affect inventory and cost of goods sold.

Compare current-year manufacturing costs with previous year

Misstatement of unit costs of inventory, especially direct labour and manufacturing overhead.



19-11

Practice problem 19-21 (p. 568)

Calculate ratios for analytical review of inventory

Assess the results



19-12

Methodology for designing tests of details of balances for inventory



19-13

Tests of details for physical inventory observation: existence

Select a random sample of tag numbers and identify the tag with that number attached to the actual inventory

If inventory is not tagged (e.g. scanned), may need to select a location number

Observe whether movement of inventory takes place during the count



19-14

Tests of details for physical inventory observation: completeness

Examine inventory to make sure it is tagged

If tags are not used, the auditor may need to examine exception reports identifying locations/items not counted

Enquire as to inventory in other locations



19-15

Tests of details for physical inventory observation: accuracy

Recount client’s counts to make sure the recorded counts are accurate on the tags (or as recorded in the computer system if recorded into hand-held computer devices)

Compare physical counts with perpetual inventory master file

Record client counts test-counted for subsequent testing



19-16

Tests of details for physical inventory observation: classification

Examine inventory descriptions on the tags (or in the handheld computers) and compare with the actual inventory counted

Evaluate whether the percent of completion recorded on the tags (or job cost records) for work in process is reasonable



19-17

Tests of details for physical inventory observation: cutoff

Record in the working papers for subsequent follow-up the last shipping document number used at year end

Make sure the inventory for that shipment was excluded from the physical count

Review shipping area for inventory set aside for shipment but not counted

Conduct similar tests for receiving process



19-18

Tests of details for physical inventory observation: valuation

Test for obsolete inventory by enquiry of factory employees and management

Be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places



19-19

Tests of details for physical inventory observation: rights and obligations

Enquire as to consignment of customer inventory included on client’s premises

Be alert for inventory that is set aside or specially marked as indications of non-ownership



19-20


Examine the purpose of observing the physical inventory count

Discuss the extent of reliance on outside specialists during the audit of inventory



19-21

Tests of details for pricing and compilation: detail tie-in

Perform compilation tests Extend the quantity times the price on

selected items (or the entire inventory if using generalized audit software or other computer assisted audit software)

Foot (or test-foot) the inventory listings Trace the totals to the general ledger



19-22

Tests of details for pricing and compilation: existence

Trace inventory listed in the schedule to inventory tags (or to computerized records of the count) and to the auditor’s records of test counts for existence and description



19-23

Tests of details for pricing and compilation: completeness

Account for unused tag numbers shown in the auditor’s working papers to make sure no tags have been added

Account for the tag numbers to make sure none have been deleted

Where hand-held computers have been used, reconcile hash totals or other control totals at the end of the count to final inventory count



19-24

Tests of details for pricing and compilation: accuracy

Trace inventory listed in the schedule to inventory tags (or computer files) and auditor’s recorded counts for quantity and description

Perform price tests of inventory



19-25

Tests of details for pricing and compilation: classification

Compare the classification into raw materials, work in process, and finished boods by comparing the descriptions on inventory tags and auditor’s recorded test counts with the inventory listing schedule



19-26

Tests of details for pricing and compilation: valuation

Perform test of lower of cost or market, selling price, and obsolescence



19-27

Tests of details for pricing and compilation: rights and obligations

Trace inventory tags identified as non-owned during the physical observation to the inventory listing schedule to make sure these have not been included

Review contracts with suppliers and customers and enquire of management for the possibility of the inclusion of consigned or other non-owned inventory, or the exclusion of owned inventory



19-28

Tests of details for pricing and compilation: presentation and

disclosure Examine financial statements for proper

presentation and disclosure, including:– Separate disclosure of raw materials, work in

process, and finished goods– Proper description of the inventory costing

method– Description of pledged inventory– Inclusion of significant sales and purchase

commitments



19-29


Application of monetary unit sampling (MUS) to the audit of inventory

Assess the results of the tests to determine whether the book value is misstated



19-30

Interrelationship of various audit tests



19-31


Audit of an automated inventory system

Which controls can be relied upon?

How would you test the controls?


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