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(1)

Audit of the Inventory

and Warehousing Cycle


(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.


(3)

DOCUMENTS AND

RECORDS

 Production schedule.  Receiving report.

 Material requisition.  Inventory master file.

 Production data information.

 Cost accumulation and variance report.  Inventory status report.


(4)

Raw Materials Work in Process

Manufacturing Overhead

Flow of Inventory and Costs

Manufacturing Direct Labor Beginning

inventory Rawmaterials used

Purchases Ending


(5)

Work in Process Finished Goods

Flow of Inventory and Costs

Beginning inventory Ending inventory

Cost of Goods Sold Cost of goods

manufactured Beginning inventory Ending inventory Cost of goods sold


(6)

Functions in the Inventory and

Warehousing Cycle

Process purchase orders Process purchase orders Receive raw materials Receive raw materials Store raw Store


(7)

Functions in the Inventory and

Warehousing Cycle

Perpetual inventory master file Perpetual inventory master file Store finished goods Store finished goods Ship finished goods Ship finished goods


(8)

Audit of Inventory

Acquire and record raw materials, labor,

and overhead. Internally transfer

assets and costs.

Part of audit Cycle in which tested

Acquisition and payment plus

payroll and personnel Inventory and


(9)

Audit of Inventory

Ship goods and record revenue and costs. Physically observe

inventory.

Price and compile inventory.

Cycle in which tested Part of audit

Sales and collection Inventory and warehousing Inventory and warehousing


(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.


(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


(12)

CONTROL RISK

ASSESSMENT

Planning and performing tests of controls on inventory transactions

Understanding and documenting the inventory management process based

on the planned level of control risk

Assessing and documenting the control risk for the


(13)

AUDITING INVENTORY

 Substantive tests of transactions

 Analytical procedures


(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


(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.


(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.


(17)

Analytical Procedures for

Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare unit costs of Overstatement or

inventory with those of understatement of

previous years. unit costs

Compare extended Misstatements in

inventory value with that compilation, unit


(18)

Analytical Procedures for

Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare current year Misstatement of unit

manufacturing costs with costs of inventory,

those of previous years especially direct

(variable costs should be labor and

adjusted for changes in manufacturing


(19)

Cost Accounting Controls

2. Controls over the related costs 1. Physical Controls


(20)

Tests of Cost Accounting

Physical Controls

Documents and records for transferring inventory

Perpetual inventory master files Unit cost records


(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


(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


(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


(24)

Controls

Proper instructions for the physical count Supervision by responsible personnel

Independent interval verification of the counts Independent reconciliations of the physical counts with perpetual inventory master files


(25)

Audit of Pricing and

Compilation

Inventory compilation tests Inventory price tests


(26)

Valuation of inventory Pricing and

compilation procedures Pricing and

compilation controls

Audit of Pricing and

Compilation


(27)

Valuation (Pricing)

of Inventory

Pricing Purchased Inventory Pricing Manufactured Inventory


(28)

TESTS OF ACCOUNT

BALANCES

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


(29)

POSSIBLE CAUSES OF

BOOK-TO-PHYSICAL

DIFFERENCES

 Inventory cutoff errors.

 Unreported scrap or spoilage.


(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


(31)

Interrelationship of

Various Audit Tests

Tests of acquisition and payment cycle

Raw materials

Acquisitions of raw materials

Work in process

Other manufacturing overhead


(32)

Interrelationship of

Various Audit Tests

Tests of payroll and personnel cycle

Work in process

Direct labor

Work in process


(33)

Interrelationship of

Various Audit Tests

Inventory tests

Raw materials

Ending inventory

Work in process

Ending inventory

Finished goods


(34)

Interrelationship of

Various Audit Tests

Tests of sales and collection cycle


(1)

POSSIBLE CAUSES OF

BOOK-TO-PHYSICAL

DIFFERENCES

Inventory cutoff errors.

Unreported scrap or spoilage.

Pilferage or theft.


(2)

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.


(3)

Interrelationship of

Various Audit Tests

Tests of acquisition

and payment cycle

Raw materials

Acquisitions of

raw materials

Work in process

Other manufacturing

overhead


(4)

Interrelationship of

Various Audit Tests

Tests of payroll

and personnel cycle

Work in process

Direct labor

Work in process


(5)

Interrelationship of

Various Audit Tests

Inventory tests

Raw materials

Ending inventory

Work in process

Ending inventory


(6)

Interrelationship of

Various Audit Tests

Tests of sales and

collection cycle

Finished goods