Prepared by:

Alex Almodiel, CPA, MBA

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Business Processes Affecting Inventory
Management Process
Inventory
Purchasing Revenue
Process Management Process
Process
 Purchase raw materials  Sale of goods
 Payment of overhead
costs
Payroll / HR
Management  Assignment of direct
Process and indirect labor

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
Conversion Cycle

Raw Materials
Sales Forecast
Warehouse

Production
Actual Inventory General
Planning &
Production Control Ledger
Control
Process Process Process
Process

Cost Finished Goods

Accounting Warehouse

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Documents and Records
Sales Forecast Receiving Report
Inventory Status Report Inventory Master File
Production Schedule Production Data Information
Bill of Materials Cost Accumulation and
Route Sheet Variance Report
Move ticket Shipping Order
Materials Requisition Slip
Materials Return Slip
Purchase Requisition

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Functions in the Inventory Management Process
Major Function Details
Inventory Management Authorization of production and maintenance of inventory at
appropriate levels; issuance of purchase requisitions to the purchasing
department.
Raw materials stores Custody of raw materials and issuance of raw materials to
manufacturing departments
Manufacturing Actual production of goods
Finished goods stores Custody of finished goods and issuance of goods to the shipping
department.
Cost Accounting Maintenance of the cost of manufacturing and inventory in cost
records.
General Ledger Proper accumulation, classification, and summarization of inventory
and related costs in ledger.

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Key Segregation of Duties in the Inventory Management
Process and Possible Errors & Fraud
Segregation of Duties Possible Errors or Fraud Resulting from Conflict of Duties
Inventory management function and the If the individual responsible for inventory management
cost-accounting function. also has access to the cost-accounting records, production
and inventory costs can be manipulated. This may lead to
an over or understatement of inventory and net income.
Inventory stores function and cost- If one individual is responsible for both controlling and
accounting function. accounting for inventory, unauthorized shipments can be
made or theft of goods can be covered up.
Cost accounting function and general If one individual is responsible for the inventory records
ledger function. and also for the general ledger, it is possible for that
individual to conceal unauthorized shipments. This can
result in the theft of goods, leading to an overstatement of
inventory.

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Key Segregation of Duties in the Inventory Management
Process and Possible Errors & Fraud
Segregation of Duties Possible Errors or Fraud Resulting from Conflict of Duties
Supervision of physical inventory and If the individual responsible for production management
inventory management function and or inventory stores function is also responsible for physical
inventory stores function. inventory, it is possible that inventory shortages can be
covered up through the adjustment of the inventory
records to the physical inventory, resulting in an
overstatement of inventory.

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Recommended Segregation of Duties for Inventory Function
by Department
Raw Finished
Inventory Cost
Payroll Functions Materials Goods IT
Management Accounting
Stores Warehouse
Preparation of production schedules X
Issuance of materials requisitions that
accompany goods to the manufacturing X
department
Updating cost records with materials,
X
labor and overhead usage
Updating of inventory records X
Release of finished goods to shipping
X
department
Approval and issuance of purchase
X
requisitions
AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
Inherent Risk Assessment

Industry related factors – E.g. intense

competition and technology

Engagement & Operating Characteristics – E.g.

nature of inventory and related party transaction

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Control Risk Assessment
Components of Example of Specific Situations or Circumstances Risk
Internal Control that may Influence Control Risk Assessment Assessment
Control Environment Existence of written sanctions for theft assets as part of Code of Low
Conduct of the audit client.
Entity’s Risk Audit client invests large amount of money to research and Low
Assessment Process development to keep their products in demand or introduce new
products while old products are starting to get obsolete.
Control Procedures Inventory management function, custody of inventories, cost Low
accounting and general ledger functions are segregated.
Information Systems Uses sales forecast to plan production and detailed process of Low
& Communication requesting and issuance of materials to work centers.
Monitoring Controls Internal audit done routinely on conversion cycle. Low

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
 Examples of Assertions, Possible Misstatements, Internal Control & Audit Procedure

Assertion Possible Misstatement Control Procedure Audit Procedure

Occurrence Fictitious inventory
Completeness Inventory recorded but
not on hand due to theft.
Rights Already sold inventories
mixed with unsold
inventories.
Accuracy Inventory and cost of
goods sold not properly
costed.
Presentation Misclassification of
& Disclosure inventory transactions.
Use of approved pre-numbered Review and test
receiving report for inventory procedures for transfer of
transfers to inventory department inventory.
Physical safeguards over inventory. Observe physical
safeguards over inventory.
Sold inventories are removed from Inspect shipping
warehouse, sent to shipping documents.
department, and properly
documented.
Standard costs are reviewed by Review and test
management. procedures used to
develop standard costs.
Chart of accounts Review accounts for
inventories used by client.

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
AuditofBusinessProcess/InventoryMgt/AlexAlmodiel
References
Primary Reference
• Philippine Standards on Auditing
• Auditing & Assurance Services 4th Edition by Messier/Glover/Prawitt

AuditofBusinessProcess/InventoryMgt/AlexAlmodiel