CHAPTER 18 Audit of the Inventory and Warehousing Cycle 18 - 2 Copyright 2003 Pearson Education Canada I nc. What is the sequence of functions in the
inventory and warehousing cycle? 18 - 3 Copyright 2003 Pearson Education Canada I nc. 1. An employee recognizes a need for a purchase; com- pletes a requisition and sends it to purchasing. PURCHASING DEPARTMENT Ace Company PURCHASE REQUISITION The production dept. needs 200 kgs. of dry #4 solvent. authorized employee 18 - 4 Copyright 2003 Pearson Education Canada I nc. 2. Purchasing shops for the ap- propriate quality at the best price, then prepares a pur- chase order. PURCHASING DEPARTMENT Ace Company PURCHASE ORDER To: Big Chemical Co. Please ship 200 kgs. of dry #4 sol- vent by 6/2/04 Price $38.40/kg. purchasing agent BIG Chemical Co. 18 - 5 Copyright 2003 Pearson Education Canada I nc. 3. When goods arrive from the vendor, the receiving dept. inspects, counts, and pre- pares a receiving report. RECEIVING DEPARTMENT Ace Company RECEIVING REPORT Received 200 kgs. of dry #4 solvent on 6/1/04. Condition: OK receiving employee BIG Chemical Co. BIG Chemical Co. 18 - 6 Copyright 2003 Pearson Education Canada I nc. WAREHOUSE 4. Goods are moved from re- ceiving to a warehouse; per- petual inventory is updated. RECEIVING DEPARTMENT perpetual inventory description $$ 6/1/04-dry #4 solvent-200 kgs.7680 18 - 7 Copyright 2003 Pearson Education Canada I nc. PRODUCTION DEPARTMENT WAREHOUSE 5. When needed, goods are moved from the warehouse to production; perpetu- al inventory and cost accounting re- cords are updated. cost acctg. system description _ $$ _ June 8, 2004 Raw matl added - dry #4 solvent (200 kgs.) 7680 perpetual inventory description $$ 6/1/01-dry #4 solvent-200 kgs.7680 6/8/04-trans.200 kgs.to prod. -7680 18 - 8 Copyright 2003 Pearson Education Canada I nc. WAREHOUSE 6. When finished, goods are moved from production to the warehouse; perpetu- al inventory and cost accounting re- cords are updated. perpetual inventory description $$ 6/9/04-fin.goods 50 litres x7g 9680 PRODUCTION DEPARTMENT cost acctg. system description _ $$ _ 6/9/04-trans. 50 litres of finished x7g to warehouse 9680
18 - 9 Copyright 2003 Pearson Education Canada I nc. 7. When sold, goods are shipped and perpetual inventory re- cords are updated. A C E perpetual inventory description $$ 6/9/04-fin.goods 50 litres-x7g 9680 8/5/03- sold 30 litres-x7g -5808
Ace Co. 18 - 10 Copyright 2003 Pearson Education Canada I nc. What are the primary audit
objectives with regard to inventory? 18 - 11 Copyright 2003 Pearson Education Canada I nc. What are the primary audit objectives with regard to inventory? - existence 18 - 12 Copyright 2003 Pearson Education Canada I nc. What are the primary audit objectives with regard to inventory? - existence - rights ABC Electronics Co. Sales Invoice 18 - 13 Copyright 2003 Pearson Education Canada I nc. What are the primary audit objectives with regard to inventory? - existence - rights - accuracy 18 - 14 Copyright 2003 Pearson Education Canada I nc. What are the primary audit objectives with regard to inventory? - existence - rights - accuracy - realizable value 18 - 15 Copyright 2003 Pearson Education Canada I nc. What is the primary audit procedure with regard to inventory? 18 - 16 Copyright 2003 Pearson Education Canada I nc. What is the primary audit procedure with regard to inventory? Observe the clients inventory-taking procedures. 18 - 17 Copyright 2003 Pearson Education Canada I nc. What is the primary audit procedure with regard to inventory? Observe the clients inventory-taking procedures. 18 - 18 Copyright 2003 Pearson Education Canada I nc. When do client inventory- taking procedures occur? 18 - 19 Copyright 2003 Pearson Education Canada I nc. When do client inventory- taking procedures occur? If the client has a periodic inventory system, the physical inventory count determines the balance in inventory accounts and will probably occur on the balance sheet date. December 18 - 20 Copyright 2003 Pearson Education Canada I nc. When do client inventory- taking procedures occur? If the client has a perpetual inventory system, the physical inventory count may occur any time during the accounting period. Whenever the count occurs, the auditor is required to observe. June 18 - 21 Copyright 2003 Pearson Education Canada I nc. Some clients use statistical sampling in their inventory methods. why? 18 - 22 Copyright 2003 Pearson Education Canada I nc. Some clients use statistical sampling in their inventory methods. reduces the need to count every inventory item (sample results can be statistically extended to the population) 18 - 23 Copyright 2003 Pearson Education Canada I nc. Some clients use statistical sampling in their inventory methods. What are the auditors concerns? 18 - 24 Copyright 2003 Pearson Education Canada I nc. Some clients use statistical sampling in their inventory methods. The auditor is concerned that the statistical inventory plan: - has statistical validity - is properly applied - achieves reasonable results 18 - 25 Copyright 2003 Pearson Education Canada I nc. Should the auditor test beginning inventory balances? January 18 - 26 Copyright 2003 Pearson Education Canada I nc. Should the auditor test beginning inventory balances? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances. 18 - 27 Copyright 2003 Pearson Education Canada I nc. Should the auditor test beginning inventory balances? how? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances. 18 - 28 Copyright 2003 Pearson Education Canada I nc. how? analytical procedures review of prior inventory count records tests of inventory transactions and documents When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances. 18 - 29 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? client head- quarters & auditors office public warehouse 18 - 30 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Are additional procedures necessary? 18 - 31 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Confirmation, alone, will not be sufficient if inventory quantities held at the warehouse are significant. 18 - 32 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review clients procedures for investigating and evaluating the warehouse 18 - 33 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review clients procedures for investigating and evaluating the warehouse ~ obtain report from warehouses auditor regarding internal controls 18 - 34 Copyright 2003 Pearson Education Canada I nc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review clients procedures for investigating and evaluating the warehouse ~ obtain report from warehouses auditor regarding internal controls ~ observe warehouses physical counts (if practical) 18 - 35 Copyright 2003 Pearson Education Canada I nc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. 18 - 36 Copyright 2003 Pearson Education Canada I nc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. What are the auditing implications? 18 - 37 Copyright 2003 Pearson Education Canada I nc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the clients
18 - 38 Copyright 2003 Pearson Education Canada I nc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the clients - the auditor still should observe the physical inventory count
18 - 39 Copyright 2003 Pearson Education Canada I nc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the clients - the auditor still should observe the physical inventory count - the auditor must test the effectiveness of the inventory-taking companys procedures 18 - 40 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures perform analytical procedures to test inventory reasonableness 18 - 41 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures regarding the client physical inventory count: Review the clients plan for counting the physical inventory. Attend client count planning meetings. 18 - 42 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Observe the physical inventory count. Determine whether clients counting methods are effective. regarding the client physical inventory count: 18 - 43 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Observe the quality and condition of the inventory. Consider obsolescence. regarding the client physical inventory count: 18 - 44 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures On a random basis: - select a sample of inventory items from the warehouse floor, count them, trace the quantity to client count records regarding the client physical inventory count: 18 - 45 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures On a random basis: - select a sample of inventory items from the client count records, find them in the warehouse, count them regarding the client physical inventory count: 18 - 46 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures On a random basis: - select a sample of inventory items from the client count records, trace them to the perpetual inventory records 4/30/x7 Physical Inventory 18# widgets - purple 4/30/04 Physical Inventory 18# widgets - purple 4/30/04 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18
regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the perpetual inventory records trace them to the client count records 18 - 48 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures
determine whether any inventory has been pledged as collateral (disclosure) 18 - 49 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories. consignments R us ACE 18 - 50 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the clients inventory, confirm that amount with the consignee 18 - 51 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the clients inventory, confirm that amount with the consignee - if a client consignee holds a portion of a consignors inventory, confirm that amount with the consignor 18 - 52 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures
Consider the effects of sales and purchases cutoff tests on inventories. 18 - 53 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures Test the clients application of their inventory valuation method (FIFO, LIFO) and the lower-of-cost-or- market rule. 18 - 54 Copyright 2003 Pearson Education Canada I nc. Inventory Audit Procedures For manufactured inventories: test the cost accumulation process as it affects valuation of ending inventories and COGS