CHAPTER 4 and 5:AUDIT OF

INVENTORIES AND FIXED

ASSETS

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 4.1. Inventory Auditing

 The Special Significance of Audit of

Inventories
1. The valuation of goods on hand and in process often presents
complex and difficult issues
2. Determining the quantities of inventories may require specialized
techniques
3. Inventories often represent the largest current asset of a company
4. Misstatements of inventories directly affect cost of goods sold and,
therefore, net income
5. Management fraud has often involved the fraudulent
overstatement of inventories

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 Cont’d
Source of Inventories Includes:
1. Goods on hand ready for sale
2. Goods in the process of production
3. Goods to be consumed directly or indirectly in
production such as raw materials, purchased parts and
supplies

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 Audit Steps
A. Use the understanding of the client and its environment to
consider inherent risks, including fraud risks, related to
inventories and cost of goods sold.
B. Obtain an understanding of internal control over inventories
and cost of goods sold.
C. Assess the risks of material misstatement and design
further audit procedures.
D. Perform further audit procedures—tests of controls.
1. Examples of tests of controls:
a. Examine significant aspects of a sample of purchase transactions.
b. Perform tests of the cost accounting system.
2. If necessary, revise the risks of material misstatement based on the
results of tests of controls

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 Cont’d
E. Perform further audit procedures—substantive procedures for
inventories and cost of goods sold.
1. Obtain listings of inventory and reconcile to ledgers.
2. Evaluate the client’s planning of physical inventory.
3. Observe the taking of physical inventory and make test counts.
4. Review the year-end cutoff of purchases and sales transactions.
5. Obtain a copy of the completed physical inventory, test its clerical
accuracy, and trace test counts.
6. Evaluate the bases and methods of inventory pricing.
7. Test the pricing of inventories.
8. Perform analytical procedures.
9. Determine whether any inventories have been pledged and review
purchase and sales commitments.
10. Evaluate financial statement presentation of inventories and cost of
goods sold, including the adequacy of disclosure.
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 4.2. Auditor’s consideration of internal controls
OBJECTIVES

There are 4 internal control objectives and

associated potential errors or frauds and
their related audit procedures for
inventory. These objectives are:
– Authorization
– Execution
– Recording
– Access to assets

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 4.3. Fixed assets auditing
 Fixed assets are those assets acquired by a business
for the purpose of use in the business with the object
of earning revenue, and which are not intended for
resale at the profit and conversion into cash in the
ordinary course of business.
 Documents related to fixed assets are:
1. Detailed records for each asset
a. Purchase date, cost, depreciation method, life, salvage,
accumulated depreciation
b. Reconcile detailed records with general ledger control
accounts
c. Insurance records fixed assets
2. Additions, disposals authorized
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 TESTING CONTROLS: Fixed Asset
Records

1. Reconcile total of detailed records with

GL & investigate differences
2. Physically inspect sampled fixed assets
3. Review adequacy insurance coverage

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 TESTING CONTROLS: Fixed
Asset Additions

1. Obtain summary fixed asset additions

2. Foot summary; reconcile to GL
3. For a sample
a. Examine authorization, PO, receiving report,
invoice, etc.
b. Examine evidence of cash payment & trace to
voucher register
c. Examine evidence of obligations
d. Determine classification appropriate
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 TESTING CONTROLS: Fixed
Asset Disposals

1. Obtain summary disposals & retirements

2. Foot summary; reconcile to GL
3. For a sample
a. Examine authorization, contract, invoice,
etc.
b. Examine entry cash receipts journal
c. Examine note receivable; trace to GL
d. Calculate gain, loss & trace to GL
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 TESTING CONTROLS: Fixed
Asset Depreciation
1. Review depreciation methods by asset
class & policies for life, salvage
2. For a sample
a. Determine whether life, salvage consistent
with policies
b. Recalculate depreciation expense,
accumulated depreciation

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 .4.4 Auditor’s consideration of internal controls
of fixed assets

INTERNAL CONTROL OBJECTIVES

There are 4 internal control objectives and associated
potential errors or frauds and their related audit
procedures of fixed assets. These objectives are:
1. Authorization
2. Execution
3. Recording
4. Access to assets

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 THE END OF CH4 and 5

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