AUDITING CHAPTER 15 Inventory Fixed Assets By David

AUDITING CHAPTER 15 Inventory & Fixed Assets By David N. Ricchiute GBW 8 th ed. , Ch. 15

TOPICS Nature of conversion cycle Auditor’s consideration of controls for inventory, fixed assets Substantive tests for inventory, fixed assets Audit judgment for impaired assets Computer-assisted audit techniques for inventory, fixed assets Assurance service opportunities 2 GBW 8 th ed. , Ch. 15

INVENTORY DOCUMENTS Labor charge report n Summary labor costs for work-in-process Materials requisition Perpetual inventory record 3 GBW 8 th ed. , Ch. 15

DOCUMENTS FOR FIXED ASSETS Depreciation schedule Overhead application report n 4 Summary overhead applied to work-in-process GBW 8 th ed. , Ch. 15

INVENTORY CONVERSION: Nonmanufacturing Retailer Wholesaler Costs: n 5 Holding & physically controlling prior to sale GBW 8 th ed. , Ch. 15

INVENTORY CONVERSION: Manufacturing Costs n n Raw materials Transformation costs w Direct labor w Manufacturing overhead 6 GBW 8 th ed. , Ch. 15

INVENTORY CONTROLS Supervisor approval for materials requisition Inventory Control personnel control raw materials, finished goods n n 7 Segregation from purchasing, receiving, shipping, production, recording Responsible for transfers in, out, inventory levels, reports slow moving, damaged goods GBW 8 th ed. , Ch. 15

MONITORING INVENTORY LEVELS Economic order quantity models n Optimize carrying costs with risk of shortages Just-in-time inventory management 8 GBW 8 th ed. , Ch. 15

INVENTORY ACCOUNTING Perpetual inventory records n Quantities, locations, selected cost information Cost records n n Accumulates raw materials, direct labor, overhead Applies costs by appropriate method w FIFO, LIFO, AVERAGE 9 GBW 8 th ed. , Ch. 15

INTERNAL CONTROL OBJECTIVES Authorization Execution Recording Access to assets 10 GBW 8 th ed. , Ch. 15

AUTHORIZATION: Inventory Objective, Error, Procedure Objective Error Procedure Production Unauthorized Criteria for authorized quantities, products & produced; quantities obsolete, excess, unusable inventory 11 GBW 8 th ed. , Ch. 15

EXECUTION: Inventory Objective, Error, Procedure Objective Error Procedures for using, transferring inventory in accord with management’s authorization Circumvent existing procedures; stolen, misused inventory Inventory misplaced Inventory procedures manual for control Restrict access to inventory 12 GBW 8 th ed. , Ch. 15

RECORDING: Inventory Objectives, Errors, Procedures Objectives Errors Procedures Inventory recorded at proper amounts, period, classification Inventory not recorded; inventory, CGS misstated Recording procedures; prenumber, control release forms; log inventory movement; periodic counts Adjustments authorized Unauthorized adjustments mean misused, misstated inventory Approval for adjustments; prenumber, control forms 13 GBW 8 th ed. , Ch. 15

ACCESS: Inventory Objectives, Errors, Procedures Objectives Errors Procedures Access to inventory restricted Inventory stolen, lost, diverted Physical controls; employee insurance, fidelity bonds; inventory insurance; segregate handling & recording Access to production, accounting, records restricted Records misused, destroyed, lost Physical controls over forms, records; files authorized signatures, periodic compliance audits 14 GBW 8 th ed. , Ch. 15

FIXED ASSET ACCOUNTING Detailed records for each asset n n n Purchase date, cost, depreciation method, life, salvage, accumulated depreciation Reconcile detailed records with general ledger control accounts Insurance records fixed assets Additions, disposals authorized 15 GBW 8 th ed. , Ch. 15

AUTHORIZATION: Fixed Assets Objective, Error, Procedure Objective Plant additions, disposals, retirements authorized 16 Error Assets purchased, sold without management knowledge Assets sold at unfavorable prices GBW 8 th ed. , Ch. 15 Procedure Written procedures additions, disposals, retirements Compare scrap prices received with published

EXECUTION: Fixed Assets Objective, Error, Procedure Objective Error Procedures for operating, using moving fixed assets Stolen, misused, misplaced equipment Establish procedures for operating, using moving fixed assets; restrict access to movable assets 17 GBW 8 th ed. , Ch. 15

RECORDING: Fixed Assets Objectives, Errors, Procedures Objectives Errors Procedures Additions, Unreported disposals, transactions retirements recorded, classified correctly Procedures for recording; for disposal eligibility; detailed records; reconcile detailed records with assets Depreciation, amortization proper Policies for depreciation 18 Depreciation miscalculated, misstated GBW 8 th ed. , Ch. 15

ACCESS: Fixed Assets Objectives, Errors, Procedures Objectives Errors Procedures Access to assets restricted Assets lost, stolen Physical controls; insurance coverage Access to records restricted Records misused, destroyed, lost Physical controls over forms, records; periodic compliance audits 19 GBW 8 th ed. , Ch. 15

CONSIDERING INTERNAL CONTROL: Inventory Obtain an understanding n n Preliminary review Document system Perform transaction walkthrough Determine whether controls are potentially reliable in assessing control risk below maximum • Test controls 20 GBW 8 th ed. , Ch. 15

INTERNAL CONTROL DOCUMENTATION Internal control questionnaire Flowchart Memorandum 21 GBW 8 th ed. , Ch. 15

TESTS OF CONTROLS: Inventory Records Perpetual records Cost records 22 GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Raw Materials Perpetual Records For sampled raw materials n 23 Compare quantities, unit costs invoice to records GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Inventory Transfers For sampled transfers n Raw materials trace to w Approved requisitions, Work-in-process records, Summary entries in GL n Work-in-process, trace to w Transfers to finished goods records, Summary entries in GL n Finished goods, trace to w Shipping documents w Summary of CGS, Sales 24 GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Inventory Cost Records Obtain summaries of charges to work-in -process Test direct labor & overhead Review basis for standard overhead rates Determine disposition over-, underapplied overhead 25 GBW 8 th ed. , Ch. 15

CONSIDERING INTERNAL CONTROLS: Fixed Assets Obtain an understanding n n Preliminary review System documentation Transaction walk-through Determine whether controls are potentially reliable in assessing control risk below maximum • Test controls 26 GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Fixed Asset Records Reconcile total of detailed records with GL & investigate differences Physically inspect sampled fixed assets Review adequacy insurance coverage 27 GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Fixed Asset Additions Obtain summary fixed asset additions Foot summary; reconcile to GL For a sample n n 28 Examine authorization, PO, receiving report, invoice, etc. Examine evidence of cash payment & trace to voucher register Examine evidence of obligations Determine classification appropriate GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Fixed Asset Disposals Obtain summary disposals & retirements Foot summary; reconcile to GL For a sample n n 29 Examine authorization, contract, invoice, etc. Examine entry cash receipts journal Examine note receivable; trace to GL Calculate gain, loss & trace to GL GBW 8 th ed. , Ch. 15

TESTING CONTROLS: Fixed Asset Depreciation Review depreciation methods by asset class & policies for life, salvage For a sample n n 30 Determine whether life, salvage consistent with policies Recalculate depreciation expense, accumulated depreciation GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS: Existence, Occurrence Inventory Fixed Assets Observe physical inventory Confirm off-premises inventory Test cutoff Observe asset additions Test cutoff 31 GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS: Completeness Inventory Fixed Assets Observe physical inventory Confirm off-premises inventory Test cutoff Perform analytical procedures Observe asset additions Test cutoff Perform analytical procedures 32 GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS: Rights & Obligations Inventory Fixed Assets Confirm off-premises inventory Test cutoff Review consignment & purchase commitments Test additions Test cutoff Examine contracts, documentation 33 GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS: Valuation, Allocation Inventory Fixed Assets Test priced inventory Review physical inventory for obsolete, slow moving, unsalable goods Verify accuracy recorded fixed assets, depreciation Test additions, disposals 34 GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS: Presentation, Disclosure Inventory Fixed Assets Compare presentation, disclosures with GAAP 35 GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS & ASSERTIONS: Inventory 1 Existence, Completeness n Observe physical inventory Existence, Completeness, Rights n Confirm off-premises inventory Valuation n 36 Obtain records; test mathematical accuracy GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS & ASSERTIONS: Inventory 2 Existence, Occurrence, Completeness, Rights n Test cutoff & coordinate with sales, A/R Completeness n Analytical procedures Presentation, Disclosure n 37 Review for classification, disclosure GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 1 Valuation n Verify mathematical accuracy fixed assets, depreciation Existence, Occurrence, Completeness, Rights, Valuation n 38 Test additions, disposals; physically inspect GBW 8 th ed. , Ch. 15

SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 2 Completeness n Analytical tests Presentation, Disclosure n 39 Fixed assets, depreciation properly classified, disclosed GBW 8 th ed. , Ch. 15

MANAGEMENT & AUDITOR INCENTIVES Management incentives n Income smoothing via “big baths” Auditor incentives n 40 Need persuasive evidence of permanent loss in value GBW 8 th ed. , Ch. 15

COMPUTER ASSISTED TESTS: Inventory, Fixed Assets Substantive test Computer task Verify mathematical Foot, cross-foot, test accuracy extensions Compare details Compare quantities master file, perpetual file Perform price tests Compare prices final inventory with invoices Merge physical counts, perpetual records Update & print exceptions 41 GBW 8 th ed. , Ch. 15