CHAPTER 18 Audit of the Inventory and Warehousing

CHAPTER 18 Audit of the Inventory and Warehousing Cycle Copyright 2003 Pearson Education Canada Inc. 18 - 1

What is the sequence of functions in the inventory and warehousing cycle? Copyright 2003 Pearson Education Canada Inc. 18 - 2

1. An employee recognizes a need for a purchase; completes a requisition and sends it to purchasing. Ace Company PURCHASE REQUISITION PURCHASING DEPARTMENT The production dept. needs 200 kgs. of dry #4 solvent. authorized employee Copyright 2003 Pearson Education Canada Inc. 18 - 3

2. Purchasing shops for the appropriate quality at the best price, then prepares a purchase order. PURCHASING DEPARTMENT Ace Company PURCHASE ORDER To: Big Chemical Co. Please ship 200 kgs. of dry #4 solvent by 6/2/04 Price $38. 40/kg. purchasing agent BIG Chemical Co. Copyright 2003 Pearson Education Canada Inc. 18 - 4

3. When goods arrive from the vendor, the receiving dept. inspects, counts, and prepares a receiving report. BIG Chemical Co. RECEIVING DEPARTMENT BIG Chemical Co. Ace Company RECEIVING REPORT Received 200 kgs. of dry #4 solvent on 6/1/04. Condition: OK receiving employee Copyright 2003 Pearson Education Canada Inc. 18 - 5

4. Goods are moved from receiving to a warehouse; perpetual inventory is updated. RECEIVING DEPARTMENT WAREHOUSE perpetual inventory description $$ 6/1/04 -dry #4 solvent-200 kgs. 7680 Copyright 2003 Pearson Education Canada Inc. 18 - 6

5. When needed, goods are moved from the warehouse to production; perpetual inventory and cost accounting records are updated. WAREHOUSE perpetual inventory description $$ 6/1/01 -dry #4 solvent-200 kgs. 7680 6/8/04 -trans. 200 kgs. to prod. -7680 PRODUCTION DEPARTMENT cost acctg. system description _ $$ _ June 8, 2004 Raw mat’l added - dry #4 solvent (200 kgs. ) 7680 Copyright 2003 Pearson Education Canada Inc. 18 - 7

6. When finished, goods are moved from production to the warehouse; perpetual inventory and cost accounting records are updated. WAREHOUSE perpetual inventory description $$ 6/9/04 -fin. goods 50 litres x 7 g 9680 PRODUCTION DEPARTMENT cost acctg. system description _ $$ _ 6/9/04 -trans. 50 litres of finished x 7 g to warehouse 9680 Copyright 2003 Pearson Education Canada Inc. 18 - 8

7. When sold, goods are shipped and perpetual inventory records are updated. A C E Ace Co. perpetual inventory description $$ 6/9/04 -fin. goods 50 litres-x 7 g 9680 8/5/03 - sold 30 litres-x 7 g -5808 Copyright 2003 Pearson Education Canada Inc. 18 - 9

What are the primary audit objectives with regard to inventory? Copyright 2003 Pearson Education Canada Inc. 18 - 10

What are the primary audit objectives with regard to inventory? - existence Copyright 2003 Pearson Education Canada Inc. 18 - 11

What are the primary audit objectives with regard to inventory? - existence - rights ABC Electronics Co. Sales Invoice Copyright 2003 Pearson Education Canada Inc. 18 - 12

What are the primary audit objectives with regard to inventory? - existence - rights - accuracy Copyright 2003 Pearson Education Canada Inc. 18 - 13

What are the primary audit objectives with regard to inventory? - existence - rights - accuracy - realizable value Copyright 2003 Pearson Education Canada Inc. 18 - 14

What is the primary audit procedure with regard to inventory? Copyright 2003 Pearson Education Canada Inc. 18 - 15

What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures. Copyright 2003 Pearson Education Canada Inc. 18 - 16

What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures. Copyright 2003 Pearson Education Canada Inc. 18 - 17

When do client inventorytaking procedures occur? Copyright 2003 Pearson Education Canada Inc. 18 - 18

When do client inventorytaking procedures occur? December 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. Copyright 2003 Pearson Education Canada Inc. 18 - 19

When do client inventorytaking procedures occur? June 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. Copyright 2003 Pearson Education Canada Inc. 18 - 20

Some clients use statistical sampling in their inventory methods. why? Copyright 2003 Pearson Education Canada Inc. 18 - 21

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) Copyright 2003 Pearson Education Canada Inc. 18 - 22

Some clients use statistical sampling in their inventory methods. What are the auditor’s concerns? Copyright 2003 Pearson Education Canada Inc. 18 - 23

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 Copyright 2003 Pearson Education Canada Inc. 18 - 24

Should the auditor test beginning inventory balances? January Copyright 2003 Pearson Education Canada Inc. 18 - 25

Should the auditor test beginning inventory balances? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropriateness of beginning balances, if they are satisfied as to the current balances. Copyright 2003 Pearson Education Canada Inc. 18 - 26

Should the auditor test beginning inventory balances? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropriateness of beginning balances, if they are satisfied as to the current balances. how? Copyright 2003 Pearson Education Canada Inc. 18 - 27

When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropriateness of beginning balances, if they are satisfied as to the current balances. how? analytical procedures review of prior tests of inventory transactions and inventory documents count records Copyright 2003 Pearson Education Canada Inc. 18 - 28

How should the auditor test inventory held at a public warehouse? client headquarters & auditor’s office public warehouse Copyright 2003 Pearson Education Canada Inc. 18 - 29

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Are additional procedures necessary? Copyright 2003 Pearson Education Canada Inc. 18 - 30

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. Copyright 2003 Pearson Education Canada Inc. 18 - 31

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public warehouse is significant: ~ review client’s procedures for investigating and evaluating the warehouse Copyright 2003 Pearson Education Canada Inc. 18 - 32

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public warehouse is significant: ~ review client’s procedures for investigating and evaluating the warehouse ~ obtain report from warehouse’s auditor regarding internal controls Copyright 2003 Pearson Education Canada Inc. 18 - 33

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public warehouse is significant: ~ review client’s procedures for investigating and evaluating the warehouse ~ obtain report from warehouse’s auditor regarding internal controls ~ observe warehouse’s physical counts (if practical) Copyright 2003 Pearson Education Canada Inc. 18 - 34

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. Copyright 2003 Pearson Education Canada Inc. 18 - 35

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. What are the auditing implications? Copyright 2003 Pearson Education Canada Inc. 18 - 36

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 client’s Copyright 2003 Pearson Education Canada Inc. 18 - 37

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 client’s - the auditor still should observe the physical inventory count Copyright 2003 Pearson Education Canada Inc. 18 - 38

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 client’s - the auditor still should observe the physical inventory count - the auditor must test the effectiveness of the inventory-taking company’s procedures Copyright 2003 Pearson Education Canada Inc. 18 - 39

Inventory Audit Procedures perform analytical procedures to test inventory reasonableness Copyright 2003 Pearson Education Canada Inc. 18 - 40

Inventory Audit Procedures regarding the client physical inventory count: Review the client’s plan for counting the physical inventory. Attend client count planning meetings. Copyright 2003 Pearson Education Canada Inc. 18 - 41

Inventory Audit Procedures regarding the client physical inventory count: Observe the physical inventory count. Determine whether client’s counting methods are effective. Copyright 2003 Pearson Education Canada Inc. 18 - 42

Inventory Audit Procedures regarding the client physical inventory count: Observe the quality and condition of the inventory. Consider obsolescence. Copyright 2003 Pearson Education Canada Inc. 18 - 43

Inventory Audit Procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the warehouse floor, count them, trace the quantity to client count records Copyright 2003 Pearson Education Canada Inc. 18 - 44

Inventory Audit Procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the client count records, find them in the warehouse, count them Copyright 2003 Pearson Education Canada Inc. 18 - 45

Inventory Audit Procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the client count records, trace them to the perpetual inventory records 4/30/x 7 Physical 4/30/04 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 Copyright 2003 Pearson Education Canada Inc. 18 - 46

Inventory Audit Procedures 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 4/30/x 7 Physical 4/30/04 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 Copyright 2003 Pearson Education Canada Inc. 18 - 47

Inventory Audit Procedures determine whether any inventory has been pledged as collateral (disclosure) Copyright 2003 Pearson Education Canada Inc. 18 - 48

Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories. consignments “R” us ACE Copyright 2003 Pearson Education Canada Inc. 18 - 49

Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the client’s inventory, confirm that amount with the consignee Copyright 2003 Pearson Education Canada Inc. 18 - 50

Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the client’s inventory, confirm that amount with the consignee - if a client consignee holds a portion of a consignor’s inventory, confirm that amount with the consignor Copyright 2003 Pearson Education Canada Inc. 18 - 51

Inventory Audit Procedures Consider the effects of sales and purchases cutoff tests on inventories. Copyright 2003 Pearson Education Canada Inc. 18 - 52

Inventory Audit Procedures Test the client’s application of their inventory valuation method (FIFO, LIFO) and the lower-of-cost-ormarket rule. Copyright 2003 Pearson Education Canada Inc. 18 - 53

Inventory Audit Procedures For manufactured inventories: test the cost accumulation process as it affects valuation of ending inventories and COGS Copyright 2003 Pearson Education Canada Inc. 18 - 54