21 - 1 ©2006 prentice hall business publishing, auditing 11/e, arens/beasley/elder audit of the...
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21 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit of the InventoryAudit of the Inventoryand Warehousing and Warehousing CycleCycle
Chapter 21Chapter 21
21 - 2©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 1Learning Objective 1
Describe the business functionsDescribe the business functions
and the related documents andand the related documents and
records in the inventory andrecords in the inventory and
warehousing cycle.warehousing cycle.
21 - 3©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Flow of Inventory and CostsFlow of Inventory and Costs
ActualActual
Raw Materials Raw Materials
BeginningBeginninginventoryinventory
RawRawmaterialsmaterialsusedused
PurchasesPurchases
EndingEndinginventoryinventory
Direct LaborDirect Labor
ActualActual
AppliedApplied
AppliedAppliedManufacturing OverheadManufacturing Overhead
Work in ProcessWork in Process
BeginningBeginninginventoryinventory
EndingEndinginventoryinventory
Cost ofCost ofgoodsgoodsmanufacturedmanufactured
Cost ofCost ofgoods soldgoods soldFinished GoodsFinished Goods
BeginningBeginninginventoryinventory
EndingEndinginventoryinventory
Cost ofCost ofgoods soldgoods sold
21 - 4©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Functions in the Inventory and Functions in the Inventory and Warehousing CycleWarehousing Cycle
ProcessProcesspurchasepurchaseordersorders
ReceiveReceiverawrawmaterialsmaterials
StoreStorerawrawmaterialsmaterials
ProcessProcessthethegoodsgoods
StoreStorefinishedfinishedgoodsgoods
ShipShipfinishedfinishedgoodsgoods
ReceiveReceiverawrawmaterialsmaterials
PutPutmaterialsmaterialsininstoragestorage
PutPutmaterialsmaterialsininproductionproduction
PutPutcompletedcompletedgoods ingoods instoragestorage
ShipShipfinishedfinishedgoodsgoods
FlowFlowofofinventoryinventory
21 - 5©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 2Learning Objective 2
Describe how e-commerceDescribe how e-commerce
affects inventory management.affects inventory management.
21 - 6©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
How E-Commerce Affects How E-Commerce Affects Inventory ManagementInventory Management
The Internet enables clients to provideThe Internet enables clients to provideexpanded descriptions of theirexpanded descriptions of theirinventory on a real-time basis.inventory on a real-time basis.
The use of the Internet and other e-commerceThe use of the Internet and other e-commerceapplications may lead to financial reportingapplications may lead to financial reportingrisks if access to inventory databases andrisks if access to inventory databases andsystems is not adequately controlled.systems is not adequately controlled.
21 - 7©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 3Learning Objective 3
Explain the five parts of the auditExplain the five parts of the audit
of the inventory and warehousingof the inventory and warehousing
cycle.cycle.
21 - 8©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit of InventoryAudit of Inventory
Acquire and recordAcquire and recordraw materials, labor,raw materials, labor,and overhead.and overhead.
Part of auditPart of audit Cycle in which testedCycle in which tested
Acquisition andAcquisition andpayment pluspayment pluspayroll and personnelpayroll and personnel
Internally transferInternally transferassets and costs.assets and costs.
Inventory andInventory andwarehousingwarehousing
21 - 9©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit of InventoryAudit of Inventory
Ship goods and recordShip goods and recordrevenue and costs.revenue and costs.
Cycle in which testedCycle in which testedPart of auditPart of audit
Sales and collectionSales and collection
Physically observePhysically observeinventory.inventory.
Inventory andInventory andwarehousingwarehousing
Price and compilePrice and compileinventory.inventory.
Inventory andInventory andwarehousingwarehousing
21 - 10©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 4Learning Objective 4
Design and perform audit testsDesign and perform audit tests
of cost accounting.of cost accounting.
21 - 11©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Cost Accounting ControlsCost Accounting Controls
2. Controls over the related costs2. Controls over the related costs
1. Physical controls over raw1. Physical controls over raw materials, work in process,materials, work in process, and finished goods inventoryand finished goods inventory
21 - 12©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Methodology for Designing Tests of Methodology for Designing Tests of Balances – Accounts ReceivableBalances – Accounts Receivable
Understand internalUnderstand internalcontrol – costcontrol – costaccounting system.accounting system.
AuditAuditproceduresprocedures
Items toItems toselectselect
SampleSamplesizesize TimingTiming
Assess planned controlAssess planned controlrisk – costrisk – costaccounting system.accounting system.
Design tests of controls and substantive tests ofDesign tests of controls and substantive tests oftransactions for the cost accounting systemtransactions for the cost accounting systemto meet transaction-related audit objectives.to meet transaction-related audit objectives.
Determine extent of testing controls.Determine extent of testing controls.
21 - 13©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Tests of Cost AccountingTests of Cost Accounting
Physical ControlsPhysical Controls
Documents and records forDocuments and records fortransferring inventorytransferring inventory
Perpetual inventory master filesPerpetual inventory master files
Unit cost recordsUnit cost records
21 - 14©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 5Learning Objective 5
Apply analytical procedures toApply analytical procedures to
the accounts in the inventorythe accounts in the inventory
and warehousing cycle.and warehousing cycle.
21 - 15©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Compare inventory turnoverCompare inventory turnover(cost of goods sold divided by(cost of goods sold divided byaverage inventory) with thataverage inventory) with thatof previous year.of previous year.
Obsolete inventoryObsolete inventory
Overstatement orOverstatement orunderstatementunderstatementof inventoryof inventory
Analytical procedureAnalytical procedure
Compare gross marginCompare gross marginpercentage with that ofpercentage with that ofprevious years.previous years.
Overstatement orOverstatement orunderstatement ofunderstatement ofinventory and costinventory and costof goods soldof goods sold
Possible misstatementPossible misstatement
21 - 16©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Compare extended inventoryCompare extended inventoryvalue with that of previousvalue with that of previousyears.years.
Misstatements inMisstatements incompilation, unit costs, orcompilation, unit costs, orextensions, which affectextensions, which affectinventory and cost ofinventory and cost ofgoods soldgoods sold
Analytical procedureAnalytical procedure
Compare unit costs ofCompare unit costs ofinventory with thoseinventory with thoseof previous years.of previous years.
Overstatement orOverstatement orunderstatement of unitunderstatement of unitcosts, which affectcosts, which affectinventory and cost ofinventory and cost ofgoods soldgoods sold
Possible misstatementPossible misstatement
21 - 17©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment
Analytical procedureAnalytical procedure
Compare current yearCompare current yearmanufacturing costs with thosemanufacturing costs with thoseof previous years (variableof previous years (variablecosts should be adjusted forcosts should be adjusted forchanges in volume).changes in volume).
Misstatements of unit costsMisstatements of unit costsof inventory, especiallyof inventory, especiallydirect labor anddirect labor andmanufacturing overhead,manufacturing overhead,which affect inventory andwhich affect inventory andcost of goods soldcost of goods sold
Possible misstatementPossible misstatement
21 - 18©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Identify client risks affecting the inventory andIdentify client risks affecting the inventory andwarehousing cycle.warehousing cycle.
Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other AccountsPhase IPhase I
Set tolerable misstatement and assess inherentSet tolerable misstatement and assess inherentrisk for the inventory and warehousing cycle.risk for the inventory and warehousing cycle.
Assess control risk for several cycles.Assess control risk for several cycles.
21 - 19©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Design and perform tests of controls andDesign and perform tests of controls andsubstantive tests of transactionssubstantive tests of transactionsfor several cycles.for several cycles.
Phase IIPhase II
Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other Accounts
21 - 20©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Design and perform analytical proceduresDesign and perform analytical proceduresfor the inventory and warehousing cycle.for the inventory and warehousing cycle.
Phase IIIPhase III
AuditAuditproceduresprocedures
Items toItems toselectselect
SampleSamplesizesize TimingTiming
Design tests of details of inventory to satisfyDesign tests of details of inventory to satisfybalance-related audit objectives.balance-related audit objectives.
Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other Accounts
21 - 21©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 6Learning Objective 6
Design and perform physicalDesign and perform physical
observation audit testsobservation audit tests
for inventory.for inventory.
21 - 22©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
ControlsControls
Proper instructions for the physical countProper instructions for the physical count
Supervision by responsible personnelSupervision by responsible personnel
Independent interval verification of the countsIndependent interval verification of the counts
Independent reconciliations of the physicalIndependent reconciliations of the physicalcounts with perpetual inventory master filescounts with perpetual inventory master files
Adequate control over count sheets or tagsAdequate control over count sheets or tags
21 - 23©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit DecisionsAudit Decisions
TimingTiming
SampleSamplesizesize
SelectionSelectionof itemsof items
21 - 24©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Physical Observation TestsPhysical Observation Tests
The most important part of the observation ofThe most important part of the observation ofinventory is determining whether the physicalinventory is determining whether the physicalcount is being taken in accordance with thecount is being taken in accordance with theclient’s instructions.client’s instructions.
21 - 25©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Balance-Related Audit Objectives: Balance-Related Audit Objectives: Physical Inventory ObservationPhysical Inventory Observation
ExistenceExistence Inventory as recordedInventory as recordedon tags exist.on tags exist.
CompletenessCompleteness Existing inventory isExisting inventory iscounted and tagged.counted and tagged.
AccuracyAccuracy Inventory is countedInventory is countedaccurately.accurately.
21 - 26©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
ClassificationClassification Inventory is classified Inventory is classified correctly on the tags.correctly on the tags.
CutoffCutoff Transactions are recordedTransactions are recorded in the proper period.in the proper period.
Balance-Related Audit Objectives: Balance-Related Audit Objectives: Physical Inventory ObservationPhysical Inventory Observation
21 - 27©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Balance-Related Audit Objectives: Balance-Related Audit Objectives: Physical Inventory ObservationPhysical Inventory Observation
Rights Rights The client has rightsThe client has rightsto inventory recordedto inventory recordedon tags.on tags.
Realizable Realizable ValueValue
Obsolete and unusableObsolete and unusableinventory items areinventory items areexcluded or noted.excluded or noted.
21 - 28©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective7Learning Objective7
Design and perform audit testsDesign and perform audit tests
of pricing and compilationof pricing and compilation
for inventory.for inventory.
21 - 29©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Audit of Pricing and CompilationAudit of Pricing and Compilation
Inventory compilation testsInventory compilation tests
Inventory price testsInventory price tests
21 - 30©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Valuation of inventoryValuation of inventory
Pricing and compilation proceduresPricing and compilation procedures
Pricing and compilation controlsPricing and compilation controls
Audit of Pricing and CompilationAudit of Pricing and Compilation
21 - 31©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Balance-Related Objectives: Balance-Related Objectives: Inventory Pricing and CompilationInventory Pricing and Compilation
Detail tie-inDetail tie-in ExistenceExistence
CompletenessCompleteness AccuracyAccuracy
21 - 32©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Balance-Related Objectives: Balance-Related Objectives: Inventory Pricing and CompilationInventory Pricing and Compilation
ClassificationClassification Realizable Realizable valuevalue
RightsRights PresentationPresentationand disclosureand disclosure
21 - 33©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Valuation of InventoryValuation of Inventory
Pricing purchased inventoryPricing purchased inventory
Pricing manufactured inventoryPricing manufactured inventory
Cost or marketCost or market
21 - 34©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Learning Objective 8Learning Objective 8
Integrate the various parts ofIntegrate the various parts of
the audit of the inventorythe audit of the inventory
and warehousing cycle.and warehousing cycle.
21 - 35©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Interrelationship of VariousInterrelationship of VariousAudit TestsAudit Tests
Tests of acquisitionTests of acquisitionand payment cycleand payment cycle
Acquisitions ofAcquisitions ofraw materialsraw materials
Raw materialsRaw materials
Other manufacturingOther manufacturingoverheadoverhead
Work in processWork in process
Raw material usedRaw material usedRaw material usedRaw material used
21 - 36©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Interrelationship of VariousInterrelationship of VariousAudit TestsAudit Tests
Tests of payroll andTests of payroll andpersonnel cyclepersonnel cycle
Direct laborDirect labor
Work in processWork in process
Indirect laborIndirect labor
Work in processWork in process
21 - 37©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Interrelationship of VariousInterrelationship of VariousAudit TestsAudit Tests
Inventory testsInventory tests• Tests of cost accounting recordsTests of cost accounting records• Tests of physical inventory observationTests of physical inventory observation• Tests of pricing and compilationTests of pricing and compilation
Ending inventoryEnding inventory
Raw materialsRaw materials
Ending inventoryEnding inventory
Work in processWork in process
Ending inventoryEnding inventory
Finished goodsFinished goods
21 - 38©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
Interrelationship of VariousInterrelationship of VariousAudit TestsAudit Tests
Cost of goodsCost of goodsmanufacturedmanufactured
Work in processWork in process
Cost of goodsCost of goodsmanufacturedmanufactured
Finished goodsFinished goods
Tests of salesTests of salesandandcollection cyclecollection cycle
Cost of goods soldCost of goods sold
Finished goodsFinished goods
21 - 39©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder
End of Chapter 21End of Chapter 21