2d - 1 audit of the inventory and warehousing cycle chapter 2d
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2D - 2
OVERVIEW OF THE INVENTORY
MANAGEMENT PROCESS
Figure 13-1 shows how other processes interact with the inventory management process.
Figure 13-2 presents a flowchart for a reasonably complex inventory management process.
2D - 3
DOCUMENTS AND RECORDS
Production schedule. Receiving report. Material requisition. Inventory master file. Production data information. Cost accumulation and variance report. Inventory status report. Shipping order.
2D - 4
Raw Materials Work in Process
ManufacturingOverhead
Flow of Inventory and Costs
Actual Applied
ManufacturingDirect Labor
Actual Applied
Beginninginventory
RawmaterialsusedPurchases
Endinginventory
2D - 5
Work in Process Finished Goods
Flow of Inventory and Costs
Beginninginventory
Endinginventory
Cost of Goods Sold
Cost of goodsmanufactured
Beginninginventory
Endinginventory
Cost ofgoods sold
2D - 6
Functions in the Inventory and Warehousing Cycle
Processpurchase
orders
Processpurchase
ordersReceive raw
materialsReceive raw
materials
Storeraw
materials
Storeraw
materialsProcess the materialsProcess the materials
2D - 7
Functions in the Inventory and Warehousing Cycle
Perpetual inventorymaster file
Perpetual inventorymaster file
Storefinishedgoods
Storefinishedgoods
Shipfinishedgoods
Shipfinishedgoods
2D - 8
Audit of Inventory
Acquire and recordraw materials, labor,
and overhead.
Internally transferassets and costs.
Part of audit Cycle in which tested
Acquisition andpayment plus
payroll and personnel
Inventory andwarehousing
2D - 9
Audit of Inventory
Ship goods and recordrevenue and costs.
Physically observeinventory.
Price and compileinventory.
Cycle in which testedPart of audit
Sales andcollection
Inventory andwarehousing
Inventory andwarehousing
2D - 10
SEGREGATION OF DUTIES
The inventory management function should be segregated from the cost accounting function.
The inventory stores function should be segregated from the cost-accounting function.
The cost-accounting function should be segregated from the general ledger function.
The responsibility of supervising physical inventory taking should be separated from the inventory management and inventory stores functions.
2D - 11
INHERENT RISK ASSESSMENT
Industry-related factors Competition Inventory valuation issues Rapid technology changes
Engagement and Operating Characteristics Types of product Valuation can lead to disagreements with client Possible related-parties transactions
2D - 12
CONTROL RISK ASSESSMENT
Planning and performing tests of controlson inventory transactions
Understanding and documenting the inventory management process based
on the planned level of control risk
Assessing and documenting thecontrol risk for the
inventory management process
2D - 13
AUDITING INVENTORY
Substantive tests of transactions Analytical procedures Tests of account balances
2D - 14
SUBSTANTIVE TESTS OF TRANSACTIONS
Because the inventory management process interacts with the revenue, purchasing, and payroll processes, control procedures over the receipt of raw materials, shipment of goods, and assignment of labor costs are normally tested as part of those processes.
If the auditor intends to obtain substantive evidence on the perpetual inventory records, the tests of receipt and shipment of goods can be extended by tracing the transactions into the perpetual inventory records.
2D - 15
ANALYTICAL PROCEDURES
Compare raw material, finished goods, and total inventory turnover to previous years’ and industry averages.
Compare days outstanding in inventory to previous years’ and industry averages.
Compare gross profit percentage by product line with previous years and industry data.
Compare actual cost of goods sold to budgeted amounts.
2D - 16
ANALYTICAL PROCEDURE (continued)
Compare current year standard costs with prior years’ after considering current conditions.
Compare actual manufacturing overhead costs with budgeted or standard manufacturing overhead costs.
2D - 17
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare unit costs of Overstatement orinventory with those of understatement ofprevious years. unit costs
Compare extended Misstatements ininventory value with that compilation, unitof previous years. costs, or extensions
2D - 18
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare current year Misstatement of unitmanufacturing costs with costs of inventory,those of previous years especially direct(variable costs should be labor andadjusted for changes in manufacturingvolume). overhead
2D - 19
Cost Accounting Controls
2. Controls over the related costs
1. Physical Controls
Raw materials WIP Finished goods
2D - 20
Tests of Cost Accounting
Physical Controls
Documents and records fortransferring inventory
Perpetual inventory master files
Unit cost records
2D - 21
OBSERVATION OF PHYSICAL INVENTORY
The auditor's observation of inventory is a generally accepted auditing procedure.
The observation of the physical inventory provides evidence primarily on the validity audit objective (also ownership and valuation).
2D - 22
OBSERVATION PROCEDURES
Insure that no production is scheduled. Ensure that there is no movement of goods during the
inventory count. Make sure that the client's count teams are following the
inventory count instructions. Ensure that inventory tags are issued sequentially to
individual departments. Perform test counts and record a sample of counts in the
working papers.
2D - 23
OBSERVATION PROCEDURES
(continued) Obtain tag control information for testing the client's
inventory compilation. Obtain cutoff information. Observe the condition of the inventory for items that
may be obsolete, slow moving, or in excess quantities.
Inquiry about goods held on consignment for others or held on a "bill and hold" basis.
2D - 24
Controls
Proper instructions for the physical count
Supervision by responsible personnel
Independent interval verification of the counts
Independent reconciliations of the physicalcounts with perpetual inventory master files
Adequate control over count sheets or tags
2D - 26
Valuationof inventory
Pricing andcompilationprocedures
Pricing andcompilation
controls
Audit of Pricing and Compilation
2D - 27
Valuation (Pricing)of Inventory
Pricing Purchased Inventory
Pricing Manufactured Inventory
Cost or Market
2D - 28
TESTS OF ACCOUNT BALANCES
Table 13-8 summarizes the tests of the inventory account balance for each audit objective.
2D - 29
POSSIBLE CAUSES OF BOOK-TO-PHYSICAL
DIFFERENCES Inventory cutoff errors. Unreported scrap or spoilage. Pilferage or theft.
2D - 30
SAMPLE DISCLOSURE ITEMS FOR INVENTORY AND RELATED ACCOUNTS
Cost method (FIFO, LIFO, retail method). Components of inventory. Long-term purchase contracts. Consigned inventory. Purchases from related parties. LIFO liquidations. Pledged or assigned inventory. Disclosure of unusual losses from writedowns of
inventory or losses on long-term purchase commitments.
Warranty obligations.
2D - 31
Interrelationship ofVarious Audit Tests
Tests of acquisitionand payment cycle
Raw materialsAcquisitions ofraw materials
Work in processOther manufacturing
overhead
2D - 32
Interrelationship ofVarious Audit Tests
Tests of payrolland personnel cycle
Work in processDirect labor
Work in processIndirect labor
2D - 33
Interrelationship ofVarious Audit Tests
Inventory tests
Raw materialsEnding inventory
Work in processEnding inventory
Finished goodsEnding inventory
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