16 - 1 ©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley Audit of the Inventory and Warehousing Cycle Chapter 16

16 - 1©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley

Audit of the Inventoryand Warehousing Cycle

Chapter 16


Learning Objective 1

Identify the business functions

and the related documents

and records in the inventory

and warehousing cycle.


Functions in the Inventoryand Warehousing Cycle

Processpurchase

orders

Processpurchase

orders

Storeraw

materialsProcess the goodsProcess the goods

Receive rawmaterials

Receive rawmaterials


Functions in the Inventoryand Warehousing Cycle

Storefinishedgoods

Shipfinishedgoods

Shipfinishedgoods



Describe how e-commerce

affects inventory management.


How E-Commerce Affects Inventory Management

The Internet enables clients to provide expandeddescriptions of their inventory on a real-time basis.

The use of the Internet and other e-commerceapplications may lead to financial reportingrisks if access to inventory databases and

systems is not adequately controlled.



Explain the five parts of

the audit of the inventory

and warehouse cycle.


Audit of Inventory

Internally transferassets and costs.

Acquire and recordraw materials, labor,

and overhead.

Part of audit Cycle in which testedAcquisition and

payment pluspayroll and personnel

Inventory andwarehousing


Audit of Inventory

Physically observeinventory.

Price and compileinventory.

Cycle in which testedShip goods and record

revenue and costs.

Part of auditSales andcollection





Design and perform audit

tests of cost accounting.


Cost Accounting Controls

2. Controls over the related costs

1. Physical Controls

Raw materials WIP Finished goods


Tests of Cost Accounting

Physical Controls

Documents and records fortransferring inventory

Perpetual inventory master files

Unit cost records



Apply analytical procedures to

the accounts in the inventory



Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare gross margin Overstatement orpercentage with that of understatement ofprevious years. inventory and cost

of goods soldCompare inventory turnover Obsolete inventory(cost of goods sold divided Overstatement or by average inventory) with understatement ofthat of previous years. inventory




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




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


Methodology for DesigningTests of Details of Balances

Identify client business risks affectingthe inventory and warehousing cycles.

Set tolerable misstatement andassess inherent risk for the

inventory and warehousing cycles.

Assess control risk for several cycles.



Design and perform tests ofcontrols and substantive tests

of transactions for theseveral cycles.

Design and perform analyticalprocedures for the inventory




Design tests of detailsof inventory to satisfy

balance-relatedaudit objectives.

Audit proceduresSample size

Items to selectTiming



Design and perform

physical observation

audit tests for inventory.


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


Selection of items

Sample size

Timing

Audit Decisions


Physical Observation Tests

The most important part of the observationof inventory is determining whether the

physical count is being taken in accordancewith the client’s instructions.


Balance-Related Objectives: Physical Inventory Observation

Existence

Completeness

Accuracy

Inventory as recorded on tags exist.

Existing inventory iscounted and tagged.

Inventory is countedaccurately.


Classification

Cutoff

Inventory is classified correctly on the tags.

Transactions are recorded in the proper period.




Rights The client has rights

to inventory recorded on tags

Realizable Value

Obsolete and unusableinventory items areexcluded or noted.



Design and perform audit

tests of pricing and

compilation for inventory.


Audit of Pricing and Compilation

Inventory compilation tests

Inventory price tests


Valuationof inventory

Pricing andcompilationprocedures

Pricing andcompilation

controls

Audit of Pricing and Compilation


Balance-Related Objectives:Inventory Pricing and Compilation

Detailtie-in

Existence

Completeness Accuracy


Balance-Related Objectives:Inventory Pricing and Compilation

ClassificationRealizable

value

RightsPresentation

and disclosure


Valuation (Pricing) of Inventory

Pricing Purchased Inventory

Pricing Manufactured Inventory

Cost or Market



Integrate the various parts of

the audit of the inventory



Interrelationship ofVarious Audit Tests

Tests of acquisitionand payment cycle

Raw materialsAcquisitions ofraw materials

Work in processOther manufacturing

overhead



Tests of payrolland personnel cycle

Work in processDirect labor

Work in processIndirect labor



Inventory tests

Raw materialsEnding inventory

Work in processEnding inventory

Finished goodsEnding inventory



Tests of sales andcollection cycle

Tests of sales andcollection cycle

Finished goodsCost of goods sold


Integration of the Tests

Acquisition and payment cycle

Payroll and personnel cycle

Sales and collection cycle

Cost accounting

Physical inventory, pricing, and compilation


End of Chapter 16