Chapter 12 Flashcards
(24 cards)
Special significance of Audit of Inventories
- The valuation of goods on hand and in process often presents complex and difficult issues.
- Determining the quantities of inventories may require specialized techniques.
- Inventories often represent the largest current asset of a company.
- Misstatement of inventories directly affect cost of goods sold and, therefore, net income.
- Management fraud has often involved that fraudulent overstatement of inventories.
- The determination of inventory quality, condition, and value is inherently a more complex and difficult task than is the case with most other elements of financial position
Sources of Inventories
- Goods on hand ready for sale.
- Goods in the process of production
- Goods to be consumed directly or indirectly in production such as raw materials, purchased parts and supplies.
Objectives
1- Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to inventories and cost of goods Sold.
2- Obtain an Understanding of internal control over inventories and cost of goods sold
3- Assess the risk of material misstatement and design test of controls and substantive procedures that:
- Substantiate the existence and the occurrence of transactions affecting COGS.
- Establish the completeness of recorded inventories.
- Verify the cutoff of transactions affecting COGS.
- Determine that the client has rights to the recorded inventories.
- Establish the proper valuation of inventories and the accuracy of transactions affecting COGS
- Determine that the presentation and disclosure of information about inventories and COGS.
Inventories Methods
- Periodic inventory system
- Determine inventory quantities solely by an annual physical count.
- Perpetual inventory records.
- Inventory updated constantly
- Strong internal control over inventories
- May use test counts throughout the year.
Internal Control
Monitoring
Risk assessment
Control environment
Control Environment
Commitment to competence and human resource policies and practices
- Appropriately qualified and trained personnel assigned to inventory
Integrity and ethical values
- Company purchasing agents do not accept “kickbacks”
Organizational structure and assignment of authority and responsibility.
- purchasing, receiving and production understand roles.
Risk Assessment
Related to
- availability of a supply of goods, services, and skilled labor.
- stability of prices and labor rates.
- generation of sufficient cash flow to pay for purchases.
- changes in technology that affect manufacturing processes.
- Obsolescence of inventory.
Monitoring
- Observations by production supervisors of performance of various activities and functions
- quality and performance reviews
- formal program to consider improvements in purchasing and production notedly internal auditors.
Functions related to inventories
- Purchasing
- receiving
- storing
- issuing
- processing
- shipping.
Purchasing functions
Internal control
- segregation of purchasing receiving and recording
Cycle
- purchase requisition form completed by department
- purchasing prepares purchase order.
. may obtain bids but need approval
. item description and quantity
. copy forwarded to accounting
. copy forwarded to receiving should not include quantity.
Receiving and storing Functions
Receiving
- determines quantity of goods received.
- detects damaged or defective merchandise
- prepares receiving report.
- prompt transmittal of goods received to stores department.
Storing
- counts, inspects and receives goods.
- notifies accounting of receipt.
- physically secures inventory.
Issuing and production functions
Stores department issues goods to requesting department.
- prenumbered requisiiton
Production
- controlled with master production schedule
- production orders
- materials requisitions and move tickets
- job time tickets.
Shipping Functions
Shipment upon authorized sales order approved by credit department
- generates
- One copy in shipping renumbered shipping document
- one copy to billing
- third copy used as packing slip.
- for goods shipped comon carrier- fourth copy serves as bill of lading.
Cost Accounting
- Accounts for usage of raw materials
- determines content and value of goods in progress.
- compute finished inventory.
Control over the conversion cycle.
- Segregation of duties over purchases and custody of inventory
- use of pre-numberers requisitions, purchase orders, and receiving reports.
- Procedures for authorizing purchase transactions and verifying them for payment.
- general ledger control of inventories and reconciliations to production records.
- cost accounting controls
- analysis of variances fro standard costs
- use of perpetual records for inventories
- use of appropriate procedures for taking inventory
- appropriate physical controls over inventories.
Sample of purchase transactions
- examine purchase requisition for approval
- examine the vendor’s invoice, receiving report, and paid check
- trace transactions to the voucher register and check register
- inspect vendors’ invoices for approval of prices, freight and credit terms, and accounts distribution, and recompute extensions and footings.
- compare quantities and prices in the invoice, purchase order, and receiving report.
- trace postings from voucher register to general ledger and any applicable subsidiary ledgers.
Major - substantive procedures for inventories and COGS
- Obtain listings of inventory and reconcile to ledgers. (existence, occurrence and rights)
- Evaluate the client’s planning of physical inventory.((existence, occurrence and rights)
- Observe the taking of physical inventory and make test counts.
- Review the year-end cutoff of purchases and sales transactions. (Completeness)
- Obtain a copy of the completed physical inventory, test its clerical accuracy, and trace test counts. (valuation and cutoff)
- Evaluate the bases and methods of inventory pricing.
- Test the pricing of inventories
- Perform analytical procedures.
- Determine whether any inventories have been pledged and review purchase and sales commitments.
- Evaluate financial statement presentation of inventories and COGS, including the adequacy of disclosure.
Consideration in planning a physical inventory
- Selection of the appropriate date
- suspend production
- segregation obsolete and defective goods.
- establishing control over the accounting process
- achieving proper cutoff of sales and purchases
- arranging for the services of specialists.
Inventory Observation
- Client counts and supervises inventory
- auditors observe - determine all items included
- employees comply with instructions
- be alert for inclusion of obsolete or damaged merchandise
- record numbers of final receiving and shipping documents issued before inventory taking.
- make test counts
- tag control.
When the auditors are engaged after year-end
May conclude that sufficient appropriate evidence cannot be obtained to express an opinion.
or could obtain satisfaction with alternative auditing procedures
- existence of strong internal control
- perpetual inventory records
- documentation of well-planned and executed physical inventory
- making of test counts.
Proper cut-off of Inventory
Examine on a test basis the purchase invoices and receiving reports for several days before and after the inventory date.
- determine that liability has been recorded for all goods in inventory.
- make sure shipments and purchases recorded in proper period.
Inventory Pricing
Emphasize:
- what method of pricing does the client use?
- is the method of pricing the same as that used in prior years.
- has the method selected by the client been applied consistently and accurately in practice?
- test the pricing of inventories.
Presentation and disclosure
- Disclosure of inventory pricing methods or methods use
- other important disclosures:
- Changes in methods
- classifications of inventory
- details of pledged inventory
- deduction of valuation allowance for inventory losses
- existence and terms of inventory purchase commitments.
Problems with first year clients
Procedures to obtain evidence that beginning inventory is fairly stated.
- review predecessor’s working papers.
- discuss with person who supervised physical inventory at beginning.
- study written instructions in planning.
- trace numerous items from inventory tags to final summary sheets.
- test perpetual inventory records for previous year.
- Test overall reasonableness of beginning inventory.
