Production And Inventory Cycle

Question 2

Risks within the cycle.

Answer 2

1. Inventory can be stolen due:
   - inadequate physical control
   - inadequate control over the transfer of inventory
   - inadequate isolation of responsibility
   - inadequate division of duties
2. Inventory deteriorate in value due to:
   - inadequate physical control
   - it’s nature
3. Delay and inefficiency in production
   - incorrect raw materials used
   - non availability of material
   - poor quality of material
4. Unauthorized production
5. Inadequate recording of costs
6. Error and fraud
7. Difficult to establish net realizable value
8. Goods store in multiple locations
9. Other inherent risks
   - omission of stock on hand
   - omission of inventory in transit
   - inclusion of inventory more than once
   - inclusion of inventory already sold but not yet delivered
   - incorrect pricing of obsolete and damaged inventory

Question 3

Three major functions of the cycle

Answer 3

Production,planning and design
Production process (movement of goods)
Inventory management

Question 4

Documents within the cycle

Answer 4

Customer production order
Inventory production order
Customer job card
Job transfer/inventory movement sheet (GRN)
Inventory master file
Daily production report
Completed production report
Transfer to finished goods note
Inventory count sheet
Inventory adjustment form

Question 5

Audit assertions in production transactions

Answer 5

Occurrence - records equal to actual, no duplicated
Completeness and cut off - all recorded and correct accounting period
Accuracy and classification - expenses calculated correctly and recorded in accordance with accounting framework at consistent basis

Question 6

Audit assertions for inventory and cost of sales balances

Answer 6

Existence - physically exist at year end
Rights and obligations - entity has valid title to inventory at year end
Completeness - all exist and none omitted or duplicated
Valuation and allocation - allocated in accordance to accounting policies
Presentation and disclosure - correctly disclosed according to accounting framework and appropriate disclosure for inventory pledged to secure liabilities

Question 7

Risks involved with inventory

Answer 7

Theft
Obsolescence
Error in receipt and issue
Error in recording

Question 8

General controls

Answer 8

Supervision and review
Segregation of duties
Management control
Internal control
Sufficient stationery control
Scrutinize all records and documents for extraordinary items
Test casting and calculations

Question 9

Ideal internal controls

Answer 9

Inventory should be safeguarded against theft and damage (lock, etc)-safeguard
Inventory leaves the storeroom based on properly authorized documentation - completeness and occurrence
All inventory accurately recorded at correct quantity and prices

Question 10

Production planning and design functions

Answer 10

Authorization
Appropriate segregation of duties
Customer job card generated capturing all costs involved ( raw material, labour hours, machine hours)
Signature as evidence of function
Daily production of all jobs distributed and monitored
Management review

Question 11

Production process function

Answer 11

Pre-numbered raw material issue slip
Accounted for in customer job card
List on daily production report copy sent to store staff to compare with inventory master file record for the day

Question 12

List the detail procedure for inventory

Answer 12

Primary risk = overstatement
Test direction = GL to supporting documents
Assertions:
Valuation - inventory at lower of cost or net realizable value (primary)
Existence - physically existed at year end (primary)
Rights and obligation - entitlement at year end (primary)
Completeness - everything recorded (secondary)
Cut off - correct period (standard)
Accuracy - inventory determined thru allocation(standard)
Presentation and disclosure - correctly classified and disclosed (standard)

Question 13

General procedures for inventory

Answer 13

Evaluate effectiveness of internal control to determine timing, nature and extent of substantive procedure
Obtain trial balances or schedule of significant balances
- agree balances to prev year
- review movements for unusual items and investigate
Perform analytical procedure
- compare balances of current to prev
Obtain management representation letter for…
Inspect sequence tests for completeness
Scrutinize accounts and records and supporting documents
Observe security checkpoint
Select sample to ensure correct cut off
Inspect financial statements for presentation and disclosure

Question 14

Planning for inventory count

Answer 14

Fixing the date
Fixing the responsibility
Control over stationery
Control over Inventory movements
Cut off point established
Explicit instructions

Question 15

Inventory counts are…

Answer 15

Under proper supervision
Two per team
Everyone initial page to proof functions
All count sheet accounted for and return at the end of count
Auditor obtain copy of plan and procedure and ensure procedures were followed

Question 15

What are the two objectives of the production and inventory cycle?

Answer 15

1. Taking custody of inventory as well as the safekeeping thereof
2. The recording of cost when dealing with a production or manufacturing environment

Question 16

How should the auditor observe the count of inventory?

Answer 16

1. Obtain a rough plan of the premises and visit these accompanied by an official
   - take note of where high value items are situated
   - inventories which may be troublesome or difficult to count
2. Plan the work to be done during observation
3. Arrive at the premise prior to the commencement of the inventory count on the day of the count
   - observe issuing of count sheets and recording of their serial numbers and record the last serial number of the document issued
4. Visit the areas where counting is in progress and observe whether
   - count is being done competently, conscientiously and in accordance with the instructions
   - the tag or count sheet are being properly written up
   - any deterioration of stock overlooked at prior sorting is noted by the counter and recorder
   - the procedure of checking the count is proceeding according to instructions
5. Observe the manner in which the count is completed:
   - to ascertain whether instructions are properly implemented
   - to witness the return of tags or count sheets to the responsible official
   - to note whether all tags or count sheets are accounted for by checking the sequence of tags or count sheets returned
6. Settle queries arising with the appropriate supervisor
7. Select predetermined sample of items and count these
8. Complete the audit working paper on the observation made noting any weaknesses or failure of implementation
9. Summarize the conclusions about all aspects of the inventory count
10. Report to management any weaknesses observed. File a copy of working paper and ascertain subsequently whether management has taken appropriate action to investigate and rectify them.