Learning Objectives LO1 Explain the key risks of misstatement in production and payroll processes. LO2 Outline the production process: typical transactions, account balances, source documents, and controls. LO3 Give examples of control tests for auditing control over conversion of materials and labour in the production process. LO4 Give examples of the typical substantive procedures used to address the assessed risk of material misstatement in the main accounts in the production process. 1

Production Process: Typical Activities The production cycle includes transactions that flow through the following business activities:  production planning, inventory planning and management,  producing goods and services, and  cost accounting and cost of goods sold administration. LO2 2

Production Most of the transactions in a production cycle are cost accounting allocations, unit cost determinations and standard cost calculations.  Think of the audit of inventory as two phases:  verification of physical units and  testing of unit costs. LO2 3

Production Process Start Here Production planning Cost accounting Determine cost of goods sold Produce goods and services Inventory planning LO2 4

Production Process: Authorization Production planning starts with a sales forecast and interacts with inventory planning to create production orders.  Managers approve the plans and production orders.  The production order includes a bill of materials, which authorize the purchase and release of materials. LO2 5

Custody Supervisors and workers have physical custody of materials, equipment and labour while production work is performed.  They can also requisition materials, and direct labour.  Control over this type of moving inventory is more difficult than control over a closed warehouse of goods. LO2 6

Recordkeeping (Cost Accounting) When production is complete, production records including the production orders and materials and labour records are sent to the accounting department.  Effective separation of duties require that costs be determined from cost information independent of the production area.  For example, material costs should come from the inventory custodian, labour costs from the payroll department. LO2 7

Periodic Reconciliation Reconciliation of physical assets and liabilities to amounts recorded in the company accounts should include a comparison of physical inventory to the recorded inventory. LO2 8

Audit Evidence in Management Reports and Files Production accounting systems produce timely reports to supervise and control production. These can be used as supporting evidence for assertions:  Sales Forecast - Provides the basis for management planning.  Production Plans and Reports - Plan for the amount and timing of production, based on sales forecast.  Amortization Schedule - Detailed schedule of depreciation on fixed assets, prepared by cost accounting. LO2 9