CHAPTER 19 Audit of the Inventory and Warehousing Cycle

What is the sequence of functions in the inventory and warehousing cycle?

1. An employee recognizes a need for a purchase; com- pletes a requisition and sends it to purchasing. Ace Company PURCHASE REQUISITION The production dept. needs 200 lbs. of dry #4 solvent. authorized employee PURCHASING DEPARTMENT

2. Purchasing shops for the ap- propriate quality at the best price, then prepares a pur- chase order. PURCHASING DEPARTMENT Ace Company PURCHASE ORDER BIG Chemical Co. To: Big Chemical Co. Please ship 200 lbs. of dry #4 sol- vent by 6/2/x0. Price $38.40/lb. purchasing agent

3. When goods arrive from the vendor, the receiving dept. inspects, counts, and pre- pares a receiving report. RECEIVING DEPARTMENT Ace Company RECEIVING REPORT BIG Chemical Co. Received 200 lbs. of dry #4 solvent on 6/1/x0. Condition: OK BIG Chemical Co. receiving employee

4. Goods are moved from re- ceiving to a warehouse; per- petual inventory is updated. RECEIVING DEPARTMENT WAREHOUSE perpetual inventory description $$ 6/1/X0-dry #4 solvent-200 lbs.7680

5. When needed, goods are moved from the warehouse to production; perpetu- al inventory and cost accounting re- cords are updated. WAREHOUSE PRODUCTION DEPARTMENT perpetual inventory description $$ 6/1/X0-dry #4 solvent-200 lbs.7680 6/8/x0-trans.200 lbs. to prod. -7680 cost acctg. system description _ $$ _ June 8, 19x0 Raw mat’l added - dry #4 solvent (200 lbs.) 7680

6. When finished, goods are moved from production to the warehouse; perpetu- al inventory and cost accounting re- cords are updated. WAREHOUSE PRODUCTION DEPARTMENT perpetual inventory description $$ 6/9/X0-fin.goods 50 gallons-x7g 9680 cost acctg. system description _ $$ _ 6/9/x0-trans. 50 gallons of finished x7g to warehouse 9680

7. When sold, goods are shipped and perpetual inventory re- cords are updated. Ace Co. A C E perpetual inventory description $$ 6/9/X0-fin.goods 50 gallons-x7g 9680 8/5/x0- sold 30 gallons-x7g -5808

What are the primary audit objectives with regard to inventory?

What are the primary audit objectives with regard to inventory? - existence

What are the primary audit objectives with regard to inventory? - existence - rights ABC Electronics Co. Sales Invoice

What are the primary audit objectives with regard to inventory? - existence - rights - accuracy

What are the primary audit objectives with regard to inventory? - existence - rights - accuracy - realizable value

What is the primary audit procedure with regard to inventory?

What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures.

What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures. required by AU 331

When do client inventory-taking procedures occur?

When do client inventory-taking procedures occur? December If the client has a periodic inventory system, the physical inventory count determines the balance in inventory accounts and will probably occur on the balance sheet date.

When do client inventory-taking procedures occur? June If the client has a perpetual inventory system, the physical inventory count may occur any time during the accounting period. Whenever the count occurs, the auditor is required to observe.

Some clients use statistical sampling in their inventory methods. why?

Some clients use statistical sampling in their inventory methods. reduces the need to count every inventory item (sample results can be statistically extended to the population)

Some clients use statistical sampling in their inventory methods. What are the auditor’s concerns?

Some clients use statistical sampling in their inventory methods. The auditor is concerned that the statistical inventory plan: - has statistical validity - is properly applied - achieves reasonable results

Should the auditor test beginning inventory balances? January

Should the auditor test beginning inventory balances? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances.

Should the auditor test beginning inventory balances? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances. how?

how? When the auditing firm has not audited beginning balances, the auditors must satisfy themselves as to the appropri- ateness of beginning balances, if they are satisfied as to the current balances. how? review of prior inventory count records tests of inventory transactions and documents analytical procedures

How should the auditor test inventory held at a public warehouse? client head- quarters & auditor’s office public warehouse

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Are additional procedures necessary?

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Confirmation, alone, will not be sufficient if inventory quantities held at the warehouse are significant.

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review client’s procedures for investigating and evaluating the warehouse

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review client’s procedures for investigating and evaluating the warehouse ~ obtain report from warehouse’s auditor regarding internal controls

How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse - if inventory held at the public ware- house is significant: ~ review client’s procedures for investigating and evaluating the warehouse ~ obtain report from warehouse’s auditor regarding internal controls ~ observe warehouse’s physical counts (if practical)

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory.

What are the auditing implications? Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. What are the auditing implications?

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the client’s

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the client’s - the auditor still should observe the physical inventory count

Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. - since the inventory-taking company is a third party, their work has greater reliability than the client’s - the auditor still should observe the physical inventory count - the auditor must test the effectiveness of the inventory-taking company’s procedures

inventory audit procedures perform analytical procedures to test inventory reasonableness

inventory audit procedures regarding the client physical inventory count: Review the client’s plan for counting the physical inventory. Attend client count planning meetings.

inventory audit procedures regarding the client physical inventory count: Observe the physical inventory count. Determine whether client counting methods are effective.

inventory audit procedures regarding the client physical inventory count: Observe the quality and condition of the inventory. Consider obsolescence.

inventory audit procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the warehouse floor, count them, trace the quantity to client count records

inventory audit procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the client count records, find them in the warehouse, count them

inventory audit procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the client count records, trace them to the perpetual inventory records 4/30/x7 Physical Inventory 18# widgets - purple 4/30/x7 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 4/30/x7 Physical Inventory 18# widgets - purple

inventory audit procedures regarding the client physical inventory count: On a random basis: - select a sample of inventory items from the perpetual inventory records trace them to the client count records 4/30/x7 Physical Inventory 18# widgets - purple 4/30/x7 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 4/30/x7 Physical Inventory 18# widgets - purple

inventory audit procedures determine whether any inventory has been pledged as collateral (disclosure)

inventory audit procedures Inquire of client management regarding the existence of consigned inventories. consignments “R” us ACE

inventory audit procedures Inquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the client’s inventory, confirm that amount with the consignee

inventory audit procedures Inquire of client management regarding the existence of consigned inventories: - if a consignee holds a portion of the client’s inventory, confirm that amount with the consignee - if a client consignee holds a portion of a consignor’s inventory, confirm that amount with the consignor

inventory audit procedures Consider the effects of sales and purchases cutoff tests on inventories.

inventory audit procedures Test the client’s application of their inventory valuation method (FIFO, LIFO) and the lower-of-cost-or-market rule.

inventory audit procedures For manufactured inventories: test the cost accumulation process as it affects valuation of ending inventories and COGS