1. 18 - 1 Copyright  2003 Pearson Education Canada Inc. CHAPTER 18 Audit of the Inventory and Warehousing Cycle

2. 18 - 2 Copyright  2003 Pearson Education Canada Inc. What is the sequence of functions in the inventory and warehousing cycle?

3. 18 - 3 Copyright  2003 Pearson Education Canada Inc. 1. An employee recognizes a need for a purchase; com- pletes a requisition and sends it to purchasing. PURCHASING DEPARTMENT Ace Company PURCHASE REQUISITION The production dept. needs 200 kgs. of dry #4 solvent. authorized employee

4. 18 - 4 Copyright  2003 Pearson Education Canada Inc. 2. Purchasing shops for the ap- propriate quality at the best price, then prepares a pur- chase order. PURCHASING DEPARTMENT Ace Company PURCHASE ORDER To: Big Chemical Co. Please ship 200 kgs. of dry #4 sol- vent by 6/2/04 Price $38.40/kg. purchasing agent BIG Chemical Co.

5. 18 - 5 Copyright  2003 Pearson Education Canada Inc. 3. When goods arrive from the vendor, the receiving dept. inspects, counts, and pre- pares a receiving report. RECEIVING DEPARTMENT Ace Company RECEIVING REPORT Received 200 kgs. of dry #4 solvent on 6/1/04. Condition: OK receiving employee BIG Chemical Co. BIG Chemical Co.

6. 18 - 6 Copyright  2003 Pearson Education Canada Inc. WAREHOUSE 4. Goods are moved from re- ceiving to a warehouse; per- petual inventory is updated. RECEIVING DEPARTMENT perpetual inventory description $$ 6/1/04-dry #4 solvent-200 kgs.7680

7. 18 - 7 Copyright  2003 Pearson Education Canada Inc. PRODUCTION DEPARTMENT WAREHOUSE 5. When needed, goods are moved from the warehouse to production; perpetu- al inventory and cost accounting re- cords are updated. cost acctg. system description _ $$ _ June 8, 2004 Raw mat’l added - dry #4 solvent (200 kgs.) 7680 perpetual inventory description $$ 6/1/01-dry #4 solvent-200 kgs.7680 6/8/04-trans.200 kgs.to prod. -7680

8. 18 - 8 Copyright  2003 Pearson Education Canada Inc. WAREHOUSE 6. When finished, goods are moved from production to the warehouse; perpetu- al inventory and cost accounting re- cords are updated. perpetual inventory description $$ 6/9/04-fin.goods 50 litres x7g 9680 PRODUCTION DEPARTMENT cost acctg. system description _ $$ _ 6/9/04-trans. 50 litres of finished x7g to warehouse 9680

9. 18 - 9 Copyright  2003 Pearson Education Canada Inc. 7. When sold, goods are shipped and perpetual inventory re- cords are updated. A C E perpetual inventory description $$ 6/9/04-fin.goods 50 litres-x7g 9680 8/5/03- sold 30 litres-x7g -5808 Ace Co.

10. 18 - 10 Copyright  2003 Pearson Education Canada Inc. What are the primary audit objectives with regard to inventory?

11. 18 - 11 Copyright  2003 Pearson Education Canada Inc. What are the primary audit objectives with regard to inventory? - existence

12. 18 - 12 Copyright  2003 Pearson Education Canada Inc. What are the primary audit objectives with regard to inventory? - existence - rights ABC Electronics Co. Sales Invoice

13. 18 - 13 Copyright  2003 Pearson Education Canada Inc. What are the primary audit objectives with regard to inventory? - existence - rights - accuracy

14. 18 - 14 Copyright  2003 Pearson Education Canada Inc. What are the primary audit objectives with regard to inventory? - existence - rights - accuracy - realizable value

15. 18 - 15 Copyright  2003 Pearson Education Canada Inc. What is the primary audit procedure with regard to inventory?

16. 18 - 16 Copyright  2003 Pearson Education Canada Inc. What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures.

17. 18 - 17 Copyright  2003 Pearson Education Canada Inc. What is the primary audit procedure with regard to inventory? Observe the client’s inventory-taking procedures.

18. 18 - 18 Copyright  2003 Pearson Education Canada Inc. When do client inventory- taking procedures occur?

19. 18 - 19 Copyright  2003 Pearson Education Canada Inc. When do client inventory- taking procedures occur? 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. December

20. 18 - 20 Copyright  2003 Pearson Education Canada Inc. When do client inventory- taking procedures occur? 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. June

21. 18 - 21 Copyright  2003 Pearson Education Canada Inc. Some clients use statistical sampling in their inventory methods. why?

22. 18 - 22 Copyright  2003 Pearson Education Canada Inc. 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)

23. 18 - 23 Copyright  2003 Pearson Education Canada Inc. Some clients use statistical sampling in their inventory methods. What are the auditor’s concerns?

24. 18 - 24 Copyright  2003 Pearson Education Canada Inc. 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

25. 18 - 25 Copyright  2003 Pearson Education Canada Inc. Should the auditor test beginning inventory balances? January

26. 18 - 26 Copyright  2003 Pearson Education Canada Inc. 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.

27. 18 - 27 Copyright  2003 Pearson Education Canada Inc. Should the auditor test beginning inventory balances? 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.

28. 18 - 28 Copyright  2003 Pearson Education Canada Inc. how? analytical procedures review of prior inventory count records tests of inventory transactions and documents 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.

29. 18 - 29 Copyright  2003 Pearson Education Canada Inc. How should the auditor test inventory held at a public warehouse? client head- quarters & auditor’s office public warehouse

30. 18 - 30 Copyright  2003 Pearson Education Canada Inc. How should the auditor test inventory held at a public warehouse? - direct written confirmation with the public warehouse Are additional procedures necessary?

31. 18 - 31 Copyright  2003 Pearson Education Canada Inc. 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.

32. 18 - 32 Copyright  2003 Pearson Education Canada Inc. 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

33. 18 - 33 Copyright  2003 Pearson Education Canada Inc. 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

34. 18 - 34 Copyright  2003 Pearson Education Canada Inc. 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)

35. 18 - 35 Copyright  2003 Pearson Education Canada Inc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory.

36. 18 - 36 Copyright  2003 Pearson Education Canada Inc. Some large merchandisers use outside inventory-taking companies that specialize in counting inventory. What are the auditing implications?

37. 18 - 37 Copyright  2003 Pearson Education Canada Inc. 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

38. 18 - 38 Copyright  2003 Pearson Education Canada Inc. 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

39. 18 - 39 Copyright  2003 Pearson Education Canada Inc. 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

40. 18 - 40 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures perform analytical procedures to test inventory reasonableness

41. 18 - 41 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures regarding the client physical inventory count: Review the client’s plan for counting the physical inventory. Attend client count planning meetings.

42. 18 - 42 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Observe the physical inventory count. Determine whether client’s counting methods are effective. regarding the client physical inventory count:

43. 18 - 43 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Observe the quality and condition of the inventory. Consider obsolescence. regarding the client physical inventory count:

44. 18 - 44 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures On a random basis: - select a sample of inventory items from the warehouse floor, count them, trace the quantity to client count records regarding the client physical inventory count:

45. 18 - 45 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures On a random basis: - select a sample of inventory items from the client count records, find them in the warehouse, count them regarding the client physical inventory count:

46. 18 - 46 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures 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 4/30/04 Physical Inventory 18# widgets - purple 4/30/04 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 regarding the client physical inventory count:

47. 18 - 47 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures 4/30/x7 Physical Inventory 18# widgets - purple 4/30/04 Physical Inventory 18# widgets - purple 4/30/04 Physical Inventory 18# widgets - purple perpetual inventory description qty widgets - red 87 widgets - green 4 widgets - purple 18 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

48. 18 - 48 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures determine whether any inventory has been pledged as collateral (disclosure)

49. 18 - 49 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Enquire of client management regarding the existence of consigned inventories. consignments “R” us ACE

50. 18 - 50 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Enquire 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

51. 18 - 51 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Enquire 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

52. 18 - 52 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Consider the effects of sales and purchases cutoff tests on inventories.

53. 18 - 53 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures Test the client’s application of their inventory valuation method (FIFO, LIFO) and the lower-of-cost-or- market rule.

54. 18 - 54 Copyright  2003 Pearson Education Canada Inc. Inventory Audit Procedures For manufactured inventories: test the cost accumulation process as it affects valuation of ending inventories and COGS