1. Part Eight Production & Cost Audit

2. Structure of Seminar 1. Inventory 2. Payroll

3. 1. Inventory 1) Introduction to auditing inventory The key assertions relating to inventory are: Existence Completeness Rights and obligations Valuation Cut-off

4. Inventory 2 ) Accounting for inventory The valuation and disclosure rules for inventory are laid down in IAS 2 Inventories. Inventory should be valued at the lower of cost and net realisable value. Production costs (costs of conversion) include: (a) Costs specifically attributable to units of production (b) Production overheads (c) Other overheads attributable to bringing the

5. Inventory product or service to its present location and condition 3) Audit procedures for inventory Audit objectives: (1) completeness (2) existence (3) right and obligation (4) valuation and allocation (5) cut-off (6) accuracy (7) occurrence and right and obligation

6. Inventory 4) The physical inventory count ISA 501 Audit evidence – specific considerations for selected items provides guidance to auditors on attending the physical inventory count to obtain evidence regarding the existence and condition of inventory It states that where inventory is material, auditors shall obtain sufficient appropriate audit evidence regarding its existence and condition by attending the physical inventory count (unless this is impracticable)

7. Inventory to do the following: Evaluate management’s instructions and procedures for recording and controlling the result of the physical inventory count. Observe the performance of the count procedures. Inspect the inventory. Perform test counts. Factors to consider when planning attendance at the inventory count include the following:

8. Inventory The risks of material misstatement of inventory Internal controls related to inventory Whether adequate procedures are expected to be established and proper instructions issued for counting The timing of the count Whether the entity maintains a perpetual inventory system Locations at which inventory is held (including materiality at different locations) Whether the assistance of an auditor’s expert is required

9. Inventory (1) The inventory count A business may count inventory by one or a combination of the following methods. (a) Physical inventory counts at the year-end (b) Physical inventory counts before or after the year-end (c) Perpetual (or continuous) inventory where management has a programme of inventory-counting throughout the year If perpetual inventory counting is used, auditors will verify that management: (a) Ensures that all inventory lines are counted at least once a year

10. Inventory (b) Maintains adequate inventory records that are kept up-to-date. (c) Has satisfactory procedures for inventory counts and test-counting. (d) Investigates and corrects all material differences. (2) Planning attendance at inventory count Before the physical inventory count the auditors should ensure audit coverage of the count is appropriate, and that the client's count instructions have been reviewed.

12. (3) Attendance at inventory count

13. Inventory The auditors' working papers should include: Details of their observations and tests The manner in which points that are relevant and material to the inventory being counted or measured have been dealt with by the client Instances where the client's procedures have not been satisfactorily carried out Items for subsequent testing, such as photocopies of (or extracts from) rough inventory sheets Details of the sequence of inventory sheets The auditors' conclusions

14. Inventory (4) After the inventory count After the count the auditors should check that final inventory sheets have been properly compiled from count records and that book inventory has been appropriately adjusted. (5)Inventory held by third parties Where the entity has inventory that is held by third parties and which is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence by performing one or both of the following:

15. Inventory Direct confirmation from the third party regarding quantities and condition (in accordance with ISA 505 External confirmations) Inspection or other appropriate audit procedures (if third party’s integrity and objectivity are doubtful, for example) The other appropriate audit procedures referred to above could include the following: Attending, or arranging for another auditor to attend, the third party’s inventory count

16. Inventory Obtaining another auditor’s report on the adequacy of the third party’s internal control for ensuring that inventory is properly counted and adequately safeguarded Inspecting documentation in respect of third party inventory (e.g. warehouse receipts) Requesting confirmation from other parties when inventory has been pledged as collateral

17. 2. Payroll 1) Tests of control Test sample of time sheet, clock cards for approval by responsible official  Observe wages distribution to ensure right person collect right pay  Test authorization of payroll amendments  Examine evidence of checking payroll calculation  Examine evidence of approval  Examine evidence independence checks of payroll  Test controls over unclaimed wages  Examine explanation for variance

18. Payroll 2)Substantive tests Substantive tests in respect of payroll focus primarily on whether or not expenses have been overstated as a result of: Payments being made to fictitious employees Genuine employees being paid for hours they have not worked Inappropriate rate

19. Payroll The main tests are as follows: 1. analytical review  compare with production level, sales level  Compare levels of payroll throughout the year on a month-by-month basis  Check leavers and joiners, changes in the rates of pay 2. test cast and calculation 3. test samples of personnel records for rate of pay, authorization of changes, leavers` and joiners` detail

20. Payroll 4. Cut-off test 5. select sample check to time records, test to personnel records, test cast and calculations with reference to tax 6. test posting of payroll to general ledger account 7. test total cheques to net pay(PAYE)