21 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit of the...

21 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder

Audit of the InventoryAudit of the Inventoryand Warehousing and Warehousing CycleCycle

Chapter 21Chapter 21


Learning Objective 1Learning Objective 1

Describe the business functionsDescribe the business functions

and the related documents andand the related documents and

records in the inventory andrecords in the inventory and

warehousing cycle.warehousing cycle.


Flow of Inventory and CostsFlow of Inventory and Costs

ActualActual

Raw Materials Raw Materials

BeginningBeginninginventoryinventory

RawRawmaterialsmaterialsusedused

PurchasesPurchases

EndingEndinginventoryinventory

Direct LaborDirect Labor

ActualActual

AppliedApplied

AppliedAppliedManufacturing OverheadManufacturing Overhead

Work in ProcessWork in Process



Cost ofCost ofgoodsgoodsmanufacturedmanufactured

Cost ofCost ofgoods soldgoods soldFinished GoodsFinished Goods



Cost ofCost ofgoods soldgoods sold


Functions in the Inventory and Functions in the Inventory and Warehousing CycleWarehousing Cycle

ProcessProcesspurchasepurchaseordersorders

ReceiveReceiverawrawmaterialsmaterials

StoreStorerawrawmaterialsmaterials

ProcessProcessthethegoodsgoods

StoreStorefinishedfinishedgoodsgoods

ShipShipfinishedfinishedgoodsgoods

ReceiveReceiverawrawmaterialsmaterials

PutPutmaterialsmaterialsininstoragestorage

PutPutmaterialsmaterialsininproductionproduction

PutPutcompletedcompletedgoods ingoods instoragestorage

ShipShipfinishedfinishedgoodsgoods

FlowFlowofofinventoryinventory



Describe how e-commerceDescribe how e-commerce

affects inventory management.affects inventory management.


How E-Commerce Affects How E-Commerce Affects Inventory ManagementInventory Management

The Internet enables clients to provideThe Internet enables clients to provideexpanded descriptions of theirexpanded descriptions of theirinventory on a real-time basis.inventory on a real-time basis.

The use of the Internet and other e-commerceThe use of the Internet and other e-commerceapplications may lead to financial reportingapplications may lead to financial reportingrisks if access to inventory databases andrisks if access to inventory databases andsystems is not adequately controlled.systems is not adequately controlled.



Explain the five parts of the auditExplain the five parts of the audit

of the inventory and warehousingof the inventory and warehousing

cycle.cycle.


Audit of InventoryAudit of Inventory

Acquire and recordAcquire and recordraw materials, labor,raw materials, labor,and overhead.and overhead.

Part of auditPart of audit Cycle in which testedCycle in which tested

Acquisition andAcquisition andpayment pluspayment pluspayroll and personnelpayroll and personnel

Internally transferInternally transferassets and costs.assets and costs.

Inventory andInventory andwarehousingwarehousing


Audit of InventoryAudit of Inventory

Ship goods and recordShip goods and recordrevenue and costs.revenue and costs.

Cycle in which testedCycle in which testedPart of auditPart of audit

Sales and collectionSales and collection

Physically observePhysically observeinventory.inventory.


Price and compilePrice and compileinventory.inventory.




Design and perform audit testsDesign and perform audit tests

of cost accounting.of cost accounting.


Cost Accounting ControlsCost Accounting Controls

2. Controls over the related costs2. Controls over the related costs

1. Physical controls over raw1. Physical controls over raw materials, work in process,materials, work in process, and finished goods inventoryand finished goods inventory


Methodology for Designing Tests of Methodology for Designing Tests of Balances – Accounts ReceivableBalances – Accounts Receivable

Understand internalUnderstand internalcontrol – costcontrol – costaccounting system.accounting system.

AuditAuditproceduresprocedures

Items toItems toselectselect

SampleSamplesizesize TimingTiming

Assess planned controlAssess planned controlrisk – costrisk – costaccounting system.accounting system.

Design tests of controls and substantive tests ofDesign tests of controls and substantive tests oftransactions for the cost accounting systemtransactions for the cost accounting systemto meet transaction-related audit objectives.to meet transaction-related audit objectives.

Determine extent of testing controls.Determine extent of testing controls.


Tests of Cost AccountingTests of Cost Accounting

Physical ControlsPhysical Controls

Documents and records forDocuments and records fortransferring inventorytransferring inventory

Perpetual inventory master filesPerpetual inventory master files

Unit cost recordsUnit cost records



Apply analytical procedures toApply analytical procedures to

the accounts in the inventorythe accounts in the inventory

and warehousing cycle.and warehousing cycle.


Analytical Procedures for Analytical Procedures for Manufacturing EquipmentManufacturing Equipment

Compare inventory turnoverCompare inventory turnover(cost of goods sold divided by(cost of goods sold divided byaverage inventory) with thataverage inventory) with thatof previous year.of previous year.

Obsolete inventoryObsolete inventory

Overstatement orOverstatement orunderstatementunderstatementof inventoryof inventory

Analytical procedureAnalytical procedure

Compare gross marginCompare gross marginpercentage with that ofpercentage with that ofprevious years.previous years.

Overstatement orOverstatement orunderstatement ofunderstatement ofinventory and costinventory and costof goods soldof goods sold

Possible misstatementPossible misstatement



Compare extended inventoryCompare extended inventoryvalue with that of previousvalue with that of previousyears.years.

Misstatements inMisstatements incompilation, unit costs, orcompilation, unit costs, orextensions, which affectextensions, which affectinventory and cost ofinventory and cost ofgoods soldgoods sold


Compare unit costs ofCompare unit costs ofinventory with thoseinventory with thoseof previous years.of previous years.

Overstatement orOverstatement orunderstatement of unitunderstatement of unitcosts, which affectcosts, which affectinventory and cost ofinventory and cost ofgoods soldgoods sold





Compare current yearCompare current yearmanufacturing costs with thosemanufacturing costs with thoseof previous years (variableof previous years (variablecosts should be adjusted forcosts should be adjusted forchanges in volume).changes in volume).

Misstatements of unit costsMisstatements of unit costsof inventory, especiallyof inventory, especiallydirect labor anddirect labor andmanufacturing overhead,manufacturing overhead,which affect inventory andwhich affect inventory andcost of goods soldcost of goods sold



Identify client risks affecting the inventory andIdentify client risks affecting the inventory andwarehousing cycle.warehousing cycle.

Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other AccountsPhase IPhase I

Set tolerable misstatement and assess inherentSet tolerable misstatement and assess inherentrisk for the inventory and warehousing cycle.risk for the inventory and warehousing cycle.

Assess control risk for several cycles.Assess control risk for several cycles.


Design and perform tests of controls andDesign and perform tests of controls andsubstantive tests of transactionssubstantive tests of transactionsfor several cycles.for several cycles.

Phase IIPhase II

Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other Accounts


Design and perform analytical proceduresDesign and perform analytical proceduresfor the inventory and warehousing cycle.for the inventory and warehousing cycle.

Phase IIIPhase III

AuditAuditproceduresprocedures

Items toItems toselectselect

SampleSamplesizesize TimingTiming

Design tests of details of inventory to satisfyDesign tests of details of inventory to satisfybalance-related audit objectives.balance-related audit objectives.

Methodology for Designing Tests Methodology for Designing Tests of Balances – Other Accountsof Balances – Other Accounts



Design and perform physicalDesign and perform physical

observation audit testsobservation audit tests

for inventory.for inventory.


ControlsControls

Proper instructions for the physical countProper instructions for the physical count

Supervision by responsible personnelSupervision by responsible personnel

Independent interval verification of the countsIndependent interval verification of the counts

Independent reconciliations of the physicalIndependent reconciliations of the physicalcounts with perpetual inventory master filescounts with perpetual inventory master files

Adequate control over count sheets or tagsAdequate control over count sheets or tags


Audit DecisionsAudit Decisions

TimingTiming

SampleSamplesizesize

SelectionSelectionof itemsof items


Physical Observation TestsPhysical Observation Tests

The most important part of the observation ofThe most important part of the observation ofinventory is determining whether the physicalinventory is determining whether the physicalcount is being taken in accordance with thecount is being taken in accordance with theclient’s instructions.client’s instructions.


Balance-Related Audit Objectives: Balance-Related Audit Objectives: Physical Inventory ObservationPhysical Inventory Observation

ExistenceExistence Inventory as recordedInventory as recordedon tags exist.on tags exist.

CompletenessCompleteness Existing inventory isExisting inventory iscounted and tagged.counted and tagged.

AccuracyAccuracy Inventory is countedInventory is countedaccurately.accurately.


ClassificationClassification Inventory is classified Inventory is classified correctly on the tags.correctly on the tags.

CutoffCutoff Transactions are recordedTransactions are recorded in the proper period.in the proper period.




Rights Rights The client has rightsThe client has rightsto inventory recordedto inventory recordedon tags.on tags.

Realizable Realizable ValueValue

Obsolete and unusableObsolete and unusableinventory items areinventory items areexcluded or noted.excluded or noted.


Learning Objective7Learning Objective7

Design and perform audit testsDesign and perform audit tests

of pricing and compilationof pricing and compilation

for inventory.for inventory.


Audit of Pricing and CompilationAudit of Pricing and Compilation

Inventory compilation testsInventory compilation tests

Inventory price testsInventory price tests


Valuation of inventoryValuation of inventory

Pricing and compilation proceduresPricing and compilation procedures

Pricing and compilation controlsPricing and compilation controls

Audit of Pricing and CompilationAudit of Pricing and Compilation


Balance-Related Objectives: Balance-Related Objectives: Inventory Pricing and CompilationInventory Pricing and Compilation

Detail tie-inDetail tie-in ExistenceExistence

CompletenessCompleteness AccuracyAccuracy


Balance-Related Objectives: Balance-Related Objectives: Inventory Pricing and CompilationInventory Pricing and Compilation

ClassificationClassification Realizable Realizable valuevalue

RightsRights PresentationPresentationand disclosureand disclosure


Valuation of InventoryValuation of Inventory

Pricing purchased inventoryPricing purchased inventory

Pricing manufactured inventoryPricing manufactured inventory

Cost or marketCost or market



Integrate the various parts ofIntegrate the various parts of

the audit of the inventorythe audit of the inventory

and warehousing cycle.and warehousing cycle.


Interrelationship of VariousInterrelationship of VariousAudit TestsAudit Tests

Tests of acquisitionTests of acquisitionand payment cycleand payment cycle

Acquisitions ofAcquisitions ofraw materialsraw materials

Raw materialsRaw materials

Other manufacturingOther manufacturingoverheadoverhead

Work in processWork in process

Raw material usedRaw material usedRaw material usedRaw material used



Tests of payroll andTests of payroll andpersonnel cyclepersonnel cycle

Direct laborDirect labor


Indirect laborIndirect labor




Inventory testsInventory tests• Tests of cost accounting recordsTests of cost accounting records• Tests of physical inventory observationTests of physical inventory observation• Tests of pricing and compilationTests of pricing and compilation

Ending inventoryEnding inventory

Raw materialsRaw materials




Finished goodsFinished goods



Cost of goodsCost of goodsmanufacturedmanufactured


Cost of goodsCost of goodsmanufacturedmanufactured


Tests of salesTests of salesandandcollection cyclecollection cycle

Cost of goods soldCost of goods sold



End of Chapter 21End of Chapter 21

21 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit of the...

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Transcript of 21 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit of the...