AUDITINGCHAPTER 15
Inventory & Fixed AssetsByDavid N. Ricchiute
GBW 8th ed., Ch. 152
TOPICS
Nature of conversion cycleAuditor’s consideration of controls for inventory, fixed assetsSubstantive tests for inventory, fixed assetsAudit judgment for impaired assetsComputer-assisted audit techniques for inventory, fixed assetsAssurance service opportunities
GBW 8th ed., Ch. 153
INVENTORY DOCUMENTS
Labor charge report Summary labor costs for work-in-
process
Materials requisitionPerpetual inventory record
GBW 8th ed., Ch. 154
DOCUMENTS FOR FIXED ASSETS
Depreciation scheduleOverhead application report Summary overhead
applied to work-in-process
GBW 8th ed., Ch. 155
INVENTORY CONVERSION: Nonmanufacturing
RetailerWholesalerCosts: Holding & physically
controlling prior to sale
GBW 8th ed., Ch. 156
INVENTORY CONVERSION: Manufacturing
Costs Raw materials Transformation costs
Direct labor Manufacturing overhead
GBW 8th ed., Ch. 157
INVENTORY CONTROLS
Supervisor approval for materials requisitionInventory Control personnel control raw materials, finished goods Segregation from purchasing,
receiving, shipping, production, recording
Responsible for transfers in, out, inventory levels, reports slow moving, damaged goods
GBW 8th ed., Ch. 158
MONITORING INVENTORY LEVELS
Economic order quantity models Optimize carrying costs
with risk of shortages
Just-in-time inventory management
GBW 8th ed., Ch. 159
INVENTORY ACCOUNTING
Perpetual inventory records Quantities, locations, selected cost
information
Cost records Accumulates raw materials, direct
labor, overhead Applies costs by appropriate method
FIFO, LIFO, AVERAGE
GBW 8th ed., Ch. 1510
INTERNAL CONTROL OBJECTIVES
AuthorizationExecutionRecordingAccess to assets
GBW 8th ed., Ch. 1511
AUTHORIZATION: Inventory Objective, Error, Procedure
Objective Error Procedure
Production authorized
Unauthorized quantities, products produced; obsolete, excess, unusable inventory
Criteria for products & quantities
GBW 8th ed., Ch. 1512
EXECUTION: Inventory Objective, Error, Procedure
Objective Error ProcedureProcedures
for using, transferring inventory in accord with management’s authorization
Circumvent existing procedures; stolen, misused inventoryInventory misplaced
Inventory procedures manual for controlRestrict access to inventory
GBW 8th ed., Ch. 1513
RECORDING: Inventory Objectives, Errors, Procedures
Objectives Errors ProceduresInventory
recorded at proper amounts, period, classification
Inventory not recorded; inventory, CGS misstated
Recording procedures; prenumber, control release forms; log inventory movement; periodic counts
Adjustments authorized
Unauthorized adjustments mean misused, misstated inventory
Approval for adjustments; prenumber, control forms
GBW 8th ed., Ch. 1514
ACCESS: Inventory Objectives, Errors, Procedures
Objectives Errors ProceduresAccess to inventory restricted
Inventory stolen, lost, diverted
Physical controls; employee insurance, fidelity bonds; inventory insurance; segregate handling & recording
Access to production, accounting, records restricted
Records misused, destroyed, lost
Physical controls over forms, records; files authorized signatures, periodic compliance audits
GBW 8th ed., Ch. 1515
FIXED ASSET ACCOUNTING
Detailed records for each asset Purchase date, cost, depreciation
method, life, salvage, accumulated depreciation
Reconcile detailed records with general ledger control accounts
Insurance records fixed assets
Additions, disposals authorized
GBW 8th ed., Ch. 1516
AUTHORIZATION: Fixed Assets Objective, Error, Procedure
Objective Error ProcedurePlant additions, disposals, retirements authorized
Assets purchased, sold without management knowledgeAssets sold at unfavorable prices
Written procedures additions, disposals, retirementsCompare scrap prices received with published
GBW 8th ed., Ch. 1517
EXECUTION: Fixed Assets Objective, Error, Procedure
Objective Error ProcedureProcedures
for operating, using moving fixed assets
Stolen, misused, misplaced equipment
Establish procedures for operating, using moving fixed assets; restrict access to movable assets
GBW 8th ed., Ch. 1518
RECORDING: Fixed Assets Objectives, Errors, Procedures
Objectives Errors ProceduresAdditions, disposals, retirements recorded, classified correctly
Unreported transactions
Procedures for recording;for disposal eligibility; detailed records; reconcile detailed records with assets
Depreciation, amortization proper
Depreciation miscalculated, misstated
Policies for depreciation
GBW 8th ed., Ch. 1519
ACCESS: Fixed Assets Objectives, Errors, Procedures
ObjectivesErrors ProceduresAccess to assets restricted
Assets lost, stolen
Physical controls; insurance coverage
Access to records restricted
Records misused, destroyed, lost
Physical controls over forms, records; periodic compliance audits
GBW 8th ed., Ch. 1520
CONSIDERING INTERNAL CONTROL: Inventory
Obtain an understanding Preliminary review Document system Perform transaction walk-
through Determine whether controls
are potentially reliable in assessing control risk below maximum• Test controls
GBW 8th ed., Ch. 1521
INTERNAL CONTROL DOCUMENTATION
Internal control questionnaireFlowchartMemorandum
GBW 8th ed., Ch. 1522
TESTS OF CONTROLS: Inventory Records
Perpetual recordsCost records
GBW 8th ed., Ch. 1523
TESTING CONTROLS: Raw Materials Perpetual Records
For sampled raw materials Compare quantities, unit costs invoice to
records
GBW 8th ed., Ch. 1524
TESTING CONTROLS: Inventory Transfers
For sampled transfers Raw materials trace to
Approved requisitions, Work-in-process records, Summary entries in GL
Work-in-process, trace to Transfers to finished goods records, Summary
entries in GL Finished goods, trace to
Shipping documents Summary of CGS, Sales
GBW 8th ed., Ch. 1525
TESTING CONTROLS: Inventory Cost Records
Obtain summaries of charges to work-in-processTest direct labor & overheadReview basis for standard overhead ratesDetermine disposition over-, under-applied overhead
GBW 8th ed., Ch. 1526
CONSIDERING INTERNAL CONTROLS: Fixed Assets
Obtain an understanding Preliminary review System documentation Transaction walk-through Determine whether controls are
potentially reliable in assessing control risk below maximum• Test controls
GBW 8th ed., Ch. 1527
TESTING CONTROLS: Fixed Asset Records
Reconcile total of detailed records with GL & investigate differencesPhysically inspect sampled fixed assetsReview adequacy insurance coverage
GBW 8th ed., Ch. 1528
TESTING CONTROLS: Fixed Asset Additions
Obtain summary fixed asset additionsFoot summary; reconcile to GLFor a sample Examine authorization, PO, receiving report,
invoice, etc. Examine evidence of cash payment & trace
to voucher register Examine evidence of obligations Determine classification appropriate
GBW 8th ed., Ch. 1529
TESTING CONTROLS: Fixed Asset Disposals
Obtain summary disposals & retirementsFoot summary; reconcile to GLFor a sample Examine authorization, contract, invoice,
etc. Examine entry cash receipts journal Examine note receivable;trace to GL Calculate gain, loss & trace to GL
GBW 8th ed., Ch. 1530
TESTING CONTROLS: Fixed Asset Depreciation
Review depreciation methods by asset class & policies for life, salvageFor a sample Determine whether life, salvage
consistent with policies Recalculate depreciation expense,
accumulated depreciation
GBW 8th ed., Ch. 1531
SUBSTANTIVE TESTS: Existence, Occurrence
Inventory Fixed Assets
Observe physical inventoryConfirm off-premises inventoryTest cutoff
Observe asset additionsTest cutoff
GBW 8th ed., Ch. 1532
SUBSTANTIVE TESTS: Completeness
Inventory Fixed Assets
Observe physical inventoryConfirm off-premises inventoryTest cutoffPerform analytical procedures
Observe asset additionsTest cutoffPerform analytical procedures
GBW 8th ed., Ch. 1533
SUBSTANTIVE TESTS: Rights & Obligations
Inventory Fixed Assets
Confirm off-premises inventoryTest cutoffReview consignment & purchase commitments
Test additionsTest cutoffExamine contracts, documentation
GBW 8th ed., Ch. 1534
SUBSTANTIVE TESTS: Valuation, Allocation
Inventory Fixed Assets
Test priced inventoryReview physical inventory for obsolete, slow moving, unsalable goods
Verify accuracy recorded fixed assets, depreciationTest additions, disposals
GBW 8th ed., Ch. 1535
SUBSTANTIVE TESTS: Presentation, Disclosure
Inventory Fixed Assets
Compare presentation, disclosures with GAAP
Compare presentation, disclosures with GAAP
GBW 8th ed., Ch. 1536
SUBSTANTIVE TESTS & ASSERTIONS: Inventory 1
Existence, Completeness Observe physical inventory
Existence, Completeness, Rights Confirm off-premises inventory
Valuation Obtain records; test mathematical
accuracy
GBW 8th ed., Ch. 1537
SUBSTANTIVE TESTS & ASSERTIONS: Inventory 2
Existence, Occurrence, Completeness, Rights Test cutoff & coordinate with sales,
A/R
Completeness Analytical procedures
Presentation, Disclosure Review for classification, disclosure
GBW 8th ed., Ch. 1538
SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 1
Valuation Verify mathematical accuracy
fixed assets, depreciation
Existence, Occurrence, Completeness, Rights, Valuation Test additions, disposals;
physically inspect
GBW 8th ed., Ch. 1539
SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 2
Completeness Analytical tests
Presentation, Disclosure Fixed assets, depreciation properly
classified, disclosed
GBW 8th ed., Ch. 1540
MANAGEMENT & AUDITOR INCENTIVES
Management incentives Income smoothing via “big baths”
Auditor incentives Need persuasive evidence of
permanent loss in value
GBW 8th ed., Ch. 1541
COMPUTER ASSISTED TESTS: Inventory, Fixed Assets
Substantive test Computer taskVerify mathematical accuracy
Foot, cross-foot, test extensions
Compare details Compare quantities master file, perpetual file
Perform price tests
Compare prices final inventory with invoices
Merge physical counts, perpetual records
Update & print exceptions
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