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Chapter 13
Inventory
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Inventory Remember that the inventory balance on the
statement of financial position is also the closinginventory figure on the statement of profit or loss. Assuch, Cut of is also a relevant assertion in addition tothe usual assertions for account balances.
The main source of evidence for inventory, is normallythe year end inventory count (although some clientsmay use continuous inventory counting, throughoutthe year).
ISA 501Audit evidence
specific considerations forselected items requires the auditor to attend thephysical inventory count (unless impracticable), ifinventory is material to the financial statements.
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Inventory
Inventory include :
Raw material
Work in progress
Finished goods
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Inventory
The inventory count is the responsibility of the
client. The auditor attends the count to help obtainsufficient appropriate evidence to form an opinion
as to whether inventory is free from material
misstatement.
In order to obtain sufficient appropriate evidence,
the auditor must perform procedures before, during
and after the inventory count during the final audit.
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Before inventory count1) Contact client to obtain a copy of the inventory count
instructions, to understand how the count will be conducted
and assess the effectiveness of the count process.2) Review prior year working papers to understand the
inventory count process and identify any issues that wouldneed to be taken into account this year.
3) Finalize audit staff to attend the inventory counts.
4) Ascertain whether any inventory is held by third parties,and if applicable determine how to gather sufficientappropriate evidence.
5) Consider the need for using an expert to assist in valuing theinventory being counted.
6) Send a letter requesting direct confirmation of inventorybalances held at year end from any third party warehouse
providers used regarding quantities and condition.
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During the inventory count1) Observation of stock count supervisor giving clear
instruction to counters.
2) Observe the count to ensure that the instructions arebeing followed.
3) Verify that counter are provided with pre-numberedinventory sheets.
4) Attend the inventory count (if one is to be performed)at the third party warehouses to review the controls inoperation: verifies completeness and existence.
5) Perform a two way test count: Select a sample of
items from the inventory count sheets and physicallyinspect the items in the warehouse: verifies existence.
6) Select a sample of physical items from the warehouseand trace to the inventory count sheets to ensure that
they are recorded accurately :verifies completeness.
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During the inventory count7) Ensure that goods held on behalf of third parties is
segregated and recorded separately: verifies rights
and obligations.
8) Inspect the inventory being counted for evidence ofdamage or obsolescence that may affect the net
realizable value: verifies valuation.9) Record details of the last deliveries prior to the year
end. This information will be used in final auditprocedures to ensure that no further amendments
have been made thereby overstating or understatinginventory: verifies cutoff.
10) Obtain copies of inventory count sheets at the end ofthe inventory count, ready for checking against final
inventory listing after the inventory count.
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After the inventory count1) Inspect purchase invoices for a sample of inventory
items to agree their cost and
2) Inspect post yearend sales invoices for a sample ofinventory items to determine if the net realizablevalue is reasonable. This will also assist in determiningif inventory is held at the lower of cost and net
realizable value has been used: verifies valuation.3) Inspect the ageing of inventory items to identify
old/slow moving amounts that may require provision,and discuss these with management: verifies
valuation.4) Calculate inventory turnover/days and compare this to
prior year, to assess whether inventory is being heldlonger and therefore requires greater provision:
verifies valuation.
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After the inventory count
7)Trace the goods received immediately prior to
the yearend to yearend payables and inventorybalances: verifies cutoff.
8)Trace goods dispatched immediately prior to the
yearend to the nominal ledgers to ensure the itemsare removed from inventory and a sale (and
receivable where relevant) has been recorded:
verifies cutoff.
9)Inspect any documentation in respect of third
party inventory.
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Valuation of inventory IAS 2 requires that all inventories must be valued at
the lower of cost and net realizable value (NRV).
Cost = Purchase cost of materials and labour, plusattributable production overheads (based onnormal level of activity)
NRV = Actual or estimated selling price, less allfurther costs to completion, and all costs to beincurred in marketing, selling and distributing the
product. Where a number of identical goods have been
purchased, a costing method such as FIFO oraverage cost may be used to determine the costs of
the items in inventory at the year-end.
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How to identify Problem stock
I would calculate stock days for individual stock
lines to highlights problem stock line. I would ask store supervisor Are you aware of any
damaged goods .
I would inspect the goods in the warehouse forconditions Looking for dust in particular.
I would observe the sales team reports and
investigate any stock they struggle to sell. I would recompute the inventory aged analysis and
investigate any old stock.
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Audit valuation of NRV
I would surf competitor website to get a feel for the
value of goods I would ask the production manager Do you think
damaged goods can be mended if not NRV is zero.
I would inspect sale team guidance to identify thesale price expected for problems goods.
I would recalculate the NRV.
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Valuation of inventory
Items must be written down to NRV if this is below
cost. Typical situations are:1) an increase in costs or a fall in selling price (e.g.,
computers)
2) physical deterioration (e.g., food going stale)3) obsolescence (e.g., clothes going out of fashion)
4) a decision to sell some items as loss leaders
5) errors in production or purchasing
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Definition Aging of inventory
As the name implies, the purpose of the InventoryAgingreport is to focus on inventory in stock that isstarting to get old.
An inventory itemhaving a slower rate of turnover
than the average turnover for the entire inventory.
Inventory turnover days
The days in the period can then be divided by the
inventory turnover formula to calculate the days ittakes to sell the inventory on hand or "inventoryturnover days."
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Assertions (ERCV) Financial statement assertions and inventory
substantive procedures for balances at the yearend.
(i) Existence
Assets, liabilities and equity interests exist.
Substantive procedures
During the inventory count select a sample of assetsrecorded in the inventory records and agree to the
warehouse to confirm the assets exist. Obtain a sample of pre year-end goods dispatch
notes and agree that these finished goods are
excluded from the inventory records.
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Assertions (ERCV)
(ii) Rights and obligations
The entity holds or controls the rights to assets, andliabilities are the obligations of the entity.
Substantive procedures
Confirm during the inventory count that any goodsbelonging to third parties are excluded from the
inventory records and count.
For year-end raw materials and finished goodsconfirm title belongs to the company by agreeing
goods to a recent purchase invoice in the company
name.
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Assertions (ERCV)
Completeness
All assets, liabilities and equity interests that shouldhave been recorded have been recorded.
Substantive procedures
Obtain a copy of the inventory listing and agree thetotal to the general ledger and the financial
statements. During the inventory count select a
sample of goods physically present in thewarehouse and confirm recorded in the inventory
records.
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Assertions (ERCV)
Valuation and allocation
Assets, liabilities and equity interests are included inthe financial statements at appropriate amounts and
any resulting valuation or allocation adjustments are
appropriately recorded.
Substantive procedures
Select a sample of goods in inventory at the year end,
agree the cost per the records to a recent purchase
invoice and ensure that the cost is correctly stated.
Select a sample of year-end goods and review post
year-end sales invoices to ascertain if net realisable
value is above cost or if an adjustment is required..
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CutOff I would select a sample of GRN Pre-yearend and
verify that the transaction is included in theinventory , purchase and payable.
I would select a number of GRN Post-yearendandverify that the transaction is excluded from
inventory , purchase and payable. I would select a sample of GDN Pre-yearendand
verify the transaction is recorded in sales andreceivables and excluded from inventory.
I would select a sample of GDN Post-yearendandverify that transaction is excluded from sale andreceivable but Included in the inventory.
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