Audit of the Inventory and Warehousing Cycle · PDF fileTitle: Completing the Accounting Cycle...

Chapter 20

Audit of the

Inventory and

Warehousing

Describe the business functions and the

related documents and records in the

Raw Materials Work-in-Process

Beginning inventory

Raw materials used

Purchases

Ending inventory

Beginning inventory

Cost of goods manufactured

Ending inventory

Cost of goods sold Finished Goods

Beginning inventory

Cost of goods sold

Ending inventory

Direct Labor

Actual Applied

Manufacturing Overhead

Actual Applied

Process purchase

orders

Receive raw

materials

Store raw

materials

Process the

Store finished goods

Ship finished goods

Flow of

Inventory

Receive

materials

storage

materials

production

completed

goods in

storage

finished

Explain the five parts of the audit of the inventory and warehousing cycle.

Part of audit

Acquire and record

raw materials, labor,

and overhead

Internally transfer

assets and costs

Acquisition and payment Payroll and personnel

Cycle(s) Where tested

Inventory and Warehousing

Part of audit

Ship goods

and record

revenue

and costs

Physically

observe

inventory

Price and

compile

inventory

Cycle where tested

Sales and collection Inventory and warehousing

Inventory and warehousing

Design and perform audit tests of cost accounting.

Physical controls over raw materials,

work in process, and finished goods inventory

Controls over the related costs

Understand internal control –

cost accounting system

Assess planned control risk –

cost accounting system

Determine extent of testing controls

Design tests of controls and

substantive tests of transactions

for the cost accounting system

to meet transaction-related

audit objectives

Audit procedures

Sample size

Items to select

Timing

Physical controls over inventory

Documents and records for transferring

inventory

Perpetual inventory master files

Unit cost records

Apply analytical procedures to the accounts

in the inventory and warehousing cycle.

Analytical procedure Possible misstatement

Compare gross margin percentage with that of previous years

Compare inventory turnover (cost of goods sold divided by average inventory) with that of previous year

Overstatement or understatement of inventory and cost of goods sold

Obsolete inventory overstatement or understatement of inventory

Compare unit costs of inventory with those of previous years

Compare extended inventory value with that of previous years

Overstatement or understatement of unit costs, which affect inventory and cost of goods sold

Misstatements in compilation, unit costs, or extensions, which affect inventory and cost of goods sold

Compare current year manufacturing costs with those of previous years (variable costs should be adjusted for changes in volume)

Misstatements of unit costs of inventory, especially direct labor and manufacturing overhead, which affect inventory and cost of goods sold

Design and perform physical observation audit tests for inventory.

Be present at the time the client counts inventory

Observe the client’s counting procedures

Make inquiries of client personnel about their counting procedures

Make their own independent tests of the physical count

Proper instructions for the physical count

Supervision by responsible personnel

Independent internal verification of the counts

Independent reconciliations of the physical

counts with perpetual inventory master files

Adequate control over count sheets or tags

Timing

Sample

Selection

of items

The most important part of the observation of

inventory is determining whether the physical

count is being taken in accordance with the

client’s instructions.

Existence: Inventory as recorded on tags exist. Completeness: Existing inventory is counted and tagged. Accuracy: Inventory is counted accurately. Classification: Inventory is classified correctly on the tags.

Cutoff:

Transactions are recorded in the proper period.

Realizable value:

Obsolete and unusable inventory items are

excluded or noted.

Rights:

The client has rights to inventory recorded

on tags.

Design and perform audit tests of pricing and compilation for inventory.

Inventory price tests

Pricing and

compilation

procedures

Pricing and

compilation

controls

Valuation

of inventory

Purchased

inventory

Manufactured

inventory

Tests of acquisition

and payment cycle

Other manufacturing costs

Raw material used

Work in process Raw materials

Acquisitions of raw materials

Raw material used

Tests of payroll and

personnel cycle

Work in process Work in process

Indirect labor Direct labor

Inventory tests Cost accounting records Physical inventory observation Pricing and compilation

Work in process

Ending inventory

Raw materials

Ending inventory

Finished goods

Ending inventory

Work in process Finished goods

Cost of goods manufactured

Tests of

sales and

collection cycle

Cost of goods sold

Finished goods

Copyright

stored in a retrieval system, or transmitted, in any form or by any

means, electronic, mechanical, photocopying, recording, or otherwise,

without the prior written permission of the publisher. Printed in the

United States of America.

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