Chapter 12

Inventories and
Cost of Goods
Sold

The Special Significance of

Audit of Inventories

122

The valuation of goods on hand and in process

often presents complex and difficult issues
Determining the quantities of inventories may
require specialized techniques
Inventories often represent the largest current
asset of a company
Misstatements of inventories directly affect
cost of goods sold and, therefore, net income
Management fraud has often involved the
fraudulent overstatement of inventories

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Controls Over the

Conversion Cycle

123

Segregation of duties over purchases and custody of

inventory
Use of pre-numbered requisitions, purchase orders,
and receiving reports
Procedures for authorizing purchase transactions and
verifying them for payment
General ledger control of inventories and reconciliation
to production records
Cost accounting controls
Analysis of variances from standard costs
Use of perpetual records for inventories
Use of appropriate procedures for taking inventory
Appropriate physical controls over inventories

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Objectives for the Audit of

Inventories and Cost of Goods
Sold
1.

2.
3.

124

Use the understanding of the client and its environment

to consider inherent risk, including fraud risks, related
to inventories and cost of goods sold.
Obtain an understanding of internal control over
inventories and cost of goods sold.
Assess the risks of material misstatement and design
tests of controls and substantive procedures that:
a.Substantiate

the existence of inventories and the

occurrence of cost of goods sold
b.Establish the completeness of recorded inventories
c.Verify the cutof of transactions affecting cost of goods sold
d.Determine that the client has rights to recorded inventories
e.Establish the proper valuation of inventories and the
accuracy of transactions affecting cost of goods sold
f.Determine that the presentation and disclosure of
inventories and cost of goods sold are appropriate

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Figure 12.1 Objectives of Major Substantive

Procedures for Inventories and Cost of Goods
Sold

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126

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127

Relating
Controls to
Assertions

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Considerations in
Planning a
Physical
Inventory

128

Selecting of the appropriate date

Suspending production
Segregating obsolete and defective
goods
Establishing control over the counting
process
Achieving proper cutoff of sales and
purchases
Arranging for the services of specialists

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129

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