ch19 70 360

Chapter 19: Audit of the
Inventory and Warehousing

Cycle
1
Copyright © 2007 Pearson Education
Canada
Chapter 19 objectives
 Identify the five different parts of the inventory
and warehousing cycle that are audited
 Describe the process used to audit the inventory
and warehousing cycle
 Discuss the role of specific tests in the audit of
inventory
 Describe how the relationship between the tests
of different cycles affects the audit of inventory
19-2
Copyright © 2007 Pearson Education Canada
Auditing inventory can be complex
 Reasons include:
– It may be a major item on the balance sheet
– Inventory items could be at different locations
– Very diverse items are included (jewels,
chemicals, electronic parts)
– Valuation needs to consider obsolescence
– One client may use several methods for
valuing inventory
19-3
Functions in the inventory and
warehousing cycle
 Process purchase orders
 Receive new materials
 Store materials
 Process goods
 Store finished goods
 Ship finished goods
19-4
Five parts of the audit of inventory,
and the cycle in which tested
19-5
Audit of cost accounting
 Cost accounting systems vary more than
the other transaction cycle areas due to the
wide variety of types of inventory and the
differences in level of sophistication
required by management
19-6
Cost accounting controls
 These are controls that are related to the
physical inventory and the compilation of
the costs of that inventory from raw
material requisition through to finished
product
 Broken into two categories:
– Physical control over inventory movement
– Controls over related costs
19-7
Methodology for designing tests of
controls for cost accounting
19-8
Analytical procedures for the
inventory and warehousing cycle
Analytical procedure Possible misstatement
Compare gross margin Overstatement or understatement

percentage with previous of inventory and cost of goods
years sold
Compare inventory Obsolete inventory
turnover with previous
years
Compare unit costs of Over/understatement of
inventory with previous inventory. Over/understatement
years of unit costs
19-9
Analytical procedures for the
inventory and warehousing cycle
(cont’d)
Analytical procedure Possible misstatement
Compare extended Misstatements in compilation, unit

inventory value with costs, or extensions that affect
previous years inventory and cost of goods sold.
Compare current-year Misstatement of unit costs of

manufacturing costs inventory, especially direct labour
with previous year and manufacturing overhead.
19-10
Practice problem 19-21 (p. 568)
 Calculate ratios for
analytical review of
inventory
 Assess the results
19-11
Methodology for designing tests of
details of balances for inventory
19-12
Tests of details for physical
inventory observation: existence
 Select a random sample of tag numbers
and identify the tag with that number
attached to the actual inventory
 If inventory is not tagged (e.g. scanned),
may need to select a location number
 Observe whether movement of inventory
takes place during the count
19-13
Tests of details for physical inventory
observation: completeness
 Examine inventory to make sure it is
tagged
 If tags are not used, the auditor may need
to examine exception reports identifying
locations/items not counted
 Enquire as to inventory in other locations
19-14
inventory observation: accuracy
 Recount client’s counts to make sure the
recorded counts are accurate on the tags
(or as recorded in the computer system if
recorded into hand-held computer devices)
 Compare physical counts with perpetual
inventory master file
 Record client counts test-counted for
subsequent testing
19-15
observation: classification
 Examine inventory descriptions on the tags
(or in the handheld computers) and
compare with the actual inventory counted
 Evaluate whether the percent of
completion recorded on the tags (or job
cost records) for work in process is
reasonable
19-16
inventory observation: cutoff
 Record in the working papers for
subsequent follow-up the last shipping
document number used at year end
 Make sure the inventory for that shipment
was excluded from the physical count
 Review shipping area for inventory set
aside for shipment but not counted
 Conduct similar tests for receiving process
19-17
inventory observation: valuation
 Test for obsolete inventory by enquiry of
factory employees and management
 Be alert for items that are damaged, rust-
or dust-covered, or located in inappropriate
places
19-18
observation: rights and obligations
 Enquire as to consignment of customer
inventory included on client’s premises
 Be alert for inventory that is set aside or
specially marked as indications of non-
ownership
19-19
 Examine the purpose
of observing the
physical inventory
count
 Discuss the extent of
reliance on outside
specialists during the
audit of inventory
19-20
Tests of details for pricing and
compilation: detail tie-in
 Perform compilation tests
 Extend the quantity times the price on
selected items (or the entire inventory if
using generalized audit software or other
computer assisted audit software)
 Foot (or test-foot) the inventory listings
 Trace the totals to the general ledger
19-21
compilation: existence
 Trace inventory listed in the schedule to
inventory tags (or to computerized records
of the count) and to the auditor’s records of
test counts for existence and description
19-22
compilation: completeness
 Account for unused tag numbers shown in the
auditor’s working papers to make sure no tags
have been added
 Account for the tag numbers to make sure none
have been deleted
 Where hand-held computers have been used,
reconcile hash totals or other control totals at the
end of the count to final inventory count
19-23
compilation: accuracy
 Trace inventory listed in the schedule to
inventory tags (or computer files) and
auditor’s recorded counts for quantity and
description
 Perform price tests of inventory
19-24
compilation: classification
 Compare the classification into raw
materials, work in process, and finished
boods by comparing the descriptions on
inventory tags and auditor’s recorded test
counts with the inventory listing schedule
19-25
compilation: valuation
 Perform test of lower
of cost or market,
selling price, and
obsolescence
19-26
compilation: rights and obligations
 Trace inventory tags identified as non-owned
during the physical observation to the inventory
listing schedule to make sure these have not been
included
 Review contracts with suppliers and customers
and enquire of management for the possibility of
the inclusion of consigned or other non-owned
inventory, or the exclusion of owned inventory
19-27
compilation: presentation and
disclosure
 Examine financial statements for proper
presentation and disclosure, including:
– Separate disclosure of raw materials, work in
process, and finished goods
– Proper description of the inventory costing
method
– Description of pledged inventory
– Inclusion of significant sales and purchase
commitments
19-28
 Application of
monetary unit
sampling (MUS) to
the audit of inventory
 Assess the results of
the tests to determine
whether the book
value is misstated
19-29
Interrelationship of various audit tests
19-30
 Audit of an automated
inventory system
 Which controls can be
relied upon?
 How would you test
the controls?
19-31

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Chapter 19: Audit of the

Inventory and Warehousing

Compare gross margin Overstatement or understatement

Compare extended Misstatements in compilation, unit

Compare current-year Misstatement of unit costs of

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