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1、Chapter 21Audit of the Inventory and Warehousing Cycle Review Questions21-1Inventory is often the most difficult and time consuming part of many audit engagements because:1.Inventory is generally a major item on the balance sheet and often the largest item making up the accounts included in working
2、capital.2.The need for organizations to have the inventory in diverse locations makes the physical control and counting of the inventory difficult.3.Inventory takes many different forms that are difficult for the auditor to fully understand.4.The consistent application of different valuation methods
3、 can be fairly complicated.5.The valuation of inventory is difficult due to such factors as the large number of different items involved, the need to allocate the manufacturing costs to inventory, and obsolescence.21-2The acquisition and payment cycle includes the system for purchasing all goods and
4、 services, including raw materials and purchased parts for producing finished goods. Purchase requisitions are used to notify the purchasing department to place orders for inventory items. When inventory reaches a predetermined level or automatic reorder point, requisitions may be initiated by stock
5、room personnel or by computer. In other systems, orders may be placed for the materials required to produce a customer order, or orders may be initiated upon periodic evaluation of the situation in light of the prior experience of inventory activity. After receiving the materials ordered, as part of
6、 the acquisition and payment cycle, the materials are inspected with a copy of the receiving document used to book perpetual inventory. In a standard cost inventory system, the acquisition and payment cycle computes any inventory purchase variances, which then enter the inventory system.The followin
7、g audit procedures in the acquisition and payment cycle illustrate the relationship between that cycle and the inventory and warehousing cycle.1.Compare the inventory cost entered into the inventory system to the supporting invoice to determine that it was properly recorded and the purchase variance
8、 (standard cost system), if any, was properly reflected.2.Test the purchase cutoff at the physical inventory date and year-end to determine whether or not the physical inventory and year-end inventory cutoffs are proper from a purchase standpoint.21-3Companies provide online access to descriptions o
9、f inventory products and on-hand quantity levels to key inventory suppliers because this information helps the suppliers work with management to monitor the flow of inventory items. There are risks associated with providing this information, however. First, there is a risk that sensitive proprietary
10、 information may be made available to unauthorized users. The use of the Internet and other e-commerce applications may also lead to financial reporting risks if access to inventory databases and systems is not adequately controlled. The risks of providing online access to inventory information can
11、be reduced by the use of security access password restrictions, firewalls, and other IT management controls.21-4Cost accounting records are those which are concerned with the processing and storage of raw materials, work in process, and finished goods, insofar as these activities constitute internal
12、 transfers within the inventory and warehousing cycle. These records include computerized files, ledgers, worksheets and reports which accumulate material, labor, and overhead costs by job or process as the costs are incurred.Cost accounting records are important in conducting an audit because they
13、indicate the relative profitability of the various products for management planning and control, and determine the valuation of inventories for financial statement purposes.21-5The most important tests of the perpetual records the auditor must make before assessed control risk can be reduced, which
14、may permit a reduction in other audit tests are:1.Tests of the purchases of raw materials and pricing thereof.2.Tests of the cost accounting documents and records by verifying the reduction of the raw material inventory for use in production and the increase in the quantity of finished goods invento
15、ry when goods have been manufactured.3.Tests of the reduction in the finished goods inventory through the sale of goods to customers.Assuming the perpetuals are determined to be effective, physical inventory tests may be reduced, as well as tests of inventory cutoff. In addition, an effective perpet
16、ual inventory will allow the company to test the physical inventory prior to the balance sheet date.21-6The continuation of shipping operations during the physical inventory will require the auditor to perform additional procedures to insure that a proper cutoff is achieved. The auditor must conclud
17、e that merchandise shipped is either included in the physical count or recorded as a sale, but not both.Since no second count is taken, the auditor must increase the number of test counts to determine that the counts recorded are accurate.21-7The auditor must not give the controller a copy of his or
18、 her test counts. The auditors test counts are the only means of controlling the original counts recorded by the company. If the controller knows which items were test counted, he or she will be able to adjust other uncounted items without detection by the auditor.21-8The most important audit proced
19、ures to test for the ownership of inventory during the observation of the physical counts and as a part of subsequent valuation tests are:1.Discuss with the client.2.Obtain an understanding of the clients operations.3.Be alert for inventory set aside or specially marked.4.Review contracts with suppl
20、iers and customers to test for the possibility of consigned inventory or inventory owned by others that is in the clients shop for repair or some other purpose.5.Examine vendor invoices indicating that merchandise on hand was sold to the company.6.Test recorded sales just before and just after the p
21、hysical inventory to determine that the items were or were not on hand at the physical inventory date and that a proper cutoff was achieved.21-9Auditing procedures to determine whether slow-moving or obsolete items have been included in inventory are:1.Obtain a sufficient understanding of the client
22、s business to aid in recognizing inventory that is no longer useful in the clients business.2.Review the perpetual records for slow-moving items.3.Discuss the quality of the inventory with management.4.Ask questions of production personnel during physical inventory observation about the extent of th
23、e use or nonuse of inventory items.5.Make observations during the physical inventory for rust, damaged inventory, inventory in unusual locations, and unusual amounts of dust on the inventory.6.Be aware of inventory that is tagged obsolete, spoiled, or damaged, or is set aside because it is obsolete
24、or damaged.7.Examine obsolescence reports, scrap sales, and other records in subsequent periods that may indicate the existence of inventory that should have been excluded from the physical inventory or included at a reduced cost.8.Calculate inventory ratios, by type of inventory if possible, and co
25、mpare them to previous years or industry standards.21-10 The auditor could have uncovered the misstatement if there were adequate controls over the use of inventory tags. More specifically, the auditor should have assured himself or herself that the client had accounted for all used and unused tag n
26、umbers by examining all tags, if necessary. In addition, the auditor should have selected certain tags (especially larger items) and had the client show him or her where the goods were stored. The tag numbers used and unused should have been recorded in the auditors working papers for subsequent fol
27、low-up. As part of substantive procedures, the auditor could have performed analytical tests on the inventory and cost of sales. A comparison of ratios such as gross margin percentage and inventory turnover could have indicated that a problem was present.21-11A proper cutoff of purchases and sales i
28、s heavily dependent on the physical inventory observation because a proper cutoff of sales requires that finished goods inventory included in the physical count be excluded from sales and all inventory received be included in purchases.To make sure the cutoff for sales is accurate, the following inf
29、ormation should be obtained during the taking of the physical inventory:1.The last shipping document number should be recorded in the working papers for subsequent follow-up to sales records.2.A review should be made of shipping to test for the possibility of shipments set aside for shipping and not
30、 counted or other potential cutoff problems.3.When prenumbered shipping documents are not used, a careful review of the clients method of getting a proper sales cutoff is the first step in testing the cutoff.4.A list of the most recent shipments should be included in the working papers for subsequen
31、t follow-up to sales records.For the purchase cutoff, the following information should be noted:1.The last receiving report number should be noted in the working papers for subsequent follow-up to purchase records.2.A review should be made of the receiving department to make sure all inventory has b
32、een properly included in the physical inventory.21-12Compilation tests are the tests of the summarization of physical counts, the extension of price times quantity, footing the inventory summary, and tracing the totals to the general ledger.Several examples of audit procedures to verify compilation
33、are:1.Trace the tag numbers used to the final inventory summary to make sure they were properly included and the numbers not used to the final inventory summary to make sure no tag numbers have been added.21-12 (continued) 2.Trace the test counts recorded in the working papers to the final inventory
34、 summary to make sure they are correctly included.3.Trace inventory items on the final inventory list to the tags as a test of the existence of recorded inventory.4.Test the extensions and footings of the physical inventory summary.21-13ANALYTICAL PROCEDURETYPE OF POTENTIAL MISSTATEMENT1.Compare gro
35、ss margin percentage with previous years.Overstatement or understatement of inventory amounts (prices and/or quantities).2.Compare inventory turnover with previous years.Obsolete inventory.3.Compare unit costs with previous years.Overstatement or understatement of unit costs.4.Compare extended inven
36、tory value with previous years.Errors in compilation, unit costs, or extensions.5.Compare current year manufacturing costs with previous years.Misstatement of unit costs of inventory, especially direct labor and manufacturing overhead.21-14DATEPURCHASEQUANTITYPRICE TO BE INCLUDED IN12-31-07 INVENTOR
37、YEXTENSION 11-26-0712-06-07 2,4001,900$2.07$2.28 700 $2.071,900 $2.28$1,449.00 4,332.00$5,781.00Assuming FIFO inventory valuation, the 12-31-07 inventory should be valued at $5,781, and is thus currently overstated by $121.If the 1-26-08 purchase was for 2,300 binders at $2.12 each, the 12-31-07 inv
38、entory should be valued at $5,477.00 (1,900 $2.12 + 700 $2.07) and is thus currently overstated by $425. The reason is the lower of cost or market rule, with the $2.12 being the replacement cost.21-15The direct labor hours for an individual inventory item would be verified by examining engineering s
39、pecifications or similar information to determine whether the number of hours to complete a unit of finished goods was correctly computed. Ordinarily it is difficult to test the number of hours to an independent source.The manufacturing overhead rate is calculated by dividing the total annual number
40、 of labor hours into total manufacturing overhead. These two totals are verified as a part of the payroll and personnel and acquisition and payment cycles.Once these two numbers are verified (overhead rate per direct labor hour and the number of direct labor hours per unit of each type of inventory)
41、, it is not difficult to verify the overhead cost in inventory.21-16With a job cost system, labor charged to a specific job is accumulated on a job cost sheet. The direct labor dollars included on the job cost sheet can be traced to the employee job time sheet to make sure the hours are correctly in
42、cluded on the job cost sheet. The labor rate can be verified by comparing it to the amount on the employees earnings record.21-17Assuming the auditor properly documents receiving report numbers as a part of the physical inventory observation procedures, the auditor should verify the proper cutoff of
43、 purchases as a part of subsequent tests by examining each invoice to see if a receiving report is attached. If the receiving report is dated on or before the inventory date and the last recorded number, the received inventory must have been included in the physical inventory; therefore the invoice
44、should be included in accounts payable. Those invoices that are received after the balance sheet date but shipped F.O.B. shipping point on or before the close of the year would indicate merchandise in transit. Multiple Choice Questions From CPA Examinations21-18a.(4)b.(2)c.(1)21-19a.(1)b.(2)c.(2)21-
45、20a.(4)b.(3)c.(2) Discussion Questions and Problems21-21PURPOSE OF INTERNAL CONTROLTEST OF CONTROLPOTENTIAL FINANCIAL MISSTATEMENTSUBSTANTIVE AUDIT PROCEDURE1.For a proper valuation of inventory. (Accuracy)Examine receiving and requisition documents, trace to perpetual records.Misstatement of invent
46、ory.Compare physical count to perpetual inventory record.2.To ensure inventory is recorded when received, payments made are for goods received, and quantities and descriptions are accurate. (Completeness, existence and accuracy)Account for a numerical sequence of receiving reports and observe matchi
47、ng invoices received from vendors.Understatement of inventory or payment for goods not received.Trace quantity and description on vendors invoice to receiving report.21-21 (continued)PURPOSE OF INTERNAL CONTROLTEST OF CONTROLPOTENTIAL FINANCIAL MISSTATEMENTSUBSTANTIVE AUDIT PROCEDURE3.To minimize th
48、eft or unrecorded shipments of inventory. (Existence)Discuss with client and observe whether personnel prepare shipping documents.Overstatement of inventory.Compare physical count to perpetual records.4.To ensure inventory shipments are recorded as sales. (Completeness)Account for a numerical sequence of shipping orders.Understatement of sales.Trace quantity and description on bills of lading to recorded sales.5.
