Audit of the Inventory
and Warehousing Cycle
OVERVIEW OF THE
INVENTORY
MANAGEMENT PROCESS
Figure 13-1 shows how other processes interact with the inventory management process.
Figure 13-2 presents a flowchart for a
DOCUMENTS AND
RECORDS
Production schedule.
Receiving report.
Material requisition.
Inventory master file.
Production data information.
Cost accumulation and variance report.
Inventory status report.
Raw Materials Work in Process
Manufacturing Overhead
Flow of Inventory and Costs
Manufacturing Direct Labor Beginning
inventory Rawmaterials used
Purchases Ending
Work in Process Finished Goods
Flow of Inventory and Costs
Beginning inventory
Ending inventory
Cost of Goods Sold Cost of goods
manufactured
Beginning inventory
Ending inventory
Cost of
Functions in the Inventory and
Warehousing Cycle
Process
Receive raw materials
Receive raw materials
Store raw
Store
Functions in the Inventory and
Warehousing Cycle
Perpetual inventory master file
Perpetual inventory master file
Audit of Inventory
Acquire and record raw materials, labor,
and overhead.
Internally transfer assets and costs.
Part of audit Cycle in which tested
Acquisition and payment plus
payroll and personnel
Audit of Inventory
Ship goods and record revenue and costs.
Physically observe inventory.
Price and compile inventory.
Cycle in which tested Part of audit
Sales and collection
Inventory and warehousing
SEGREGATION OF DUTIES
The inventory management function should be
segregated from the cost accounting function.
The inventory stores function should be segregated
from the cost-accounting function.
The cost-accounting function should be segregated
from the general ledger function.
The responsibility of supervising physical inventory
INHERENT RISK
ASSESSMENT
Industry-related factors
Competition
Inventory valuation issues Rapid technology changes
Engagement and Operating Characteristics
Types of product
CONTROL RISK
ASSESSMENT
Planning and performing tests of controls on inventory transactions
Understanding and documenting the inventory management process based
on the planned level of control risk
Assessing and documenting the control risk for the
AUDITING INVENTORY
Substantive tests of transactions
Analytical procedures
SUBSTANTIVE TESTS OF
TRANSACTIONS
Because the inventory management process interacts with
the revenue, purchasing, and payroll processes, control procedures over the receipt of raw materials, shipment of goods, and assignment of labor costs are normally tested as part of those processes.
If the auditor intends to obtain substantive evidence on
the perpetual inventory records, the tests of receipt and shipment of goods can be extended by tracing the
ANALYTICAL
PROCEDURES
Compare raw material, finished goods, and total
inventory turnover to previous years’ and industry averages.
Compare days outstanding in inventory to previous
years’ and industry averages.
Compare gross profit percentage by product line with
previous years and industry data.
ANALYTICAL
PROCEDURE (continued)
Compare current year standard costs with prior years’ after considering current conditions.
Analytical Procedures for
Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare unit costs of Overstatement or
inventory with those of understatement of
previous years. unit costs
Compare extended Misstatements in
inventory value with that compilation, unit
Analytical Procedures for
Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare current year Misstatement of unit
manufacturing costs with costs of inventory,
those of previous years especially direct
(variable costs should be labor and
adjusted for changes in manufacturing
Cost Accounting Controls
2. Controls over the related costs 1. Physical Controls
Tests of Cost Accounting
Physical Controls
Documents and records for transferring inventory
OBSERVATION OF
PHYSICAL INVENTORY
The auditor's observation of inventory is a generally accepted auditing procedure.
The observation of the physical inventory provides evidence primarily on the validity
OBSERVATION
PROCEDURES
Insure that no production is scheduled.
Ensure that there is no movement of goods during the
inventory count.
Make sure that the client's count teams are following the
inventory count instructions.
Ensure that inventory tags are issued sequentially to
individual departments.
Perform test counts and record a sample of counts in the
OBSERVATION
PROCEDURES
(continued)
Obtain tag control information for testing the client's
inventory compilation.
Obtain cutoff information.
Observe the condition of the inventory for items that
may be obsolete, slow moving, or in excess quantities.
Inquiry about goods held on consignment for others or
Controls
Proper instructions for the physical count Supervision by responsible personnel
Independent interval verification of the counts Independent reconciliations of the physical counts with perpetual inventory master files
Audit of Pricing and
Compilation
Valuation of inventory Pricing and
compilation procedures Pricing and
compilation controls
Valuation (Pricing)
of Inventory
Pricing Purchased Inventory
Pricing Manufactured Inventory
TESTS OF ACCOUNT
BALANCES
POSSIBLE CAUSES OF
BOOK-TO-PHYSICAL
DIFFERENCES
Inventory cutoff errors.
Unreported scrap or spoilage.
SAMPLE DISCLOSURE ITEMS
FOR INVENTORY AND
RELATED ACCOUNTS
Cost method (FIFO, LIFO, retail method). Components of inventory.
Long-term purchase contracts. Consigned inventory.
Purchases from related parties. LIFO liquidations.
Pledged or assigned inventory.
Disclosure of unusual losses from writedowns of
Interrelationship of
Various Audit Tests
Tests of acquisition and payment cycle
Raw materials
Acquisitions of raw materials
Work in process
Interrelationship of
Various Audit Tests
Tests of payroll and personnel cycle
Work in process
Direct labor
Work in process
Interrelationship of
Various Audit Tests
Inventory tests
Raw materials
Ending inventory
Work in process
Ending inventory
Finished goods
Interrelationship of
Various Audit Tests
Tests of sales and collection cycle
