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Audit of the Inventory and Warehousing Cycle. Chapter 20. Learning Objective 1. Describe the business functions and the related documents and records in the inventory and warehousing cycle. Flow of Inventory and Costs. Raw Materials. Work in Process. Beginning inventory. Raw

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learning objective 1
Learning Objective 1

Describe the business functions

and the related documents and

records in the inventory

and warehousing cycle.

flow of inventory and costs
Flow of Inventory and Costs

Raw Materials

Work in Process

Beginning

inventory

Raw

materials

used

Purchases

Ending

inventory

Manufacturing

Direct Labor

Manufacturing

Overhead

Actual Applied

Actual Applied

flow of inventory and costs1
Flow of Inventory and Costs

Work in Process

Finished Goods

Beginning

inventory

Ending

inventory

Beginning

inventory

Ending

inventory

Cost of

goods sold

Cost of goods

manufactured

Cost of Goods Sold

functions in the inventory and warehousing cycle
Functions in the Inventory and Warehousing Cycle

Process

purchase

orders

Receive raw

materials

Store

raw

materials

Process the materials

functions in the inventory and warehousing cycle1
Functions in the Inventory and Warehousing Cycle

Store

finished

goods

Ship

finished

goods

Perpetual inventory

master file

learning objective 2
Learning Objective 2

Describe how e-commerce

affects inventory management.

how e commerce affects inventory management
How E-Commerce Affects Inventory Management

The Internet enables clients to provide expanded

descriptions of their inventory on a real-time basis.

The use of the Internet and other e-commerce

applications may lead to financial reporting

risks if access to inventory databases and

systems is not adequately controlled.

learning objective 3
Learning Objective 3

Explain the five parts of

the audit of the inventory

and warehouse cycle.

audit of inventory
Audit of Inventory

Part of audit

Cycle in which tested

Acquire and record

raw materials, labor,

and overhead.

Acquisition and

payment plus

payroll and personnel

Internally transfer

assets and costs.

Inventory and

warehousing

audit of inventory1
Audit of Inventory

Part of audit

Cycle in which tested

Ship goods and record

revenue and costs.

Sales and

collection

Physically observe

inventory.

Inventory and

warehousing

Price and compile

inventory.

Inventory and

warehousing

learning objective 4
Learning Objective 4

Design and perform audit

tests of cost accounting.

cost accounting controls
Cost Accounting Controls

1. Physical Controls

over

Raw materials

WIP

Finished goods

2. Controls over the related costs

methodology for designing controls and substantive tests
Methodology for Designing Controls and Substantive Tests

Understand internal control –

cost accounting system.

Assess planned control risk –

cost accounting system.

Evaluate cost-benefit

of testing controls.

methodology for designing controls and substantive tests1
Methodology for Designing Controls and Substantive Tests

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

tests of cost accounting
Tests of Cost Accounting

Physical Controls

Documents and records for

transferring inventory

Perpetual inventory master files

Unit cost records

learning objective 5
Learning Objective 5

Apply analytical procedures to

the accounts in the inventory

and warehousing cycle.

analytical procedures for manufacturing equipment
Analytical Procedures for Manufacturing Equipment

Analytical Procedure Possible Misstatement

Compare gross margin Overstatement or

percentage with that of understatement of

previous years. inventory and cost

of goods sold

Compare inventory turnover Obsolete inventory

(cost of goods sold divided Overstatement or

by average inventory) with understatement of

that of previous years. inventory

analytical procedures for manufacturing equipment1
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

of previous years. costs, or extensions

analytical procedures for manufacturing equipment2
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

volume). overhead

methodology for designing tests of balances other accounts
Methodology for Designing Tests ofBalances – Other Accounts

Identify client business risks affecting

the inventory and warehousing cycles.

Set tolerable misstatement and

assess inherent risk for the

inventory and warehousing cycles.

Assess control risk for several cycles.

methodology for designing tests of balances other accounts1
Methodology for Designing Tests ofBalances – Other Accounts

Design and perform tests of

controls and substantive tests

of transactions for the

several cycles.

Design and perform analytical

procedures for the inventory

and warehousing cycle.

methodology for designing tests of balances other accounts2
Methodology for Designing Tests ofBalances – Other Accounts

Design tests of details

of inventory to satisfy

balance-related

audit objectives.

Audit procedures

Sample size

Items to select

Timing

learning objective 6
Learning Objective 6

Design and perform

physical observation

audit tests for inventory.

controls
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

Adequate control over count sheets or tags

audit decisions
Audit Decisions

Timing

Sample size

Selection

of items

physical observation tests
Physical Observation Tests

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.

balance related objectives physical inventory observation
Balance-Related Objectives: Physical Inventory Observation

Existence

Inventory as

recorded on tags exist.

Completeness

Existing inventory is

counted and tagged.

Accuracy

Inventory is counted

accurately.

balance related objectives physical inventory observation1
Balance-Related Objectives: Physical Inventory Observation

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.

balance related objectives physical inventory observation2
Balance-Related Objectives: Physical Inventory Observation

Realizable

Value

Obsolete and unusable

inventory items are

excluded or noted.

Rights

The client has rights

to inventory recorded

on tags

learning objective 7
Learning Objective 7

Design and perform audit

tests of pricing and

compilation for inventory.

audit of pricing and compilation
Audit of Pricing and Compilation

Inventory price tests

Inventory compilation tests

audit of pricing and compilation1
Audit of Pricing and Compilation

Pricing and

compilation

controls

Pricing and

compilation

procedures

Valuation

of inventory

balance related objectives inventory pricing and compilation
Balance-Related Objectives: InventoryPricing and Compilation

Detail

tie-in

Existence

Completeness

Accuracy

balance related objectives inventory pricing and compilation1
Balance-Related Objectives: InventoryPricing and Compilation

Classification

Realizable

value

Rights

Presentation

and disclosure

valuation pricing of inventory
Valuation (Pricing)of Inventory

Pricing Purchased Inventory

Pricing Manufactured Inventory

Cost or Market

learning objective 8
Learning Objective 8

Integrate the various parts of

the audit of the inventory

and warehousing cycle.

interrelationship of various audit tests
Interrelationship ofVarious Audit Tests

Tests of acquisition

and payment cycle

Raw materials

Acquisitions of

raw materials

Work in process

Other manufacturing

overhead

interrelationship of various audit tests1
Interrelationship ofVarious Audit Tests

Tests of payroll

and personnel cycle

Work in process

Direct labor

Work in process

Indirect labor

interrelationship of various audit tests2
Interrelationship ofVarious Audit Tests

Inventory tests

Raw materials

Ending inventory

Work in process

Ending inventory

Finished goods

Ending inventory

interrelationship of various audit tests3
Interrelationship ofVarious Audit Tests

Tests of sales and

collection cycle

Finished goods

Cost of goods sold

integration of the tests
Integration of the Tests
  • Acquisition and Payment Cycle
  • Payroll and Personnel Cycle
  • Sales and Collection Cycle
  • Cost Accounting
  • Physical Inventory, Pricing, and Compilation