Audit Chapter 12 (Inventory)

Which of the following is an effective control that encourages receiving department personnel to count and inspect all merchandise received? A. Internal auditors periodically examine, on a surprise basis, the receiving department copies of receiving reports B. Quantities ordered are excluded from the receiving department copy of the PO C. Vouchers are prepared by accounts payable department personnel only after they match item counts on the receivinig report with the PO D. Receiving department personnel are expected to match and reconcile the receiving report with the PO

Quantities ordered are excluded from the receiving department copy of the PO

A client uses a periodic inventory system. Would one expect a credit to Sales or Inventory at point of sale?

Sales, since the client uses a periodic system, they only record revenue at point of sale. COGS is recorded at a later time

To assure that all purchases are authorized before payment is made, accounting department personnel should match the vendor's invoice to

The purchase order

Are confirmations of accounts receivable and accounts payable required?

-AR is required (unless amount is material) because existence is more important for assets/revenues -AP is not required because it is a liability, which is more related to completness

Why is the audit of inventory so important?

-Largest asset for a company -a way to overstate profits is to overstate inventory, auditors typically emphasize tests aimed at finding overstatements -although JIT inventory has grown in popularity, inventories are still large for many companies and suseptible to errors and fraud

When would an auditor confirm AP?

1. Bad internal control 2. Bad financial position 3. When some vendors don't send monthly statements

Potential problems with inventory counting

1. Double counting/missing items 2. Inventory doesn't belong to the client 3. Inventory is obsolete 4. Cutoff problems (inventory coming in and out during the count) 5. Needing a specialist

How to search for unrecorded liabilities

1. Examine disbursements after year end (generall considered best procedure) 2. Examine vendors' invoices and statements 3. Examine purchase agreement documents 4. Unrecorded vouchers (examine receiving reports, vendors invoices, purchase orders) 5. Reconcile liabilities with monthly statements from creditors

Perform further audit procedures- test of control

1. Examine significant aspects of a sample of purchase transactions 2. Perform tests of the cost accounting system 3. If necessary, revise the risks of material misstatement based on the results of the tests of controls

Inventory and the assertions

1. Existence- observe the inventory count 2. Rights- awareness of consigned goods 3. Completeness- observe inventory count 4. Valuation- LIFO/FIFO, inventory obsolsescence 5. Presentation- is inventory manufacturer (so RM, WIP, or FG) or non-manufacturerer. Is any inventory pledged as collateral? 6. Cut off- look at FOB shipping point and destination

Inventory circumstances and their subsequent audit procedures 1. Inventory determinded periodically by physical count 2. Perpetual records kept, adjusted periodically for physical count 3. Engaged to audit after year end 4. Client requests auditor not to observe taking of inventory 5. Material inventory stored in public warehouse 6. First year audit, auditor not satisfied with opening inventory

1. Extensive test counts 2. Limited test counts 3. Do alternative procedures 4. Disclaimer of opinion 5. Go to public warehouse and evaluate 6. Unqualified on balance sheet but not unqualified on IS and statement of cash flowas

Red flags for potential fraudulent billing

1. Invoices for unspecified consultuing or other poorly defined services 2. Unfamiliar vendors 3. Vendors that only have a PO box address 4. Vendors with company names consisting of only initials 5. rapidly increasing purchases from one vendor 6. Vendor billings more than once a month 7. Vendor address matches employee address 8. Large billings broken into multiple smaller invoices 9. Internal control defeciencies such as allowing a person who processes payments to approve new vendors

What are the adequate written instructions needed for the count of physical inventory?

1. Names of employees responsible 2. Date of count 3. Location to be counted 4. Detaileed instructions on how the counts are to be made and instructions for controlling inventory country 5. Use of electronic count media 6. Instructions for handling receipt, shipment and movement of goods during count

Perform further audit procedures- substantive procedures for inventories and costs of goods sold. What are some common tests?

1. Obtain listings of inventory and reconcile to ledger 2. Evaluate the client's planning of inventory 3. Observe the taking of inventory 4. Inventory cutoff 5. Obtain a copy of the completed physical inventory and test its accuracy 6. Evaluate the bases and methods of inventory pricing. Test the pricing of inventories 7. Perform analytical procedures 8. Determine whether any inventories have been pledged 9. Evaluate financial statement presentation and disclosure

How to obtain an understanding of internal control over inventories and COGS

1. Purchase of goods- purchase requisitions & purchase orders 2. Receiving- receiving reports 3. Issuing goods- material requisitions 4. Production schedule- production orders, move tickets, time tickets 5. Shipping- shipping documents & bill of lading

Things to watch for during the observation of inventory

1. Review physical layout, observing proper segregation of obsolete and defective goods 2. Observe client's team as they take inventory 3. Watch for movement of inventory 4. Observe tag control procedures 5. Take test counts

Overview for evaluating inventory (steps)

1. Use understanding of client and its enviornment to consider inherent risks, including fraud, related to inventories and COGS 2. Obtain an understanding of internal control over inventories and COGS 3. Assess the risks of material misstatement and design further audit procedures 4. Perform audit procedures (ie test the controls) 5. Perform further audit procedures (ie substantive procedures for inventories and COGS)

Evaluate the bases and methods of inventory pricing

1. What method of pricing does the client use? 2. Is the method of pricing the same that was used in previous years 3. Has the method been applied consistently and accurately? 4. Lower of cost and market

Evaluate the cient's planning of physical inventory

1. Who is doing the counts- the client counts the inventory, but we push them to count the inventory in the correct manner 2. Dates of counts 3. Adequate written instructions (names of employees, date, locations, detailed instructions on how the counts are made, instructions for controlling inventory counts, Use and control of electronic count media (prenumbered inventory tags), Instructions for handling the receipt, shipment, and movement of goods during the counts) 4. Tags (paper, RFID, bar) *ideally, suspend all activity when involving movement of inventory 5. Proper cutoff of sales and purchase transactions

Which of the following is not a reason for the special significance attached by the auditors to the verification of inventories? A. Inventories are often the largest current asset in a company B. The determination of inventory valuation directly affects net income C. Just in Time inventory methods increase the importance to audit inventory D. Special Valuation problems often exist in inventory

C. Just in time inventory methods increase the importance to audit inventory

Formula for inventory turnover

COGS/Average Inventory *this is an analytical procedure used to test for inventory obsolescence

General rule for counting inventory

Client counts at the end of year, auditor observes the counting

An auditor has examined the inventory tags on certain inventory items in the warehouse and is now tracing information on a representitive number of tags to the inventory summary sheets. Which assertion does this procedure relate to most directly?

Completeness, because tracing

Obtain listing of inventory and reconcile to the ledgers

Existence, occurence, and rights

Purchase cutoff procedures should be designed to test that merchandise is included in the inventory of the client company, if the company 1. Has paid 2. Holds the shipping documents for the merchandise issued 3. Holds legal title to the merchandise 4. Has physical possession of the merchandise

Holds legal title to the merchandise

Which of the followinig is least likely to be performed efficiently using data analytics? 1. Identification of defective inventory 2. Identification of purchases recorded more than once 3. Identification of overvalued inventory items based on sales of those items 4. Identification of slow-moving inventory

Identification of defective inventory items

Which of the following is an auditor least likely to consider a departure from US generally accepted accounting principles? A. Valuing inventory at cost B. Including in inventory items that are consigned to vendors, but not yet sold C. Including in inventory items shipped subsequent to year end, but for which valid orders did not exist at year end D. Using standard cost as the measure of inventory cost

Including in inventory items that are consigned to vendors but not yet sold

How is inventory valued?

Lower of cost or market Cost- LIFO, FIFO etc. Market- basically what you can sell it for

Types of inventory

Manufacturer= raw materials, work in process, FG or Nonmanufacturer= FG

The most reliable procedure for an auditor to use to test the existence of a client's inventory at an outside location would be to?

Observe physical counts of the inventory items

Your audit client shipped merchandise costing $50,000 with a sales price of $75,000 to a consignee on December 24, year 2. The consignee received the merchandise on December 30, year 2. The audit client records the sale on that date. The consignee had not sold the merchandise as of January 1, year 3. Your audit client uses the periodic method. Record the necessary year 2 adjustments that the auditors should propose to the client?

Since the audit client uses periodic method, they recorded Debit: AR and Credit: Revenue This entry must be reversed since the inventory has not been sold yet, so Debit: Revenue Credit: A/R

Observe the taking of the inventory

The auditor does not take the count, but instead observes inventory -review physical layout, observe proper segregation of obsolete and defective goods -watch for the movement of inventory -observe tag control procedures -take test counts

Which of the following is not true relating to the auditors observation of the client's physical inventory? A. Auditor should supervise taking of inventory B. Auditor should evaluate the adequacy of the client's counting procedures C. The auditor's should take test counts of the client's inventory D. The auditors should evaluate the client's planning of the physical inventory

The auditor should supervise the taking of the inventory (the auditor should simply observe, they should not be in charge of taking inventory counts)

When testing AR do we sample the highest AR balance at the end of the year, or the accounts with the highest sales?

The auditor tests the AR balances thaht are the highest, because we are concerned that this asset exists

Voucher system for accounts payable

Used to achieve strong internal control over cash disbursements. A voucher is created to pay a liability when all three of the following documents are present 1. PO 2. Receiving report 3. Vendor invoice -most frequently, when a voucher system is used, client pays by voucher as opposed by paying account balance at end of month (thus if 3 vouchers were issued throughout the month, the client would make three payments as opposed to one at the end of the month)

When testing AP do we sample the highest AP balance at the end of the year of the highest total purchases from vendor during the year?

We test the accounts with the highest total purchases from vendor during the year because we are testing completeness (we want to know if the lasrgest purchases made it through the accounting system)

Instead of taking a physical inventory count on the balance sheet date, the client may take physical counts prior to year end if internal control is adequate and...

Well kept records of perpetual inventory are maintained

A client uses a perpetual inventory system. Would one expect a credit to Sales and Inventory at the point of sale

Yes to both At point of sale Debit: COGS Credit: Inventory Debit: A/R Credit: Revenue

How does the tagging process affect the existence and completeness assertions?

existence- insure all inventory exists (vouch accumulation sheet, tag, inventory items) completeness- insure all inventory is recorded (trace inventory items, tag, inventory accumulation sheet)