Audit of the Inventory and Warehousing Cycle
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1 Audit of the Inventory and Warehousing Cycle Chapter Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-1
2 Learning Objective 1 Describe the business functions and the related documents and records in the inventory and warehousing cycle Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-2
3 Flow of Inventory and Costs Raw Materials Beginning inventory Purchases Ending inventory Actual Raw materials used Direct Labor Actual Applied Manufacturing Overhead Applied Work-in-Process Beginning inventory Ending inventory Cost of goods manufactured Finished Goods Beginning inventory Ending inventory Cost of goods sold Cost of goods sold 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-3
4 Learning Objective 2 Describe how e-commerce affects inventory management Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-4
5 How E-Commerce Affects Inventory Management The Internet enables companies to provide complete 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 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-5
6 Learning Objective 3 Explain the five parts of the audit of the inventory and warehousing cycle Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-6
7 Functions in the Cycle Process purchase orders Receive raw materials Store raw materials Process the goods Store finished goods Ship finished goods Flow of Inventory Receive raw materials Put materials in storage Put materials in production Put completed goods in storage Ship finished goods 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-7
8 Audit of Inventory Part of audit Acquire and record raw materials, labor, and overhead Internally transfer assets and costs Cycle in which tested Acquisition and payment plus payroll and personnel Inventory and warehousing 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-8
9 Audit of Inventory Part of audit Ship goods and record revenue and costs Physically observe inventory Price and compile inventory Cycle in which tested Sales and collection Inventory and warehousing Inventory and warehousing 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-9
10 Learning Objective 4 Design and perform audit tests of cost accounting Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-10
11 Cost Accounting Controls 1. Physical controls over raw materials, work in process, and finished goods inventory 2. Controls over the related costs 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-11
12 Methodology for Designing Controls and Substantive Tests Understand internal control cost accounting system Assess planned control risk cost accounting system Determine extent of testing controls 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 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-12
13 Tests of Cost Accounting Physical controls over inventory Documents and records for transferring inventory Perpetual inventory master files Unit cost records 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-13
14 Learning Objective 5 Apply analytical procedures to the accounts in the inventory and warehousing cycle Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-14
15 Analytical Procedures: Inventory and Warehousing Cycle Analytical procedure Compare gross margin percentage with that of previous years Compare inventory turnover (cost of goods sold divided by average inventory) with that of previous year Possible misstatement Overstatement or understatement of inventory and cost of goods sold Obsolete inventory overstatement or understatement of inventory 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-15
16 Analytical Procedures: Inventory and Warehousing Cycle Analytical procedure Compare unit costs of inventory with those of previous years Compare extended inventory value with that of previous years Possible misstatement Overstatement or understatement of unit costs, which affect inventory and cost of goods sold Misstatements in compilation, unit costs, or extensions, which affect inventory and cost of goods sold 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-16
17 Analytical Procedures: Inventory and Warehousing Cycle Analytical procedure Compare current year manufacturing costs with those of previous years (variable costs should be adjusted for changes in volume) Possible misstatement Misstatements of unit costs of inventory, especially direct labor and manufacturing overhead, which affect inventory and cost of goods sold 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-17
18 Methodology for Designing Tests of Balances Inventory Identify client business risks affecting inventory Set tolerable misstatement and assess inherent risk for inventor Assess control risk for several cycles Phase I Phase I Phase I 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-18
19 Methodology for Designing Tests of Balances Inventory Design and perform tests of controls and substantive tests of transactions for several cycles Phase II 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-19
20 Methodology for Designing Tests of Balances Inventory Design and perform analytical procedures for inventory Design tests of details of inventory to satisfy balancerelated audit objectives Phase III Audit procedures Sample size Items to select Timing Phase III 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-20
21 Learning Objective 6 Design and perform physical observation audit tests for inventory Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-21
22 Controls Over Perpetual Inventory Master Files 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 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-22
23 Audit Decisions Timing Sample size Selection of items 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-23
24 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 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-24
25 Balance-related Audit Objectives Existence: Inventory as recorded on tags exist. Completeness: Existing inventory is counted and tagged. Accuracy: Inventory is counted accurately. Classification: Inventory is classified correctly on the tags Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-25
26 Balance-Related Audit Objectives Cutoff: Transactions are recorded in the proper period. Realizable value: Obsolete and unusable inventory items are excluded or noted. Rights: The client has rights to inventory recorded on tags Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-26
27 Learning Objective 7 Design and perform audit tests of pricing and compilation for inventory Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-27
28 Audit of Pricing and Compilation Inventory price tests Pricing and compilation controls Pricing and compilation procedures Valuation of inventory 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-28
29 Balance-Related Objectives: Inventory Pricing and Compilation Detail tie-in Existence Completeness Accuracy Classification Realizable value Rights 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-29
30 Valuation of Inventory Pricing purchased inventory Pricing manufactured inventory Cost or market 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-30
31 Learning Objective 8 Integrate the various parts of the audit of the inventory and warehousing cycle Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-31
32 Interrelationship of Various Audit Tests Tests of acquisition and payment cycle Raw materials Acquisitions of raw materials Work in process Other manufacturing costs Raw material used Raw material used 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-32
33 Interrelationship of Various Audit Tests Tests of payroll and personnel cycle Work in process Direct labor Work in process Indirect labor 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-33
34 Interrelationship of Various Audit Tests Inventory tests Tests of cost accounting records Tests of physical inventory observation Tests of pricing and compilation Raw materials Ending inventory Work in process Ending inventory Finished goods Ending inventory 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-34
35 Interrelationship of Various Audit Tests Work in process Cost of goods manufactured Finished goods Cost of goods manufactured Tests of sales and collection cycle Finished goods Cost of goods sold 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-35
36 End of Chapter Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 21-36
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