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Audit of The Inventory and Warehousing Cycle Business Functions in The Cycle and Related Documents and Records

The document summarizes the audit of the inventory and warehousing cycle. It describes the key functions and documents involved, including perpetual inventory records. It outlines the main parts of auditing inventory, such as acquiring raw materials, shipping finished goods, physically observing inventory, and pricing and compiling the inventory. It discusses requirements for auditors to observe the physical inventory count and make independent tests. It also covers integrating the inventory audit with testing other cycles like payroll, sales, and cost accounting.

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205 views3 pages

Audit of The Inventory and Warehousing Cycle Business Functions in The Cycle and Related Documents and Records

The document summarizes the audit of the inventory and warehousing cycle. It describes the key functions and documents involved, including perpetual inventory records. It outlines the main parts of auditing inventory, such as acquiring raw materials, shipping finished goods, physically observing inventory, and pricing and compiling the inventory. It discusses requirements for auditors to observe the physical inventory count and make independent tests. It also covers integrating the inventory audit with testing other cycles like payroll, sales, and cost accounting.

Uploaded by

vv
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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AUDIT OF THE INVENTORY AND WAREHOUSING CYCLE

Business Functions In The Cycle And Related Documents And Records


The inventory and warehousing cycle is unique because of its close relationship to other
transaction cycles.
Auditing this cycle is often the most complex and time-consuming part of the audit for these
reasons:

 Inventory is often the largest account on the balance sheet.


 Inventory is often in different locations, making physical control and counting difficult.
 Diverse inventory items such as jewels, chemicals, and electronic parts are often difficult
for auditors to observe and value.
 Valuation is also difficult when estimation of inventory obsolescence is necessary and
when manufacturing costs must be allocated to inventory.
 There are several acceptable inventory valuation methods

Six functions make up the inventory and warehousing cycle:

 Process purchase orders


 Receive raw materials
 Store raw materials
 Process the goods
 Store finished goods
 Ship finished goods

Perpetual Inventory Master File

 Includes information about the units of inventory acquired, sold, and on hand, and often
includes information about unit cost
 Separate perpetual records are likely to be kept for raw materials, work-in-process, and
finished goods.

Parts Of The Audit Of Inventory


The audit of the inventory and warehousing cycle can be divided into five activities within the
cycle:

 Acquire and record raw materials, labor, and overhead


 Transfer assets and costs
 Ship goods and record revenue and costs
 Physically observe inventory
 Price and compile inventory
Audit Of Cost Accounting
Cost Accounting Controls: There are two broad categories of controls:

 Physical controls over raw materials, work-in-process, and finished goods inventory
 Controls over the related costs

Perpetual inventory master files maintained by persons who do not have custody of or access to
assets are a useful control

Tests of Cost Accounting: The auditor is concerned with four aspects of cost accounting:

 Physical controls over inventory


 Documents and records for transferring inventory
 Perpetual inventory master files
 Unit cost records

Physical Observation Of Inventory


Auditors have been required to perform physical observation tests of inventory since a major
fraud involving recording of nonexistent inventory in 1938.

Inventory Observation Requirements for the Auditor:

 Be present at the time the client counts its inventory.


 Observe the client’s counting procedures.
 Make inquiries of client personnel about their counting procedures.
 Make their own independent tests of the physical count.

Controls Over Physical Count: Regardless of inventory method, the client must make a periodic
physical count of inventory. The count may be done at or near the balance sheet date or at an
interim date.

Audit Decisions: The auditor must make some decisions regarding the observation of the
physical inventory count:

 Timing—The auditor must decide whether the physical count can be taken before year-
end.
 Sample Size—The number of items to count is difficult because the auditor should
concentrate on observing the client’s procedures.

 Selection of Items—When auditors observe the client counting inventory, they should be
careful to:
 Observe the counting of the most significant items.
 Inquire about items that are likely obsolete or damaged.
 Discuss with management the reasons for excluding any material items.

Physical Observation Tests: Balance-related audit objectives for inventory are similar to those
for other cycles.

Audit Of Pricing And Compilation


Auditors must verify that the physical counts of inventory are correctly priced and compiled.
 Inventory price tests include tests of the client’s unit prices to determine whether they are
correct.
Pricing and Compilation Controls: Standard cost records that indicate variances in material,
labor, and overhead costs are helpful to evaluate the reasonableness of production records.
Valuation of Inventory: The auditor has three primary concerns:
 The method must be in accordance with accounting standards.
 The application of the method must be consistent from year to year.
 Inventory cost versus market value (replacement cost or net realizable value) must be
considered.
Pricing Purchased Inventory: This includes raw materials, purchased parts, and supplies.
Pricing Manufactured Inventory: In pricing work-in-process and finished goods, the auditor must
consider the cost of raw materials, direct labor, and manufacturing overhead.
Cost or Market: Auditors consider whether market value is lower than historical cost.

Integration Of The Tests


Tests of the Payroll and Personnel Cycle:
Cost accounting records for direct and indirect labor can be tested as part of the audit of the
payroll and personnel cycle.

Tests of the Sales and Collection Cycle:


The audit testing in the storage of finished goods, as well as the shipment and recording of sales,
takes place when the sales and collection cycle is tested.

Tests of Cost Accounting:


Tests of cost accounting records verify the controls affecting inventory. Auditors test the
physical controls, transfers of raw material costs to work-in-process, transfer of completed goods
to finished goods, perpetual inventory records, and unit cost records.

Physical Inventory, Pricing, and Compilation:


All of these are equally important in the audit of inventory because a misstatement in any one
activity results in misstated inventory and cost of goods sold.

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