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20 - 1
Audit of the Inventoryand Warehousing
CycleChapter 20
20 - 2
Learning Objective 1
Describe the business functions
and the related documents and
records in the inventory
and warehousing cycle.
20 - 3
Raw Materials Work in Process
ManufacturingOverhead
Flow of Inventory and Costs
Actual Applied
ManufacturingDirect Labor
Actual Applied
Beginninginventory
RawmaterialsusedPurchases
Endinginventory
20 - 4
Work in Process Finished Goods
Flow of Inventory and Costs
Beginninginventory
Endinginventory
Cost of Goods Sold
Cost of goodsmanufactured
Beginninginventory
Endinginventory
Cost ofgoods sold
20 - 5
Functions in the Inventory and Warehousing Cycle
Processpurchase
orders
Processpurchase
ordersReceive raw
materialsReceive raw
materials
Storeraw
materials
Storeraw
materialsProcess the materialsProcess the materials
20 - 6
Functions in the Inventory and Warehousing Cycle
Perpetual inventorymaster file
Perpetual inventorymaster file
Storefinishedgoods
Storefinishedgoods
Shipfinishedgoods
Shipfinishedgoods
20 - 7
Learning Objective 2
Describe how e-commerce
affects inventory management.
20 - 8
How E-Commerce Affects Inventory Management
The Internet enables clients to provide expandeddescriptions of their inventory on a real-time basis.
The use of the Internet and other e-commerceapplications may lead to financial reportingrisks if access to inventory databases and
systems is not adequately controlled.
20 - 9
Learning Objective 3
Explain the five parts of
the audit of the inventory
and warehouse cycle.
20 - 10
Audit of Inventory
Acquire and recordraw materials, labor,
and overhead.
Internally transferassets and costs.
Part of audit Cycle in which tested
Acquisition andpayment plus
payroll and personnel
Inventory andwarehousing
20 - 11
Audit of Inventory
Ship goods and recordrevenue and costs.
Physically observeinventory.
Price and compileinventory.
Cycle in which testedPart of audit
Sales andcollection
Inventory andwarehousing
Inventory andwarehousing
20 - 12
Learning Objective 4
Design and perform audit
tests of cost accounting.
20 - 13
Cost Accounting Controls
2. Controls over the related costs
1. Physical Controls
Raw materials WIP Finished goods
20 - 14
Methodology for Designing Controls and Substantive Tests
Understand internal control –cost accounting system.
Assess planned control risk –cost accounting system.
Evaluate cost-benefitof testing controls.
20 - 15
Methodology for Designing Controls and Substantive Tests
Design tests of controlsand substantive tests oftransactions for the cost
accounting system to meettransaction-relatedaudit objectives.
Audit procedures
Sample size
Items to select
Timing
20 - 16
Tests of Cost Accounting
Physical Controls
Documents and records fortransferring inventory
Perpetual inventory master files
Unit cost records
20 - 17
Learning Objective 5
Apply analytical procedures to
the accounts in the inventory
and warehousing cycle.
20 - 18
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare gross margin Overstatement orpercentage with that of understatement ofprevious years. inventory and cost
of goods soldCompare inventory turnover Obsolete inventory(cost of goods sold divided Overstatement or by average inventory) with understatement ofthat of previous years. inventory
20 - 19
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare unit costs of Overstatement orinventory with those of understatement ofprevious years. unit costs
Compare extended Misstatements ininventory value with that compilation, unitof previous years. costs, or extensions
20 - 20
Analytical Procedures for Manufacturing Equipment
Analytical Procedure Possible Misstatement
Compare current year Misstatement of unitmanufacturing costs with costs of inventory,those of previous years especially direct(variable costs should be labor andadjusted for changes in manufacturingvolume). overhead
20 - 21
Methodology for Designing Tests of
Balances – Other Accounts
Identify client business risks affectingthe inventory and warehousing cycles.
Set tolerable misstatement andassess inherent risk for the
inventory and warehousing cycles.
Assess control risk for several cycles.
20 - 22
Methodology for Designing Tests of
Balances – Other Accounts
Design and perform tests ofcontrols and substantive tests
of transactions for theseveral cycles.
Design and perform analyticalprocedures for the inventory
and warehousing cycle.
20 - 23
Methodology for Designing Tests of
Balances – Other Accounts
Design tests of detailsof inventory to satisfy
balance-relatedaudit objectives.
Audit proceduresSample size
Items to selectTiming
20 - 24
Learning Objective 6
Design and perform
physical observation
audit tests for inventory.
20 - 25
Controls
Proper instructions for the physical count
Supervision by responsible personnel
Independent interval verification of the counts
Independent reconciliations of the physicalcounts with perpetual inventory master files
Adequate control over count sheets or tags
20 - 26
Selection of items
Sample size
Timing
Audit Decisions
20 - 27
Physical Observation Tests
The most important part of the observationof inventory is determining whether the
physical count is being taken in accordancewith the client’s instructions.
20 - 28
Balance-Related Objectives: Physical Inventory Observation
Existence
Completeness
Accuracy
Inventory as recorded on tags exist.
Existing inventory iscounted and tagged.
Inventory is countedaccurately.
20 - 29
Classification
Cutoff
Realizable Value
Inventory is classified correctly on the tags.
Transactions are recorded in the proper period.
Obsolete and unusableinventory items areexcluded or noted.
Balance-Related Objectives: Physical Inventory Observation
20 - 30
Balance-Related Objectives: Physical Inventory Observation
Rights The client has rights
to inventory recorded on tags
Realizable Value
Obsolete and unusableinventory items areexcluded or noted.
20 - 31
Learning Objective 7
Design and perform audit
tests of pricing and
compilation for inventory.
20 - 32
Audit of Pricing and Compilation
Inventory compilation tests
Inventory price tests
20 - 33
Valuationof inventory
Pricing andcompilationprocedures
Pricing andcompilation
controls
Audit of Pricing and Compilation
20 - 34
Balance-Related Objectives: Inventory
Pricing and Compilation
Detailtie-in
Existence
Completeness Accuracy
20 - 35
Balance-Related Objectives: Inventory
Pricing and Compilation
ClassificationRealizable
value
RightsPresentation
and disclosure
20 - 36
Valuation (Pricing)of Inventory
Pricing Purchased Inventory
Pricing Manufactured Inventory
Cost or Market
20 - 37
Learning Objective 8
Integrate the various parts of
the audit of the inventory
and warehousing cycle.
20 - 38
Interrelationship ofVarious Audit Tests
Tests of acquisitionand payment cycle
Raw materialsAcquisitions ofraw materials
Work in processOther manufacturing
overhead
20 - 39
Interrelationship ofVarious Audit Tests
Tests of payrolland personnel cycle
Work in processDirect labor
Work in processIndirect labor
20 - 40
Interrelationship ofVarious Audit Tests
Inventory tests
Raw materialsEnding inventory
Work in processEnding inventory
Finished goodsEnding inventory
20 - 41
Interrelationship ofVarious Audit Tests
Tests of sales andcollection cycle
Finished goodsCost of goods sold
20 - 42
Integration of the Tests
Acquisition and Payment Cycle
Payroll and Personnel Cycle
Sales and Collection Cycle
Cost Accounting
Physical Inventory, Pricing, and Compilation
20 - 43
End of Chapter 20