Audit of the Inventory
and Warehousing Cycle
Chapter 21
Learning Objective 1
Describe the business functions
and the related documents and
records in the inventory and
warehousing cycle.
Flow of Inventory and Costs
Actual
Raw Materials
Beginning
inventory
Raw
materials
used
Purchases
Ending
inventory
Direct Labor
Actual
Applied
Applied
Manufacturing Overhead
Work in Process
Beginning
inventory
Ending
inventory
Cost of
goods
manufactured
Cost of
goods sold
Finished Goods
Beginning
inventory
Ending
inventory
Cost of
goods sold
Functions in the Inventory and Warehousing Cycle
Process
purchase
orders
Receive
raw
materials
Store
raw
materials
Process
the
goods
Store
finished
goods
Ship
finished
goods
Receive
raw
materials
Put
materials
in
storage
Put
materials
in
production
Put
completed
goods in
storage
Ship
finished
goods
Flow
of
inventory
Learning Objective 2
Describe 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
Explain the five parts of the audit
of the inventory and warehousing
cycle.
Audit of Inventory
Acquire and record
raw materials, labor,
and overhead.
Part of audit
Cycle in which tested
Acquisition and
payment plus
payroll and personnel
Internally transfer
assets and costs.
Inventory and
warehousing
Audit of Inventory
Ship goods and record
revenue and costs.
Cycle in which tested
Part of audit
Sales and collection
Physically observe
inventory.
Inventory and
warehousing
Price and compile
inventory.
Inventory and
warehousing
Learning Objective 4
Design and perform audit tests
of cost accounting.
Cost Accounting Controls
2. Controls over the related costs
1. Physical controls over raw
materials, work in process,
and finished goods inventory
Methodology for Designing Tests of Balances – Accounts Receivable
Understand internal
control – cost
accounting system.
Audit
procedures
Items to
select
Sample
size
Timing
Assess planned control
risk – cost
accounting system.
Design tests of controls and substantive tests of
transactions for the cost accounting system
to meet transaction-related audit objectives.
Determine extent of testing controls.
Tests of Cost Accounting
Physical Controls
Documents and records for
transferring inventory
Perpetual inventory master files
Unit cost records
Learning Objective 5
Apply analytical procedures to
the accounts in the inventory
and warehousing cycle.
Analytical Procedures for Manufacturing Equipment
Compare inventory turnover
(cost of goods sold divided by
average inventory) with that
of previous year.
Obsolete inventory
Overstatement or
understatement
of inventory
Analytical procedure
Compare gross margin
percentage with that of
previous years.
Overstatement or
understatement of
inventory and cost
of goods sold
Possible misstatement
Analytical Procedures for Manufacturing Equipment
Compare extended inventory
value with that of previous
years.
Misstatements in
compilation, unit costs, or
extensions, which affect
inventory and cost of
goods sold
Analytical procedure
Compare unit costs of
inventory with those
of previous years.
Overstatement or
understatement of unit
costs, which affect
inventory and cost of
goods sold
Possible misstatement
Analytical Procedures for Manufacturing Equipment
Analytical procedure
Compare current year
manufacturing costs with those
of previous years (variable
costs should be adjusted for
changes in volume).
Misstatements of unit costs
of inventory, especially
direct labor and
manufacturing overhead,
which affect inventory and
cost of goods sold
Possible misstatement
Methodology for Designing Tests of Balances – Other Accounts
Identify client risks affecting the inventory and
warehousing cycle.
Phase I
Set tolerable misstatement and assess inherent
risk for the inventory and warehousing cycle.
Assess control risk for several cycles.
Methodology for Designing Tests of Balances – Other Accounts
Design and perform tests of controls and
substantive tests of transactions
for several cycles.
Phase II
Methodology for Designing Tests of Balances – Other Accounts
Design and perform analytical procedures
for the inventory and warehousing cycle.
Phase III
Audit
procedures
Items to
select
Sample
size
Timing
Design tests of details of inventory to satisfy
balance-related audit objectives.
Learning Objective 6
Design and perform physical
observation audit tests
for inventory.
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
Timing
Sample
size
Selection
of items
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 Audit 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 Audit Objectives: Physical Inventory Observation
Classification
Inventory is classified
correctly on the tags.
Cutoff
Transactions are recorded
in the proper period.
Balance-Related Audit Objectives: Physical Inventory Observation
Rights
The client has rights
to inventory recorded
on tags.
Realizable
Value
Obsolete and unusable
inventory items are
excluded or noted.
Learning Objective7
Design and perform audit tests
of pricing and compilation
for inventory.
Audit of Pricing and Compilation
Inventory compilation tests
Inventory price tests
Audit of Pricing and Compilation
Valuation of inventory
Pricing and compilation procedures
Pricing and compilation controls
Balance-Related Objectives: Inventory Pricing and Compilation
Detail tie-in
Existence
Completeness
Accuracy
Balance-Related Objectives: Inventory Pricing and Compilation
Classification
Realizable
value
Rights
Presentation
and disclosure
Valuation of Inventory
Pricing purchased inventory
Pricing manufactured inventory
Cost or market
Learning Objective 8
Integrate the various parts of
the audit of the inventory
and warehousing cycle.
Interrelationship of Various
Audit Tests
Tests of acquisition
and payment cycle
Acquisitions of
raw materials
Raw materials
Other manufacturing
overhead
Work in process
Raw material used
Raw material used
Interrelationship of Various
Audit Tests
Tests of payroll and
personnel cycle
Direct labor
Work in process
Indirect labor
Work in process
Interrelationship of Various
Audit Tests
Inventory tests
Tests of cost accounting records
Tests of physical inventory observation
Tests of pricing and compilation
Ending inventory
Raw materials
Ending inventory
Work in process
Ending inventory
Finished goods
Interrelationship of Various
Audit Tests
Cost of goods
manufactured
Work in process
Cost of goods
manufactured
Finished goods
Tests of sales
and
collection cycle
Cost of goods sold
Finished goods
End of Chapter 21
