Audit of the Inventory

and Warehousing Cycle

Chapter 21
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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5

 Learning Objective 1

Describe the business functions and the

related documents and records in the
inventory and warehousing cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 2

 Flow of Inventory and Costs
Raw Materials Work-in-Process
Beginning Raw Beginning Cost of
inventory materials inventory goods
used manufactured
Purchases Ending
inventory
Ending
inventory
Cost of
Direct Labor Finished Goods goods sold
Actual Applied Beginning Cost of
inventory goods sold
Manufacturing Overhead
Ending
Actual Applied inventory

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 3

 Functions in the Cycle
Process Receive Store Process Store Ship
purchase raw raw the finished finished
orders materials materials goods goods goods

Put Put Put

Flow Receive Ship
materials materials completed
of raw finished
in in goods in
Inventory materials goods
storage production storage

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 4

 Learning Objective 2

Explain the five parts of the audit of the

inventory and warehousing cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 5

 Audit of Inventory

Part of audit
Acquire and record Internally transfer
raw materials, labor, assets and costs
and overhead

Cycle(s) Where tested

Acquisition and payment Inventory and
Payroll and personnel Warehousing

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 6

 Audit of Inventory

Part of audit
Ship goods Physically Price and
and record observe compile
revenue inventory inventory
and costs

Cycle where tested

Sales and collection Inventory and Inventory and
warehousing warehousing

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 7

 Learning Objective 3

Design and perform audit tests of cost

accounting.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 8

 Cost Accounting Controls

Physical controls over raw materials,

work in process, and finished goods inventory

Controls over the related costs

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 9

 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 Audit procedures

substantive tests of transactions Sample size
for the cost accounting system
to meet transaction-related Items to select
audit objectives Timing
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 10
 Tests of Cost Accounting

 Physical controls over inventory

Documents and records for transferring

inventory

Perpetual inventory master files

Unit cost records

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 11

 Learning Objective 4

Apply analytical procedures to the accounts

in the inventory and warehousing cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 12

 Analytical Procedures: Inventory
and Warehousing Cycle
Analytical procedure Possible misstatement
Compare gross margin Overstatement or
percentage with that of understatement of
previous years inventory and cost
of goods sold
Compare inventory turnover Obsolete inventory
(cost of goods sold divided by overstatement or
average inventory) with that understatement
of previous year of inventory

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 13

 Analytical Procedures: Inventory
and Warehousing Cycle
Analytical procedure Possible misstatement
Compare unit costs of Overstatement or
inventory with those understatement of unit
of previous years costs, which affect
inventory and cost of
goods sold
Compare extended inventory Misstatements in
value with that of previous compilation, unit costs, or
years extensions, which affect
inventory and cost of
goods sold

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 14

 Analytical Procedures: Inventory
and Warehousing Cycle
Analytical procedure Possible misstatement
Compare current year Misstatements of unit
manufacturing costs with costs of inventory,
those of previous years especially direct labor and
(variable costs should be manufacturing overhead,
adjusted for changes which affect inventory and
in volume) cost of goods sold

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 15

 Learning Objective 5

Design and perform physical observation

audit tests for inventory.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 16

 Audit Responsibilities for Client
Physical Counts
 Be present at the time the client counts
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
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 17
 Controls Over Physical Count

 Proper instructions for the physical count

 Supervision by responsible personnel

 Independent internal verification of the counts

 Independent reconciliations of the physical

counts with perpetual inventory master files

 Adequate control over count sheets or tags

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 18
 Audit Decisions

Sample
size

Selection
Timing
of items

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 19

 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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 20

 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.
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 21
 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.
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 22
 Learning Objective 6

Design and perform audit tests of pricing

and compilation for inventory.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 23

 Audit of Pricing and Compilation

Inventory price tests

Pricing and Pricing and

Valuation
compilation compilation
of inventory
procedures controls

Purchased Manufactured
inventory inventory

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 24

 Learning Objective 7

Integrate the various parts of the audit of

the inventory and warehousing cycle.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 25

 Interrelationship of Various
Audit Tests
Tests of acquisition
and payment cycle

Raw materials Work in process

Acquisitions of Other manufacturing
raw materials costs

Raw material used Raw material used

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 26

 Interrelationship of Various
Audit Tests
Tests of payroll and
personnel cycle

Work in process Work in process

Direct labor Indirect labor

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 27

 Interrelationship of Various
Audit Tests
Inventory tests
 Cost accounting records
 Physical inventory observation
 Pricing and compilation

Raw materials Work in process

Ending inventory Ending inventory

Finished goods
Ending inventory
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 28
 Interrelationship of Various
Audit Tests
Work in process Finished goods
Cost of goods Cost of goods
manufactured manufactured

Finished goods
Tests of
sales and Cost of goods sold
collection cycle

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 21 - 29

 End of Chapter 21

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 5-5