Module 9 - Inventory/warehousing

Question 1

Flow of accounts of the inventory and warehousing cycle:

Answer 1

^{Notice the connection to the acquisition cycle and payroll cycle}

Question 2

What are the primary business functions involved in the inventory and warehousing cycle?

Answer 2

1. Process Purchase Orders
2. Receive raw materials
3. Store Raw materials
4. Process the Goods
5. Store Finished Goods
6. Ship Finished Goods
   7.

Question 3

Provide a brief description of these business functions involved in the inventory/warehousing cycle:

• Process Purchase Orders
• Receive Raw Materials

Answer 3

_{Note: these functions part of acquisition cycle as well}

Process Purchase Orders

• Acquisition of raw materials/finished goods
• Adequate controls in form of purchase requisitions and purchase orders

Receive Raw Materials

• Goods received, inspected, receiving report made and compared to invoice before payment is disbursed

Question 4

Provide a brief description of these business functions involved in the inventory/warehousing cycle:

• Store Raw Materials
• Process the Goods

Answer 4

Store Raw Materials

• Material normally placed in warehouse
• Other dept. submits requisition form for disbursement of materials; req form substantiates perpetual invetory

Process the Goods

• Separate production/cost accounting dept. determines cost accounting records
• When jobs completed, costs transferred from WIP to finished goods based on prod. dept reports

Question 5

What is a perpetual inventory master file?

Answer 5

• File that is updated continuously as raw material moved from storeroom to production or as goods purchased
• Includes info about units acquired, sold, and on-hand and includes unit cost
• In manufactures: Separate master file kept for raw material, WIP, and finished goods

Question 6

What are the two primary cost systems that exist to transfer costs between inventory accounts?

Answer 6

1) Job Order Costing

• Each job is unique
• Costs of mat./labor accumulated by individual job

2) Process Cost System

• Mass producing the same product
• Costs accumulated per process and unit cost assigned to goods

Question 7

Provide a brief description of these business functions involved in the inventory/warehousing cycle:

• Store into finished goods
• Ship Finished goods

Answer 7

Store into finished goods

• Once processing complete, product moved to finished goods
• Finished goods perpetual master file added to

Ship Finished goods

• Goods sold to customer
• Shipping document produced and FG master file reduced

Question 8

What are the 5 parts of the audit of inventory?

Answer 8

1. Acquire and record raw materials, labor, and overhead
   
   • Tested in acq./pay and payroll cycle
2. Internally Transfer assets and costs
3. Ship goods and record revenue and costs
   
   • Tested in sales/collection cycle
4. Physically Observe inventory
5. Price and compile inventory

Question 9

The auditor tests internal transfers of assets and costs (part 2 of inventory audit) by:

Answer 9

designing and performing audit tests of cost accounting:

• Test of cost accounting controls
• tests of cost accounting

Question 10

Cost accounting controls can be divided into two categories:

Answer 10

1. Physical controls over raw materials, WIP, and finished goods inventory
2. Controls over related costs

Question 11

How do perpetual inventory master files serve as a cost accounting control?

Answer 11

• Provides record of inventory on hand
  
  • Used to initiate production/acquistion of additional inventory
• Proves record of use of raw materials/sale of finished goods
• Provide record to pinpoint responsibility when differences in inventory counts are discovered

Question 12

What are the 4 main tests of cost accounting?

Answer 12

1. Physical controls over inventory
2. Documents and records for transferring inventory
3. Perpetual inventory master files
4. Unit Costs records

Question 13

What are some tests for physical control of inventory types?

Answer 13

Generally limited to observation and inquiry

• Inventory protected from theft/misuse
  
  • Locks/assignment of assets

Question 14

What are the auditor’s primary objectives when observing documents/records for transferring inventory?

What controls tests may be performed?

Answer 14

• Recorded transferes exist (Occurence)
• All transfers recorded (completeness)
• Details of transfer (quant/date) are accurate

Tests:

• Inspect raw materials requisitions for proper approval and compare to perpetual inventory master file
• Compare completed production records with perpetual inventory master file

Question 15

How can the auditor test the perpetual inventory master files?

What is the importance of testing perpetual inventory master files?

Answer 15

• Examining documentation that supports additions/reductions
  
  • Usually done in the acquisitons/payment cycle (raw materials) and sales cycle (fin. goods)

Importance:

• Affects the timing and extent of physical examination of inventory
  
  • Can be tested throughout period
  • when accurate, reduces capacity of inv. count

Question 16

What is the importance of unit cost records during tests of cost accounting?

What are the tests performed to verify cost records?

Answer 16

Accurate cost data (raw mat/labor/overhead) is essential for fairly stated inventories

Tests:

• Trace units/unit cost of raw materials to master files
  
  • Performed in acq/pay cycle
• Determine and vouch overhead allocation method; usually affected by labor hours
  
  • performed in payroll cycle

Question 17

Are analytical procedures effective in the inventory cycle?

Answer 17

Yes; can be helpful, though substantive procedures always required

Question 18

What are some analytical procedures auditors can perform for the inventory cycle?

• What possible misstatements can they indicate?

Answer 18

Compare gross margin % with previous years

Over/understatement of inventory and COGS

Compare inv. turnover (COGS/avg inv) with prev. years

Obsolete inventory ; over/understatement of inv.

Compare manufacturing costs with previous years

Misstatement of unit costs for direct labor/overhead

Question 19

The most important part of the inventory cycle audit is:

Answer 19

Physical observation of the client’s inventory count and the subsequent testing

Question 20

Are physical examinations required?

Answer 20

Yes; auditing standards required auditors to satisfy themselves about the effectiveness of client’s representation of quantities and condition

Question 21

Explain the differences between the client’s and auditor’s requirements for the physical observation of inventory.

Answer 21

Client’s requirements

• Schedule inventory count
• Count 100% of the inventory
• Reconcile differences between files and inventory and make adjustments to master file

Auditor’s requirements

• Understand client’s inventory and protocols
• Evaluating and observing client’s inventory count
• Performing independent tests and counts
• drawing conclusions on adequacy of inventory and client’s policies

Question 22

What type of test is physical obsevation of inventory?

Answer 22

Dual test: Serves as both an control and substantive test

Control test: Observing client count and ensuring the counting policy/reconciliation works effectively

Substantive test: Auditor’s secondary count substantiates inventory and provides assurance

Question 23

What key auditing assertions does physical observation address and how?

Answer 23

Key Assetions: Important to test both ways

Completeness: Full testing: Select sample out of items on floor (warehouse) and trace to sheet (inv. records)

Existence: False testing: Select items from sheet (inv. records) and find on floor (warehouse)

_{Secondary assertions: Cut-off and Realizable value}

Question 24

What controls should be in place and tested during a physical observation of inventory:

Answer 24

• Proper instructions for count

Separation of duties:

• Independent supervisor part of count
• Independent internal verification of counts; 1 employee counts while 1 employee consults record for match
• Reconcilations and adjustments performed by independent employee

Question 25

**Explain** the 5th activity of the inventory cycle audit: ## Footnote **Price and compile inventory**

Answer 25

Auditors must verify that the physical counts or perpetual records are **correctly** _priced_ and _compiled_ Auditor performs **inventory price tests**

Question 26

What are inventory price tests? What are some examples?

Answer 26

Tests of client's **unit prices** of inventory for correctness Include: * Testing client's summarization of inventory counts * Recalculating price \* quantity * footing inventory summary * Tracing totals to general ledger

Question 27

What **types of tests** are performed during the **audit of pricing and compilation** (part 5 of audit)?

Answer 27

* Pricing and compilation controls * Pricing and Compilation procedures * Valuation of inventory tests

Question 28

How can auditor ensure **pricing and compilation** **controls** are effective?

Answer 28

Auditor should ensure cient has proper controls in place like: * Formal review and reporting of obsolete/slow-moving inv * Controls to ensure physical counts are correctly summarized and priced at correct unit cost * Internal verification by employee by reviewing cost records and physical exam. records

Question 29

How can auditor ensure **valuation of inventory** is accurate and effective?

Answer 29

Consider whether inventory is **purchased**: * Raw materials, supplies, and parts are included at cost less any discounts/other items * Understand client's inventory valuation system (FIFO) Consider whether inventory is **manufactured**: * Cost of raw materials, direct labor, overhead * Evaluation of overhead rate for reasonableness