1. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 5 - 5 Audit of the Inventory and Warehousing Cycle Chapter 20

2. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 2 Learning Objective 1 Describe the business functions and the related documents and records in the inventory and warehousing cycle.

3. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 3 Flow of Inventory and Costs Actual Raw Materials Beginning inventory Raw materials used Purchases Ending inventory Direct Labor Actual 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

4. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 4 Functions in the 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

5. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 5 Learning Objective 2 Explain the five parts of the audit of the inventory and warehousing cycle.

6. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 6 Audit of Inventory Acquire and record raw materials, labor, and overhead Part of audit Cycle(s) Where tested  Acquisition and payment  Payroll and personnel Internally transfer assets and costs  Inventory and Warehousing

7. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 7 Audit of Inventory Ship goods and record revenue and costs Cycle where tested Part of audit Sales and collection Physically observe inventory Price and compile inventory Inventory and warehousing Inventory and warehousing

8. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 8 Learning Objective 3 Design and perform audit tests of cost accounting.

9. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 9 Cost Accounting Controls  Physical controls over raw materials, work in process, and finished goods inventory  Controls over the related costs

10. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 10 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 Audit procedures Sample size Items to select Timing Design tests of controls and substantive tests of transactions for the cost accounting system to meet transaction-related audit objectives

11. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 11 Tests of Cost Accounting  Physical controls over inventory  Documents and records for transferring inventory  Perpetual inventory master files  Unit cost records

12. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 12 Learning Objective 4 Apply analytical procedures to the accounts in the inventory and warehousing cycle.

13. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 13 Analytical Procedures: Inventory and Warehousing Cycle Analytical procedure Compare gross margin percentage with that of previous years Overstatement or understatement of inventory and cost of goods sold Possible misstatement Compare inventory turnover (cost of goods sold divided by average inventory) with that of previous year Obsolete inventory overstatement or understatement of inventory

14. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 14 Analytical Procedures: Inventory and Warehousing Cycle Compare unit costs of inventory with those of previous years Overstatement or understatement of unit costs, which affect inventory and cost of goods sold 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 procedurePossible misstatement

15. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 15 Analytical Procedures: Inventory and Warehousing Cycle 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 Analytical procedurePossible misstatement

16. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 16 Learning Objective 5 Design and perform physical observation audit tests for inventory.

17. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 17 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

18. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 18 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

19. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 19 Audit Decisions Timing Sample size Selection of items

20. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 20 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.

21. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 21 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.

22. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 22 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.

23. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 23 Learning Objective 6 Design and perform audit tests of pricing and compilation for inventory.

24. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 24 Audit of Pricing and Compilation Inventory price tests Valuation of inventory Pricing and compilation procedures Pricing and compilation controls Purchased inventory Manufactured inventory

25. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 25 Learning Objective 7 Integrate the various parts of the audit of the inventory and warehousing cycle.

26. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 26 Interrelationship of Various Audit Tests Tests of acquisition and payment cycle Acquisitions of raw materials Raw materials Other manufacturing costs Work in process Raw material used

27. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 27 Interrelationship of Various Audit Tests Tests of payroll and personnel cycle Direct labor Work in process Indirect labor Work in process

28. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 28 Interrelationship of Various Audit Tests Inventory tests  Cost accounting records  Physical inventory observation  Pricing and compilation Ending inventory Raw materials Ending inventory Work in process Ending inventory Finished goods

29. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 20 - 29 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

30. ©2012 Pearson Education, Auditing 14/e, Arens/Elder/Beasley 5 - 5 End of Chapter 20