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Inventory & Fixed Assets By David N. Ricchiute

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1 Inventory & Fixed Assets By David N. Ricchiute
AUDITING CHAPTER 15 Inventory & Fixed Assets By David N. Ricchiute

2 TOPICS Nature of conversion cycle
Auditor’s consideration of controls for inventory, fixed assets Substantive tests for inventory, fixed assets Audit judgment for impaired assets Computer-assisted audit techniques for inventory, fixed assets Assurance service opportunities GBW 8th ed., Ch. 15

3 INVENTORY DOCUMENTS Labor charge report Materials requisition
Summary labor costs for work-in-process Materials requisition Perpetual inventory record GBW 8th ed., Ch. 15

4 DOCUMENTS FOR FIXED ASSETS
Depreciation schedule Overhead application report Summary overhead applied to work-in-process GBW 8th ed., Ch. 15

5 INVENTORY CONVERSION: Nonmanufacturing
Retailer Wholesaler Costs: Holding & physically controlling prior to sale GBW 8th ed., Ch. 15

6 INVENTORY CONVERSION: Manufacturing
Costs Raw materials Transformation costs Direct labor Manufacturing overhead GBW 8th ed., Ch. 15

7 INVENTORY CONTROLS Supervisor approval for materials requisition
Inventory Control personnel control raw materials, finished goods Segregation from purchasing, receiving, shipping, production, recording Responsible for transfers in, out, inventory levels, reports slow moving, damaged goods GBW 8th ed., Ch. 15

8 MONITORING INVENTORY LEVELS
Economic order quantity models Optimize carrying costs with risk of shortages Just-in-time inventory management GBW 8th ed., Ch. 15

9 INVENTORY ACCOUNTING Perpetual inventory records Cost records
Quantities, locations, selected cost information Cost records Accumulates raw materials, direct labor, overhead Applies costs by appropriate method FIFO, LIFO, AVERAGE GBW 8th ed., Ch. 15

10 INTERNAL CONTROL OBJECTIVES
Authorization Execution Recording Access to assets GBW 8th ed., Ch. 15

11 AUTHORIZATION: Inventory Objective, Error, Procedure
Production authorized Unauthorized quantities, products produced; obsolete, excess, unusable inventory Criteria for products & quantities GBW 8th ed., Ch. 15

12 EXECUTION: Inventory Objective, Error, Procedure
Procedures for using, transferring inventory in accord with management’s authorization Circumvent existing procedures; stolen, misused inventory Inventory misplaced Inventory procedures manual for control Restrict access to inventory GBW 8th ed., Ch. 15

13 RECORDING: Inventory Objectives, Errors, Procedures
Inventory recorded at proper amounts, period, classification Inventory not recorded; inventory, CGS misstated Recording procedures; prenumber, control release forms; log inventory movement; periodic counts Adjustments authorized Unauthorized adjustments mean misused, misstated inventory Approval for adjustments; prenumber, control forms GBW 8th ed., Ch. 15

14 ACCESS: Inventory Objectives, Errors, Procedures
Access to inventory restricted Inventory stolen, lost, diverted Physical controls; employee insurance, fidelity bonds; inventory insurance; segregate handling & recording Access to production, accounting, records restricted Records misused, destroyed, lost Physical controls over forms, records; files authorized signatures, periodic compliance audits GBW 8th ed., Ch. 15

15 FIXED ASSET ACCOUNTING
Detailed records for each asset Purchase date, cost, depreciation method, life, salvage, accumulated depreciation Reconcile detailed records with general ledger control accounts Insurance records fixed assets Additions, disposals authorized GBW 8th ed., Ch. 15

16 AUTHORIZATION: Fixed Assets Objective, Error, Procedure
Plant additions, disposals, retirements authorized Assets purchased, sold without management knowledge Assets sold at unfavorable prices Written procedures additions, disposals, retirements Compare scrap prices received with published GBW 8th ed., Ch. 15

17 EXECUTION: Fixed Assets Objective, Error, Procedure
Procedures for operating, using moving fixed assets Stolen, misused, misplaced equipment Establish procedures for operating, using moving fixed assets; restrict access to movable assets GBW 8th ed., Ch. 15

18 RECORDING: Fixed Assets Objectives, Errors, Procedures
Additions, disposals, retirements recorded, classified correctly Unreported transactions Procedures for recording;for disposal eligibility; detailed records; reconcile detailed records with assets Depreciation, amortization proper Depreciation miscalculated, misstated Policies for depreciation GBW 8th ed., Ch. 15

19 ACCESS: Fixed Assets Objectives, Errors, Procedures
Access to assets restricted Assets lost, stolen Physical controls; insurance coverage Access to records restricted Records misused, destroyed, lost Physical controls over forms, records; periodic compliance audits GBW 8th ed., Ch. 15

20 CONSIDERING INTERNAL CONTROL: Inventory
Obtain an understanding Preliminary review Document system Perform transaction walk-through Determine whether controls are potentially reliable in assessing control risk below maximum Test controls GBW 8th ed., Ch. 15

21 INTERNAL CONTROL DOCUMENTATION
Internal control questionnaire Flowchart Memorandum GBW 8th ed., Ch. 15

22 TESTS OF CONTROLS: Inventory Records
Perpetual records Cost records GBW 8th ed., Ch. 15

23 TESTING CONTROLS: Raw Materials Perpetual Records
For sampled raw materials Compare quantities, unit costs invoice to records GBW 8th ed., Ch. 15

24 TESTING CONTROLS: Inventory Transfers
For sampled transfers Raw materials trace to Approved requisitions, Work-in-process records, Summary entries in GL Work-in-process, trace to Transfers to finished goods records, Summary entries in GL Finished goods, trace to Shipping documents Summary of CGS, Sales GBW 8th ed., Ch. 15

25 TESTING CONTROLS: Inventory Cost Records
Obtain summaries of charges to work-in-process Test direct labor & overhead Review basis for standard overhead rates Determine disposition over-, under-applied overhead GBW 8th ed., Ch. 15

26 CONSIDERING INTERNAL CONTROLS: Fixed Assets
Obtain an understanding Preliminary review System documentation Transaction walk-through Determine whether controls are potentially reliable in assessing control risk below maximum Test controls GBW 8th ed., Ch. 15

27 TESTING CONTROLS: Fixed Asset Records
Reconcile total of detailed records with GL & investigate differences Physically inspect sampled fixed assets Review adequacy insurance coverage GBW 8th ed., Ch. 15

28 TESTING CONTROLS: Fixed Asset Additions
Obtain summary fixed asset additions Foot summary; reconcile to GL For a sample Examine authorization, PO, receiving report, invoice, etc. Examine evidence of cash payment & trace to voucher register Examine evidence of obligations Determine classification appropriate GBW 8th ed., Ch. 15

29 TESTING CONTROLS: Fixed Asset Disposals
Obtain summary disposals & retirements Foot summary; reconcile to GL For a sample Examine authorization, contract, invoice, etc. Examine entry cash receipts journal Examine note receivable;trace to GL Calculate gain, loss & trace to GL GBW 8th ed., Ch. 15

30 TESTING CONTROLS: Fixed Asset Depreciation
Review depreciation methods by asset class & policies for life, salvage For a sample Determine whether life, salvage consistent with policies Recalculate depreciation expense, accumulated depreciation GBW 8th ed., Ch. 15

31 SUBSTANTIVE TESTS: Existence, Occurrence
Inventory Fixed Assets Observe physical inventory Confirm off-premises inventory Test cutoff Observe asset additions GBW 8th ed., Ch. 15

32 SUBSTANTIVE TESTS: Completeness
Inventory Fixed Assets Observe physical inventory Confirm off-premises inventory Test cutoff Perform analytical procedures Observe asset additions GBW 8th ed., Ch. 15

33 SUBSTANTIVE TESTS: Rights & Obligations
Inventory Fixed Assets Confirm off-premises inventory Test cutoff Review consignment & purchase commitments Test additions Examine contracts, documentation GBW 8th ed., Ch. 15

34 SUBSTANTIVE TESTS: Valuation, Allocation
Inventory Fixed Assets Test priced inventory Review physical inventory for obsolete, slow moving, unsalable goods Verify accuracy recorded fixed assets, depreciation Test additions, disposals GBW 8th ed., Ch. 15

35 SUBSTANTIVE TESTS: Presentation, Disclosure
Inventory Fixed Assets Compare presentation, disclosures with GAAP GBW 8th ed., Ch. 15

36 SUBSTANTIVE TESTS & ASSERTIONS: Inventory 1
Existence, Completeness Observe physical inventory Existence, Completeness, Rights Confirm off-premises inventory Valuation Obtain records; test mathematical accuracy GBW 8th ed., Ch. 15

37 SUBSTANTIVE TESTS & ASSERTIONS: Inventory 2
Existence, Occurrence, Completeness, Rights Test cutoff & coordinate with sales, A/R Completeness Analytical procedures Presentation, Disclosure Review for classification, disclosure GBW 8th ed., Ch. 15

38 SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 1
Valuation Verify mathematical accuracy fixed assets, depreciation Existence, Occurrence, Completeness, Rights, Valuation Test additions, disposals; physically inspect GBW 8th ed., Ch. 15

39 SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 2
Completeness Analytical tests Presentation, Disclosure Fixed assets, depreciation properly classified, disclosed GBW 8th ed., Ch. 15

40 MANAGEMENT & AUDITOR INCENTIVES
Management incentives Income smoothing via “big baths” Auditor incentives Need persuasive evidence of permanent loss in value GBW 8th ed., Ch. 15

41 COMPUTER ASSISTED TESTS: Inventory, Fixed Assets
Substantive test Computer task Verify mathematical accuracy Foot, cross-foot, test extensions Compare details Compare quantities master file, perpetual file Perform price tests Compare prices final inventory with invoices Merge physical counts, perpetual records Update & print exceptions GBW 8th ed., Ch. 15

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