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
Inventorymaterials 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 inventor

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 turnoverObsolete inventory
(cost of goods sold divided by
overstatement or
average inventory) with thatunderstatement
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,
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 an
(variable costs should be manufacturing overhead,
adjusted for changes which affect inventory an
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 clients 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 coun

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
clients 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