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Day 26 – Inventory system [Question Practice]

Question 1 [March/June 2016 CBE]

You are an audit senior of Hessonite & Co and are in the process of reviewing the inventory system
documentation for your audit client, Lemon Quartz Co (Quartz) which manufactures computer
equipment. The company’s factory and warehouse are based on one large site, and their year end is
30 June 2016. Quartz is planning to undertake a full inventory count at the year end of its raw
materials, work in progress and finished goods and you will be attending this count. In preparation
you have been reviewing the inventory count instructions for finished goods provided by Quartz.

The count will be undertaken by 15 teams of two counters from the warehouse department with
Quartz’s financial controller providing overall supervision. Each team of two is allocated a number of
bays within the warehouse to count and they are provided with sequentially numbered inventory
sheets which contain product codes and quantities extracted from the inventory records. The counters
move through each allocated bay counting the inventory and confirming that it agrees with the
inventory sheets. Where a discrepancy is found, they note this on the sheet.

The warehouse is large and approximately 10% of the bays have been rented out to third parties with
similar operations; these are scattered throughout the warehouse. For completeness, the counters
have been asked to count the inventory for all bays noting the third party inventories on separate
blank inventory sheets, and the finance department will make any necessary adjustments.

Some of Quartz’s finished goods are high in value and are stored in a locked area of the warehouse
and all the counting teams will be given the code to access this area. There will be no despatches of
inventory during the count and it is not anticipated that there will be any deliveries from suppliers.

Each area is counted once by the allocated team; the sheets are completed in ink, signed by the team
and returned after each bay is counted. As no two teams are allocated the same bays, there will be no
need to flag that an area has been counted. On completion of the count, the financial controller will
confirm with each team that they have returned their inventory sheets.

Required:

In respect of the inventory count procedures for Lemon Quartz Co:

(i) Identify and explain FIVE deficiencies;

(ii) Recommend a control to address each of these deficiencies; and
(iii) Describe a TEST OF CONTROL the external auditors would perform to assess if each of these
controls, if implemented, is operating effectively.

Note: The total marks will be split equally between each part. (15 marks)

AA Short Notes Kappan’s School of Accountancy & Management Basil Neelambra

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Answer

Deficiencies Control Recommendation Test of Control

The count will be undertaken The counting teams should be Attend the year-end count and
by teams of warehouse staff. independent of the warehouse; enquire of the counting teams
hence members of alternative which department they
There should be a segregation departments should undertake normally work in.
of roles between those who the counting rather than the
have day-to-day responsibility warehouse staff. Inspect the updated inventory
for inventory and those who count instructions to verify
are checking it. that they have been
communicated to members of
If the same team are staff outside the warehouse
responsible for maintaining department.
and checking inventory, then
errors and fraud could be
hidden.
The inventory sheets contain The count sheets should be Inspect a sample of the
quantities as per the inventory sequentially numbered and counting sheets being used by
records. contain product codes and the counting teams to verify
descriptions but no quantities. that only the inventory product
There is a risk that the codes and description are pre-
counting teams may simply printed on them.
agree with the pre-printed
quantities rather than
counting the balances
correctly, resulting in
significant errors in
inventory.
There are 15 teams of Each team should be informed Observe the counting teams to
counters, each team having that both members are assess if they are counting
two members of staff. required to count their assigned together or if one counts and
inventory separately. the other then double checks
However, there is no clear the quantities counted.
division of responsibilities Therefore, one member counts
within the team. and the second member also Review the records of the
undertakes a count and then sample checks undertaken by
Therefore, both members of records the inventory on the the supervisor of the inventory
staff could count together count sheets correctly. count.
rather than checking each
other’s count; and errors in In addition, the financial
their count may not be controller supervising the count
identified. should undertake some sample
checks of inventory counted by
each team.
Inventory owned by third All inventories belonging to Enquire of the count supervisor
parties is also being counted third parties should be moved where the third party
by the teams with to one location. inventory is to be stored,
adjustments being made by This area should be clearly confirm through inspection of
the finance team to split these marked and excluded from the the counting sheets that these
goods out later. counting process. bays are not included on any
pre-printed forms.

AA Short Notes Kappan’s School of Accountancy & Management Basil Neelambra

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There does not appear to be a

method for counters to
identify which items are third
party inventory.

There is a risk that these

goods may not be correctly
removed from the inventory
count sheets, resulting in
inventory being overstated.
High value inventory which is The high value inventory should Attempt to access the area
normally stored in a secure be kept in the locked area of the where the high value inventory
location will be accessible by warehouse. is stored; this should not be
all team members as they will possible without the access
be given the access code. Senior members of the team code.
should be allocated to count
This significantly increases the these goods, and they should be
risk of theft as any member of given the access code to enter
the counting team could the area.
subsequently access these
goods. Upon completion of the count
the access code should be
changed.
Each bay of the warehouse is Once all inventories have been Observe the counting team
counted once only. counted once, each area should undertake second counts of all
be recounted by a different areas; confirm that different
If inventory is only checked team. teams undertake this process.
once, then counting errors
may arise resulting in under Any differences on the first
or overstated inventory. count should be promptly
notified to the count supervisor
and a third count undertaken if
necessary.

If a full second count would be

too time-consuming for the
company, then sample checks
on the inventory counted
should be undertaken by a
different counting team.
Once areas are counted, the All bays should be flagged as Physically confirm that the
teams are not marking the completed, once the inventory completed bays of the
bays as completed. has been counted. warehouse have been flagged
to indicate that the goods have
Therefore there is the risk In addition, the count been counted.
that some areas of the supervisor should check at the
warehouse could be double end of the count that all of the At the end of the count, review
counted or missed out. bays with Quartz’s inventory any bays containing Quartz’s
have been flagged as goods which have not been
completed. flagged.

AA Short Notes Kappan’s School of Accountancy & Management Basil Neelambra


The inventory sheets are
sequentially numbered and at
the end of the count they are
given to the count supervisor
who confirms with each team
that they have returned all
sheets.
However, no sequence check
of the sheets is performed. If
sheets are missing, then the
inventory records could be
understated.
AA Short Notes Kappan’s School of Accountancy & Management
After the counting has finished,
each team should return all of
their sequentially numbered
sheets and the supervisor
should check the sequence of
all sheets at the end of the
count.
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Review the sequence of the
inventory sheets for any gaps
in the sequence and obtain an
explanation from the count
supervisor.
Basil Neelambra