Substantive Procedures

Inventory cycle

Assertion Inventory(Account balance)

Existence  Perform an inventory count.

 Select a sample of records from the
ledger and then trace to the
ground/actual products.

Rights  Enquire of management as to whether

any inventory is held on consignment
for other parties.
 Obtain a listing of inventory of goods in
transit at the financial year-end and
inspect relevant orders/contracts to
determine whether ownership has
passed to the client by scrutiny of the
terms of purchase e.g. FOB, CIF.
 Establish whether inventory is in any
way encumbered (e.g. offered as
security) by
 discussion with management
 inspection of bank confirmations
 review of directors’ minutes
 Review of correspondence/contracts
with suppliers and credit providers.
 When performing the pricing
procedures for the valuation assertion
inspect invoices to ensure that they are
made out to the client.

Valuation and allocation arithmetic accuracy

 Compare the quantities of inventory
items on the auditor’s copies of the
inventory sheets to the client’s priced
inventory sheets (to confirm that the
client has not altered the quantities).
Test the arithmetical accuracy of the
inventory sheets by reperforming all
extensions (quantity x cost) and casting
the extension column (total inventory
value).
 Review inventory sheets for any
negative “inventory item values”
(should not be any). Compare the total
inventory value per the inventory sheets
to the general ledger and trial balance.
pricing inventory purchased locally
  Using the sample selected for inventory
items which were test counted at the
inventory count (or another sample):
 Trace to relevant suppliers invoices to
establish whether the correct purchase
prices have been used in obtaining the
cost in terms of the cost formula used by
the company, e.g. for FIFO, if there are
10 items on hand, and the most recent
invoice was for 8 items at R200 each and
the invoice prior to that was for 12 items
at R190 each, the 10 items on hand
would be valued at 8 x R200 - R1600 2 x
R190 - R380
 Re-perform the weighted average
calculation (if this basis is used by the
client) and compare result to the
weighted average price used by the
client,
 By enquiry of the costing clerk and
inspection of invoices from
transporters, establish that relevant
carriage costs have been included in unit
cost calculations.
pricing imported inventory purchases
 For a sample of imported high value
items, obtain the relevant suppliers
invoices /shipping contracts and costing
schedule, and reperform the unit cost
calculations for the sample of imported
items and verify that:
 The correct exchange rate was used to
convert the foreign currency to dollars
(rate at date of transaction should be
used.
 This rate should be confirmed by
enquiry of a financial institution.)
 The appropriate import and customs
duties and shipping charges were
included (obtained from shipping agents
invoices)
 The allocation of the above costs to the
individual inventory items purchased is
reasonable, and accurately performed.
lower of cost/net realisable value
 Using a sample verify the selling price of
inventory items by:
 Reference to sales lists
 Reference to the most recent sales
invoice for the particular item.
  Compare sales prices on invoices for a
small sample of sales made in the post
reporting date period to the cost prices
on the inventory sheets. This provides
evidence of the most up to date
realisable value.
inventory obsolescence allowance
 Discuss with management:
 The process used to determine the
obsolescence allowance and evaluate
the process for reasonableness and
consistency with prior years, e.g. is a
fixed percentage used each year (only
acceptable if there is strong historical
evidence to support it) or is a detailed
analysis carried out?
 Any procedures in place for the approval
of the final allowance, e.g. is the
allowance approved by the financial
director after consultation with the
warehouse manager?
 Any specific events which may have
occurred during the year which may
have an impact on the allowance – e.g.
a flood may have damaged some
inventory items.
 Any specific inventory items which may
already be obsolete (or soon will be) and
how this has been recognised in
calculating the allowance for
obsolescence.
 Perform analytical procedures to give a
general overview as to the
reasonableness of the allowance by
comparison of current year figures
and/or ratios to prior year figures/ratios
 Reperform the aging of inventory by
tracing back to source documents.
 Compare allowances raised in prior
years to actual write offs in subsequent
years (to determine “accuracy” of
management’s allowances).
 Review working papers from year-end
test counts to ensure that inventory
items identified as
damaged/obsolete/slow moving have
been included in the allowance.
 Reperform any calculations of the
inventory obsolescence allowance and
discuss the reasonableness of the
 allowance in terms of evidence
gathered, with management.

Completeness  Perform physical inventory count

 Select a few items from the ground,
trace these to the ledger.

Classification  By enquiry of management and

inspection of inventory (at the count)
and/or observation of the
manufacturing process, confirm that
inventory included in the account
balance, satisfies the definition of
inventory, i.e. the asset is held for sale in
the ordinary course of the company’s
business or in the process of production
for such sale in the form of materials or
supplies to be consumed in the
production process.

Read on presentation assertion and use of audit software (Auditing notes)