AUDIT II

Prepared by: Siti Hajar Asmah bt Ali

1. An employee recognizes a
need for a purchase; completes
a requisition and sends
it to purchasing.
Ace Company PURCHASING
PURCHASE DEPARTMENT
REQUISITION
The production
dept. needs 200
kgs. of dry #4
solvent.
authorized
employee
 2. Purchasing prepares a purchase
order shops for the appropriate
quality at the best price.

Ace Company
PURCHASE BIG
PURCHASING
DEPARTMENT ORDER Chemical Co.
To: Big Chemical Co.
Please ship 200
kgs. of dry #4 sol-
vent by 6/2/04
Price $38.40/kg.
purchasing agent
 3. When goods arrive from the
vendor, the receiving dept.
inspects, counts, and pre-
pares a receiving report.

Ace Company
RECEIVING
BIG RECEIVING REPORT
Chemical Co. DEPARTMENT Received 200
kgs. of dry #4
solvent on 6/1/04.
Condition: OK

BIG receiving employee

Chemical Co.
4. Goods are moved from receiving to a
warehouse; per-petual inventory is
updated.

RECEIVING WAREHOUSE
DEPARTMENT

Dr Inventory
Cr AP
5. When needed, goods are moved from
the warehouse to production.

WAREHOUSE PRODUCTION
DEPARTMENT
6. When finished, goods are moved from
production to the warehouse.

WAREHOUSE PRODUCTION
DEPARTMENT
7. When sold, goods are shipped
and perpetual inventory re-
cords are updated.
A Ace Co.
C
E
Dr AR
Cr Sales
Dr COGS
CrInventory
 Production
Production
1. Production Schedule Schedule
Schedule

2. Receiving Report
3. Materials Requisition
4. Inventory Master File
5. Production Data Information
6. Cost Accumulation and Variance Report
7. Inventory Status Report
8. Shipping Order
Segregation of Duties
The inventory management function
should be segregated from the cost-
accounting function.
The inventory stores function should
be segregated from the cost-
accounting function.
The cost-accounting function should
be segregated from the general
ledger function.
The responsibility for supervising
physical inventory should be
separated from the inventory
management and inventory stores
functions.
Possible Errors or Fraud
If the individual responsible for inventory management
also has access to the cost-accounting records,
production and inventory costs can be manipulated.
This may lead to an over- or understatement of
inventory and net income.
If one individual is responsible for both controlling and
accounting for inventory, unauthorized shipments can
be made or theft of goods can be covered up.
If one individual is responsible for the inventory
records and also for the general ledger, it is possible for
that individual to conceal unauthorized shipments. This
can result in the theft of goods, leading to an
overstatement of inventory.
If the individual responsible for production
management or inventory stores functions is also
responsible for the physical inventory, it is possible that
inventory records to the physical inventory, resulting in
an overstatement of inventory.
 The auditor should consider industry-related factors
and operating and engagement characteristics
when assessing the possibility of a material
misstatement.
If industry competition is intense, Products that are small and of
there may be problems with the high value are more susceptible
proper valuation of inventory. to theft. The auditor must be
Technology changes in certain alert to related-party transactions
industries may also promote for acquiring raw materials and
material misstatement due to selling finished products. Prior-year
obsolescence. misstatements are good indicators
of potential misstatements in the
current year.
Assertions about Classes of Transactions :
Occurrence. Inventory transactions and events are valid.
Completeness. All inventory transactions and events have
been recorded.
Authorization . All inventory transactions and events are
properly authorized.
Cutoff. Inventory receipts and shipments are recorded in the
correct accounting period.
Classification . Inventory is recorded in the proper accounts.
Assertions about Account Balances at the Period
Existence. Inventory recorded on the books and records
actually exists.
Rights and obligations. The entity has the legal right to the
recorded inventory.
Completeness. All inventory is recorded.
Valuation and allocation. Inventory is properly recorded in
accordance with GAAP (e.g., lower of cost or market).
Assertion Test of Controls

Observe and evaluate proper segregation of duties. Review and test procedures for transfer
Occurrence of inventory. Review and test procedures for issuing materials to manufacturing
departments. Review and test client procedures for account for numerical sequence of
materials requisitions. Observe the physical safeguards over inventory.
Completeness Review and test client's procedures for consignment goods.
Review and test procedures for taking physical inventory. Review and test procedures used
to develop standard costs. Review and test cost accumulation and variance reports. Review
Accuracy
and test procedures for identifying obsolete, slow-moving, and excess quantities. Review
the reconciliation of perpetual inventory to general ledger control account.
Review and test procedures for processing inventory included on receiving reports into the
Cutoff perpetual records. Review and test procedures for removing inventory from perpetual
records based on shipments of goods.
Classification Review the procedures and forms used to classify inventory.
Observe the client’s
inventory-taking
procedures.
 December
the client has a
eriodic inventory
ystem, the
hysical inventory
ount determines
he balance in
nventory accounts and will probably
ccur on the balance sheet date.
 the client has a June
erpetual inventory
ystem, the
hysical inventory
ount may occur
ny time during
he accounting period.
Whenever the count occurs, the auditor
required to observe.
When the auditing firm has not audited
eginning balances, the auditors must
atisfy themselves as to the appropri-
teness of beginning balances, if they
re satisfied as to the current balances.
When the auditing firm has not audited
eginning balances, the auditors must
atisfy themselves as to the appropri-
teness of beginning balances, if they
re satisfied as to the current balances.

how?
When the auditing firm has not audited
eginning balances, the auditors must
atisfy themselves as to the appropri-
teness of beginning balances, if they
re satisfied as to the current balances.

how?
analytical review of prior tests of inventory
inventory transactions and
procedures documents
count records
 perform
analytical
procedures
to test
inventory
reasonablenes
s
Substantive Analytical Procedure Possible Misstatement Detected
Compare raw material, finished goods, and total inventory
Obsolete, slow-moving, or excess inventory
turnover to previous years' and industry averages.
Compare days outstanding in inventory to previous years' Obsolete, slow-moving, or excess inventory
and industry average.
Compare gross profit percentage by product line with
Unrecorded or fictitious inventory
previous years' and industry data.
Compare actual cost of goods sold to budgeted amounts. Over- or understated inventory
Compare current-year standard costs with prior years' after
Over- or understated inventory
considering current conditions.
Compare actual manufacturing overhead costs with
Inclusion or exclusion of overhead costs
budgeted or standard overhead costs.
ure there is no movement of inventory
ure that is no production scheduled
iew the client’s plan for counting the physical
tory. Attend client count planning meetings.
Observe the physical inventory count.
Determine whether client’s counting methods
e effective.
Observe the quality and condition of the
ventory. Consider obsolescence.
• On a random basis:
- select a sample of inventory items from
the
warehouse floor, count them, trace the
quantity to client count records
On a random basis:
- select a sample of inventory items from
the
client count records, find them in the
warehouse, count them
On a random basis:
- select a sample of inventory items from the
client count records, trace them to the
perpetual inventory records
4/30/x7 Physical
4/30/04 Physical
Inventory
Inventory
4/30/04 Physical
perpetual inventory
Inventory
description qty
widgets - red 87
18# widgets widgets - green 4
18# widgets
- purple widgets - purple 18
18# widgets
- purple
- purple
On a random basis:
- select a sample of inventory items from the
perpetual inventory records trace them to
the client count records
4/30/x7 Physical
4/30/04 Physical
Inventory
Inventory
4/30/04 Physical
Inventory perpetual inventory
description qty
18# widgets widgets - red 87
18# widgets widgets - green 4
- purple
18# widgets
- purple widgets - purple 18
- purple
• • Inventory cut-off errors
• • Unreported scrap or salvage
• • Theft
At the conclusion of testing, the auditor
should aggregate all identified misstatements.
The likely misstatement is compared to the
tolerable misstatement allocated to the
inventory account.