POPA

INVENTORY AND PRODUCTION

CYCLE – INTRODUCTION

Department of Accounting
2024
 SOURCES OF REFERENCE

Auditing Notes for SA Students CH12

Lecture Notes

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 Learning objectives

1. Understand the Inventory and Production cycle

and the appropriate documents, records,
functions, business risks and internal controls.
2. Consider the effectiveness of the internal controls
in the different processes of the cycle and be able
to identify weakness and recommend
improvements
3. Design an effective internal control system for an
organisation for their Inventory and Production
cycle

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 How can this topic be assessed

· You could be required to:

○ Identify the weaknesses in Internal controls of an
organization over the cycle
○ Recommend improvements to internal controls
○ Design controls for an organization
○ Identify Business Risks of the cycle

(The list is not exhaustive and is meant only as a

guideline!)

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 Introduction
Basic requirements of cycle
· Controls over physical transfer (movement)
· Protection of inventory (held for resale or manufacture)
· Planning, controlling and recording of production costs
○ Process costing vs job costing
https://www.youtube.com/watch?v=9Eq4C9ch-vk (process costing)

Characteristics of the cycle (what to consider)

· Heart of business (inventory nature shapes the organisation)
· Pervasive impact on FS (Acc system must be well designed)
· Internal cycle (Purchases (puts in) / Revenue (takes out))
· Physical asset susceptible to theft and damage
· Inventory fraud (e.g. manipulation by directors)
· Diversity of stock (nature, location, permanence and dev stage)

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 Introduction

Diversity of stock
· Nature - easy/hard to identify/ growing or moving
· Location - multiple warehouses, consignment stock, in
transit, obscure locations
· Permanence - expiry dates, technological expiration
· Stage of development - Raw Materials, Work in
Progress, Finished Goods.

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 INVENTORY

Internal
Acquisition
and Inventory Revenue and
payments cycle Receipts Cycle
Cycle

Our focus is here!!

Supplier Customer

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 Quick Overview of Cycle

Warehouse
Warehouse
(Raw Material
Production (Finished
& Component
Goods)
store)

Manufactured Goods

Receiving Despatch
Inventory purchased for resale

Warehouse
Goods for
Resale

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 Documents in the Cycle
https://youtube.com/shorts/FbvTTHB6OvU?si=BnxZiXBAhRDkdw4e Goods
Inventory Received
Inventory tag example Inventory Adjustment Note (GRN)
Tag Form Materials
Inventory (Components)
Sheet Requisition

Materials
Delivery (Components)
Notes DOCUMENTS IN Issue Note
THE CYCLE
Manufacturing
Picking Slip / Production
Schedule
Transfer to Finished
Goods Note Costing Production Job
Schedule Report Cards
(budget)

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QUICK RECAP

· What are the basic requirements of the cycle?

· What are the characteristics of the cycle?
· What are its two supporting cycles?
· Documents involved in the cycle

Thank you for your participation!!

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 Control Objectives

Adequate design and implementation of

internal controls should provide the auditors
with the following assurance surrounding
data capturing of the entity:
· Transactions are valid
· Transaction data is recorded accurately
· Transaction data is complete
(VAC)

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 WAREHOUSING

Function
• Control the transfer of goods in and out of ALL warehousing facilities
• Physically protect inventory in ALL Warehouses

Documents
• Goods received note (GRN)
• Material Requisition
• Picking Slips
• Material Issue Note
• Delivery Note (DN)
• Perpetual Inventory Records
• Inventory Count Documentation

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 WAREHOUSING
RISKS
Goods that are
received may not be
Stock is lost or stolen Stock deteriorates
transferred to the (due to poor security, (damaged due to poor
warehouse timeously collusion, poor isolation of physical controls or
responsibility) expired)
or at all

No record of Goods/Materials
issued are incorrect Transfer of material
goods/Materials
(production delays = lost recorded inaccurately
moved
sales)

Inventory shortages are Fictitious transfers

concealed recorded

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 WAREHOUSING

CONTROLS: damage, theft & loss of stock

Physical controls
- Limited entry and exit
- Controlled entry and exit
- Restricted entry
- Secure buildings
- Environmental controls –
dry, clean, temperature
- Surveillance
Comparison & Reconciliation
- Physical inventory compared
to theoretical inventory
- Actual Production compared
to production schedules and
to budgets
- All material variances should
be investigated

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 WAREHOUSING

Controls: Movement of Inventory

Both the deliverer and

No movement No movement receiver agree on the
without written without goods being transferred,
sign and retain a copy of
authority recording any transfer documents

Transfer documents
sequenced and filed Review for Recording of
numerically authorising inventory should
(sequence checks, missing signature be checked
documents investigated)

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 PRODUCTION
Function
• Manufacturing of products, Production department will be required to:
• Requisition and receive components from warehouse
• Control manufacturing costs
• Record actual costs
• Account for items produced and transferred to a Warehouse
• Compare actual and budgeted costs

Documents
• Materials requisitions
• Materials Issue Notes
• Job Cards
• Production Schedules
• Production Reports
• Transfer to Finished Goods Notes

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 PRODUCTION
RISKS
Too much/ Too little
Requisition/Issue
manufacturing of Theft of materials
Incorrect Materials
inventory

No record of Invalid transfers/

Transfers recorded
goods/Materials inaccurately Fictitious transfers
transferred in/out recorded

Actual costs &

Costs not budgeted variances not
appropriately managed &
followed up on

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 PRODUCTION

1. CONTROLS: Budgeting/Costing schedules

Costing Schedule (Budget) must be prepared for products to
be manufactured:
○ Carefully by costing personnel
○ Contain detailed listings of all
 materials to be used,
 expected labour costs and
 allocation of production overheads
○ Schedules should be sequenced, dated and approved by senior
production personnel
○ Schedules may be used as source documents for purchase
requisitions.

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 PRODUCTION
2. CONTROLS: Job orders details on the schedule
○ Material issues to Job cards supported by
 Materials Requisitions + authorized job card
 Cross-referenced by production manager to customer order, materials requisition
and issue notes, daily production schedule
○ Job cards should be sequentially numbered & filed numerically
○ Job cards should be held in pending file whilst job in production
○ At the end of production, a “transfer to finished goods” form is filled out.
 Cross referenced to the job card
 Accompany goods to stores
 Used to write up perpetual inventory records
○ Each job card once complete should be costed
○ Production manager to sequence test completed job cards confirm that:
 Cross referenced to “Transfer to FG” note
 Missing job cards are for pending jobs only
○ Management compare completed job cards to quotes and costing
schedules, investigate variances
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 PRODUCTION
3. CONTROLS: Process Costing
○ All process runs should be recorded on manufacturing / production
schedules which are:
 Sequenced and dated
 Cross referenced to production plans, material requisitions.
 Authorised by the production manager.
○ As items leave production, they should be divided into manageable
quantities and transferred to finished goods
○ The transferred to finished goods note should:
 Accompany the goods to the stores
 Cross referenced to the production schedule
 Used to compile the perpetual inventory

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 PRODUCTION
3. CONTROLS: Process Costing (Continued)
○ Performance reports showing production, wastage etc per shift
○ Completed production schedules & performance reports should be
forwarded to costing where production is costed (usually using
standard costs)
○ Sequence test the costed production schedules
 Cross reference to “transfer to stores” documents
 All missing production schedules are in fact still in production
○ Management should review performance reports
○ Actual vs. Standard costs should be reviewed and variances
investigated
○ Posting from signed costed production schedules
 Raw materials, direct labour, Manufacturing overheads
• Dr Finished Goods
• Cr WIP
○ Check all calculations (casts, cross casts, extensions)
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 QUICK RECAP

· What are the objectives of these internal controls?

· What are the functions of warehousing?
· What are the documents involved in warehousing?
· What are the risks facing warehousing and the
controls to address them?
· What are the functions of the production dept.?
· What are the documents involved in production
dept.?
· What are the risks facing the production dept. and
the controls to address them?

Thank you for your participation!!

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 INVENTORY COUNTS

An inventory count entails counting the physical stock to verify the

theoretical stock. This is a very common activity to control physical assets

· Cycle Counts
○ Ongoing comparison throughout the year (stock adjustments are
made throughout the year)
· Year-end Counts
○ Counts at year-end to determine Inventory balances at year end

(Both will use the same general procedures; the main

differences are timing and size of count!) Audit plan:
Nature,
Timing &
Extent
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 INVENTORY COUNTS

CYCLE COUNTS

· Cost benefit decision

○ Benefit: Strengthening internal control
 Discrepancies are timeously identified & investigated
○ Cost
 Resources
 Items are most susceptible to theft during cycle counts

· Usually, Sample counts

○ Random basis from perpetual system,
○ High value
○ Items susceptible to theft
○ Particular section of the warehouse
○ Entire population divided in sections
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 INVENTORY COUNTS

YEAR-END COUNTS
· Entire population
· Financial statements Inventory balance
· Auditors in attendance

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 INVENTORY COUNTS: GENERAL PROCEDURES

MAIN PRINCIPLES FOR STOCK COUNTS:

1. Planning and Preparation
2. Design of stationery
3. Written Instructions
4. Conducting the Count

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 INVENTORY COUNTS: GENERAL PROCEDURES

PRINCIPLES FOR STOCK COUNTS:

1. Planning and Preparation
○ Date and time
○ Method (e.g Counted twice, Tag system)
○ Staff requirements : independent of inventory function
○ Supervision
○ Preparation of the warehouse
 Tiding up, etc.
○ Drafting floor plan
○ Identifying all categories and locations of stock

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 INVENTORY COUNTS: GENERAL PROCEDURES

PRINCIPLES FOR STOCK COUNTS:

2. Design of stationery
○ Inventory sheets pre-printed, numbered
sequentially, sensible layout.
○ DO NOT include perpetual inventory quantity
○ Stock tags
○ Stock adjustment forms

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 INVENTORY COUNTS: GENERAL PROCEDURES

PRINCIPLES FOR STOCK COUNTS:

3. Written Instructions
○ ID count teams and those responsible
○ Method of counting
○ ID of slow moving/damaged/consignment stock
○ Stationery control of sheets
 Count controller
○ Procedures adopted if problems arise
○ Detailed instructions concerning
 Dates,
 Times
 Locations,
 Etc
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INVENTORY COUNTS: GENERAL PROCEDURES

PRINCIPLES FOR STOCK COUNTS:

4. Conducting the Count
○ Divide into count teams
 At least one member independent
○ Provide teams with a floor plan detailing the areas the team is
responsible for
○ All stock should be counted twice (by 2 people)
 One counts one records and swaps and checks.
 Teams can swap locations and double check
○ Neatly mark items counted
○ Counters should sign each sheet and scratch out any spaces
○ Mark damaged stock as such on the stock sheets
○ Open and count a random number of boxes

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 INVENTORY COUNTS: GENERAL PROCEDURES

PRINCIPLES FOR STOCK COUNTS:

4. Conducting the Count (Continued)
○ The controller (count supervisor) should
 Walk through the warehouse to ensure that all items have been marked,
tags detached
 Agreed 1st and 2nd to the perpetual inventory
 Instruct count teams who identified discrepancies to recount.
○ Count controller should check the control procedures have been
complied with.
○ Teams should be dismissed only once all discrepancies have been
resolved.
○ NO Movement of Inventory during Count
○ Cut-off procedures: Obtain the last GRV, DN, Invoice, before the
count and the first after the count & confirm if items have been
correctly treated

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 Accounting treatment

· IAS 2 (Looking at accuracy)

· Categories
○ Raw Materials
○ Work in Progress
○ Finished Goods >> Retailer? Only FG
· Lower of cost or net realisable value
· Cost of inventories
○ Bought and manufactured
○ Cost Formulae
○ FIFO, Weighted average
· Pricing of imported Inventory
· Appropriate VAT treatment Objective: implement
controls that allow
the business to
comply with IFRS

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 Fraud in the cycle

Management may:
· Include fictitious inventory (existence)
· Underestimate obsolescence provision (valuations)
· Overstate write-downs (existence & valuations)
· Concealed by:
○ Empty containers
○ Hollow stacking (e.g. arranging items around pallet edges)
○ Packaging bricks (i.e. packaging non-inventory items)
○ Re-packing damaged or second-hand goods
○ Changing the count after the stock count (to hide discrepancies)
○ Including recently sold goods in count
○ Double counting
○ False 3rd party confirmations
○ Including consignment inventory
○ Pre-invoicing

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QUICK RECAP

· What are the two types of inventory counts?

· What are the four procedures of stock counts?
· What is the IAS 2 Accounting treatment?
· How is fraud committed and concealed?

Thank you for your participation!!

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COMPUTERISATION IN THE CYCLE

· Computerised inventory controls refer to the use of

software and digital systems to manage and
optimise (make them effective) inventory-related
processes within an organization.
· These controls use technology to their advantage
to smoothen operations, improve accuracy, and
enhance decision-making across inventory
management cycle.

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 COMPUTERISATION IN THE CYCLE

KEY COMPONENTS:

Inventory management software

· Central platform for tracking inventory levels, orders & reorders, and deliveries.
· Real-time updates

Barcodes
· Barcodes or tags attached to inventory items
· Scanners read tags to update inventory records automatically (manual capturing
eliminated)

Point of sale (POS) systems

· Integrate sales data directly into inventory
· Ensure real-time tracking of sold items and inventory levels

Database management
· Inventory Masterfile (stores all inventory-related data)
· Only items in the Masterfile can be included in the purchase order 36 36
 COMPUTERISATION IN THE CYCLE

Production control activities can be done on the system

e.g. Creating production schedules, costing schedules,
accumulating and allocating costs.

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 COMPUTERISATION IN THE CYCLE
RISKS (not exhaustive)

Barcode Printing Errors Barcodes can get

Network Reliability damaged

Faulty or Tags or barcodes Human error in

malfunctioning may fall off or get attaching tags or
scanners misplaced scanning

POS systems can be Unauthorized Access to

targets for cyberattacks the Masterfile Backup failures

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 COMPUTERISATION IN THE CYCLE

CONTROLS
· Use reliable network infrastructure and have contingency
plans for network outages.
· Ensure barcodes are printed correctly and are of high quality
to withstand wear and tear.
· Encrypt data transmitted between POS systems and the
central inventory management system to protect against
breaches.
· Implement strong security measures, including firewalls and
antivirus software, to protect against cyber threats.
· Restrict access to the master file to authorized personnel only
to prevent unauthorized modifications (i.e. least privileged)
· Implement regular backups and ensure they are stored
securely and can be quickly restored in case of data loss,
must be in at least 3 separate locations.

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 DONE

What to do from now?

· Study and make sure you understand the entire cycle
and the documents involved.
· Be able to design, identify weaknesses in internal
controls and provide recommendations.
· Do your tutorials with understanding.
· Consult, consult, consult!! We are always eager to
help, don’t die in silence while we do offer help.

Questions?

Thank you!!

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