Inventory

Completeness (Quantity), Rights and obligations (Ownership), Existence, Valuation, Disclosure

Different types of inventories could cause issues for valuation purposes.

Completeness

1. Select a sample of visible items from relevant warehouse to the inventory sheets.
2. Obtain the latest inventory listing and count sheets and compare them to ensure that the quantities
of inventories are correct.

Rights and obligations

1. Select a sample of items held in warehouse and inspect them to supporting documentation and
invoices to ensure they should be included in the inventory balance.
2. Inquire whether inventories held for third parties have been excluded from the inventory listing.
(Existence)

Existence

1. Select a sample of items from inventory records and physically trace them to the warehouse.
2. Obtain confirmation letter for inventory held by third parties or on consignment basis to ensure the
items exist. (Right & Obligation)

Valuation (Valued at lower of cost and NRV, IAS 2)

1. For a sample of products, vouch the purchase prices to suppliers’ invoices to ensure cost is correctly
recorded on the inventory listing.
2. Confirm that an appropriate basis of valuation (FIFO or WAC) is being used through a discussion with
management.
3. Recalculate the inventory cost per unit using WAC or FIFO as per entity’s policy.
4. Inspect the condition of items of inventory to ensure they are not overvalued and that any obsolete or
damaged items have been written off.
5. Inspect/analyse the inventory ageing reports to identify slow moving items for allowance of inventory
obsolescence and whether they have been written down.
6. For a sample of inventory items held at the year-end, obtain NRV by reviewing the post year-end sales
prices.
7. Where NRV is lower than cost, ensure the items are written down to NRV.
8. Confirm that inventories are included at lower of cost and NRV in the FS.

Presentation and Disclosure

1. Inspect FS to ensure inventory if appropriately presented and the related disclosures are complete and
accurate as per relevant accounting standards.
2. Inspect FS to ensure the inventory has been classified correctly as CA and not NCA.

General procedures

1. Compare current year’s inventory balance with prior year balance and investigate significant
differences. (AP – O/U)
2. Calculate inventory turnover days, compare it with prior year and investigate significant differences.
(AP – O/U)
 3. They could apply analytical procedures for example, comparing similar inventory lines from this year
to last year to see if any changes in price appear to be reasonable.
4. Cast the inventory listing to establish that it is mathematically correct.

Activity 8: Hodgson Ltd

The following are extracts from the books and records of Hodgson Ltd, a manufacturer of garden equipment.
Identify the audit work to be performed on these inventory balances, both individually and in aggregate.

Record basis of valuation used in all three categories and ensure disclosure is accurate and inclusion in each
category is appropriate.

Test material costs (all 3 categories)

1. Trace a sample of material costs back to original invoices to ensure that they are held at cost. It is unlikely
that NRV would differ from cost for raw materials unless they have been damaged or the value was affected
by age.

2. Ensure appropriate bases are being used such as FIFO. The company might be able to identify each item
separately, in which case they can be valued at their own original cost. However, it may not be possible to value
some inventory in this way because of the nature of it. The company might have to use a technique such as
first in first out.

3. Trace a sample of material purchase invoices to costing records.

4. Review quantities used in WIP and finished goods.

Test labour costs (all 3 categories)

1. Trace payroll calculations to supporting documentation/records (e.g. timesheets)

2. Review costing against actual labour and production statistics.

3. Trace a sample of Payroll details/Time sheets to costing records.

Test application of overheads (WIP and finished goods only)

1. Ensure only production overheads are included (and that standard costs are still appropriate).

2. Ensure the allocation of production overheads is based on normal activity levels.

3. If applicable, discuss method of calculating OAR and recalculate to ensure accuracy.

Review stage of completion of WIP

Cost = “cost of purchases plus the cost of conversion (directly attributable costs & other production costs) plus
transportation cost”

Valuation of WIP is notoriously difficult

• Due to nature
• Difficulty when establishing stage of completion.
1. Discuss with management the process for establishing stage of completion and determine if reasonable –
consider physical inspection.
2. Obtain breakdown of WIP balance, cast it and agree the total to figure in FS.
3. Test calculations to ensure they are accurate.

4. Carry out analytical procedure to determine overall performance.

Net realisable value of finished goods

NRV = estimated selling price – estimated cost of completion

1. Follow through items noted at inventory count.

2. For a sample of inventory items held at the year-end, obtain NRV by reviewing the post year-end sales prices.

3. Where NRV is lower than cost, ensure the items are written down to NRV.

4. Confirm that inventories are included at lower of cost and NRV in the FS.

5. Review future orders to establish demand and likely sales prices.

6. Establish extent of any write-downs from past year.

7. Consider any background knowledge obtained during the audit.

Inventory Count
Before (Preparation)

1. Review working papers from the previous years

2. Determine arrangements with management in advance
3. Become familiar with nature of inventory
4. Consider need for an expert
5. Review procedures to account for inventory held by/for third parties
6. Review client’s inventory count instructions. This should include the following:
• In writing
• Two independent counters
• Systematic clearing of areas (Items should be marked in some ways to indicate that they
have been counted to avoid omission or double counting)
• Identification of obsolete damaged inventory
• Supervision
• Cut-off considered
 • Count sheets are pre-numbered, written in ink and controlled in distribution and collection
(Not easily amended by staff)
• Investigation of differences and instructions on what to do if two counts disagree
• Quantity should not be included in the count sheet so as not to prejudge how many units
will be found (undercount)
7. Identify potential problems/risk areas
8. Determine audit procedures required to cover a representative selection of inventory and inventory
locations
9. Count should be undertaken by independent staff, i.e. not from the warehouse

During

1. Observe client’s staff to ensure they are following the instructions (TOC)
2. Movement of inventory should be kept at minimum to avoid further reconciliation of inventory and
cut-off error (Observe whether there are any movement of inventory to ensure cut-off error will not
be occurred (TOC))
3. Test counts from the physical inventory to the records and vice versa
4. Physically inspect some of the inventory to see whether they are in good conditions (TOD)
5. Note damaged, old and obsolete inventory for valuation purposes
6. Review WIP for stage of completion
7. Inventory held by client for third parties must be excluded from count (Existence)
8. Take note of last GRN and GDN
9. Form an overall impression of inventory levels/values

After

1. Count sheets should be signed by count staff as completed

2. Check sequence of inventory sheets
3. Check the quantity in count sheet to inventory listing in the ledger
4. Investigate any differences and adjust/reconcile
5. Check client’s computation of final inventory figure
6. Trace own test count items through to inventory sheets
7. Check replies from third parties
8. Inform management of general problems
9. Follow up cut-off details
10. Slow-moving items should be recorded as provision for obsolete inventory

Inventory count procedures (Deficiency, Consequence and Recommendations)

1. D - Inventory sheets stated the quantity of items expected to be found in the store.

C - Count teams will focus on finding the expected number of items and may stop counting when the correct
number of items are found, leading to undercounting of inventory.

R - Count sheets should not state the quantity of items so as not to pre-judge how many items will be found.

2. D – Count team members are all staff from the stores.

C – Since count staff are also responsible for the inventory, they may be tempted to hide errors or missing
inventories that they have misappropriated from the store.

R – Count teams should be made up of independent staff from outside the store.
3. D – Count teams are allowed to decide which areas to count.

C – There is a danger that teams may either omit inventory or count the same inventory twice due to lack of
precise instruction on where to count.

R – Each team should be given a precise area of the store to count.

4. D – Count sheets were not signed by the staff carrying out the count.

C – Lack of signature make it difficult to raise queries about items counted because the actual staff carrying
out the count are not known.

R – All count sheets should be signed to confirm who actually carried out the count of individual items.

5. D – Inventory not marked to indicate it has been counted.

C – There is a danger that inventory will either be omitted or counted twice.

R – Inventory should be marked in some way to show that it has been counted.

6. D – Count sheets were filled with pencil.

C – Recording with pencil means that count sheets could be amended after the count has taken place and not
just during the count. This increases the risk of misstatement due to fraud.

R – Count sheets should be completed in ink.

7. D – Additional count sheets were only numbered when they are used.

C – It is possible that additional count sheets could be lost as teams may forget to numbered the sheets. There
appears to be no overall control over additional count sheets actually being used.

R – All inventory sheets, including those for extra inventory should be pre-numbered.

Perishable Nature
By the very nature of the products held in coffee shops, most items will be perishable, so food wastage should
be investigated.
This may account for some of the differences in inventory holding as some stores may be more efficient at
stock management.