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arens15irm21

Chapter21

AuditoftheInventoryandWarehousingCycle

WefindChapter21difficultforstudentstounderstandbecauseofthechapter’semphasisonauditingtheinventoryofamanufacturingcompany.Itworksbettertodiscusstheauditofinventoryforaretailorwholesalecompany.Attheendofthechapter,webringinthecomplexitiescausedwheninventoryismanufacturedratherthanpurchased.

Thefollowingaretopicareaswecover:

⏹Chapteropeningvignette

⏹Differencesbetweeninventoryandotherauditareas

⏹Partsoftheauditofinventory

⏹Physicalobservation

⏹Auditofpricingandcompilation

⏹Integrationofthetests

ChapterOpeningVignette―“PhantomInventory”

Thisvignetterevolvesaroundthewell-knownfinancialstatementfraudatPhar-Morwherebyseniormanagementrecordedfictitiousinventoryandmanipulatedinventoryvaluestooverstateinventoryandunderstatecostofgoodssold.Weusethevignettetoillustratethechallengesassociatedwithauditingclientswhohavemassiveamountsofinventoryitemslocatedinnumerouslocations.AsstudentsvisualizethevolumeofproductscarriedbyaretailchainlikePhar-Mor,theyquicklyrecognizetheopportunitiesmanagementmighthavetomanipulateinventoryvalues.Thevignettealsoprovidesaniceopportunitytointegratediscussionsaboutsamplesizesfortestsofdetails（fromChapter17）.Discussionabouttheauditor’sdecisiontoonlyvisitfourof300storesandtheauditor’sadvancedisclosureofthelocationstobevisitedhelpintegratesamplingconceptsintothischapter’sfocusonauditissuesrelatedtoinventory.

DifferencesBetweenInventoryandOtherAuditAreas

Inthissection,webrieflyaskstudentstoidentifythemajordifferencesbetweentheauditofinventoryandanaccountsuchasaccountsreceivable.

PartsoftheAuditofInventory（page676）

Westartthissectionbyfirstassumingnoperpetualrecordsforawholesalecompany.OH-21-1andOH-21-2areintendedtoshowthatcostofgoodssoldisaresidual,andendinginventoryisauditedindependentlyofanyothercycles.

（SeeOH-21-1andOH-21-2）

Whentherearenoperpetuals,therearethreemajorpartsofauditinginventoryasshowninOH-21-3.Thesecanbeshownasthestepsindetermininginventoryvalue.

（SeeOH-21-3）

Nowaddperpetualrecords,includingquantitiesandunitcostsandseetheconnectiontotheauditor’sproceduresassummarizedinOH-21-4.

（SeeOH-21-4）

Atthispoint,theperpetualrecordscanbeshownasalinkbetweensalesandinventory,andacquisitionsandinventory.WeemphasizehowtheinformationgetsintotheperpetualinventoryrecordsandhowitistestedasapartoftestsofcontrolsandsubstantivetestsoftransactionsbyusingOH-21-5.

（SeeOH-21-5）

Threemajorpartsofauditinginventory:

1.Physicalobservation–relatedtoperpetuals（units）

2.Pricetests–relatedtoperpetuals（prices）

3.Compilation–independentofotherareas

Itisalsopossibletogoonestepfurtherandshowhowperpetuals,includingtotaldollarbalances,affecttheaudit.Wedonotordinarilydothatbecausewefindthatitconfusesmoststudentswithoutstrongaccountingsystemsbackgrounds.

PhysicalObservationofInventory（page682）

Startbybringingoutthefollowingpoints:

（Wefinditimportanttouseanexampletoillustrateeachpointinthisarea.）

⏹Distinctionbetweenauditor’sandmanagement’sresponsibilities

⏹Auditingstandardsrequirementstoobserveinventoryinallaudits

⏹Thetwomostimportantinternalcontrolsinthephysicalcountandtestsofthosecontrols:

1.Perpetualrecords（masterfiles）

2.Properinventoryinstructions

⏹Auditdecisionsandfactorsaffectingeachdecision

1.Extenttowhichassessedcontrolriskwillbereducedduetothetwocontrolsabove（affectsthefollowingthreedecisions）

2.Samplesize

3.Itemstoselect

4.Timing

⏹Whattheauditordoesduringphysicalexamination（SeeTable21-2onpage686）

⏹Recordingtestcounts–whydoneandhow

⏹Obtainingcutoffinformation–importance,how,anddocumentation

（SeeTable21-2）

NextwecoverafewmiscellaneousaspectsofthephysicalobservationbyuseofthefollowingReviewQuestions:

⏹21-4–perpetualrecords,ifconceptshavenotalreadybeencovered.

（OH-21-4isusefulagainatthispoint.）

⏹21-5–deficientinternalcontrolsovercountinginventory

⏹21-6–controloftestcounts

⏹21-9–controloftags

⏹ResearchProblem21-1–useofinventorycountspecialists

AuditofPricingandCompilation（page685）

Firstwedefinetheterms“pricing”and“compilation”usingthepreviouslypreparedtransparency（OH-21-2–stepsindetermininginventoryvalue）.

NextwecoverReviewQuestion21-13,tomakesurestudentsunderstandtheissuesinvolvedinpricinginventory.Weaskquestionsorgooverproblemsasfollows:

⏹Whatcontrolswouldenabletheauditortoreducepricetests?

⏹Whymightperpetualinventoryrecordsenabletheauditortoreducetesting?

（Wegothroughthelogicfromtestsofacquisitionstocomparisonofunitcostsontheinventorysummary.）

⏹ReviewQuestion21-8–observeinventoryforobsolescence.

⏹Howmightauditsamplingbeusedinpricetestsofinventory?

⏹Case21-33–thisisadifficultcase,butitnicelyillustratesvarioustypesofpricingmisstatements.

NextwerefertoTable21-3（page687）andidentifyseveralinventorycompilationprocedurestypicallyperformed.Theemphasisisonwhyeachisdone.

IntegrationoftheTests（page689）

Oncethebasicshavebeencovered,weliketomakesurethestudentsunderstandwhatwasdiscussed.Thefollowingarecoveredifpossible:

⏹Problem21-23–purposeofaudittests

⏹Problem21-24–misstatements,controlstopreventmisstatements,andsubstantiveauditprocedures

⏹Useofanalyticalproceduresateachstageoftheauditofinventory.（Problem21-26providesausefulillustrationofhowanalyticalprocedurescanbeusedtoassessthepresenceofmisstatementsininventory.Also,seeProblem21-29foranotherillustrationofanalyticalproceduresperformedtoassessinventoryandrelatedbalances.）

⏹Useofthecutoffinformationforsalesandpurchasesobtainedduringthephysicalcounttotestsalesandpurchasescutoff.Thisisagoodopportunitytoillustratethetie-inofphysicalobservationwithsales（Chapter14）,andacquisitions（Chapter18）.（SeeProblems21-30or21-32）.

⏹Additionalproblemsthatarisewhenworkinprocessandfinishedgoodsinventoryareintroduced.

⏹ReviewofFigure21-4（page690）anditsinterrelationships.

（SeeFigure21-4;alsoseeSlides21-28through21-31）

CHAPTER21

CROSS-REFERENCEOFLEARNINGOBJECTIVESANDPROBLEMMATERIAL

21-4

LearningObjectives

ReviewQuestions

MultipleChoiceQuestions

DiscussionQuestionsandProblems

Cases

21-1Describethebusinessfunctionsandtherelateddocumentsandrecordsintheinventoryandwarehousingcycle.

21-1,21-2,21-3

21-17,21-18,21-19

21-20,21-21,

21-23,21-24

21-2Explainthefivepartsoftheauditoftheinventoryandwarehousingcycle.

21-3Designandperformaudittestsofcostaccounting.

21-3,21-4

21-18

21-20,21-21,

21-22,21-23,

21-25

21-4Applyanalyticalprocedurestotheaccountsintheinventoryandwarehousingcycle.

21-8,21-12

21-19

21-26,21-29

21-5Designandperformphysicalobservationaudittestsforinventory.

21-5,21-6,21-7,21-8,21-9,21-10,21-16

21-19

21-20,21-21,

21-23,21-24,

21-25,21-27,

21-28,21-30,

21-32

21-6Designandperformaudittestsofpricingandcompilationforinventory.

21-8,21-11,21-13,21-14

21-19

21-20,21-21,

21-23,21-24,

21-31

21-33

21-7Integratethevariouspartsoftheauditoftheinventoryandwarehousingcycle.

21-2,21-14,21-15

21-20,21-21

RELATIONSHIPOFINVENTORY

TOOTHERACCOUNTSWHEN

THEREARENOPERPETUALRECORDS

BeginningInventory

+

Purchases

of

Inventory

–

Ending

Inventory

=

Costof

GoodsSold

AuditedinAuditedAuditedResidual

prioryearprimarilythrough

throughanalytical

TOC,STOT,procedures

analyticalandtestsof

procedures,detailsof

andanalysisbalances

ofpurchases

STEPSINDETERMINING

INVENTORYVALUE

Countinventory

usingtags

orcountsheets

Summarize

inventoryby

description

Determine

correctunitcost

ofinventory

Extendpriceand

quantityandaccumulateextendedtotals=total

inventoryvalue

Recordingeneral

ledgerbyajournal

entry

Includein

financialstatements

THREEPARTSOF

INVENTORYAUDIT

1.Physicalobservation–independentofotherauditareas.

2.Testsoftheunitcosts（pricetests）–independentofotherauditareas.

3.Extensions,footingsandtracingofinventorylisting（compilation）–independentofotherauditareas.

RELATIONSHIPOFINVENTORY

TOOTHERACCOUNTS

WHENTHEREAREQUANTITIES

ANDUNITCOSTSONPERPETUALS

BeginningInventory

+

Purchases

of

Inventory

–

Ending

Inventory

=

Costof

GoodsSold

AuditedinAuditedprimarilyAuditedResidual

prioryearthroughTOC,through

STOT,analytical

Analyticalprocedures

procedures,andtestsof

andanalysisdetailsof

ofpurchasesbalances,

plusreliance

onTOC,STOT,

andanalysis

ofsales

PERPETUALRECORD

ProductC-617

DATE

RECEIVING

OR

SHIPPING#

UNIT

COST

PURCHASED

SOLD

#OF

UNITS

BALANCE

1-1-13

2-3-13

3-4-13

9-6-13

10-5-13

R1263

S26409

S26910

R1571

$49.53

51.06

94

50

69

47

36

130

61

14

64