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PRACTICAL INTERNAL AUDIT ON INVENTORIES (Lesson)

PRACTICAL INTERNAL AUDIT ON INVENTORIES

Learning Objectives

I.INTRODUCTION

II. COST OF INVENTORIES

III. METHODS OF CALCULATING THE COST OF INVENTORY

IV. INVENTORY COUNT

V. AUDIT PROCEDURE

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I.INTRODUCTION

Inventory consist of :

  • Goods purchased for resale
  • Consumable stores ( such as oil)
  • Raw Material and components ( used in the production process)
  • Partly-finished goods ( usually called Work in progress-WIP)
  • Finished goods (manufactured by the business)

II. COST OF INVENTORIES

Cost includes:

  • Cost of purchase – material costs, import duties, freight. Less: trade discounts (buying in bulk or regular customer, but not settlement discounts)
  • Cost of conversion- direct costs and production overheads. ( Direct cost: Labour cost, sundry material costs. Production overhead: heating and light, salary of supervisors, depreciation of plant, etc.)

III. METHODS OF CALCULATING THE COST OF INVENTORY

  1. When items of inventory are individually distinguishable and of high value. We will use unit cost ( actual cost or specific cost)
  2. Where inventories consist of a large number of interchangeable (ie identical or very similar) items.
  • FIFO- is a method of estimating cost which assumes that inventory is used or sold in the same order that it is purchased by the business.
  • AVCO (average cost)- method of estimating cost which assumes that all inventory purchased is mixed together. This assumption would be true for liquid inventory. Two possible AVCO- 1. periodic weighted average or simple weighted average 2. continuous weighted average.

IV. INVENTORY COUNT

There are many ways inventory could be materially misstated:

  • Items could be missed out of inventory
  • Items from the next accounting period could be accidentally included
  • It might not be valued at the lower of cost and net realisable value
  • Damaged or obsolete stock might not be identified
  • Purchase cost may not be recorded accurately
  • The stock count may not be performed thoroughly.

The auditor is not expected to attend the count with following situations:

  1. If inventory is not material ( it is possible if internal auditors are required by management or suspect of fraud), or
  2. If based on the accounting record rather than the inventory count is used as the source of inventory quantities.

We can analyse the role of the auditor in connection with the inventory count under three headings:

  1. Before the inventory count
  2. During the inventory count
  3. After the inventory count

The main objective of the auditor attending the inventory count is to obtain evidence:

  1. Audit evidence in relation to the existence of inventory.
  2. Evidence is also required on the valuation of inventory (damaged or obsolete inventory)
  3. Audit evidence in relation to the completeness of inventory.

V. AUDIT PROCEDURE

During counting the auditor will:

  • Select a sample of items from physical inventory and trace them to inventory records to confirm the completeness of accounting records
  • Select a sample of items from inventory records and trace them to physical inventories to confirm the existence of inventory assets.

Whilst the procedures are perhaps similar in nature their purpose (and relevance) is to test different assertions regarding inventory balances.

The following Questions as follows:

Question 1

Describe briefly about the main objective of inventory count.

Question 2

What is completeness assertion for inventory?

Question 3

What is existence assertion for inventory?

Question 4

What are valuation and allocation assertion for inventory?

Question 5

Describe briefly the strong internal controls for inventory purchase processes.

Question 6

KPM Co faces problem of managing inventories, so recently inventories may lose.

Now management of company requests internal auditors and accountants corporate each other to make stock management procedure for KPM Company.

Required:

Make inventory or stock management procedure.

Question 7

TOP One Trading Company buys and sells three major products such as computers, LCDs and Printers.

Recently company noted that a few computers are not included in list of inventory record. Company suspects that other stocks may not include in list of inventory record.

Required:

You are required to make procedures for auditing inventory to make sure physical inventories are completeness with list of inventory records. 

Question 8

FIRST TRADING Company is merchandising company locally.

The following extract of list of inventory record given to internal auditor for November 2016 as follows:

Type of Inventories Units
Phones 800
Computers 70
LCD 30
Air conditioners 80
Printers 50
Photocopiers 30
Scanners 80

 

Required:

You are required to make procedures for auditing stocks to make sure physical stocks are existence. 

 

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