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Part Five

AUDITING
BUSINESS PROCESSES

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Chapter 1

CHAPTER 13
AUDITING THE INVENTORY
MANAGEMENT PROCESS

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OVERVIEW OF THE
INVENTORY MANAGEMENT
PROCESS
Figure 13-1 shows how other processes interact
with the inventory management process.
Figure 13-2 presents a flowchart for a reasonably
complex inventory management process.

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13-5

DOCUMENTS AND RECORDS

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Production schedule.
Receiving report.
Material requisition.
Inventory master file.
Production data information.
Cost accumulation and variance report.
Inventory status report.
Shipping order.

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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 of supervising physical
inventory taking should be separated from the
inventory management and inventory stores
functions.

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13-7

INHERENT RISK ASSESSMENT

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Industry-related factors
Competition
Inventory valuation issues
Rapid technology changes
Engagement and Operating Characteristics
Types of product
Valuation can lead to disagreements with
client
Possible related-parties transactions

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13-8

CONTROL RISK ASSESSMENT

Understanding and documenting
the inventory management process based
on the planned level of control risk

Planning and performing tests of controls

on inventory transactions

Assessing and documenting the

control risk for the
inventory management process

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13-9

AUDITING INVENTORY

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Substantive tests of transactions

Analytical procedures
Tests of account balances

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SUBSTANTIVE TESTS OF
TRANSACTIONS

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Because the inventory management process interacts

with the revenue, purchasing, and payroll processes,
control procedures over the receipt of raw materials,
shipment of goods, and assignment of labor costs are
normally tested as part of those processes.
If the auditor intends to obtain substantive evidence
on the perpetual inventory records, the tests of
receipt and shipment of goods can be extended by
tracing the transactions into the perpetual inventory
records.

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1311

ANALYTICAL PROCEDURES

Compare raw material, finished goods, and total

inventory turnover to previous years and industry
averages.
Compare days outstanding in inventory to previous
years and industry averages.
Compare gross profit percentage by product line
with previous years and industry data.
Compare actual cost of goods sold to budgeted
amounts.

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ANALYTICAL PROCEDURE
(continued)

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Compare current year standard costs with prior

years after considering current conditions.
Compare actual manufacturing overhead costs with
budgeted or standard manufacturing overhead costs.

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1313

AUDITING STANDARD COSTS

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Materials costs
Labor costs
Overhead costs

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OBSERVATION OF
PHYSICAL INVENTORY

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The auditor's observation of inventory is a

generally accepted auditing procedure.
The observation of the physical inventory provides
evidence primarily on the validity audit objective
(also ownership and valuation).

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1315

OBSERVATION PROCEDURES

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Insure that no production is scheduled.

Ensure that there is no movement of goods during
the inventory count.
Make sure that the client's count teams are
following the inventory count instructions.
Ensure that inventory tags are issued sequentially
to individual departments.
Perform test counts and record a sample of counts
in the working papers.

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1316

OBSERVATION PROCEDURES
(continued)

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Obtain tag control information for testing the

client's inventory compilation.
Obtain cutoff information.
Observe the condition of the inventory for items
that may be obsolete, slow moving, or in excess
quantities.
Inquiry about goods held on consignment for
others or held on a "bill and hold" basis.

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1317

TESTS OF ACCOUNT BALANCES

Table 13-8 summarizes the tests of the inventory
account balance for each audit objective.

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1318

POSSIBLE CAUSES OF BOOK-TOPHYSICAL DIFFERENCES

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Inventory cutoff errors.

Unreported scrap or spoilage.
Pilferage or theft.

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SAMPLE DISCLOSURE ITEMS FOR

INVENTORY AND RELATED
ACCOUNTS

1319

Cost method (FIFO, LIFO, retail method).

Components of inventory.
Long-term purchase contracts.
Consigned inventory.
Purchases from related parties.
LIFO liquidations.
Pledged or assigned inventory.
Disclosure of unusual losses from writedowns of
inventory or losses on long-term purchase
commitments.
Warranty obligations.

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CHAPTER 13
AUDITING THE INVENTORY
MANAGEMENT PROCESS

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Chapter 1

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