Chapter 14
Auditing Inventory Processes:
Tracking and Costing Products in
the Land Development and Home
Building Industry
Prepared by Richard J. Campbell
Copyright 2011, Wiley and Sons
Learning Objectives
1. Be familiar with inventory activities in the land development and home
building industry, including important accounting standards.
2. Understand the activities, transactions, risks, ICFR, and documents
related to inventory.
3. Understand the management assertions, purposes of specific controls,
controls, and tests of controls for inventory.
4. Understand the purposes and execution of substantive audit procedures
for inventory including dual purpose tests, substantive analytical
procedures, and tests of details of balances, such as inventory counts
and inventory observation.
5. Know processes and procedures performed by management and the
auditor for estimates, and specifically for estimates related to inventory.
Chapter 14-1
LAND DEVELOPMENT AND HOME BUILDING INDUSTRY
 The largest companies in this industry are associated with
the process of turning large parcels of raw land into
completed residential communities.
 The land development and home building industry tracks
and allocates costs to individual residential units. In typical
manufacturing terms this is called job order costing.
 FASB ASC 970-10, Real Estate, defines the proper accounting
for inventory in the home building industry.
 Just as with all other companies, the possibility of a
decrease in the value of inventory below its cost must be
addressed by land development and home building
companies.
Chapter 14 -2
Learning Objective #1
LAND DEVELOPMENT AND HOME BUILDING INDUSTRY
 A complex accounting pronouncement, FASB ASC 810-1005-8, Variable Interest Entities (VIE), can also impact the
financial statements of a land development and home
building company
 In the land development and home building industry, the
relationship between inventory and revenue recognition is
direct, as a result of the use of the percentage-ofcompletion method.
 Revenue for single-family homes is recognized when the
sale closes and the title transfers to the purchaser.
 Inventory is a major focus of accounting and auditing
effort.
Chapter 14 -3
Learning Objective #1
INVENTORY IN THE MANUFACTURING ENVIRONMENT
 The unique aspect of the manufacturing industry is the
process of producing finished goods from raw materials.
 The first step in the manufacturing process is to remove
purchased raw materials from stores.
 Direct costs are traced and added to work-in-process in the
cost accounting records.
 Overhead costs are usually posted to work-in-process when
the manufacturing activities are completed.
 When the manufacturing process is complete, the finished
goods are moved from the production location to finished
goods storage, or shipping.
Chapter 14 -4
Learning Objective #2
ACCOUNTING FOR INVENTORY
 Businesses use cost accounting systems that fall somewhere
along the continuum of job costing (or job order costing) to
process costing.
 When inventory is accounted for using a perpetual
inventory system, increases and reductions to the units and
dollar amounts in the inventory accounts can be posted
when the transaction occurs.
 Under a periodic inventory system, dollar amounts of
inventory increases are captured through a purchases
account.
 Regardless of the method and process of accounting for
inventory, the amount initially recorded in the inventory
accounts is based on cost.
Chapter 14 -5
Learning Objective #2
Inventory Records
Chapter 14 -6
Learning Objective #2
Flow of Inventory through Production
EXHIBIT 14-1
Chapter 14 -7
Learning Objective #2
Activities and Related Documents
EXHIBIT 14-2
Chapter 14 -8
Learning Objective #2
Tests of Controls
 Walkthroughs are one way for the auditor to understand the
client’s information system for inventory transactions and
conclude on design effectiveness.
 Control concerns for inventory are:
 Inventory is physically safeguarded through all stages of
movement and the production process.
 Proper records are kept to support the units and costs of total
inventory shown in the financial statements as well as to track
and allocate costs to the proper jobs and batches.
 Inventory records are adjusted to reflect the inventory that has
been verified through a physical count.
 Any decrement in inventory value is properly reflected in the
amounts.
Chapter 14-9
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-10
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-11
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-12
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-13
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-14
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-15
Learning Objective #3
Examples of Tests of Controls for Inventory
EXHIBIT 14-3
Chapter 14-16
Learning Objective #3
Dual Purpose Tests
 To obtain audit evidence about account balances for the
financial statement audit, the steps presented in Exhibit 143 are modified with the following added activity:
 Trace the amount(s) tested [in the sample] to the final
compilation of inventory and agree the total of the
inventory compilation to the amount(s) shown in the
general ledger
Chapter 14-17
Learning Objective #4
Substantive Analytical Procedures
EXHIBIT 14-4
Chapter 14-18
Learning Objective #4
Audit Steps for Observing the Client’s
Inventory Count
EXHIBIT 14-5
Chapter 14 -19
Learning Objective #4
Audit Steps for Observing the Client’s
Inventory Count
EXHIBIT 14-5
Chapter 14 -20
Learning Objective #4
Auditing Estimates
EXHIBIT 14-6
Chapter 14 -21
Learning Objective #5
Common Audit Steps for Accounting Estimates
EXHIBIT 14-7
Chapter 14 -22
Learning Objective #5
Examples of Tests of Details of Balances
EXHIBIT 14-8
Chapter 14 -23
Learning Objective #5
Examples of Tests of Details of Balances
EXHIBIT 14-8
Chapter 14 -24
Learning Objective #5
Examples of Tests of Details of Balances
EXHIBIT 14-8
Chapter 14 -25
Learning Objective #5
Examples of Tests of Details of Balances
EXHIBIT 14-8
Chapter 14 -26
Learning Objective #5
AUDITING INVENTORY IN THE LAND DEVELOPMENT AND
HOME BUILDING INDUSTRY
 A striking characteristic of the inventory in the land
development and home building industry with which
auditors must deal is the uncertainty of many amounts that
are included in both total costs and costs of individual units.
 Following is a summary of the items likely to be included in
the estimating and allocating processes:
Chapter 14 - 27
Learning Objective #3
Review Question
Which of the following is not an
important control of the inventory
cycle?
(a) Proper documentary support for
cash disbursements
(b) Physical security
(c) Authorization for movement
(d) Appropriate cost accounting records
Chapter 14-28
Review Question
When auditing overhead for inventory in a
manufacturing environment, the auditor’s primary
concern is:
(a) All appropriate costs are included in overhead.
(b) Period expenses are not included in overhead.
(c) Overhead is captured and calculated properly
according to GAAP, is consistent with prior
years, and is reasonable.
(d) All of the above
Chapter 14-29
Review Question
Cost accounting records can keep
track of:
(a) only unit counts of inventory.
(b) only dollar amounts of
inventory.
(c) units and/or dollars of inventory.
(d) none of the above.
Chapter 14-30
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