Audit of the Inventory
and Warehousing Cycle
Chapter 16
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 1
Learning Objective 1
Identify the business functions
and the related documents
and records in the inventory
and warehousing cycle.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 2
Functions in the Inventory
and Warehousing Cycle
Process
purchase
orders
Store
raw
materials
Receive raw
materials
Process the goods
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 3
Functions in the Inventory
and Warehousing Cycle
Store
finished
goods
Ship
finished
goods
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 4
Learning Objective 2
Describe how e-commerce
affects inventory management.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 5
How E-Commerce Affects
Inventory Management
The Internet enables clients to provide expanded
descriptions of their inventory on a real-time basis.
The use of the Internet and other e-commerce
applications may lead to financial reporting
risks if access to inventory databases and
systems is not adequately controlled.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 6
Learning Objective 3
Explain the five parts of
the audit of the inventory
and warehouse cycle.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 7
Audit of Inventory
Part of audit
Acquire and record
raw materials, labor,
and overhead.
Cycle in which tested
Acquisition and
payment plus
payroll and personnel
Internally transfer
assets and costs.
Inventory and
warehousing
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 8
Audit of Inventory
Part of audit
Ship goods and record
revenue and costs.
Cycle in which tested
Sales and
collection
Physically observe
inventory.
Inventory and
warehousing
Price and compile
inventory.
Inventory and
warehousing
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 9
Learning Objective 4
Design and perform audit
tests of cost accounting.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 10
Cost Accounting Controls
1. Physical Controls
Raw materials
WIP
Finished goods
2. Controls over the related costs
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 11
Tests of Cost Accounting
Physical Controls
Documents and records for
transferring inventory
Perpetual inventory master files
Unit cost records
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 12
Learning Objective 5
Apply analytical procedures to
the accounts in the inventory
and warehousing cycle.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 13
Analytical Procedures for
Manufacturing Equipment
Analytical Procedure
Compare gross margin
percentage with that of
previous years.
Possible Misstatement
Overstatement or
understatement of
inventory and cost
of goods sold
Compare inventory turnover Obsolete inventory
(cost of goods sold divided
Overstatement or
by average inventory) with
understatement of
that of previous years.
inventory
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 14
Analytical Procedures for
Manufacturing Equipment
Analytical Procedure
Possible Misstatement
Compare unit costs of
inventory with those of
previous years.
Compare extended
inventory value with that
of previous years.
Overstatement or
understatement of
unit costs
Misstatements in
compilation, unit
costs, or extensions
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 15
Analytical Procedures for
Manufacturing Equipment
Analytical Procedure
Possible Misstatement
Compare current year
manufacturing costs with
those of previous years
(variable costs should be
adjusted for changes in
volume).
Misstatement of unit
costs of inventory,
especially direct
labor and
manufacturing
overhead
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 16
Methodology for Designing
Tests of Details of Balances
Identify client business risks affecting
the inventory and warehousing cycles.
Set tolerable misstatement and
assess inherent risk for the
inventory and warehousing cycles.
Assess control risk for several cycles.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 17
Methodology for Designing
Tests of Details of Balances
Design and perform tests of
controls and substantive tests
of transactions for the
several cycles.
Design and perform analytical
procedures for the inventory
and warehousing cycle.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 18
Methodology for Designing
Tests of Details of Balances
Design tests of details
of inventory to satisfy
balance-related
audit objectives.
Audit procedures
Sample size
Items to select
Timing
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 19
Learning Objective 6
Design and perform
physical observation
audit tests for inventory.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 20
Controls
Proper instructions for the physical count
Supervision by responsible personnel
Independent interval verification of the counts
Independent reconciliations of the physical
counts with perpetual inventory master files
Adequate control over count sheets or tags
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 21
Audit Decisions
Timing
Sample size
Selection
of items
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 22
Physical Observation Tests
The most important part of the observation
of inventory is determining whether the
physical count is being taken in accordance
with the client’s instructions.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 23
Balance-Related Objectives:
Physical Inventory Observation
Existence
Inventory as
recorded on tags exist.
Completeness
Existing inventory is
counted and tagged.
Accuracy
Inventory is counted
accurately.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 24
Balance-Related Objectives:
Physical Inventory Observation
Classification
Inventory is classified
correctly on the tags.
Cutoff
Transactions are recorded
in the proper period.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 25
Balance-Related Objectives:
Physical Inventory Observation
Realizable
Value
Obsolete and unusable
inventory items are
excluded or noted.
Rights
The client has rights
to inventory recorded
on tags
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 26
Learning Objective 7
Design and perform audit
tests of pricing and
compilation for inventory.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 27
Audit of Pricing and Compilation
Inventory price tests
Inventory compilation tests
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 28
Audit of Pricing and Compilation
Pricing and
compilation
controls
Pricing and
compilation
procedures
Valuation
of inventory
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 29
Balance-Related Objectives:
Inventory Pricing and Compilation
Detail
tie-in
Existence
Completeness
Accuracy
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 30
Balance-Related Objectives:
Inventory Pricing and Compilation
Classification
Realizable
value
Rights
Presentation
and disclosure
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 31
Valuation (Pricing) of Inventory
Pricing Purchased Inventory
Pricing Manufactured Inventory
Cost or Market
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 32
Learning Objective 8
Integrate the various parts of
the audit of the inventory
and warehousing cycle.
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 33
Interrelationship of
Various Audit Tests
Tests of acquisition
and payment cycle
Raw materials
Acquisitions of
raw materials
Work in process
Other manufacturing
overhead
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 34
Interrelationship of
Various Audit Tests
Tests of payroll
and personnel cycle
Work in process
Direct labor
Work in process
Indirect labor
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 35
Interrelationship of
Various Audit Tests
Inventory tests
Raw materials
Ending inventory
Work in process
Ending inventory
Finished goods
Ending inventory
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 36
Interrelationship of
Various Audit Tests
Tests of sales and
collection cycle
Finished goods
Cost of goods sold
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 37
Integration of the Tests
 Acquisition and payment cycle
 Payroll and personnel cycle
 Sales and collection cycle
 Cost accounting
 Physical inventory, pricing, and compilation
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 38
End of Chapter 16
©2003 Prentice Hall Business Publishing, Essentials of Auditing 1/e, Arens/Elder/Beasley
16 - 39