Inventory and Production Cycle – Part 1
Auditing and Internal Control 2022
Semester 2 - Learning Unit 3
Cycles
• Purchases and Payments Cycle
• Inventory and Production Cycle
• Revenue and Receipts Cycle
• Payroll Cycle
2
Learning Outcomes
You will be assessed on:
• Understanding of the functions, personnel and documents
relating to the Inventory and Production Cycle
• Understanding of the Risks in the cycle
• Ability to explain and apply concepts and principles of risk
assessment and internal control including Inventory count for
the cycle.
• Your ability to identify and understand the assertions relating to
the cycle.
• NOTE: You do NOT need to know control activities in this cycle
(but you must know what you learned in Unit 1 relating to control
activities)
3
Introduction and Characteristics of the Cycle
Characteristics of the Cycle
Cycle deals with two main activities:
• Custody and safe keeping of Inventory, and
• Recording of costs
5
Characteristics of the Cycle
Inventory is the heart of the organisation: plant and
equipment specific to the production process, warehouse
designed to suit the inventory held, etc.
Large effect on financial statements: Inventory normally a
major component in calculating cost of sales, gross profit
and net profit. Failure to properly control and account for
inventory
can
have
deadly
consequences
for
the
organisation.
A physical asset: Requires extensive physical controls
because inventory can be stolen or damaged (by fire,
water, glass products can break, etc.)
Characteristics of the Cycle
• An internal cycle: Raw materials / goods for resale
are obtained through the Purchases and Payments
Cycle, Finished goods are sold through the Revenue
and Receipts Cycle. Inventory Cycle has no interface
with external world.
• Inventory fraud: Inventory is normally central to fair
presentation of Financial Statements. Anyone wishing
to manipulate profits and asset balances can do so by
misstating inventory.
• Diversity in inventory in terms of:
• Type of inventory (wholesale, retail vs
manufacturing: Raw material, WIP and Finished
goods)
• Location (multiple warehouse, imported goods)
• Obsolete or fresh foods
• Nature: precious stones, gas, chemicals.
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Synonyms
Word
Synonyms
e.g. Warehouse
Storage
Production
Manufacturing
Word
Synonyms
Custody
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