Workshop on Stock in Trade –
Physical Stock Taking & Valuation
1
Inventories
The following topics will be covered during the workshop:
• Definitions
• Financial statements assertion
• Methods of obtaining audit evidence
• Understanding of inventory system
• Physical inventories
• Valuation of inventories
• Presentation and disclosures
• Quiz and multiple choice questions
2
Definitions
Inventories are assets
•
Held for sale in the ordinary course of business;
•
In the process of production for such sale; or
•
In the form of materials or supplies to be consumed in
the production process in the rendering of services.
Net realizable value
Is the estimated selling price in the ordinary course of
business less the estimated costs of completion and
estimated costs necessary to make the sale.
Fair value
Is the amount for which an asset could be exchanged,
or a liability settled between knowledgeable, willing
3
parties in an arm length transaction.
Financial statements assertion
Assertions about class of
transactions and events
for the period under audit
•Occurrence—transactions and
Events that have been recorded
have occurred and pertain
to the entity
•Completeness—all transactions
and events that should have
been recorded have been
recorded
•Accuracy—amounts and other data
relating to recorded transactions
and events have been recorded
appropriately.
•Cutoff—transactions and events
have been recorded in
the correct accounting period
•Classification—transactions and
events have been recorded
in the proper accounts
Assertions about account
balances at the period end
Assertions about
presentation and
disclosure
•Existence—assets, liabilities, and
•Occurrence and rights and
equity interests exist
Obligations—disclosed
•Rights and obligations—the entity
events, transactions, and
holds or controls the rights to
other matters have occurred
assets, and liabilities are the
and pertain to the entity.
obligations of the entity
•Completeness—all assets, liabilities •Completeness—all disclosures
that should have been included
and equity interests that should
in the financial statements have
have been recorded have
been included.
been recorded
•Valuation and allocation—assets, •Classification and understandability
— financial information is
liabilities, and equity interests are
appropriately presented
included in the financial statements
and described, and disclosures
at appropriate amounts and
are clearly expressed
any resulting valuation or allocation
•Accuracy and valuation—financial
adjustments are appropriately
and other information
recorded
are disclosed fairly and at4
appropriate amounts
Audit procedures of obtaining audit evidence
Audit procedures of obtaining audit evidence
Objective
The auditor obtains audit evidence to draw reasonable conclusions
on which to base the audit opinion by performing audit procedures:
Methods
– Inspection of records or documents
–
–
–
–
–
–
–
Inspection of tangible assets
Observation
Inquiry
Confirmation
Recalculation
Re performance
Analytical procedures
5
INVENTORY SYSTEM
Purchase Requisition
Store Department
Yes
Approval
Approval
Purchase Order
Finance / Store
Copy to
Quality Control
Report to
Goods Receipt Note
Goods
Issued
to
department (process)
Finance / Store
Prepared at
department
store
for
issuance
to
next
relevant
Process
Additions
Labor and overheads
Goods issued to finished goods
department
Packing
Warehouse
Sale Order
Delivery Note
Description - Date of delivery - Quality
Finance / warehouse
Invoice
6
Physical inventories
•
•
•
•
•
Objective of physical attendance
Need for physical stock taking
General audit procedures for stock take
Audit procedures for physical stock taking
Specific areas
7
Objective of physical attendance
• The attendance at the client’s physical inventory
is now regarded as a compulsory procedure.
• The purpose of observing inventory is to
determine that the client’s procedure result in
accurate count.
• The auditor will himself observe test count.
• The auditor
information.
will
extract
certain
cut-off
8
Need for physical stock taking
When inventory is material to the financial statements,
the auditor should obtain sufficient appropriate audit
evidence regarding its existence and condition by
attendance at physical inventory counting unless
impracticable.
If unable to attend the physical inventory count on
the date planned, take or observe some physical counts
on an alternative date and, when necessary, perform
audit procedures on intervening transactions.
Where attendance is impracticable, due to factors
such as the nature and location of the inventory, the
auditor should consider alternative procedures.
9
General Considerations for Stock Taking
In planning attendance at the physical inventory count or
the alternative procedures, the auditor considers the
following:
– The risks of material misstatement related to
inventory.
– The nature of the internal control related to inventory.
– Whether adequate procedures are expected to be
established and proper instructions issued for
physical inventory counting.
– The timing of the count.
– The locations at which inventory is held.
– Whether an expert’s assistance is needed.
10
Audit procedures for physical stock
taking
After stock
take
During the stock take
Before stock take
11
Audit Procedures Before Stock Take
Responsibility
The client has primary responsibility for planning and conducting the
physical inventory. The presence of Auditor during this phase is important
because of participation in the physical count.
The auditor may carry out the following procedures before the stock take:
–
–
–
–
–
–
–
–
Date and time of inventory in consultation with client
Locations of inventory in consultation with client
Stocks held in bonded ware houses
Methods of counting and recording
Instructions to employees
Determine materiality
Need for expert
Provisions for the following:
• Receipts and dispatch of inventory during the count
• Segregation of inventory held for third party
• Physical arrangement of inventory
12
Audit procedures during stock take
13
Audit Procedures During Stock Take
The main task is to ensure that the client’s staff are carrying out their
duties effectively. The auditor should:
• obtain cutoff numbers (last receiving number and last dispatch
number)
• determine extent to which client counts would be tested.
• make two-way test counts from floor to sheet, and from stock sheets
to floor.
• compare count with appears on inventory tag, sheet, bin cards, and
also compare serial number and description, of the tags, sheets, bin
cards.
• Make notes of all tags, sheets, bin cards that represents damaged
stocks and slow moving items.
• examine source of stock sheet generation
• for work in process discuss with knowledgeable employee to review
the estimated cost to complete related to labor and factory
overheads.
• Make sure that inventory not owned by the client is not included in
the stock sheets.
• If experts are used than observe the procedures performed by him.
14
Audit procedures after stock take
Following are the procedures
•
•
•
•
•
•
The sheets shall be signed by all persons who were involved in the physical
stock taking
Ensure all inventory sheets are accounted for
Ensure rough inventory sheets are retained
Cut off testing of receiving and dispatch of documents
Prepare reconciliations in order to reach at year end stock, if the physical
stock tacking is performed before or after year end
Document/ Inquire the observations/ discrepancies between physical and
sheets provided noted during the course of physical stock take
15
Specific Areas
Stocks held at third party
1.
Obtain direct confirmation
•
•
As to the quantities.
As to the condition of inventory.
2.
Depending on materiality of this inventory the auditor would also consider
the following:
•
•
The integrity and independence of the third party.
Observing, or arranging for another auditor to observe, the physical
inventory count.
Obtaining another auditor’s report on the adequacy of the third party’s
internal control for ensuring that inventory is correctly counted and
adequately safeguarded.
Inspecting documentation regarding inventory held by third parties, for
example, warehouse receipts, or obtaining confirmation from other
parties when such inventory has been pledged as collateral.
•
•
16
Specific areas
Stock in transit
–
The auditor should verify through reviewing purchase invoices
and subsequent status.
–
Considerations to quarantine inventories
Stock in bonded ware houses
1.
Auditor obtain direct confirmation in writing, from custodian.
2.
The auditor should also apply one or more of the following
additional procedures:
–
Review and test client’s procedures for investigating the
warehouseman and evaluating his or her performance.
–
observe physical counts of goods, if applicable.
–
if warehouse receipts have been pledge as collateral, confirm
details of pledged receipts with lenders.
17
Audit of Inventory valuation
Topics to Cover:
- Definition of Inventories (Detailed)
- Initial Recognition of Inventories
- Implications of ISA-500 (Audit Evidence) on audit of Inventories
- Subsequent Measurement of Inventories including different methods of
Inventory Valuation
- Other Matters which include Retail and Standard Cost Method of
Inventory Valuation and special considerations related to Joint and By
Product Costs.
18
Definition of Inventory
Inventory includes:
Inventories of Manufacturing Concern
-
Assets held for sale in the ordinary course of business (finished
goods);
-
Assets in the production process for sale in the ordinary course of
business (work in process); and
-
Materials and supplies to be consumed in the production process (raw
materials) or rendering of services. [IAS 2.6].
Inventories of Service Provider
In the case of service provider, inventories include the costs of the
services which consist primarily of the labor and other costs of
personnel directly engaged in providing of the service, including
supervisory personnel and attributable overheads for which the entity
has not yet recognized the related revenue (see IAS 18 Revenue)
19
Initial Recognition
Cost should include all: [IAS 2.10]
Costs of purchase (including taxes, transport, and handling) net of trade
discounts received;
Costs of conversion (including fixed and variable manufacturing
overheads); and
Other costs incurred in bringing the inventories to their present location
and condition.
Inventory cost should not include: [IAS 2.16-2.18]
Abnormal waste;
Storage costs;
Administrative overheads unrelated to production;
Selling costs;
Foreign exchange differences; and
Interest cost.
20
Cost Formulae
-
For inventory items that are not interchangeable, specific costs are
attributed to the specific individual items of inventory. [IAS 2.23]
-
For items that are interchangeable, IAS 2 allows the FIFO or
weighted average cost formulas. [IAS 2.25]. The same cost formula
should be used for all inventories with similar characteristics as to
their nature and use to the enterprise. For groups of inventories that
have different characteristics, different cost formulae may be
justified. [IAS 2.25]
-
The standard cost and retail methods (For Commercial Importers
and Traders) may be used for the measurement of cost, provided
that the results approximate actual cost. [IAS 2.21-22]
21
Subsequent Measurement
•
•
Any write-down to NRV should be recognized as an expense in the period
in which the write-down occurs.
Any reversal should be recognized in the income statement in the period in
which the reversal occurs. [IAS 2.34]
What is NRV:
NRV is the estimated selling price in the ordinary course of business, less
the estimated cost of completion and the estimated costs necessary to
make the sale. [IAS 2.6].
NRV = Estimated (selling price–cost to complete– cost necessary to
make sale)
22
Particulars
Item - A
Item - B
Item - C
Item - D
Item - E
Item - F
Item - G
Item - H
Item - I
Item - J
Item - K
Item - L
Item - M
Activity Based Costing Limited
Finished Goods Physical Stock Sheet
As at June 30 2005
Audit Tick
Slow Moving/
Location
Quantity
Physical
Damage/
of Item
Held
Count
Obsolete
W1-A
Audit Tick for Physical Verification
Audit Tick for Slow Moving Stock
Audit Tick for Demaged Stock
Audit Tick for Obsolete Stock
10,232
7,685
567
7,898
3,455
5,692
9,843
15,468
8,756
1,938
8,762
1,450
617
82,363
P
P
P
P
P
P
P
P
P
P
P
P
P
205
154
11
158
69
114
197
309
175
39
175
29
12
1,647
Audit Tick
Slow Moving/
Damage/ obsolete
S
S
D
O
D
S
O
D
S
O
D
S
O
P
S
D
O
23
Particulars
Item - A
Item - B
Item - C
Item - D
Item - E
Item - F
Item - G
Item - H
Item - I
Item - J
Item - K
Item - L
Item - M
Quantity
Held
10,232
7,685
567
7,898
3,455
5,692
9,843
15,468
8,756
1,938
8,762
1,450
617
82,363
Average
Cost
102.5
345.32
85.47
1257.63
628.82
419.21
314.41
251.53
209.605
179.66
104.80
69.87
52.40
Activity Based Costing Limited
Finished Goods Stock Valuation Sheet
As at June 30 2005
Estimated Estimated Estimated
Total
Selling
Completion
Selling
Cost
Price
Cost
Cost
1,048,780.00
2,653,784.20
48,461.49
9,932,761.74
2,172,555.83
2,386,143.32
3,094,713.02
3,890,604.17
1,835,301.38
348,183.85
918,279.51
101,309.08
32,331.57
28,463,209.15
117.88
397.12
98.29
1,265.70
723.14
482.09
361.57
245.35
241.05
206.61
120.52
80.35
60.26
-
2.36
7.94
1.97
25.31
14.46
9.64
7.23
4.91
4.82
4.13
2.41
1.61
1.21
Net
Realizable
Value
115.52
389.18
96.32
1,240.39
708.67
472.45
354.34
240.44
236.22
202.48
118.11
78.74
59.06
Total
NRV
Lower of
Cost/
NRV
1,181,975.06
2,990,814.79
54,616.10
9,796,568.63
2,448,470.41
2,689,183.52
3,487,741.58
3,719,172.32
2,068,384.66
392,403.20
1,034,901.00
114,175.34
36,437.68
30,014,844.29
1,048,780.00
2,653,784.20
48,461.49
9,796,568.63
2,172,555.83
2,386,143.32
3,094,713.02
3,719,172.32
1,835,301.38
348,183.85
918,279.51
101,309.08
32,331.57
28,155,584.20
24
Activity Based Costing Limited
Provision for slow moving/ demaged/ obsolete stock
As at June 30 2005
Slow Moving/
Amount
Particulars
Demage/
Average
of
Obselence
Cost
Provision
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
-
A
B
C
D
E
F
G
H
I
J
K
L
M
205
154
11
158
69
114
197
309
175
39
175
29
12
1,647
102.5
345.32
85.47
1257.63
628.82
419.21
314.41
251.53
209.605
179.66
104.80
69.87
52.40
20,975.60
53,075.68
969.23
198,655.23
43,451.12
47,722.87
61,894.26
77,812.08
36,706.03
6,963.68
18,365.59
2,026.18
646.63
569,264
25
Particulars
Item - RM - A
Item - RM - B
Item - RM - C
Item - RM - D
Item - RM - E
Item - RM - F
Item - RM - G
Item - RM - H
Item - RM - I
Item - RM - J
Item - RM - K
Item - RM - L
Item - RM - M
Location
of Item
Activity Based Costing Limited
Raw Material Physical Stock Sheet
As at June 30 2005
Slow Moving/
Quantity
Physical
Demage/
Held
Count
Obselence
W1-A
Audit Tick for Physical Verification
Audit Tick for Slow Moving Stock
Audit Tick for Demaged Stock
Audit Tick for Obsolete Stock
5,116
3,467
635
7,475
3,258
5,936
9,254
12,655
7,536
1,675
8,265
1,923
715
67,910
P
P
P
P
P
P
P
P
P
P
P
P
P
102
69
13
150
65
119
185
253
151
34
165
38
14
1,358
Audit Tick
Slow Moving/
Damage/ obsolete
S
S
D
O
D
S
O
D
S
O
D
S
O
P
S
D
O
26
Activity Based Costing Limited
Raw Material Valuation
As at June 30 2005
Particulars
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
-
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
-
A
B
C
D
E
F
G
H
I
J
K
L
M
Quantity
Held
5,116
3,467
635
7,475
3,258
5,936
9,254
12,655
7,536
1,675
8,265
1,923
715
67,910
Average
Cost
51.25
172.66
42.74
628.82
314.41
209.61
157.20
125.76
104.80
89.83
52.40
34.93
26.20
Amount
of
Valuation
262,195.00
598,612.22
27,136.73
4,700,392.13
1,024,339.64
1,244,215.28
1,454,763.50
1,591,530.77
789,791.64
150,466.45
433,096.33
67,178.40
18,733.45
12,362,451.52
27
Activity Based Costing Limited
Provision for slow moving/ demaged/ obsolete stock
As at June 30 2005
Slow Moving/
Amount
Particulars
Demage/
Average
of
Obselence
Cost
Provision
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
Item
-
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
RM
-
A
B
C
D
E
F
G
H
I
J
K
L
M
102
69
13
150
65
119
185
253
151
34
165
38
14
1,358
51.25
172.66
42.74
628.82
314.41
209.61
157.20
125.76
104.80
89.83
52.40
34.93
26.20
5,243.90
11,972.24
542.73
94,007.84
20,486.79
24,884.31
29,095.27
31,830.62
15,795.83
3,009.33
8,661.93
1,343.57
374.67
247,249.03
28
Activity Based Costing Limited
As at June 30 2005
Stock in Trade:
Finished goods
Work in progress
Raw material
Less: Provision
2005
28,155,584
14,556,654
12,362,452
55,074,690
569,264
54,505,426
2004
26,344,876
16,765,489
10,982,345
54,092,710
54,092,710
29
Presentation and Disclosure of Inventories
under Fourth Schedule and IAS-2
-
IFRS
Accounting policy for inventories.
Carrying amount, generally classified
as merchandise, supplies, materials,
work in progress, and finished goods
Carrying amount of any inventories
carried at fair value less costs to sell
Amount of any write-down of
inventories recognized as an expense
in the period
Amount of any reversal of a writedown to NRV and the circumstances
that led to such reversal
Carrying
amount
of
inventories
pledged as security for liabilities
Cost of inventories recognized as
expense (cost of goods sold)
-
Fourth Schedule
Stock in trade distinguished between
appropriate classifications.
Provision, if any, made for diminution
in the value of or loss shall be shown
as a deduction from the gross amount.
30
Multiple Choice Questions
31
Multiple Choice Questions
Which of the following analytical procedures is
most applicable to inventory?
a. Comparison of sales of current and prior years.
b. Comparison of gross profit ratios of current and
prior years.
c. Comparison of marketing expense with budget.
d. Comparison of ratios of sales to accounts
receivable of current and prior years.
Solution
b
Reason
Because the amount shown for inventory affects
cost of sale and the gross profit ratio, fluctuations in
this ratio are investigated in connection with the
32
audit inventory.
Multiple Choice Questions
The inventory observation provides least
evidence of
a. Presentation
c. Valuation
b. Existence d. Rights
Solution
A
Reason
Observation of inventory on hand provides little
evidence about the classification of inventory.
33
Multiple Choice Questions
The observation of inventories is a(n)
a. Generally accepted auditing standard.
b. Generally accepted auditing procedure
c. Alternative auditing procedure.
d. Optional auditing procedure.
Solution
b
Reason
Observation of inventories is a procedure, i.e.,
an act to be performed.
34
Multiple Choice Questions
During an inventory observation auditors normally
record certain of their test counts to
a.
b.
c.
d.
Be used in compiling the client’s inventory.
Check the accuracy of the client’s account.
Compare with the final inventory listing.
Test the client’s counting procedure.
Solution
c
Reason
Recorded test counts are compared with the client’s
final inventory listing to provide assurance that the
client’s counts were not changed between the time
they were made and the time the final inventory listing
was prepared.
35
Multiple Choice Questions
During an inventory observation an auditor
may detect absolute items by all of following
except
a. Observing unusual amounts of rust or dust.
b. Observing items with prior year inventory tags.
c. Computing gross profit ratios.
d. Inquiry of plants personnel.
Solution
C
Reason
The gross profit ratio will not detect absolute goods
in inventory although other ratios such as inventory
turnover will.
36
Multiple Choice Questions
To test the receiving cut off auditors record the
last several numbers of documents used prior
to the taking of the inventory. These
documents are
a. Vendor invoices.
b. Purchase orders.
c. Receiving reports.
d. Purchase requisition
Solution
c
Reason
Receiving reports are used to test the receiving cut off.
37
Multiple Choice Questions
In performing an inventory receiving cut off test, an
auditor determines that an item was received and
counted on 12/31/X3 (the audit date), but the purchase
was not recorded until 1/4/X4. The effect of this to
a.
b.
c.
d.
Overstate inventory and accounts payable.
Understate inventory and accounts payable.
Overstate inventory and understate accounts payable.
Overstate net income and understate accounts payable.
Solution
d
Reason
The inventory count generated an entry debiting inventory
(because inventory was physically on hand but not recorded
on the books) and crediting cost of sales (inventory overage).
The credit to cost of sales should have been to accounts
payable.
38
Multiple Choice Questions
In which of the following types of inventories
would an auditor be least likely to need the
assistance of a specialist to determine
existence?
a. Baked goods
b. Coal Pile
c. Precious gems
d. Art work
Solution
a
Reason
The auditor could evaluate baked goods, but would
need a surveyor for the coal pile and appraisers for
the gems and art work.
39
Multiple Choice Questions
The most important objective in the audit
of current liabilities is
a. Existence
b. Completeness
c. Valuation
d. Presentation and disclosure.
Solution
c
Reason
Unrecorded items constitute the auditor’s
man risk when auditing current liabilities.
40
Multiple Choice Questions
In determining which accounts payable to select for
confirmation, an auditor is most likely to pick
a.
b.
Accounts with the largest balances to obtain dollar coverage.
Major vendors and suppliers regardless of the amount of the
balances.
c. Accounts with debit balances.
d. Any account with zero balance.
Solution
b
Reason
Because the auditor is primarily concerned with the
completeness assertion, he or she sends confirmations to
vendors that should have large balances (the major vendors).
41
Multiple Choice Questions
The review of subsequent disbursements covers
the period ending on the
a. Audit Date
b. Bank cut off statement.
c. Last day of field work.
d. Day of delivery of audit report
Solution
c
Reason
The auditors are in the client’s office through the last
day of field work, and this is the date trough which the
review of subsequent disbursements is performed.
42
Multiple Choice Questions
In the audit of accrued liabilities an auditor finds
that the only recorded accrual is for payroll. This
suggests that another accrual is needed for
a. Vacation pay
b. Profit sharing
c. Executive salaries
d. Payroll taxes
Solution
d
Reason
The client should have accrued payroll taxes
applicable to the accrued payroll.
43
Multiple Choice Questions
An auditor testing pricing of inventory for a client
that uses a job-order cost system would review
a. Categories of cost flowing through the control
accounts.
b. Accumulations of cost by cost centre.
c. Standard cost buildups.
d. Variation between actual and projected cost.
Solution
a
Reason
The auditor would review costs in the direct labor,
material, and overhead control accounts.
44
Multiple Choice Questions
Goods were received on December 29 and
counted during December 31 physical inventory.
The transaction to record the purchase was
recorded January 3. Which of the following
entries will the auditor purpose?
a. Debit inventory and credit accounts payable.
b. Debit inventory and credit purchases.
c. Debit cost of sales and credit accounts payable.
d. Debit cost of sales and credit inventory.
Solution
c
Reason
Cost of sales was credited in the entry to record the
physical inventory counts, but the entry should have
been to accounts payable.
45
True and False
46
True and False
•
The taking of an accurate physical inventory is a generally accepted auditing
procedure.
F
The observation of the physical inventory is a generally accepted auditing
procedure.
•
Before the start of the inventory, the auditor should review the client’s inventory
instructions.
T
•
The auditor tests a client’s inventory cut off to determine that physical items and
their related costs are treated in a consistent manner.
T
•
The objective of a receiving cut off test is to determine whether items that are
received near the end of the year and included in inventory also are recorded as
purchases and accounts payable.
T
•
The test of inventory pricing in a job-order cost system usually involves a review of
the flow and accumulation of costs by cost centre for the major products.
F
The review of costs by cost centre is performed when auditing a process
cost
system
47
True and False
•
•
If a product is counted quarts and priced in gallon, inventory will be understated.
F Inventory will be overstated, not understated.
The auditor would perform more extensive inventory cut off procedures where there is a separate receiving
department and renumbered receiving reports are used ten where such controls do not exist.
F
The auditor would perform less extensive inventory cut off procedure in this case.
•
The auditor seldom finds amounts recorded as liabilities that are not liabilities, but unrecorded liabilities are not
unusual.
T
•
Confirmation of accounts payable is a generally accepted auditing procedure.
F
Although confirmation of accounts payable is common practice, it has not been designated as a generally
accepted auditing procedure
•
An account payable confirmation may shown an amount different from the client’s books, but both may be correct.
T
•
An advantage of using the review of subsequent disbursements in the audit of accounts payable is that provides
much broader account coverage than would be practicable with confirmations.
T
•
A good starting point in a search for unrecorded accrued liabilities is the client’s expense accounts
T
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