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4th DECEMBER, 2013

(a) Meaning of the term inventory according to IAS 2 and how value of inventory can
be estimated according to this standard:
Meaning and valuation of inventory as per IAS 2:
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 that are consumed in production [raw materials][IAS 2.6]
Value of inventory shall be measured at the lower of cost and net realizable value.
Net realizable value is the estimated selling price in the ordinary course of business
less the estimated costs of completion and the estimated costs necessary to make the
The cost of inventories shall comprise all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location and
The cost of inventories shall be assigned by using the First-In, First-Out
(FIFO) or weighted average cost formula.
(b) Why audit of inventory is important for manufacturing firm compared to service
company and the reasons for this to be complex if auditor is not well prepared:
Audit of inventory for manufacturing firm compared to Service Company is
critically important considering the nature of activities of manufacturing firms
demanding holding large amount of inventory to support production produces a
different situation with service companies the latter usually do not hold
significant amount of inventory as in manufacturing firms.
Generally it is within manufacturing firms where auditors should expect to see all
three types of inventory namely finished goods, work in progress as well as raw
materials in support of production process.
With large amount of inventory there is high possibility of inventories being held
in different locations due to shortage of required space within a single location.
This means planning for and attendance by auditors to actual stocktaking exercise
has to take into account this possibility it adds the logistical and physical
movements demands for auditor and his team in terms of attending and actual
examination of actual stocktaking by staff of client company as required by ISA
501. Recall this standard demands that if inventory is material to the financial
statements the auditor shall obtain sufficient appropriate audit evidence regarding

the existence and condition of inventory by, in addition to other procedures,

attendance at physical inventory counting unless impracticable
Audit of inventory is also important and critical because it is closely linked to
different business operations/cycles as well as touching different accounts and
financial statements.
Inventory is among the easiest assets to manipulate and misstatement affect
reported profit: misstatement of inventory balances has a direct effect on reported
Inventories identification: some inventories can be very difficult for an auditor to
identify example includes stock of gas reserve. This kind of situation needs an
expert to estimate the quantity- ISA 620 using the work of an expert.
Inventories difficult to establish: the quantities of inventory held at a specific
given moment may be difficult to establish. It may not be possible to cease
inventory movements during the inventory count and cut off may be hard to
establish with precision.
Valuation: difficult for certain a product e.g. antiques-no active markets, hospital
which is working 24/24 hours.
Inventory losses: from pilferage, wastage, obsolescence, damage, dormant stock.
Inventories may be intangible: some very significant work in progress balances
may be intangible in nature.
There are different risks associated with inventory like inadequate or
inappropriate inventory held: to meet the demands of sales and production e.g.
stock out, high inventory levels resulting in poor cash flow and financial loss.
Other risks include inaccurate or incomplete record of inventory movements
resulting in lack of awareness of the actual inventory position and difficulties in
meeting customer needs. Others include lack of security over inventory resulting
in loss, theft or misappropriation as well as obsolete inventory held or incorrectly
supplied to customers, resulting in financial loss and damage to reputation.

(c) FIVE functions for audit of inventory:

i. Before stocktaking
Review and planning: review prior years working papers, familiarize
themselves with the nature volume and location of inventories, and consider the
controlling and recording procedures over inventory and the timing of the count.
Problem identification and reliance: identify problem areas in relation to the
system of internal control and decide whether reliance can be placed on internal
Risk and materiality: assess inherent, control and detection risks and establish
- Inventory held by third parties: arrange third party confirmation of
inventories held by third parties- depending on materiality, the auditors
should also consider the integrity and independence of the third party and
whether it is necessary to arrange for other auditors to observe the count or
whether it is sufficient to obtain another auditors report on the adequacy of the

third partys systems or merely to inspect relevant documentation held at client

Expert assistance: if the nature of the inventories is specialized then the auditor
will need to arrange expert help.
Counting i n s t r u c t i o n s :
examine t h e c l i e n t s c o u n t i n g
i n s t r u c t i o n s : if f o u n d t o b e inadequate, the matter should be discussed
with the client with a view to improving them prior to the inventory count.

ii. During stocktaking

Auditors should observe that there are adequate controls within the stocktaking
exercise and instructions are being adhered accordingly by staff involved in actual
Observe whether stock is counted systematically by clients staff.
Ensure that there is no movement of stock to be counted by the stock count teams.
If stock is recorded by weight, weight a sample.
If stock is in sealed boxes, the auditor must open a sample of boxes to
confirm the quantity in each box.
Auditors must inspect goods and make some notes of damaged or obsolete stock.
auditors must gathering the cut off details such as goods received notes and
delivery notes numbers to be followed up after stock take
Auditors should observe that there proper procedures for excluding third party stock
are being exercised.

iii. After stocktaking exercise

After the stocktake, the matters recorded in the auditors working papers at the time of
the count or measurements, including apparent instances of obsolete or deteriorating
stocks, are followed up. For example, details of the last serial numbers of goods inwards
and outwards records and of movements during the stocktake may be used in order to
check cut-off.
In addition, copies of [or extracts from] the stocktake records obtained by the auditor
during the stocktake and details of test counts, and of the sequence of stocktake records
may be used to check that the results of the count have been properly reflected in the
accounting records of the entity.
The auditor reviews whether continuous records of stocks have been adjusted to the
amounts physically counted or measured and that differences have been investigated.
Where appropriate, the auditor considers whether management has instituted procedures
to ensure that all movements of stocks between the observed stocktake and the period end
have been adjusted in the accounting records, and the auditor tests these procedures to the
extent considered necessary to address the assessed risk of material misstatement.

In addition, the auditor follows up queries and notifies management and those charged
with governance of significant difficulties encountered during the stocktake.
In conclusion, the auditor considers whether attendance at the stocktake has provided
sufficient appropriate audit evidence in relation to relevant assertions principally
existence and, if not, the other procedures to be performed.
(a) A comprehensive definition of non-current assets according to IAS 16
IAS 16, which deals with accounting for the tangible Non-current Assets uses special
term for this as Property, Plant and Equipment [PPE] a comprehensive definition of
PPE include the following:
Assets held by an enterprise for use in the production/supply of goods or services for
rental to others or for administrative purposes and are
Expected to be used during more than one accounting period thus the cost of the Noncurrent Assets is systematically allocated over its useful life through depreciation. Under
this definition the useful life of a fixed asset should be understood as:
The period of time over which an asset is expected to be used by the enterprise or the
number of production units or similar units expected to be obtained from the asset by the
(b) FOUR internal control procedures to be observed by auditor while auditing noncurrent assets
The high value of PPE in many companies makes it necessary to make separation of the
authorization, custody and record keeping functions especially important. Periodic
inspection of PPE is equally important. Consequently, the internal controls over PPE
would include the following:
Authorization - As PPE are likely to have a useful life over several years, their
acquisition and disposal will involve the enterprise in significant amounts of expenditure
and these should be authorized by Capital Budgets, BOD minutes and Capital
expenditure proposals
Recording Controls there are should be a PPE register which provides different details
for management of PPE like serial number, date of purchase, description and
manufacturer/Suppliers name, gross cost or valuation as well as estimated useful life.
Other details to be contained in PPE register include depreciation provided annually,
additions and disposals as well as accumulated depreciation. Furthermore the PPE
register would include details like Net Book Value [NBV], Estimated Residual Value,
summary of capitalized repairs, location of asset, estimated replacement cost and details
of eventual disposal. Beyond PPE register, nominal ledger accounting should also be kept
for cost, accumulated depreciation and for each type of asset.
Custodial Controls - The PPE of the company should not be susceptible to misuse and
should be protected from risk of loss by theft, premature obsolescence or destruction.
Custodial controls include having adequate insurance cover to provide against risk of

destruction, safe custody of movable assets e.g. motor cars, furniture, electronic
equipment, etc as well as physical security over the documents such as title records.
Managerial Supervision - there should be a suitable capitalization policy and this should
be used to monitor capital expenditure. Similarly there are should be budgetary control
useful for monitor capital expenditure as well as periodical verification process to
confirm the existence of PPE as shown in the records.
(c) Substantive audit tests with respect to audit of non-current assets or other items
along four major assertions can be presented in tabular format as follows:

Specific substantive procedures for Tangible Non-current Assets

Example Audit Tests


Is the PPE balance in the financial statements

Are all acquisitions during the accounting
period genuine?
Have all assets which were sold during the
year been removed from the PPE register?
There is a risk that items which have been
scrapped may not have been accounted for.
Are there any expense items which have
been capitalized in error?


Is the PPE balance in the financial statements

Have all additions been included in the PPE

Select a sample of additions from the PPE

register and agree to supporting documentation
such as title deeds.
Select a sample of assets from the PPE register
and physically verify their existence.
Review board [of directors] minutes for details
of disposals and trace the disposals to the PPE
Review the description of additions in the PPE
register to ensure they are all genuine capital

The auditor could check the board minutes for

approval of capital expenditure and ensure the
related item appears in the PPE register.
A sample of physical assets could be agreed to
the PPE register to ensure they have been

Are there any capital items which have been

expensed in error?

Were all disposals genuine?

The auditor could review the breakdown of

expense accounts such as the repairs &
maintenance account to ensure no items have
been expensed in error.
Trace a sample of disposals from the PPE
register to supporting documentation such as
invoices or receipts in the bank statements.



Example Audit Tests

Does the company own or control all assets

included in the Non-current Asset register?
A company does not own assets under hire
purchase/ finance leases but is still permitted to
capitalize these assets.

Valuation and

Are the PPE held valued in accordance with the

applicable accounting standards?

Have disposals been correctly accounted for,

including any gain/loss?

Are all PPE valued at cost/value less


Have depreciation rates been properly

calculated to write off assets over their
estimated useful lives i.e. are the depreciation
rates used adequate but not excessive?

Have any revaluations been accounted for


documentation such as purchase invoices/title
deeds/ loan documentation to ensure the
company does have title to assets. Board
minutes could also be reviewed to ensure that
title of the asset is assigned.
PPE should be held at NBV. All assets, except
land, should be depreciated. Revaluation is
permitted, but only for an entire class of assets.

The auditor should review a sample of

disposals and ensure they have been treated

Select a sample of assets in the PPE register

and ensure that each asset has been

The auditor should critically review the PPE

accounting policy and assess whether the
depreciation rates used are reasonable. The
auditor should also check that the stated rates
are being used in the PPE register.
If depreciation rates are excessive, there may
be a large number of fully written down assets
in the PPE register which are still in use. If
depreciation rates are too low, there may be
assets approaching end of useful life but still
with a large carrying amount1.
The auditor should review the accounting for
any revaluations made.

(a) List and brief description of common elements of standard audit report
- There are at least eight elements of audit report listed and described as follows:
1 Also too high disposal gain/loss

Title the title of the report should be clearly stated while differentiating audit report
with other types of reports usually prepared by management of Client Company. Simple
words like independent auditor or auditors report are usually used.
Addressee focuses on whom the audit report is primarily intended to normally those
who in the first place are seen as employing or in need of auditing and assurance
services. These are none but the owners or shareholders of a particular company thus
the report will identify them as shareholders or board of directors or supervisory
Opening or introductory paragraph two issues are of particular important namely
the identification of the financial statements audited as well as a statement of the
responsibility of the entitys management and the responsibility of the auditor on these
statements. Key statements usually show clearly that it is the management of the
company that is responsible for preparing the audited FSs while the auditors duty is
limited to conducting the relevant audit work.
Scope paragraph this usually describes the nature of an audit engagement including
what actually auditor did in the audit engagement before arriving at giving relevant
audit opinion and must make reference to the ISAs or relevant national standards or
Opinion paragraph this contains expression of opinion on the financial statements
generally key terms used to express the auditors opinion are financial statements give a
true and fair view or present fairly, in all material respects, and mention the
framework used to arrive at that opinion in the context of Tanzania according to ISAs.
Date of the report the report must be dated and this date usually
coincides/corresponds with the date for which the audit work was completed - usually
the last date of field work. Auditor should not date the report earlier than the date on
which the financial statements are signed or approved by management.
Auditor's address this is none but a specific location, usually the city in which the
auditor maintains an office that serves the client audited where relevant it may mean
a city and country in which the audit report has been issued.
Auditors signature this refers to the name of the audit firm, or the personal name of
the auditor, or both, as appropriate. The auditors report is ordinarily signed in the
name of the firm because the firm assumes responsibility for the audit.

(b) Meaning of modification of auditors report containing unqualified opinion

An auditors unqualified report is sometimes modified to explain matters that do
not affect the auditors opinion, but should be emphasized to the financial
statement user.
Emphasis of Matter, under ISA 700, in certain circumstances an auditors report

may be modified by adding a fourth, emphasis of matter paragraph, to highlight a

material matter regarding a going concern problem and when there is significant
uncertainties, the resolution of which is dependent upon future events which may
affect the financial statements.