Form AP 30

Index Reference__________

Audit Program for Inventories and Cost of Sales

Legal Company Name Client:

Balance Sheet Date:

Instructions: The auditor should refer to the audit planning documentation to gain
an understanding of the financial reporting system and the planned extent of testing
for inventories and cost of sales. Modification to the auditing procedures listed below
may be necessary in order to achieve the audit objectives.
All audit work should be documented in attached working papers, with appropriate
references noted in the right column below.

Audit Objectives Financial Statement

Assertions
Existence or occurrence
Inventory reflected in the balance sheet physically
Completeness
exists and includes all materials, products, and
supplies owned by the client on hand, in transit, out on
consignment, or at outside locations.
Rights and obligations
The entity has legal title or similar rights of ownership
to the inventory.
Existence or occurrence
Usage and movement of inventory is recorded
Valuation or allocation
correctly as to account, amount, and period.
Valuation or allocation
Obsolete, slow-moving, and overstock inventory is
monitored and promptly identified, and valuation
allowances are recorded when necessary.
Existence or occurrence
The entitys policies, procedures, and controls for
Completeness
determining an accurate count of inventory are
adequate and operating as designed.

Costs are assigned to inventory in accordance with the Valuation or allocation

stated valuation method, and inventory is carried at the
lower of cost or market.
Presentation and disclosure
Inventory is properly classified and presented in the
financial statements and adequate disclosure is made
with respect to the valuation method, major
components of inventory, and encumbered inventory.

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Inventory Observation Procedures

1. Meet with clients personnel in charge of the physical count

of the inventory and perform the following planning
procedures (the auditor may wish to use form AP 37
Checklist for Observation of Inventory Counts in
performing this step):

a. Determine the physical inventory observation date, the

locations of the inventory including outside locations
and warehouses, client supervisory staff in charge of the
inventory, the materiality of inventory levels at the
respective locations, and whether any outside specialists
will be used in counting the inventory.

b. Obtain an understanding of the procedures that will be

used by the client to count the inventory. Review any
inventory instructions, location maps, samples of tags to
be used, and other relevant information that will be used
to document the inventory procedures.

c. Tour the clients inventory locations and determine

which inventory items will be material to the overall
financial statements when priced and extended.

d. Determine the nature and extent of any inventory held

for the client by warehouses or other third parties and
the need to confirm or observe such inventory.

e. Determine the adequacy of audit staffing and hold a

preplanning meeting to review the clients instructions
and procedures.

2. On the physical inventory date, perform the following

procedures:
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a. Tour the premises; evaluate the inventory arrangements;

and recommend appropriate changes as needed.

b. Determine whether property not owned by the client is

clearly segregated and identified.

c. Determine the appropriate cutoff control numbers for

receiving and shipping documents and obtain copies.

d. Ascertain that receiving and shipping departments are

informed about appropriate cutoff procedures.

e. Observe and note the clients practices and procedures

regarding segregation and identification of slow-
moving, damaged, or obsolete inventory.

f. Examine samples of inventory items for source of

identification, description, measure, and status of
completion.

g. Observe count teams and determine whether the clients

instructions and procedures are being properly followed.

h. Ascertain that pre-numbered inventory tickets and/or

count sheets are properly controlled and accounted for.

i. Make test counts, particularly of high-value items, and

record test count information such as item number,
description, stage of completion, quantity, and other
pertinent information that would assist in tracing the
inventory item to the final inventory listing.

j. Observe any omissions from count and ask for recounts

in case of errors.

k. Note any inventory movement during the observation

and obtain adequate explanations.

l. Determine whether any inventory appears to be

obsolete, slow-moving, damaged, or very old and
whether the client has properly identified those items.
Consider preparing a summary of these items.
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m. Determine if all inventory count sheets or tags have been
accounted for. Obtain a summary of tags used, unused,
voided, or damaged and summarize the sequences of
tags or count sheets into these categories.

n. Tour the shipping and receiving areas and obtain

information about inventory items therein. Determine
whether they should be counted in or excluded from the
inventory.

o. Determine the nature and extent of any inventory held

by the entity on behalf of third parties and ensure that it
is excluded from the inventory count.

p. Prepare a memorandum of observation of the physical

inventory. Include comments on the overall controls,
arrangements, procedures used, and compliance
therewith.

3. If the auditor is unable to observe the physical inventory at

the balance-sheet date, perform the following procedures.
(Note that if the client does not maintain adequate records
and controls over inventories, the following procedures may
not be adequate to compensate for not observing the
physical inventory count at the balance sheet date. In that
case, the auditor must evaluate the materiality and possible
misstatement and decide whether the audit opinion must be
modified.)

a. Observe the physical inventory at a subsequent date by

performing steps 1 and 2 above.

b. Test inventory transactions occurring between the

balance-sheet date and the date of the subsequent
physical inventory procedures. Vouch inventory
purchases to receiving documents and vendor invoices.
Vouch cost of sales transactions to customer purchase
orders and shipping documents.

c. Review documentation of the physical count taken by

the client at the balance-sheet date. Trace selected
quantities from the inventory listing to the count sheets
or tags, and from the count sheets or tags to the
inventory listing.
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d. Compare gross profit for the last month of the year

under audit to gross profit for the first month of the
subsequent period to assess reasonableness of cutoff.

Reconciliation and Valuation of Inventory

4. Obtain an understanding of the procedures used by the client

to summarize, reconcile, and value the inventory and test
these procedures as follows:

a. On a test basis, trace tag sequences of used, unused,

voided, and damaged tags to the final inventory listing
summary and ascertain consistent treatment. Investigate
any tags that have been added or deleted.

b. Trace test counts noted during the observation of the

physical inventory to the final inventory listing
summary and investigate any differences.

c. Test the arithmetical accuracy of the final inventory

listing summary with respect to both quantities and
dollar value.

d. Reconcile the final inventory listing summary to the

general ledger and review book to physical adjustments.
Investigate large adjustments for possible inventory
shrinkage, motives to overstate inventory, or weaknesses
in the clients system.

e. Trace confirmation of inventory items held by third

parties to the final inventory listing summary.

5. Determine the inventory method used (FIFO or weighted

average) and determine whether such method is consistently
applied.

6. For raw materials and purchased finished goods on the

FIFO method, test the cost as follows:

a. Vouch the cost to the most recent vendors invoice and

other external evidence; if the quantities on hand exceed
the invoice total, vouch the excesses back to previous
purchases until the quantity on hand has been built up.
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b. Determine that freight, duty, discounts, and allowances

are consistently accounted for.

c. Note the dates of purchase of the items tested and note

items that appear to be slow-moving.

d. Relate the cost of items tested to the costs of similar

products and investigate significant variations.

e. Relate the costs of other significant untested items to

prices used in the prior year and investigate significant
variations.

f. Determine the monetary difference for each item tested,

summarize total differences, and consider the impact of
misstatements found on the overall population.

7. For work in process and finished goods manufactured by the

company, perform the following:

a. Trace unit costs from the final inventory listing to the

cost accounting records.

b. Trace the raw material quantities used in producing the

work-in-process items or the finished goods items to
supporting documents (e.g., bills of material, requisition
forms, production reports).

c. Trace the cost of raw materials used to the vendor

invoices, freight invoices, and other external documents,
where appropriate.

d. Trace the labor hours used in producing the work in

process items or finished goods items to supporting
documents (e.g., time cards, time studies).

e. Agree actual labor rates used to payroll records.

f. For overhead, test the clients overhead rate as follows:

(1) Review the costs included in the overhead pool for

propriety.
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(2) Determine that overhead costs are being charged to
inventory in accordance with appropriate policy
(e.g., as a percentage of direct labor).

(3) Identify disposition of variances between actual

overhead costs incurred and overhead costs applied
to production and inventory. Determine that
variances are reasonable and that no excessive costs
for idle plant are being charged to inventory.

(4) Compare the overhead rate to the prior year for

reasonableness.

8. Perform the following procedures to test for slow-moving

and obsolete items:

a. Obtain an understanding from the client with respect to

the criteria and calculation used to determine what
constitutes slow-moving and obsolete items.
b. Note dates per vendors invoices during the inventory
price test and be alert for slow-moving items.

c. Compare items noted during the current periods review

of slow-moving and obsolete items to the prior years
listing.

d. Check that significant items written down in prior years

have not been written up in the current year; determine
if further write-downs might be required.

9. Perform the following procedures to determine lower of cost

or net realizable value applications required by IAS 2:
a. For purchased inventory items, compare, on a test basis,
the unit price used in the final inventory listing summary
to current price lists, recent sales invoices, or recent
vendor invoices.
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b. For work in process and finished goods manufactured by
the company, compare, on a test basis, inventory
carrying amounts and recent selling prices or sales
invoices; ascertain stage of completion and estimated
cost to complete for work in process items; and ascertain
that such carrying amounts are not in excess of net
realizable value.

c. Compare inventory turnover ratio and gross profit

percentage of the current period to prior periods.

d. Compare quantities on hand for selected items with

quantities noted on the sales invoices to determine that
the quantities on hand are not excessive.

10. Perform the following shipping and receiving cutoff

procedures with respect to cutoff information obtained at the
physical inventory observation date:
a. On a test basis, determine whether the last few
shipments of inventory before the physical inventory
observation date have been excluded from inventory and
included in sales for the period under audit.
b. On a test basis, determine whether the first few
shipments of inventory after the physical inventory
observation date have been included in inventory and
excluded from sales for the period under audit.
c. On a test basis, determine whether the last few inventory
items received before the physical inventory observation
date have been included in inventory and accounts
payable for the period under audit.
d. On a test basis, determine whether the first few
inventory items received after the physical inventory
observation date have been excluded from inventory and
accounts payable for the period under audit.

11. If the inventory physical count was taken as of an interim

date, obtain an analysis and reconciliation of the inventory
per the physical count to the inventory per the balance sheet
and perform the following:
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a. Review and analyze the general ledger inventory control
accounts from the date of the physical count to the
balance-sheet date.

b. Trace inventory additions to appropriate sources, such as

the purchases journal and cost accounting records.

c. Trace inventory reductions to cost of sales.

d. Determine the propriety and reasonableness of any other

reconciling items.

12. Perform the following analytical procedures for inventories

and investigate any significant fluctuations or deviations
from the expected balances:

a. Compare the current years account balances with the

prior years account balances for inventories and the
reserves for slow-moving or obsolete items.

b. Compare the current years components of inventory

(i.e., raw materials, work in process, finished goods) as a
percentage of total inventory with the prior years
percentages.

c. Compare the current years composition of total product

cost (i.e., materials, labor, and overhead) with the prior
years.

d. Compute the following ratios for the current year and

compare with the prior years ratios:

(1) Inventory turnover in total and by major product or

division.

(2) Average age of inventory in total and by major

product or division.

(3) Gross profit percentage in total and by major product

or division.

(4) Shrinkage ratio (i.e., inventory write-offs to average

inventory).
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13. If inventory held in public warehouses or by other outside

custodians is significant in relation to current assets and
total assets, perform one or more of the following
procedures:

a. Confirm the inventory held in public warehouses or by

other custodians.

b. Test the clients control activities used in investigating

and evaluating the performance of the warehouseman.

c. Observe the warehousemans or clients count of goods

whenever practical and reasonable.

d. If warehouse receipts have been pledged as collateral,

confirm details with the lenders.

e. Obtain an independent auditors report on the

warehousemans system of internal control relevant to
custody of goods and, if applicable, pledge of receipts,
or apply alternative procedures at the warehouse to gain
reasonable assurance that information received from the
warehouseman is reliable.

14. If the auditor is concerned about the risk of fraud, audit

procedures such as the following should be considered in
addition to the ones listed above:

a. Examine individual entries in the general ledger

inventory account to search for expenses or other items
that are improperly charged to inventory.

b. Scrutinize any material book to physical inventory

adjustments and examine supporting documents.

c. Review year-end accruals and adjustments to the

inventory account and ascertain that the entries are
normal and required.

d. Perform detailed price testing of labor and overhead

rates.

e. Look for evidence of bulk sales at steep discounts which

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could indicate a declining value for the products.

f. Perform a detailed analysis of scrap sales.

g. Examine journal entries made to the inventory account

subsequent to year-end.

h. Expand the inventory cutoff procedures.

i. Confirm accounts payable.

j. In connection with the inventory observation:

(1) Observe all inventory locations simultaneously.

(2) Obtain copies of all inventory count sheets or tags

before leaving the physical inventory sites.

(3) Physically examine the inventory by opening boxes

to assure that the purported inventory is actually
present and match content to the labels.

15. Determine if any inventory is pledged or subject to liens.

16. Determine if the inventory amount includes any significant

intercompany profit that should be eliminated.

17. Determine if the inventory is properly classified in the

balance sheet and if adequate disclosure is made with
respect to the valuation method, major components of
inventory, and pledged inventory.

Based on the procedures performed and the results obtained, it is my opinion that the
objectives listed in this audit program have been achieved.

Performed by Date

Reviewed and approved by Date

Conclusions:

Comments: