AUDITING II (CLASS D)

Group 7:

Anagustin Zalelijka Putri (F0317038)

Maria Vita Nirmala Christy (F0317063)
Maryani (F0317064)
Sedar Panji Gumilang (F0317093)

CHAPTER 21

AUDIT OF THE INVENTORY AND WAREHOUSING CYCLE

BUSINESS FUNCTIONS IN THE CYCLE AND RELATED DOCUMENTS AND

RECORDS

Inventory takes many different forms, depending on the nature of the business. For
retail or wholesale businesses, the largest account in the financial statements is often
merchandise inventory available for sale. Figure 21-1 shows the physical flow of goods and
the flow of costs in the inventory and warehousing cycle for a typical manufacturing
company.

The inventory and warehousing cycle can be thought of as comprising two separate
but closely related systems, one involving the physical flow of goods and the other the related
costs. Six functions make up the inventory and warehousing cycle. Each of these is discussed
next.
 Process purchase orders

 Receive raw materials

 Store raw materials

 Process the goods

 Store finished goods

 Ship finished goods

 Perpetual inventory master files

PARTS OF THE AUDIT OF INVENTORY

The overall objective in the audit of the inventory and warehousing cycle is to provide
assurance that the financial statements fairly account for raw materials, work-in-process,
finished goods inventory, and cost of goods sold. The audit of the inventory and warehousing
cycle can be divided into five activities within the cycle:

1. Acquire and record raw materials, labor, and overhead

2. Internally transfer assets and costs

3. Ship goods and record revenue and costs

4. Physically observe inventory

5. Price and compile inventory

AUDIT OF COST ACCOUNTING

Cost accounting systems and controls of different companies vary more than most
other audit areas because of the wide variety of items of inventory and the level of
sophistication desired by management.

Cost accounting controls are those related to processes affecting physical inventory and the
tracking of related cost from the time raw materials are requisitioned to the completion of the
manufactured product and its transfer to storage.

Test of cost accounting the auditor is concerned with four aspects of cost accounting:

1. Physical controls over inventory

2. Documents and records for transferring inventory

3. Perpetual inventory master files

4. Unit cost records

SUBSTANTIVE ANALYTICAL PROCEDURES

Substantive analitycal procedures are important in auditing inventory and

warehousing, as they are in all other cycles. Table 21-1 shows several common analitycal
procedures and possible misstatements that may be indicated when fluctuations occur. We’ve
discussed several of those analitycal procedures, such as gross margin percentage, in relation
to other cycles.

PHYSICAL OBSERVATION OF INVENTORY

Because inventory varies significantly for different companies, obtaining an

understanding of the cient’s industry and business is more important for both physical
inventory observation and inventory pricing and compilation than for most audit area.

Inventory observation requirements. To meet the requirement, auditor must:

1. Be present at the time the client counts its inventory for determining year-end balances
2. Observe the client’s counting procedures
3. Make inquiries of client personnel about their counting procedures
4. Make their own independent tests of the physical count

Controls over physical count. Regardless of the inventory record-keeping method, the client
must make a periodic physical count of inventory, but not necessarily every year.

Audit decisions in the physical observation of inventory are similar to those made for other
audir areas. They include selecting audit procedures, deciding the timing of the procedures,
determining sample size, and selecting items for testing.

Physical observation tests. The same balance-related audit objectives discussed in previous
sections for tests of details of balances provide a frame of reference for discussing the
physical observation tests.

AUDIT OF PRICING AND COMPILATION

Inventory price tests include all the tests of the client’s unit prices to determine
whether they are correct. Inventory compilation tests include testing the client’s
summarization of the inventory counts, recalculating price times quantity, footing the
inventory summary, and tracing the totals to the general ledger.
INTEGRATION OF THE TEST

Tests of the acquisition and payment cycle when auditors verify inventory acquisitions as
part of the tests of the acquisitions and payment cycle, they are also obtaining evidance about
the accuracy of raw materials acquired and all manufacturing overhead costs incurred except
labor.
 Similarly, if manufacturing costs are assigned to individual jobs or process, they are
usually tested as a part of the same cycle.
1. Tests of the payroll and personnel cycle
2. Tests of the sale and collection cycle
3. Tests of cost accounting
4. Physical inventory. Pricing, and compilation