SESSION 6 – MOCK EXAM

Kitchen Create Limited is a UK based company whose principal activity is the retail
and installation of luxury kitchens and bathrooms selling both to the public and large
house building companies. The company carries a considerable amount of finished
product inventory and has one central warehouse in Leeds and two smaller
warehouses in Newcastle and Milton Keynes.

The financial year end is 31 December 2012 and the projected turnover of the
company for the year is £65 million with a projected profit before tax of £7 million.
The total inventory at the year end is £6 million of which £2.5 million is contained at
the Leeds central warehouse, £1.7 million at Milton Keynes and £800,000 at
Newcastle. The remaining £1 million is on consignment at the sites of several large
customers.

Computerised inventory records are kept for the Leeds and Milton Keynes
warehouse. However, at the Newcastle warehouse there are no book records of the
inventory and the company has to rely on the inventory count to verify the inventory
quantities.

Inventory is valued at invoice price. There are a number of kitchen and bathroom
products in inventory that are greater than one year old and are considered to be
unfashionable items. Kitchen Create plan to sell these items at a discount in January
2013.

The inventory count will be performed on 30 and 31 December and in the past has
been well controlled at both the Leeds and Newcastle warehouse. However, major
irregularities were discovered last year at the Milton Keynes warehouse where
certain inventory was counted twice, while some inventory was not counted at all.
Management have asserted that they have now improved count procedures and this
should not happen again.

You are the auditor senior in charge of the area of inventory and your audit manager
has informed you that he wants you to attend the inventory counts and perform 60
inventory counts across the three warehouses. He wants you to devise an audit
program based on your assessment of audit risk.
Required:

a) Taking into consideration audit risk set out how you would allocate the
60 inventory counts over the three warehouses, explain your reasoning.
(5 marks)

b) As audit senior explain the procedures that you should undertake before
and during the inventory count of Kitchen Create Limited. (8 marks)

c) Draft seven audit tests to perform at the final audit to verify the valuation
of inventory focusing on the key risk areas. (7 marks)
TOTAL 20 MARKS
a) Taking into consideration audit risk how would you allocate the 60
inventory counts over the three warehouses, explain your reasoning.
(5 marks)

1 mark per relevant point. For full marks must present a reasoned audit
strategy based on audit risk.

Comments could include

 Would attend all warehouses because inventory is material at each
site
 Would not allocate 60 counts equally over the three sites but would
consider audit risk and materiality at each site
 Would focus highest number of counts at Milton Keynes given higher
control risk because of problems in the past
 Although Leeds has the largest inventory control risk would be the
lowest at this site given no problems in the past and computerised
inventory records kept. Perform least number of counts at this site.
 Control risk at Newcastle would be considered high given no inventory
records kept. However, number of items tested would be reduced
given lower level of inventory at this site.
 Would use computerised audit risk tables to determine exactly how
many items to test at each site

b) As audit senior explain the procedures that you should undertake before
and during the inventory count of Kitchen Create Limited.
(8 marks)

1 mark per procedure – for maximum marks must consider procedures before
and during the inventory count

Procedures could include:

Before the inventory count

 Review previous year’s working papers to identify problems and discuss
changes with management.
 Identify how they have improved the count procedures at the Milton
Keynes site
 Enquire whether there any concerns over theft or mis-management at
the Newcastle site
 Review and discuss with management the inventory count instructions
which are to be given to staff
 Become familiar with nature/volume of inventory – identify material
items/problematic areas that will require specific counting
 Plan audit staffing requirements and brief audit teams attending the
counts (e.g inform teams of previous problems at the Milton Keynes site)
 Determine how many items are to be counted at each site

During the inventory count

  Observe the inventory count to ensure compliance with established
procedures (tests of controls)
 Perform test counts of inventory and record these for subsequent
checking with the final inventory sheets (floor to sheet, sheet to floor)
 Note any old or damaged inventory for follow up at the final audit
 Identify any third party inventory and ensure these are excluded from the
count
 Note Cut Off information e.g identify last goods received note, last
despatch note for follow up at the final audit

c) Draft seven audit tests to perform at the final audit to verify the valuation
of inventory focusing on the key risk areas.
(7 marks)

1 mark per test

Tests could include:

 Trace stock counts to final stock papers.

 Check final compilation of stock papers to inventory figure in the
financial statements
 Follow up cut-off information from stock count e.g ensure last goods
received note is included in payables, last despatch note is included in
receivables
 Ensure obsolete/old items noted at stock count are appropriately
written off to net realisable value
 Ensure all old stock and stock that is to be sold off at a discount in
January is recorded at the lower of cost and net realisable value
 Trace stock valuation to purchase invoices
 Confirm quantities of consignment stock with the third parties