Transcript Special Note: Physical Inventory Observation

Special Note: Physical Inventory
Observation
Importance of Inventory
• Major component of
current assets on the
balance sheet.
• Significant effect on net
income.
• Valuation is usually very
subjective.
– Potential obsolescence
– Goods have not been sold,
so marketability may be
uncertain.
Special Note: Physical Inventory
Observation
• AICPA Professional Standards specifically address the
need to observe the client's inventory counting
procedures: "it will always be necessary for the auditor to
make, or observe, some physical counts of the inventory
and apply appropriate tests of intervening transactions"
(AU 331.12).
• If the client is on a perpetual system, the auditor may
make test counts at a time other than year-end.
– If inventory is observed on a date other than fiscal year-end, the
auditor must be able to rely on the client's internal controls in
order to roll-forward (or back) inventory quantities to fiscal yearend balances.
Special Note: Physical Inventory
Observation
• If possible, try to stop flow of goods on
inventory date
• Make TEST COUNTS
– From INVENTORY LISTING, choose sample of items
to count (Existence)
– From WAREHOUSE FLOOR, choose sample of items
to count to TRACE to final INVENTORY LISTING
(Completeness)
– Record all counts in working papers
Special Note: Physical Inventory
Observation
• Use tags to indicate whether all items have been
counted
• Be wary of "Hollow squares" and "empty boxes”
• Tour shipping and receiving areas
• Watch for OBSOLETE and SLOW-MOVING inventory
(Valuation)
• Inventory on CONSIGNMENT and at other locations
should be CONFIRMED (Rights and obligations)
• For Specialty Inventory, consider the use of
SPECIALISTS
• Inventory in transit must be confirmed.
Inventory Cost Testing
• Valuation (Price Tests)
– VENDOR INVOICE or cost records (include cost of
inventory, freight, and other costs)
– Consider COST FLOW ASSUMPTION
– Evaluate LOWER OF COST OR MARKET for
inventory
• Check Extensions and Footings of INVENTORY
LISTING and agree to PERPETUAL
INVENTORY RECORDS.
Purchase Cutoffs
• Verify CUT-OFFs for purchases
– Examine Receiving Reports and Vendor
Sales Invoices occurring around year-end to
ensure inventory received is included in the
appropriate period.
Analytic Procedures
• Verify REASONABLENESS of COGS
– Calculate Gross Profit Margin
– Compare to prior year, industry averages
• Verify REASONABLENESS of ending inventory
– Days Sales in Inventory - provides evidence
concerning management's assertion about valuation.
– Inventory Turnover - provides evidence concerning
management's assertion about valuation.