Inventory Audit: A Comprehensive Guide for Auditors

Posted on Aug 28, 2024 in Economy

Inventory Audit

General.

From the standpoint of the audit, inventory is the largest item of current assets in a business:

• Due to its economic size.
• Because of its impact on the income statement.
• Because of its financial impact.

1. Objectives of the Audit

The objectives of the audit in this area are:

• Check the accuracy and reliability of the physical inventory contained in the balance:
  • Periodic physical count.
  • Permanent inventory.
• Check the accuracy and reliability of the valuation of inventory and uniformity of that assessment.
  • Raw materials.
  • Work in process.
  • Finished goods.
• Check the obsolescence of inventory.
• Check whether the inventory is owned by the company and determine:
  • Inventory of companies held by third parties.
  • Inventory of others held by the company.
  • Inventory in transit.
• Check the cuts between the various stages:
  • Tickets.
  • Production.
  • Outputs.
• Check the cost of sales corresponds to transactions and events held during the period and it has been determined in a reasonable and consistent manner.
• Check the appropriate financial statement presentation.
• Check that internal control measures and administrative procedures are working properly. Check for adequate insurance coverage of inventory.

Internal Control.

The internal control of inventory is related to purchasing activities, manufacturing, distribution, and sale. An adequate internal control of inventory is required to be properly:

• Ordered
• Received
• Controlled
• Used
• Physically counted
• Billed
• Authorization of the valuation method chosen by the company.
• Segregation of duties for authorization, custody, and registration.
• Timely recording of inventory investment and liability.
• Timely recording of all shipments and, where appropriate, billing, including accounting for cost of sales.
• Control of returns.
• Physical custody of inventory.
• Physical inventories.
• Adequate procedures for recording and accumulation of cost elements.
• Adequate records for inventory control.
• Adequate records for inventory control in warehouses owned by third parties for the company.
• Periodic comparison of the sum of the auxiliary with the largest account balance accordingly.
• Verification of physical inventory by independent internal staff.
• Procedures for determining the loss in value of inventory and the recording of the estimates.
• Adequate protection to the entity through purchase of insurance.
• Information systems with updated figures.

The implementation of audit evidence depends on a proper analysis of the factors to be considered:

• Nature and characteristics of own inventory
• Changes or significant fluctuations in:
  • Profit margins.
  • Prices of materials.
  • Product demand.
  • Levels and types of inventory or production, including the classification, collection, or application of overhead.
• Launch of new products, changes in technology, or engineering modifications.
• New products and lower prices from competition.
• Discontinued products.
• Importance of defective production or reprocessing.
• Decrease or increase the installed capacity used.
• Production and important shipments near the end of the fiscal year.
• Effect of official regulations, price controls, restrictions on imports or exports.
• Material contracts with specific terms and conditions as to quality, deadlines, etc. compliance with conventional punishments.
• Check the appropriate financial statement presentation.
• Check that internal control measures and administrative procedures are working properly. Check for adequate insurance coverage of inventory.

Internal Control.

• Lack of procedures for physical safeguards.
• Lack of segregation of duties.
• Differences in procedures for physical inventories.
• Frequency of major adjustments for physical inventories.
• Physical inventories that differ from the year-end.
• Auxiliary records unreliable.
• Significant inventory figures identified as obsolete or slow moving, but not investigated or reported as such.
• Materials held by third parties or received from third parties.
• System features inventory control costs or the method of valuation and changes in them.
• Poor procedures for reviewing or updating of unit costs and so on.

For planning, information must be available on the characteristics of the inventory and cost of sales such as:

• The systems cost.
• Methods of valuation.
• Procedures used.

Technical Review.

• Comparison of historical costs and figures updated with previous years.
• Analysis of financial reasons.
• If possible, comparison of figures with the available information about companies in the industry.
• Get an explanation of variations and investigate any unusual and unexpected relationship that is not between the current and previous years such as:
  • Production volume.
  • Percentages of materials, labor, and overhead.
  • Material consumption and waste.
  • Margins.
  • Unlike inventories.
  • Rates of slow-moving or obsolete inventories.
  • Age of inventory.
  • Global estimates.
  • The cost of production and sales.
  • Reconciliations of the amounts invoiced and shipped to the procurement quantities have it shipped.

Evaluation of Internal Control.

1. Are stocks under the control of a manager responsible?
2. Is there a procedure for identifying stockpiles damaged, obsolete, or slow-moving? Describe it.
3. What if there was material of value capable of being stolen, is it properly stored in a fenced and monitored by authorized personnel and responsible?
4. Is there adequate protection, either through barbed wire fences, guards, etc., avoiding material shipments or unauthorized exits?

Permanent Record.

1. a. There are stock subsidiary records for:

• What raw materials?
• What work in process?
• Finished product?
• What stores?

b. Do you use those records in the inventory management and procurement planning, and how is accounting information used? These subsidiary records show:

• What amounts in kind?
• Are minimum and maximum?
• Is unit cost?
• What cost?

These are driven by auxiliary staff:

• He has not got access to stocks?
• What does not authorize stock movements?

Is the official who reviews and approves adjustments or corrections to accounting errors in the accounts of independent existence:

• Custody of stocks?
• Did you record stock?

Do you record the movements in the auxiliary permanent stock, based solely on the entries in the account control?

Physical Counts.

1. Is there an all physical counts of inventory at least once a year?
2. Are employees who perform physical inventories are properly trained, supervised?
3. Are tests performed to ensure that all items were inventoried?
4. Are the differences are investigated by responsible staff, who does?
5. Are the accounting records conform to the true existence?
6. Is this adjustment made based on an accounting entry duly approved by a responsible officer, who does?

Audit Program.

General.

1. Verify that the low material damaged, obsolete, or slow moving are duly authorized.

Permanent Records.

1. For a period selected by the manager of the audit to obtain journal entries recorded in the accounts of stocks and analysis that support and perform the work identified in the following points. (Indicate the period covered.)
2. Control a number of admissions for purchases (local and imported) to verify the charge sheets stock with supplier invoices and receiving report in both physical units and imports. Indicate scope (taking into account work in accounts payable).
3. Using the listings valued in outlets stores of raw materials and materials:

• Select some output based on the records of stocks and vice versa, making sure to match the number of units and unit costs.
• Collate outputs selected ballots duly authorized delivery of materials by controlling their corresponding numbers.
• Check the valuation applied.
• Make sure that the previous outputs are loaded correctly in the auxiliary in-process.
• Check the journal for commodities and materials consumed during the respective month and move to higher.