Journal Accounting

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Chapter 21

Audit of the Inventory and Warehousing Cycle

Review Questions

21-1Inventory is often the most difficult and time consuming part of many audit engagements because:

1.Inventory is generally a major item on the balance sheet and often the largest item making up the accounts included in working capital. 2.The need for organizations to have the inventory in diverse locations makes the physical control and counting of the inventory difficult. 3.Inventory takes many different forms that are difficult for the auditor to fully understand. 4.The consistent application of different valuation methods can be fairly complicated. 5.The valuation of inventory is difficult due to such factors as the large number of different items involved, the need to allocate the manufacturing costs to inventory, and obsolescence.

21-2The acquisition and payment cycle includes the system for purchasing all goods and services, including raw materials and purchased parts for producing finished goods. Purchase requisitions are used to notify the purchasing department to place orders for inventory items. When inventory reaches a predetermined level or automatic reorder point, requisitions may be initiated by stockroom personnel or by computer. In other systems, orders may be placed for the materials required to produce a customer order, or orders may be initiated upon periodic evaluation of the situation in light of the prior experience of inventory activity. After receiving the materials ordered, as part of the acquisition and payment cycle, the materials are inspected with a copy of the receiving document used to book perpetual inventory. In a standard cost inventory system, the acquisition and payment cycle computes any inventory purchase variances, which then enter the inventory system.

The following audit procedures in the acquisition and payment cycle illustrate the relationship between that cycle and the inventory and warehousing cycle.

1.Compare the inventory cost entered into the inventory system to the supporting invoice to determine that it was properly recorded and the purchase variance (standard cost system), if any, was properly reflected. 2.Test the purchase cutoff at the physical inventory date and year-end to determine whether or not the physical inventory and year-end inventory cutoffs are proper from a purchase standpoint.

21-3Companies provide online access to descriptions of inventory products and on-hand quantity levels to key inventory suppliers because this information helps the suppliers work with management to monitor the flow of inventory items. There are risks associated with providing this information, however. First, there is a risk that sensitive proprietary information may be made available to unauthorized users. The use of the Internet and other e-commerce applications may also lead to financial reporting risks if access to inventory databases and systems is not adequately controlled. The risks of providing online access to inventory information can be reduced by the use of security access password restrictions, firewalls, and other IT management controls.

21-4Cost accounting records are those which are concerned with the processing and storage of raw materials, work in process, and finished goods, insofar as these activities constitute internal transfers within the inventory and warehousing cycle. These records include computerized files, ledgers, worksheets and reports which accumulate material, labor, and overhead costs by job or process as the costs are incurred.

Cost accounting records are important in conducting an audit because they indicate the relative profitability of the various products for management planning and control, and determine the valuation of inventories for financial statement purposes.

21-5The most important tests of the perpetual records the auditor must make before assessed control risk can be reduced, which may permit a reduction in other...
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