ap 30 inventories and cost of sales

Form AP 30

Index Reference__________

Audit Program for Inventories and Cost of Sales

Legal Company Name Client: Balance Sheet Date:

Instructions: The auditor should refer to the audit planning documentation to gain an understanding of the financial reporting system and the planned extent of testing for inventories and cost of sales. Modification to the auditing procedures listed below may be necessary in order to achieve the audit objectives.

All audit work should be documented in attached working papers, with appropriate references noted in the right column below.

Audit Objectives Financial Statement Assertions

Inventory reflected in the balance sheet physically exists and includes all materials, products, and supplies owned by the client on hand, in transit, out on consignment, or at outside locations.

Existence or occurrence Completeness

The entity has legal title or similar rights of ownership to the inventory.

Rights and obligations

Usage and movement of inventory is recorded correctly as to account, amount, and period.

Existence or occurrence Valuation or allocation

Obsolete, slow-moving, and overstock inventory is monitored and promptly identified, and valuation allowances are recorded when necessary.

Valuation or allocation

The entity’s policies, procedures, and controls for determining an accurate count of inventory are adequate and operating as designed.

Existence or occurrence Completeness

Costs are assigned to inventory in accordance with the stated valuation method, and inventory is carried at the

Valuation or allocation

lower of cost or market.

Inventory is properly classified and presented in the financial statements and adequate disclosure is made with respect to the valuation method, major components of inventory, and encumbered inventory.

Presentation and disclosure

Performed

By Workpaper

Reference Inventory Observation Procedures 1. Meet with client’s personnel in charge of the physical count

of the inventory and perform the following planning procedures (the auditor may wish to use form AP 37 “Checklist for Observation of Inventory Counts” in performing this step):

a. Determine the physical inventory observation date, the

locations of the inventory including outside locations and warehouses, client supervisory staff in charge of the inventory, the materiality of inventory levels at the respective locations, and whether any outside specialists will be used in counting the inventory.

b. Obtain an understanding of the procedures that will be

used by the client to count the inventory. Review any inventory instructions, location maps, samples of tags to be used, and other relevant information that will be used to document the inventory procedures.

c. Tour the client’s inventory locations and determine

which inventory items will be material to the overall financial statements when priced and extended.

d. Determine the nature and extent of any inventory held

for the client by warehouses or other third parties and the need to confirm or observe such inventory.

e. Determine the adequacy of audit staffing and hold a

preplanning meeting to review the client’s instructions and procedures.

2. On the physical inventory date, perform the following

procedures:

Performed Workpaper By Reference

a. Tour the premises; evaluate the inventory arrangements;

and recommend appropriate changes as needed.

b. Determine whether property not owned by the client is

clearly segregated and identified.

c. Determine the appropriate cutoff control numbers for

receiving and shipping documents and obtain copies.

d. Ascertain that receiving and shipping departments are

informed about appropriate cutoff procedures.

e. Observe and note the client’s practices and procedures

regarding segregation and identification of slow-moving, damaged, or obsolete inventory.

f. Examine samples of inventory items for source of

identification, description, measure, and status of completion.

g. Observe count teams and determine whether the client’s

instructions and procedures are being properly followed.

h. Ascertain that pre-numbered inventory tickets and/or

count sheets are properly controlled and accounted for.

i. Make test counts, particularly of high-value items, and

record test count information such as item number, description, stage of completion, quantity, and other pertinent information that would assist in tracing the inventory item to the final inventory listing.

j. Observe any omissions from count and ask for recounts

in case of errors.

k. Note any inventory movement during the observation

and obtain adequate explanations.

l. Determine whether any inventory appears to be

obsolete, slow-moving, damaged, or very old and whether the client has properly identified those items. Consider preparing a summary of these items.


m. Determine if all inventory count sheets or tags have been accounted for. Obtain a summary of tags used, unused, voided, or damaged and summarize the sequences of tags or count sheets into these categories.

n. Tour the shipping and receiving areas and obtain

information about inventory items therein. Determine whether they should be counted in or excluded from the inventory.

o. Determine the nature and extent of any inventory held

by the entity on behalf of third parties and ensure that it is excluded from the inventory count.

p. Prepare a memorandum of observation of the physical

inventory. Include comments on the overall controls, arrangements, procedures used, and compliance therewith.

3. If the auditor is unable to observe the physical inventory at

the balance-sheet date, perform the following procedures. (Note that if the client does not maintain adequate records and controls over inventories, the following procedures may not be adequate to compensate for not observing the physical inventory count at the balance sheet date. In that case, the auditor must evaluate the materiality and possible misstatement and decide whether the audit opinion must be modified.)

a. Observe the physical inventory at a subsequent date by

performing steps 1 and 2 above.

b. Test inventory transactions occurring between the

balance-sheet date and the date of the subsequent physical inventory procedures. Vouch inventory purchases to receiving documents and vendor invoices. Vouch cost of sales transactions to customer purchase orders and shipping documents.

c. Review documentation of the physical count taken by

the client at the balance-sheet date. Trace selected quantities from the inventory listing to the count sheets or tags, and from the count sheets or tags to the inventory listing.


d. Compare gross profit for the last month of the year

under audit to gross profit for the first month of the subsequent period to assess reasonableness of cutoff.

Reconciliation and Valuation of Inventory 4. Obtain an understanding of the procedures used by the client

to summarize, reconcile, and value the inventory and test these procedures as follows:

a. On a test basis, trace tag sequences of used, unused,

voided, and damaged tags to the final inventory listing summary and ascertain consistent treatment. Investigate any tags that have been added or deleted.

b. Trace test counts noted during the observation of the

physical inventory to the final inventory listing summary and investigate any differences.

c. Test the arithmetical accuracy of the final inventory

listing summary with respect to both quantities and dollar value.

d. Reconcile the final inventory listing summary to the

general ledger and review book to physical adjustments. Investigate large adjustments for possible inventory shrinkage, motives to overstate inventory, or weaknesses in the client’s system.

e. Trace confirmation of inventory items held by third

parties to the final inventory listing summary.

5. Determine the inventory method used (FIFO or weighted

average) and determine whether such method is consistently applied.

6. For raw materials and purchased finished goods on the

FIFO method, test the cost as follows:

a. Vouch the cost to the most recent vendor’s invoice and other external evidence; if the quantities on hand exceed the invoice total, vouch the excesses back to previous purchases until the quantity on hand has been built up.


b. Determine that freight, duty, discounts, and allowances

are consistently accounted for.

c. Note the dates of purchase of the items tested and note items that appear to be slow-moving.

d. Relate the cost of items tested to the costs of similar products and investigate significant variations.

e. Relate the costs of other significant untested items to prices used in the prior year and investigate significant variations.

f. Determine the monetary difference for each item tested, summarize total differences, and consider the impact of misstatements found on the overall population.

7. For work in process and finished goods manufactured by the company, perform the following:

a. Trace unit costs from the final inventory listing to the cost accounting records.

b. Trace the raw material quantities used in producing the work-in-process items or the finished goods items to supporting documents (e.g., bills of material, requisition forms, production reports).

c. Trace the cost of raw materials used to the vendor invoices, freight invoices, and other external documents, where appropriate.

d. Trace the labor hours used in producing the work in process items or finished goods items to supporting documents (e.g., time cards, time studies).

e. Agree actual labor rates used to payroll records.

f. For overhead, test the client’s overhead rate as follows:

(1) Review the costs included in the overhead pool for propriety.


(2) Determine that overhead costs are being charged to inventory in accordance with appropriate policy (e.g., as a percentage of direct labor).

(3) Identify disposition of variances between actual overhead costs incurred and overhead costs applied to production and inventory. Determine that variances are reasonable and that no excessive costs for idle plant are being charged to inventory.

(4) Compare the overhead rate to the prior year for reasonableness.

8. Perform the following procedures to test for slow-moving

and obsolete items:

a. Obtain an understanding from the client with respect to

the criteria and calculation used to determine what constitutes slow-moving and obsolete items.

b. Note dates per vendors’ invoices during the inventory price test and be alert for slow-moving items.

c. Compare items noted during the current period’s review of slow-moving and obsolete items to the prior year’s listing.

d. Check that significant items written down in prior years have not been written up in the current year; determine if further write-downs might be required.

9. Perform the following procedures to determine lower of cost

or net realizable value applications required by IAS 2:

a. For purchased inventory items, compare, on a test basis, the unit price used in the final inventory listing summary to current price lists, recent sales invoices, or recent vendor invoices.


b. For work in process and finished goods manufactured by the company, compare, on a test basis, inventory carrying amounts and recent selling prices or sales invoices; ascertain stage of completion and estimated cost to complete for work in process items; and ascertain that such carrying amounts are not in excess of net realizable value.

c. Compare inventory turnover ratio and gross profit percentage of the current period to prior periods.

d. Compare quantities on hand for selected items with quantities noted on the sales invoices to determine that the quantities on hand are not excessive.

10. Perform the following shipping and receiving cutoff

procedures with respect to cutoff information obtained at the physical inventory observation date:

a. On a test basis, determine whether the last few shipments of inventory before the physical inventory observation date have been excluded from inventory and included in sales for the period under audit.

b. On a test basis, determine whether the first few shipments of inventory after the physical inventory observation date have been included in inventory and excluded from sales for the period under audit.

c. On a test basis, determine whether the last few inventory items received before the physical inventory observation date have been included in inventory and accounts payable for the period under audit.

d. On a test basis, determine whether the first few inventory items received after the physical inventory observation date have been excluded from inventory and accounts payable for the period under audit.

11. If the inventory physical count was taken as of an interim

date, obtain an analysis and reconciliation of the inventory per the physical count to the inventory per the balance sheet and perform the following:


a. Review and analyze the general ledger inventory control accounts from the date of the physical count to the balance-sheet date.

b. Trace inventory additions to appropriate sources, such as the purchases journal and cost accounting records.

c. Trace inventory reductions to cost of sales.

d. Determine the propriety and reasonableness of any other reconciling items.

12. Perform the following analytical procedures for inventories and investigate any significant fluctuations or deviations from the expected balances:

a. Compare the current year’s account balances with the prior year’s account balances for inventories and the reserves for slow-moving or obsolete items.

b. Compare the current year’s components of inventory (i.e., raw materials, work in process, finished goods) as a percentage of total inventory with the prior year’s percentages.

c. Compare the current year’s composition of total product cost (i.e., materials, labor, and overhead) with the prior year’s.

d. Compute the following ratios for the current year and compare with the prior year’s ratios:

(1) Inventory turnover in total and by major product or division.

(2) Average age of inventory in total and by major product or division.

(3) Gross profit percentage in total and by major product or division.

(4) Shrinkage ratio (i.e., inventory write-offs to average inventory).


13. If inventory held in public warehouses or by other outside

custodians is significant in relation to current assets and total assets, perform one or more of the following procedures:

a. Confirm the inventory held in public warehouses or by other custodians.

b. Test the client’s control activities used in investigating and evaluating the performance of the warehouseman.

c. Observe the warehouseman’s or client’s count of goods whenever practical and reasonable.

d. If warehouse receipts have been pledged as collateral, confirm details with the lenders.

e. Obtain an independent auditor’s report on the warehouseman’s system of internal control relevant to custody of goods and, if applicable, pledge of receipts, or apply alternative procedures at the warehouse to gain reasonable assurance that information received from the warehouseman is reliable.

14. If the auditor is concerned about the risk of fraud, audit procedures such as the following should be considered in addition to the ones listed above:

a. Examine individual entries in the general ledger inventory account to search for expenses or other items that are improperly charged to inventory.

b. Scrutinize any material book to physical inventory adjustments and examine supporting documents.

c. Review year-end accruals and adjustments to the inventory account and ascertain that the entries are normal and required.

d. Perform detailed price testing of labor and overhead rates.

e. Look for evidence of bulk sales at steep discounts which


could indicate a declining value for the products.

f. Perform a detailed analysis of scrap sales.

g. Examine journal entries made to the inventory account subsequent to year-end.

h. Expand the inventory cutoff procedures.

i. Confirm accounts payable.

j. In connection with the inventory observation:

(1) Observe all inventory locations simultaneously.

(2) Obtain copies of all inventory count sheets or tags before leaving the physical inventory sites.

(3) Physically examine the inventory by opening boxes to assure that the purported inventory is actually present and match content to the labels.

15. Determine if any inventory is pledged or subject to liens. 16. Determine if the inventory amount includes any significant

intercompany profit that should be eliminated.

17. Determine if the inventory is properly classified in the

balance sheet and if adequate disclosure is made with respect to the valuation method, major components of inventory, and pledged inventory.

Based on the procedures performed and the results obtained, it is my opinion that the objectives listed in this audit program have been achieved. Performed by Date Reviewed and approved by

Date

Conclusions: Comments:

ap 30 inventories and cost of sales

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