auditing chapter 15 inventory & fixed assets by david n. ricchiute

AUDITINGCHAPTER 15

Inventory & Fixed AssetsByDavid N. Ricchiute

GBW 8th ed., Ch. 152

TOPICS

Nature of conversion cycleAuditor’s consideration of controls for inventory, fixed assetsSubstantive tests for inventory, fixed assetsAudit judgment for impaired assetsComputer-assisted audit techniques for inventory, fixed assetsAssurance service opportunities


INVENTORY DOCUMENTS

Labor charge report Summary labor costs for work-in-

process

Materials requisitionPerpetual inventory record


DOCUMENTS FOR FIXED ASSETS

Depreciation scheduleOverhead application report Summary overhead

applied to work-in-process


INVENTORY CONVERSION: Nonmanufacturing

RetailerWholesalerCosts: Holding & physically

controlling prior to sale


INVENTORY CONVERSION: Manufacturing

Costs Raw materials Transformation costs

Direct labor Manufacturing overhead


INVENTORY CONTROLS

Supervisor approval for materials requisitionInventory Control personnel control raw materials, finished goods Segregation from purchasing,

receiving, shipping, production, recording

Responsible for transfers in, out, inventory levels, reports slow moving, damaged goods


MONITORING INVENTORY LEVELS

Economic order quantity models Optimize carrying costs

with risk of shortages

Just-in-time inventory management


INVENTORY ACCOUNTING

Perpetual inventory records Quantities, locations, selected cost

information

Cost records Accumulates raw materials, direct

labor, overhead Applies costs by appropriate method

FIFO, LIFO, AVERAGE


INTERNAL CONTROL OBJECTIVES

AuthorizationExecutionRecordingAccess to assets


AUTHORIZATION: Inventory Objective, Error, Procedure

Objective Error Procedure

Production authorized

Unauthorized quantities, products produced; obsolete, excess, unusable inventory

Criteria for products & quantities


EXECUTION: Inventory Objective, Error, Procedure

Objective Error ProcedureProcedures

for using, transferring inventory in accord with management’s authorization

Circumvent existing procedures; stolen, misused inventoryInventory misplaced

Inventory procedures manual for controlRestrict access to inventory


RECORDING: Inventory Objectives, Errors, Procedures

Objectives Errors ProceduresInventory

recorded at proper amounts, period, classification

Inventory not recorded; inventory, CGS misstated

Recording procedures; prenumber, control release forms; log inventory movement; periodic counts

Adjustments authorized

Unauthorized adjustments mean misused, misstated inventory

Approval for adjustments; prenumber, control forms


ACCESS: Inventory Objectives, Errors, Procedures

Objectives Errors ProceduresAccess to inventory restricted

Inventory stolen, lost, diverted

Physical controls; employee insurance, fidelity bonds; inventory insurance; segregate handling & recording

Access to production, accounting, records restricted

Records misused, destroyed, lost

Physical controls over forms, records; files authorized signatures, periodic compliance audits


FIXED ASSET ACCOUNTING

Detailed records for each asset Purchase date, cost, depreciation

method, life, salvage, accumulated depreciation

Reconcile detailed records with general ledger control accounts

Insurance records fixed assets

Additions, disposals authorized


AUTHORIZATION: Fixed Assets Objective, Error, Procedure

Objective Error ProcedurePlant additions, disposals, retirements authorized

Assets purchased, sold without management knowledgeAssets sold at unfavorable prices

Written procedures additions, disposals, retirementsCompare scrap prices received with published


EXECUTION: Fixed Assets Objective, Error, Procedure

Objective Error ProcedureProcedures

for operating, using moving fixed assets

Stolen, misused, misplaced equipment

Establish procedures for operating, using moving fixed assets; restrict access to movable assets


RECORDING: Fixed Assets Objectives, Errors, Procedures

Objectives Errors ProceduresAdditions, disposals, retirements recorded, classified correctly

Unreported transactions

Procedures for recording;for disposal eligibility; detailed records; reconcile detailed records with assets

Depreciation, amortization proper

Depreciation miscalculated, misstated

Policies for depreciation


ACCESS: Fixed Assets Objectives, Errors, Procedures

ObjectivesErrors ProceduresAccess to assets restricted

Assets lost, stolen

Physical controls; insurance coverage

Access to records restricted

Records misused, destroyed, lost

Physical controls over forms, records; periodic compliance audits


CONSIDERING INTERNAL CONTROL: Inventory

Obtain an understanding Preliminary review Document system Perform transaction walk-

through Determine whether controls

are potentially reliable in assessing control risk below maximum• Test controls


INTERNAL CONTROL DOCUMENTATION

Internal control questionnaireFlowchartMemorandum


TESTS OF CONTROLS: Inventory Records

Perpetual recordsCost records


TESTING CONTROLS: Raw Materials Perpetual Records

For sampled raw materials Compare quantities, unit costs invoice to

records


TESTING CONTROLS: Inventory Transfers

For sampled transfers Raw materials trace to

Approved requisitions, Work-in-process records, Summary entries in GL

Work-in-process, trace to Transfers to finished goods records, Summary

entries in GL Finished goods, trace to

Shipping documents Summary of CGS, Sales


TESTING CONTROLS: Inventory Cost Records

Obtain summaries of charges to work-in-processTest direct labor & overheadReview basis for standard overhead ratesDetermine disposition over-, under-applied overhead


CONSIDERING INTERNAL CONTROLS: Fixed Assets

Obtain an understanding Preliminary review System documentation Transaction walk-through Determine whether controls are

potentially reliable in assessing control risk below maximum• Test controls


TESTING CONTROLS: Fixed Asset Records

Reconcile total of detailed records with GL & investigate differencesPhysically inspect sampled fixed assetsReview adequacy insurance coverage


TESTING CONTROLS: Fixed Asset Additions

Obtain summary fixed asset additionsFoot summary; reconcile to GLFor a sample Examine authorization, PO, receiving report,

invoice, etc. Examine evidence of cash payment & trace

to voucher register Examine evidence of obligations Determine classification appropriate


TESTING CONTROLS: Fixed Asset Disposals

Obtain summary disposals & retirementsFoot summary; reconcile to GLFor a sample Examine authorization, contract, invoice,

etc. Examine entry cash receipts journal Examine note receivable;trace to GL Calculate gain, loss & trace to GL


TESTING CONTROLS: Fixed Asset Depreciation

Review depreciation methods by asset class & policies for life, salvageFor a sample Determine whether life, salvage

consistent with policies Recalculate depreciation expense,

accumulated depreciation


SUBSTANTIVE TESTS: Existence, Occurrence

Inventory Fixed Assets

Observe physical inventoryConfirm off-premises inventoryTest cutoff

Observe asset additionsTest cutoff


SUBSTANTIVE TESTS: Completeness


Observe physical inventoryConfirm off-premises inventoryTest cutoffPerform analytical procedures

Observe asset additionsTest cutoffPerform analytical procedures


SUBSTANTIVE TESTS: Rights & Obligations


Confirm off-premises inventoryTest cutoffReview consignment & purchase commitments

Test additionsTest cutoffExamine contracts, documentation


SUBSTANTIVE TESTS: Valuation, Allocation


Test priced inventoryReview physical inventory for obsolete, slow moving, unsalable goods

Verify accuracy recorded fixed assets, depreciationTest additions, disposals


SUBSTANTIVE TESTS: Presentation, Disclosure


Compare presentation, disclosures with GAAP

Compare presentation, disclosures with GAAP


SUBSTANTIVE TESTS & ASSERTIONS: Inventory 1

Existence, Completeness Observe physical inventory

Existence, Completeness, Rights Confirm off-premises inventory

Valuation Obtain records; test mathematical

accuracy


SUBSTANTIVE TESTS & ASSERTIONS: Inventory 2

Existence, Occurrence, Completeness, Rights Test cutoff & coordinate with sales,

A/R

Completeness Analytical procedures

Presentation, Disclosure Review for classification, disclosure


SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 1

Valuation Verify mathematical accuracy

fixed assets, depreciation

Existence, Occurrence, Completeness, Rights, Valuation Test additions, disposals;

physically inspect


SUBSTANTIVE TESTS & ASSERTIONS: Fixed Assets 2

Completeness Analytical tests

Presentation, Disclosure Fixed assets, depreciation properly

classified, disclosed


MANAGEMENT & AUDITOR INCENTIVES

Management incentives Income smoothing via “big baths”

Auditor incentives Need persuasive evidence of

permanent loss in value


COMPUTER ASSISTED TESTS: Inventory, Fixed Assets

Substantive test Computer taskVerify mathematical accuracy

Foot, cross-foot, test extensions

Compare details Compare quantities master file, perpetual file

Perform price tests

Compare prices final inventory with invoices

Merge physical counts, perpetual records

Update & print exceptions

auditing chapter 15 inventory & fixed assets by david n. ricchiute

Documents

inventory slide

inventory objectives

inventory conversion

restricted inventory

classification inventory

inventory fixed assets

misstated inventory

unusable inventory criteria