PRE-FINALS AUDITING

Susceptibility to manipulation or misstatement

Inventories are often a key target for management bias or fraud, particularly in overstating inventory balances to inflate profits.

Complex valuation issues

Valuing inventory requires judgment, especially in estimating NRV, obsolescence, and applying cost allocation methods (e.g., FIFO, weighted average).

Challenges in physical verification

The physical count of inventory can be difficult due to factors like volume, location (e.g., multiple warehouses), or specialized storage conditions.

Cut-off errors

Improper timing in recording inventory purchases and sales can cause misstatements if not adequately evaluated.

Existence and ownership assertions

Verifying whether the inventory physically exists and whether the company owns it (especially for consigned goods) requires careful audit procedures.

Inventories

represent a significant portion of an entity’s current assets, particularly for companies engaged in manufacturing, service, or trading industries.

(Philippine Accounting Standards (PAS)) 2 

Inventories prescribe the proper accounting treatment for goods held for sale or use in production. The primary focus is on the cost, which is initially recognized as an asset of the entity.

Purchase 

This includes purchase price plus import duties and other taxes. It also includes shipping and any other cost directly attributable to the acquisition of finished goods, services, and materials, net of any deductions.

Costs of conversion: First Part

costs directly related to the units of production

Costs of conversion: Second Part

fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.

Other costs

incurred in bringing the inventories to their present location and condition.

physical inventory count

is a key control required under both perpetual and periodic systems, typically at year-end but sometimes at an interim date before reporting.

management

is responsible for the advance planning, execution, and supervision of the process.

Net Realizable Value (NRV)

is defined as the estimated selling price of an item, less than any predictable costs of completion and disposal.

Finished Goods 

is based on selling prices evidenced by sales made after the reporting date, or by the entity’s catalogues, price lists, or customers’ contracts, less any estimated costs to dispose of the item.

Work-in-Process (WIP) 

Tis based on selling prices evidenced by sales made after the reporting date, or by the entity’s catalogues, price lists, or customers’ contracts, less estimated costs to complete and dispose of the item.

Raw Materials 

is based on the replacement cost (by purchase or reproduction), less any estimated costs to complete and dispose of the items. Note that raw materials are no longer subjected to the lower cost or NRV test if the NRV of the resulting finished goods, into which these raw materials will be incorporated, exceeds their cost

Select Transactions

The auditor selects samples from total debits and credits recorded in the Cost of Goods Sold (COGS) account in the general ledger during the audit period.

Obtain Audit Evidence 

For each selected transaction, the auditor obtains supporting documents such as purchase orders, vendor invoices, shipping documents, and/or proof of payment.

Correct account classification

Confirm that the proper general ledger account was used by reviewing the material descriptions on the purchase orders.

Accurate amounts

Validate the recorded amount against the corresponding vendor invoice.

Ownership and timing

Ensure that the transaction pertains to the entity by inspecting shipping documents and evaluating the point at which title to the goods is transferred.

Existence and validity

Confirm that the transaction is valid by verifying the proof of payment.

Verify Time Charges 

Compare the recorded labor hours in the general ledger to the corresponding employee timecards. Verify that the correct number of hours was charged to the appropriate accounting period.