Inventory and Cost of Goods Sold

Audit Risk Model

AAR = IRR*CR*PDR

First step of designing audit plan

Audit risk model

Inventory Inherent Risk

Often highly material

May be stored in many locations

Different forms (jewls, chemicals, etc)

Valuation complex (manufactured is harder than purchasing inventory)

Valuation may involve estimates

Inventory internal controls

physical controls

Separation of duties between custody and record-keeping

Periodic reconciliation between physical inventory and accounting records

Compare gross margin % with prior years

GM % = Gross margin/sales

to detect misstatements of inventory and COGS

Compare inventory turnover with prior years

InvTO = COGS/Inventory

to detect overstatement of inventory due to obsolescence

Compare unit costs of inventory with prior years

To detect: misstatements of inventory and COGS

Compare manufacturing costs with prior years

To detect: misstatements of inventory due to mis-valuation of manufactured items

Physical Count of Inventory

Auditor must observe count

Be present at all times, observe procedures, make inquiries of client personnel, make independent test of counts

Count procedures must

Prevent double counting

Ensure all items are counted

Identify inventory as “bill and hold” or “consignment” where appropriate

Provide for checks of counts

Control movement of goods

Methods of tracking inventory count

Perpetual inventory records

Count tags

Inventory count existence

select sample of tags/count sheets, locate and count inventory

confirm inventory held by third parties

Day of count Completeness

Select items from the floor and trace to tags/count sheets

Day of count valuation

examine descriptions on count tags

Look for damaged or obsolete goods

After count

Client prepare inventory schedule showing quantities and unit costs of each item in inventory

Substantive tests performed to make sure data on schedule agrees with records from physical count

Substantive procedures existence

select a sample of items from inventory schedule

vouch to count sheets or tags

Substantive procedures completeness

Select items from count sheet or tags

Trace to inventory schedule

Substantive procedures valuation

Agree unit costs to vendor invoices

Test extensions and footing of inventory schedule

Review perpetual records

Substantive procedures Rights and Obligations

Inquire about consignment or bill and hold inventory

Substantive procedures presentation and disclosure

Valuation method

Raw materials vs WIP vs finished goods

Valuation/Obsolescense

inventory must be carried at lower of cost or market value