In: Accounting
You are the audit manager assigned to the audit of MNO Corporation. MNO imports goods from around the world and sells the goods to small and midsize retailers. This is the first year of the audit. Andy has recently graduated and has joined your firm as a junior accountant. He has been assigned to the inventory section for the interim audit and is eager to do a good job. Andy uses the model documentation used by your firm. His notes show that MNO has thirty personnel at the warehouse in Brampton and four at the head office in midtown Toronto who work on inventory. Downtown there is a purchasing agent who works closely with the sales team to buy what retailers want to sell. The purchasing agent authorizes the orders that he enters into the computer system. A logistics specialist arranges for shipping and customs clearance, including any shipments to customers. The inventory analyst monitors sales and stock levels. She makes journal entries to write off any obsolete or slow moving inventory, oversees the annual inventory count, and reconciles the perpetual records with sales records. She has an assistant reporting to her. The assistant gets a copy of all receiving reports for incoming goods and a copy of all shipping documents for sales. He enters these into the computer system to match to purchase orders and customer sales orders, making notes of any backorders and short shipments to bring to the inventory analyst’s attention. At the warehouse, the warehouse manager supervises two receiving clerks and four shipping clerks as well as the twenty-three warehousemen. He also authorizes any write-offs for damaged goods. The warehousemen put received goods on the shelf as well as pick goods off the shelf to prepare for shipment to customers. They also look for any damaged goods that need to be written off. The clerical staff double check all counts for received or shipped and prepare the relevant reports. A copy of each report is kept for the warehouse records, a copy is sent to the assistant inventory analyst, and a third copy is sent to either accounts payable or to the invoicing clerks depending on whether the goods were received or shipped out.
Required
a) Evaluate the general and environmental controls over inventory.
b) How would you explain to Andy the difference between validity and completeness as they apply to testing inventory controls in a perpetual inventory system?
Answer :-
1) Evaluate the general and environmental controls over inventory.
Inventory control is the process of managing stock once it arrives at a warehouse, store or other storage location. It involves planning for sales and stock-outs, optimizing inventory for maximum benefit and preventing the pile-up of dead stock.
The four types of inventory most commonly used are Raw Materials, Work-In-Progress (WIP), Finished Goods, and Maintenance, Repair, and Overhaul (MRO). When you know the type of inventory you have, you can make better financial decisions for supply chain.
Five elements of internal controls
A) Control environment :- The foundation of internal controls is the tone of business at management level.
B) Risk assessment :- Risk assessment is the evaluation of business flow and exposure to risk. ...
C) Control activities.
D) Information and communication. ...
E) Monitoring.
Main functional aspects of inventory control include:
Specification of goods, their ID numbers and their types;
Keeping information on goods serial numbers;
Barcodes implementation and control;
ABC goods prioritizing;
Replenishment process;
Managing inventory lists;
Real-time warehouse reports;
A company's investment in inventory is usually a large one, and it may be comprised of many merchandise items that can be readily stolen and resold. If the inventory contains mostly raw materials, keeping track of it is essential for ensuring that the production processes using it will not run short of materials. This means that you need to implement an array of controls, either to prevent theft or to ensure that the manufacturing operation does not run short of inputs. We will describe below a number of the key controls to consider for inventory investment.
Key internal controls for inventory are:
· Fence and lock the warehouse. The single most important inventory control is simply locking down the warehouse. This means that you construct a fence around the inventory, lock the gate, and only allow authorized personnel into the warehouse.
· Organize the inventory. It may not seem like a control to simply organize the inventory in the warehouse, but if you cannot find it, you cannot control it. Thus, a fundamental basis for inventory internal control is to number all locations, identify each inventory item, and track these items by location.
· Count all incoming inventory. Do not just take the word of the supplier that the quantity stated on the delivery is the correct one. Count the inventory before recording it as received. This keeps errors from being introduced into the inventory records.
· Inspect incoming inventory. Verify that all incoming inventory is of the correct type and is not damaged. All items that fail inspection should be returned at once, and the accounts payable staff notified that the returned items should not be paid for.
· Tag all inventory. Every scrap of inventory in the warehouse should be identified with a tag, which states the part number, description, unit of measure, and quantity. Otherwise, inventory items are bound to be mis-identified.
· Segregate customer-owned inventory. If there is inventory on-site that customers own, the warehouse staff will likely count it as though it is owned by the company, so have a procedure in place for labeling these items as customer-owned when they arrive, and segregate them in a separate part of the warehouse.
· Standardize record keeping for inventory picking. When an item is picked from the shelf in the warehouse, for use either in the production area or for sale to customers, have a standard procedure for recording the picks as soon as they leave the warehouse (which is easier if there is a warehouse fence, and inventory can only pass through a single controlled gate).
· Sign for all inventory removed from the warehouse. If inventory items are being removed from the warehouse for reasons outside of the normal picking process, have the person removing the inventory sign for the removal, so that there is a record of who is responsible.
· Audit the bill of materials. The bill of materials is a record of the parts used to construct a product. The bill of materials is used to pick items from stock, so if the bill is incorrect, pickers will pull incorrect amounts from the warehouse. This calls for a periodic audit of every bill, as well as password-only access to the bill of material records in the computer system.
· Trace extra requisitions and returns. If the production staff asks for extra issuances of parts, or returns excess amounts to the warehouse, then there is an error in the picking records (possibly in the bill of materials, as just noted).
· Conduct a periodic obsolete inventory review. The warehouse can eventually become choked with obsolete inventory that cannot be used, which requires high storage costs and also interferes with the components that are needed in production. Form a materials review board that periodically combs through the inventory records to determine which items should be sold off or otherwise eliminated.
· Conduct cycle counts. Have the warehouse staff conduct small, frequent counts of a small portion of the inventory, and investigate and correct any errors they find. This gradually improves the inventory record accuracy.
· Investigate negative-balance inventory records. If the accounting records show that there is negative inventory on hand, then there is obviously a transactional flaw that caused the negative balance. This is a prime target for a detailed investigation.
· Record scrap transactions. Do not just throw scrap in a scrap bin when it occurs. If you do, the accounting system still thinks the scrapped item is in stock, and so will overstate the amount of inventory. Instead, create a procedure to track scrap on a regular basis.
An effective internal control structure for inventory includes a company’s plan of organization and all the procedures and actions it takes to:
· Protect its assets against theft and waste.
· Ensure compliance with company policies and federal law.
· Evaluate the performance of all personnel to promote efficient operations.
· Ensure accurate and reliable operating data and accounting reports.
What Is Inventory Management?
Inventory management is a step in the supply chain where inventory and stock quantities are tracked in and out of warehouse.
The goal of inventory management systems is to know where inventory is at any given time and how much of it you have in order to manage inventory levels correctly.
2) How would you explain to Andy the difference between validity and completeness as they apply to testing inventory controls in a perpetual inventory system?
Why Is Inventory Management Important :-
Inventory management is the fundamental building block to longevity. When inventory is properly organized, the rest of supply-chain management will fall into place. Without it, you risk a litany of mistakes like mis-shipments, out of stocks, overstocks, mis-picks, and so on.
Proper warehouse management is key. Mis-picks result from incorrect paper pick lists, disorganized shelf labels, or just a messy warehouse in general. Mis-shipments are a direct result of mis-picks at the beginning of the inventory process, and are also a result of a lack in quality control procedures.
Out of stocks and overstocks occur when a company uses manual methods to place orders without having a full grasp on the state of their inventory. This is a not a good predictor for inventory forecasting and results in too much stock or too little.
Inventory Management Techniques :-
That being said, inventory management is only as powerful as the way you use it.
Some inventory-control techniques you may choose to utilize in own warehouse.
1. Economic order quantity.
Economic order quantity, or EOQ, is a formula for the ideal order quantity a company needs to purchase for its inventory with a set of variables like total costs of production, demand rate, and other factors.
The overall goal of EOQ is to minimize related costs. The formula is used to identify the greatest number of product units to order to minimize buying. The formula also takes the number of units in the delivery of and storing of inventory unit costs. This helps free up tied cash in inventory for most companies.
2. Minimum order quantity.
On the supplier side, minimum order quantity (MOQ) is the smallest amount of set stock a supplier is willing to sell. If retailers are unable to purchase the MOQ of a product, the supplier won’t sell it to you.
For example, inventory items that cost more to produce typically have a smaller MOQ as opposed to cheaper items that are easier and more cost effective to make.
3. ABC analysis.
This inventory categorization technique splits subjects into three categories to identify items that have a heavy impact on overall inventory cost.
4. Just-in-time inventory management.
Just-in-time (JIT) inventory management is a technique that arranges raw material orders from suppliers in direct connection with production schedules.
JIT is a great way to reduce inventory costs. Companies receive inventory on an as-needed basis instead of ordering too much and risking dead stock. Dead stock is inventory that was never sold or used by customers before being removed from sale status.
5. Safety stock inventory.
Safety stock inventory management is extra inventory being ordered beyond expected demand. This technique is used to prevent stockouts typically caused by incorrect forecasting or unforeseen changes in customer demand.
7. FIFO and LIFO.
LIFO and FIFO are methods to determine the cost of inventory. FIFO, or First in, First out, assumes the older inventory is sold first. FIFO is a great way to keep inventory fresh.
LIFO, or Last-in, First-out, assumes the newer inventory is typically sold first. LIFO helps prevent inventory from going bad.
8. Reorder point formula.
The reorder point formula is an inventory management technique that’s based on a business’s own purchase and sales cycles that varies on a per-product basis. A reorder point is usually higher than a safety stock number to factor in lead time.
9. Batch tracking.
Batch tracking is a quality control inventory management technique wherein users can group and monitor a set of stock with similar traits. This method helps to track the expiration of inventory or trace defective items back to their original batch.
10. Consignment inventory.
If you’re thinking about local consignment store here, you’re exactly right. Consignment inventory is a business deal when a consigner (vendor or wholesaler) agrees to give a consignee (retailer like favorite consignment store) their goods without the consignee paying for the inventory upfront. The consigner offering the inventory still owns the goods and the consignee pays for them only when they sell.
11. Perpetual inventory management.
Perpetual inventory management is simply counting inventory as soon as it arrives. It’s the most basic inventory management technique and can be recorded manually on pen and paper or a spreadsheet.
12. Dropshipping.
Dropshipping is an inventory management fulfillment method in which a store doesn’t actually keep the products it sells in stock. When a store makes a sale, instead of picking it from their own inventory, they purchase the item from a third party and have it shipped to the consumer. The seller never sees our touches the product itself.
13. Lean Manufacturing.
Lean is a broad set of management practices that can be applied to any business practice. It’s goal is to improve efficiency by eliminating waste and any non value-adding activities from daily business.
14. Six Sigma.
Six Sigma is a brand of teaching that gives companies tools to improve the performance of their business (increase profits) and decrease the growth of excess inventory.
15. Lean Six Sigma.
Lean Six Sigma enhances the tools of Six Sigma, but instead focuses more on increasing word standardization and the flow of business.
16. Demand forecasting.
Demand forecasting should become a familiar inventory management technique to retailers. Demand forecasting is based on historical sales data to formulate an estimate of the expected forecast of customer demand. Essentially, it’s an estimate of the goods and services a company expects customers to purchase in the future.
17. Cross-docking.
Cross-docking is an inventory management technique whereby an incoming truck unloads materials directly into outbound trucks to create a JIT shipping process. There is little or no storage in between deliveries.
18. Bulk shipments.
Bulk shipments is a cost efficient method of shipping when you palletize inventory to ship more at once.