Question

You are planning the audit of BestCookies Ltd, a manufacturing company which sells biscuits and snacks food to a large number of retailers nationally. You have been assigned to conduct inventory audit have obtained the following information from client staff:

Year-end inventory is expected to be as follows (** This represent 20% of total assets);
Raw materials RM 850,000

Work in progress RM 525,000

Finished goods RM 1,005, 000

RM 2,380,000

The company uses standard costing to value its inventory, which consists of approximately 150 product line. At year-end, the relatively equal inventory value of each of these lines will be held.
The inventory is stored approximately fifty warehouses nationally. The company has a policy of taking out short-term leases on unused warehouse space (to minimize rental costs, so the number of warehouses in use varies over time.
Goods are manufactured centrally at the Bigtown factory and then shipped out to the warehouses.
The recent launch of a new biscuits, Creamycheezy bix, resulted in poorer than expected sales. Consequently, the company has excess inventory in finished goods, amounting to RM 200,000. Their expiry date is 6 weeks after the reporting date.
A new work-in-process system was successfully introduced 2 months after the previous year-end. Staff have commented on how this system is a great improvement.
Raw materials largely comprise bulk inventories of flour, rice and potatoes, these are held in large storage bins at the Bigtown factory.
Work in process largely includes biscuits dough, which is stored in several locations throughout the Bigtown factory – both in large sealed vats awaiting processing and in mixing bowls attached to the ten different production lines.
As in previous years, all warehouse and the Bigtown factory will be closed at reporting date to allow a full stock take. A perpetual inventory system is used.
From your experience in previous years, you know that the company has a highly accurate budgeting system. Final figures rarely vary more than 3% from budget.

1. How does the assessed level of detection risk have an impact on the nature, timing and extent of substantive procedures?

2. Identify and discuss the key financial assertions for the audit of inventory at BestCookies Ltd.

3. Based on the assertions that you’ve identified above; Describe in detail the audit procedures you would undertake to cover these issues.

You may present your answer in tabular format.

(14 markah / marks)

Answer 1

1. Detection Risk is the risk that the auditor will not detect a misstatement that exists in an assertion that could be material either individually or when aggregated with other misstatements. A certain amount of detection risk will always exist, but the auditor's goal is to lower the detection risk sufficiently for overall audit risk to maintain an acceptable level.

A substantive procedure is a process, step, or test that creates conclusive evidence regarding the completeness, existence, disclosure, rights, or valuation of assets and/or accounts on the financial statements. To qualify as a substantive procedure, enough documentation must be collected so that another competent auditor could conduct the same procedure on the same documents and make the same conclusion.When the risk of material misstatement is high, the auditor should set the detection risk to a low level to ensure that audit risk remains low which impacts the nature, timing and extent of procedures to be performed to obtain sufficient and appropriate audit evidence.

2. Key financial assertions for the audit of inventory at BestCookies Ltd.

1. Existence: Inventory balances reported on financial statements actually exist at the reporting date.
2. Completeness :Inventory reported on the balance sheet includes all inventory transactions that have occurred during the accounting period.
3. Rights and obligations: All inventory reported on financial statements as at the reporting date really belongs to the company.
4. Valuation :Inventory balances truly reflect its economic value.
5. Presentation and disclosure: Inventory is properly classified and sufficiently disclosed in the notes to financial statements.

Inventory audit usually focuses on Existence and Valuation as to whether the inventory does actually exist; and that it has been valued properly in accordance with applicable accounting standards.

3. Audit procedures.

Assertion	Audit Procedure
Existence	Make enquiry with the management and obtain their representation and inspection of inventories at headoffice, warehouse depending on assessed materiality would help in obtaining evidence.
Completeness	Efficiency of internal controls derives the extent of audit procedures to be performed. Omissions or error in accounting the inventory depicts weakness in internal controls which may result in material mis-statements which might lead to further audit procedures.
Rights and obligations	Inquiries with management, external confirmation, inspection would help resolve the issue.
Valuation	It order to ensure the value depics its true economic value check whether valuation is in alignment with the applicable accounting standards and perform recalculation on sample basis.
Presentation and disclosure	Check whether the presentation and disclosures made by management in financial statements are in accordance with the applicable accounting standards.