Question

Your auditing team have been assigned to perform a review of client’s inventory containing electric machine, parts, and raw materials used in making the machine.
a. What inquiries and analytical procedures should the auditor perform?
b. What will the auditor do if these procedures do not support the client’s inventory values or disclosures?
c. How would your level of professional skepticism differ depending on whether you are performing a review versus an audit engagement?
d. What are the differences between a review versus an audit engagement?

Answer 1

Answer:

a.         Review procedures would include:

Inquiry concerning:

•           Procedures used to take the latest physical inventory and date taken.

•           Procedures for rolling inventory forward or backward from date of physical inventory to date of financial statements.

•           Method of pricing the inventory, including proper inclusion of labor and overhead when applicable.

•           Method of valuing slow moving or obsolete items.

•           Inventory held at other locations or held for others by the client.

•           Purchases and sales cutoff procedures.

Analytical procedure:

•           Compute inventory turnover rate based on average inventory divided into cost of sales and compare to prior years.

•           Compute the gross margin percent and compare with prior years.

b.         If these procedures do not support the client’s inventory values or disclosures, it may be necessary for the auditor to select a sample of inventory items to test count and perform a price test. For the test counts, the auditor will need to reconcile the counts with what they should be at the balance sheet by analyzing sales and purchase between when the test counts were made and the balance sheet date. Aging, turnover and other tests should be performed to identify necessary write-downs to lower of cost or market.

c & d.         Your level of professional skepticism does not need to be as high for a review engagement compared to an audit engagement. In a review engagement, you acknowledge limited assurances regarding the depth to which you have investigated and evaluated the evidence supporting the assertions made by management. While some level or professional skepticism will still be necessary, you will not have to be as diligent in this regard compared to when you are conducting an audit engagement. This is one reason why users of a review report should place less confidence in your opinion therein.