Question

Discuss, in detail, at least 2 Management Assertions (Auditors' objectives) relating to Inventory.

Answer 1

Auditing Inventory

The objectives of an inventory audit process are to prove the existence, rights, accuracy and realizable value of items in a company's inventory. An auditor uses multiple analytical procedures to verify a company's inventory methods and confirm that the financial records match the physical counts.
Observation of inventory is a generally accepted auditing procedure, where an independent auditor issues an opinion on whether the financial records of inventory accurately represent the actual inventory being carried. Auditing inventory must verify not only the amount of inventory but also its quality and condition to see whether the value of the inventory is fairly represented in financial records and statements.

While conducting an Inventory audit the auditor has to check below ponits (audit objectives).

Verifying Existence

An auditor reviews the company's plans and procedures for counting inventory and often physically observes the actual counting methods to determine efficiency. To verify the physical inventory counts, the auditor may randomly select samples from the warehouse or storage area and locate them in the count records. This also may be done in reverse, with the auditor selecting records from the count and then matching the figures to the actual items in inventory to verify existence. If the company have multiple inventory storage locations, they may test the inventory in those locations where there are significant amounts of inventory. They may also ask for confirmations of inventory from the custodian of any public warehouse where the company is storing inventory.

Inventory Ownership
An inventory audit establishes that all inventory recorded by the business actually belongs to the company. For example, the auditor may reconcile purchase orders and vendor invoices with canceled checks to ascertain whether the inventory has been purchased. During the inventory audit process, the auditor will determine whether or not any inventory belongs to customers and has not yet been shipped and if any products and items in inventory stand as collateral for a business loan. This means the auditors will review purchase records to ensure that the inventory in your warehouse is actually owned by the company.

Test high-value items
If there are items in the inventory that are of unusually high value, the auditors will likely spend extra time counting them in inventory, ensuring that they are valued correctly, and tracing them into the valuation report that carries forward into the inventory balance in the general ledger. The auditor have to classify the inventory on the basis of their value, for that ABC analysis is the best method. An ABC analysis includes grouping different value and volume inventory. For example, high-value inventory, mid-value, and low-value products can be grouped separately. The items can be tracked and stored in their separate value groups as well.

Realizable Value

The auditor will match the inventory counts to records in the general ledger to ensure that the values are correct and conform to generally accepted accounting principles. In situations where the business carries high-value items in inventory, an auditor may do a physical count on these to verify value. The results will then be reconciled with the inventory values as listed in the financial records. The auditor checks the quality of products and items in inventory and verifies that excessive or damaged products are accurately listed at realizable value.

Review freight costs
You can either include freight costs in inventory or charge it to expense in the period incurred, but you need to be consistent in your treatment - so the auditors will trace a selection of freight invoices through your accounting system to see how they are handled. Freight cost analysis includes determining the shipping or freight costs for transporting inventory to different locations. So it is important to track the freight costs as well.

Inventory layers
If the company using a FIFO or LIFO inventory valuation system, the auditors will test the inventory layers that you have recorded to verify that they are valid.
Inventory allowances
The auditors will determine whether the amounts you have recorded as allowances for obsolete inventory or scrap are adequate, based on your procedures for doing so, historical patterns, where used reports, and reports of inventory usage (as well as by physical observation during the physical count). If you do not have such allowances, they may require you to create them.
Work-in-process testing
If you have a significant amount of work-in-process (WIP) inventory, the auditors will test how you determine the percentage of completion for WIP items.