Question

1. List at least five reasons that inventory is a complex accounting and auditing area.

2. Following is a list of activities in the acquisition and payment cycle for inventory and cost of goods sold. List at least three controls for each activity below and explain how to ensure good amount of control is proceeded.

a. Requisition for goods and services

b. Purchase of goods and services

c. Receipt of, and accounting for, goods and services

d. Approval of items for payment

e. Cash disbursements

3. Following is a list of substantive tests could be performed in auditing inventory cycle. Explain the understanding of the test, how it occurred, what acceptable level should be achieved, and what assertions could be addressed through the test.

a. Physical inventory test

i. Complete in year end

ii. Occurred before year end

b. Trace counts

c. Year-end cut-off test

d. Test inventory cost

e. Test standard costing system

f. Test perpetual inventory system

Answer 1

Solution-

1.The inventory is a complex accounting and auditing area because-

The existance and valuation assertions are usually the most relevant for the investor.

The five management assertions for inventory are-

A) existence or occurrence

B) completeness

C) rights and obligations

D) valuation and allocation

E) presentation and disclosure

2. The following ways are-

A)The receiving department electronically scans bar codes on the goods received to record quantity and visually inspects for quality.

B) computer generated purchase orders are reviewed by the purchasing department.

C) management approves contracts with suppliers.

D)magement reviews payments and compare them to data as production budgets.

E) an individual in a position of authority reviewes the completeness of supporting documentation prior to signing a check for payment.

F) a policy exists and is enforced whereby purchase department by a supervisor.

G) controls exist to ensure that only authorized goods are received.

H) controls exist to ensure that goods meet order specification.

I) the receving depatment prepares prenumberd receiving document to record all receipts.

J) supporting document is canceled on payment to avoide duplicate payments.

K) management monitors inventory and purchase levels.

3. The following test are explained as-

Physical inventory test-

An inventory audit is an analytical procedure that cross-checks if financial records match inventory records, or the count of physical goods. Inventory audits don't have to be done by auditors, but it helps to have an experienced auditor run through your finances to confirm your stock counts are accurate.

Trace Accounts-

For the purpose of reconciliation, corporates prefer credits from a failed or suspect transaction to be routed to an account other than the funding account. This account is known as the trace account. The trace account will be used when a reversal needs to be performed for failed transactions.

Year-end cut-off test-

Cutoff testing. Audit procedures are used to determine whether transactions have been recorded within the correct reporting period. For example, the shipping log can be reviewed to see if shipments to customers on the last day of the month were recorded within the correct period. Occurrence testing.

Test inventory cost-

To perform price testing, the auditor will select items from the company's inventory on a test basis and verify, through the analysis of original documentation, such as invoices and time cards, that the inventory's cost is carried in the company's financial records accurately.

Test standard costing system-

Standard costing is an important subtopic of cost accounting. Standard costs are usually associated with a manufacturing company's costs of direct material, direct labor, and manufacturing overhead.Standard costing and the related variances is a valuable management tool. If a variance arises, management becomes aware that manufacturing costs have differed from the standard costs.

Test perpetual inventory system-

A perpetual inventory system is a method of inventory management that records real-time transactions of received or sold stock through the use of technology – generally considered a more efficient method than a periodic inventory system.