Question

You are the audit senior at Zhang Zi Zi Associates. Below are issues fixed by your audit teams:

1. Valentine Creativity is a bespoke designer label located throughout Chine. 40% of the inventory can be found in warehouses in Wuxi and Guangzhou. The rest of the inventory is found in all their 300 stores across China, Hongkong, and Macau. The high value consist of designer pearls can be found in Beijing, Hongkong, and Shanghai. Special strong vaults are built in those stores to keep the pearls.

2. Delia Computers practices the vendor managed inventory system with their vendors. Digital East, your client, is one of their hard disc suppliers for their Shenzhen plant. Your client will assemble the hard discs in Wuxi and ship the hard discs to Delia’s warehouse in Shenzhen. Delia will pull from the inventory in the Shenzhen warehouse if they need to use the discs and will pay for the pull.

3. Elektroniks is a contract manufacturer in Xiamen manufacturing one behalf of few Korean smartphone companies. Elektroniks makes smartphone touch screens. The screens are made exclusively for each customer and cannot be used interchangeable. Due to patent issues any excess stock and scrap material must be destroyed.

4. Bisco is an international hypermarket chain. They have just opened shop in China by taking over two local groceries chains. Laimaicai and Jiama. Bisco have yet to integrate the inventory systems used by Laimaicai and Jiama to a common platform.

Required:

a. For each mentioned above, describe issues the auditor should consider when determining which locations to visit physically observe the client’s inventory count.

b. How would you determine which locations your teams should visit?

c. How does the type of inventory held by your client pose potential risks of material misstatements in the inventory balances?

d. How might your teams address the risks noted in part c.

Answer 1

Answer:-

CLIENT	a. ISSUES TO CONSIDER	b. LOCATIONS TO VISIT	c. POTENTIAL RISKS OF MATERIAL MISSTATEMENT	d. AUDITOR RESPONSES TO RISKS
1.Valentine Creativity	A majority of the inventory amount on the balance sheet is located at the two distribution centers. High dollar value inventory is stored in secure areas at the stores and distribution centers. Inventory consists of a large number of products, with wide variations in unit costs, which could lead to inaccurate amounts.	Given the significance of the value of inventory located in the distribution centers, the auditor would most likely want to test controls and observe the physical inventory counting at the two distribution centers. The auditor would likely test controls related to inventory at the store level and select a sample from among the 77 stores to visit. While at the distribution centers and stores, the auditor is likely to focus on testing inventory in the secure areas.	Due to the high cost and demand for medicines, there is a risk of theft of inventory both at the distribution centers and stores. Additionally, because some medicines have expiration dates, there is a risk of obsolete inventory. It will be difficult for auditors to identify specific types of medicines since their differences are not visually noticeable but rather dependent on differences in compounds and chemicals. Furthermore, the large number of products, with wide variations in unit costs, could lead to inaccurate amounts.	The auditor will likely focus extensively on inventory management controls to determine the effectiveness of those controls in the prevention of theft. The auditor may also engage a pharmaceutical specialist to assist with the identification and evaluation of various medicines as part of the inventory observation process.

CLIENT	a. ISSUES TO CONSIDER	b. LOCATIONS TO VISIT	c. POTENTIAL RISKS OF MATERIAL MISSTATEMENT	d. AUDITOR RESPONSES TO RISKS
2. Delia computers	Material amounts of inventory are most likely on site at all four manufacturing locations. Each motorcycle is of high dollar value.	Most likely the auditor would want to inspect inventory at each of the four manufacturing facilities, assuming similar amounts of inventory are located at each facility.	Because of the manufacturing process of converting raw materials into a finished motorcycle product, there are a number of risks associated with assigning costs to the raw materials, work-in-process, and finished goods inventory. Each motorcycle may have unique features, which would mean each motorcycle has a unique inventory value. Thus, there are opportunities for inaccurate inventory amounts to be included in the financial statements. Additionally, the product is highly desirable and thus would be subject to the risk of theft, which could result in recorded inventory not existing on the balance sheet date.	The auditor would want to extensively test inventory costing systems to evaluate the operating effectiveness of internal controls over raw materials, work-in-process, and finished goods inventory. The auditor would likely test perpetual inventory records to determine that recorded raw materials, work-in-process, and finished goods inventory are on hand at the balance sheet date.

CLIENT	a. ISSUES TO CONSIDER	b. LOCATIONS TO VISIT	c. POTENTIAL RISKS OF MATERIAL MISSTATEMENT	d. AUDITOR RESPONSES TO RISKS
3.Elektroniks	Inventory items are unique, given that they are dependent on customer specifications. Thus, inventory valuations may be especially difficult to determine. Additionally, it will be difficult for the auditor to inspect inventory given the auditor's lack of knowledge and expertise related to the products on hand.	All inventory is located at one manufacturing facility.	Because the client's inventory is customized to their customer's product specifications, there is risk that inventory valuations may be misstated due to inaccurate pricing information. Additionally, there is a high risk of inventory obsolescence, if there is excess inventory for a particular customer's product. Because the individual parts are quite small, there is also a risk of inventory loss or theft, which may result in inventory recorded in the financial statements that does not exist at the balance sheet date.	Because the interior components of the product are not visible to the human eye, the auditor cannot directly observe whether the inventory on hand is legitimate electronic parts. The auditor will likely need to involve electronics specialists to assist in the inspection and valuation of inventory.

CLIENT	a. ISSUES TO CONSIDER	b. LOCATIONS TO VISIT	c. POTENTIAL RISKS OF MATERIAL MISSTATEMENT	d. AUDITOR RESPONSES TO RISKS
4. Bisco	Three-fourths of the inventory balance is located at the five independent storage warehouses. There is a very high volume of different inventory products that have different unit prices. Grocery inventory is highly perishable and is of great demand by employees and customers. Customers have direct access to the inventory on the shelves in the stores.	The auditor will most likely visit the five distribution centers to inspect the inventory on hand at those locations. The auditor might be able to obtain confirmation from the independent storage warehouse management, if the amount at one of the storage warehouses is less material. The auditor will also likely select a sample of the 42 stores to visit for inventory observations.	There is a risk of theft given grocery inventory is of high demand and customers have direct access to it in the stores. Additionally, given the large volume of inventory items, there is a risk loss, which would result in inventory being recorded that is nonexistent. Furthermore, the volume of products also creates a risk of inventory pricing errors, which would lead to inaccurate amounts recorded. Obsolescence is a high risk, given the perishable nature of food items.	The auditor would examine inventory on hand at the storage warehouses and conduct pricing tests of the inventory records. The auditor would also examine controls over the movement of inventory from the storage warehouses to the stores. The auditor would also likely perform a number of analytical procedures regarding inventory at the store locations to determine if recorded inventory amounts appear reasonable and whether there is a risk of inventory obsolescence.