Question

You are an audit senior of Hessonite & Co and are in the process of reviewing the inventory system documentation for your audit client, Lemon Quartz Co (Quartz) which manufactures computer equipment. The company’s factory and warehouse are based on one large site, and their year-end is 30 June 2016. Quartz is planning to undertake a full inventory count at the yearend of its raw materials, work in progress and finished goods and you will be attending this count. In preparation, you have been reviewing the inventory count instructions for finished goods provided by Quartz.

The count will be undertaken by 15 teams of two counters from the warehouse department with Quartz’s financial controller providing overall supervision. Each team of two is allocated a number of bays within the warehouse to count, they are provided with sequentially numbered inventory sheets, which contain product codes, and quantities extracted from the inventory records. The counters move through each allocated bay counting the inventory and confirming that it agrees with the inventory sheets. Where a discrepancy is found, they note this on the sheet.

The warehouse is large and approximately 10% of the bays have been rented out to third parties with similar operations; these are scattered throughout the warehouse. For completeness, the counters have been asked to count the inventory for all bays noting the third party inventories on separate blank inventory sheets, and the finance department will make any necessary adjustments.

Some of Quartz’s finished goods are high in value and are stored in a locked area of the warehouse and all the counting teams will be given the code to access this area. There will be no dispatches of inventory during the count and it is not anticipated that there will be any deliveries from suppliers.

Each area is counted once by the allocated team; the sheets are completed in ink, signed by the team and returned after each bay is counted. As no two teams are allocated the same bays, there will be no need to flag that an area has been counted. On completion of the count, the financial controller will confirm with each team that they have returned their inventory sheets.

Required: In respect of the inventory count procedures for Lemon Quartz Co:

(i) Identify and explain FIVE deficiencies;

(ii) Recommend a control to address each of these deficiencies; and

(iii) Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if implemented, is operating effectively.

Answer 1

(i) Identify and explain FIVE deficiencies;

• Counting is done only once
• There is no mention of audit of third party bays
• All the counting teams are given access to the high value goods instead of selective 2-3 teams
• Not mentioned as to the discrepancy level allowed in the inventory checking
• Not mentioned as to how the bays will be allocated. At random or by some scientific technique.

(ii) Recommend a control to address each of these deficiencies

• Counters with high discrepency and very low discrepency can be checked once again
• Third party bays should be also be taken under the audit procedures. Practice of adjustment by controller is unacceptable
• High value items should be checked by senior associates in the audit team
• A pre determined tolerance level needs to be decided to save the efforts and improve the audit quality
• Teams with senior associates must be given price sensitive bays

(iii) Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if implemented, is operating effectively.

• Difference in the results of the two can be verified and signed by the controller as to be noted
• Third party bay users have give the list of inventory duly signed for the audit purpose
• High value items inventroy sheet are signed by the senior audit associates of the Quartz and when delieverred by them to the controller, he has taken appropriate and timely action on the shortfalls
• tolerance level is duly reasoned and documented by the management
• Bays allocation criteria is properly documented by management