Question

Hi, I am having a little difficulty understanding how an auditor would test the Inventory and Warehousing Cycle. What is the difference (Audit Objectives) between substantive tests of transactions for inventory and tests of balances for inventory? How would an auditor use the transaction related objectives to perform Substantive tests of transactions in Inventory? How would that differ from Tests of Details of balances (balance related objectives) in inventory with examples?

Thank you so much as I am a little confused and would appreciate any help!

Answer 1

1. AUDITOR WOULD TEST THE INVENTORY & WAREHOUSING CYCLE BY FOLLOWING CHECKS :-

a.Compare Gross margin % with that of previous years

b.Compare Inventory Turnover with that of previous years

c.Compare unit of cost of inventory with that of previous years

d.Compare extended inventory value with that of previous years.

2.What is the difference (Audit Objectives) between substantive tests of transactions for inventory and tests of balances for inventory?

Tests of details of balances are designed to determine the reasonableness of the balances in sales, accounts receivable, and other account balances that are affected by the sales and collection cycle. such tests include confirmation of accounts receivable, and examining documents supporting the balance in these accounts.

tests of controls and substantive tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal controls and to test the substance of the transactions that are produced by this cycle. such tests consist of activities such as examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit.the results of the tests of controls and substantive tests of transactions affect the procedures, sample size, timing and items selected for the tests of details of balances (i.e., effective internal controls will result in reduced testing when compared to the tests of details required in the case of inadequate internal controls).

3.How would an auditor use the transaction related objectives to perform Substantive tests of transactions in Inventory?

There are many substantive tests that an auditor can use. The following list is a sampling of the available tests:

• Issue a bank confirmation to test ending cash balances
• Contact customers to confirm that accounts receivable balances are correct
• Observe the period-end physical inventory count
• Confirm the validity of inventory valuation calculations
• Confirm with experts that the fair values assigned to assets obtained through a business combination are reasonable
• Physically match fixed assets to fixed asset records
• Contact suppliers to confirm that accounts payable balances are correct
• Contact lenders to confirm that loan balances are correct
• Review board of directors minutes to verify the existence of approved dividends

As indicated by the examples, substantive testing is likely to include confirmation of account balances with third parties (such as confirming receivables), recalculating calculations made by the client (such as valuing inventory), and observing transactions being performed (such as the physical inventory count).

4.How would that differ from Tests of Details of balances (balance related objectives) in inventory with examples?

First, as the terms imply, balance-related audit objectives are applied to
account balances such as accounts receivable and inventory rather than classes of
transactions such as sales transactions and purchases of inventory. Second, there
are eight balance-related audit objectives compared to six transaction-related audit
objectives.?