AUDITING

CHAPTER 15

Inventory & Fixed Assets

By
David N. Ricchiute
TOPICS
Nature of conversion cycle
Auditors consideration of controls for
inventory, fixed assets
Substantive tests for inventory, fixed
assets
Audit judgment for impaired assets
Computer-assisted audit techniques for
inventory, fixed assets
Assurance service opportunities

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INVENTORY
DOCUMENTS
Labor charge report
Summary labor costs for work-in-
process
Materials requisition
Perpetual inventory record

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DOCUMENTS FOR FIXED
ASSETS
Depreciation schedule
Overhead application
report
Summary overhead
applied to work-in-
process

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INVENTORY
CONVERSION:
Nonmanufacturing
Retailer
Wholesaler
Costs:
Holding & physically
controlling prior to
sale

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INVENTORY
CONVERSION:
Manufacturing
Costs
Raw materials
Transformation costs
Direct labor
Manufacturing overhead

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INVENTORY CONTROLS
Supervisor approval for materials
requisition
Inventory Control personnel control
raw materials, finished goods
Segregation from purchasing, receiving,
shipping, production, recording
Responsible for transfers in, out,
inventory levels, reports slow moving,
damaged goods

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MONITORING INVENTORY
LEVELS
Economic order quantity
models
Optimize carrying costs
with risk of shortages
Just-in-time inventory
management

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INVENTORY
ACCOUNTING
Perpetual inventory records
Quantities, locations, selected cost
information
Cost records
Accumulates raw materials, direct
labor, overhead
Applies costs by appropriate method
FIFO, LIFO, AVERAGE

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INTERNAL CONTROL
OBJECTIVES
Authorization
Execution
Recording
Access to assets

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AUTHORIZATION: Inventory
Objective, Error, Procedure
Objective Error
Procedure
Productio Unauthorized Criteria
n quantities, for
authorize products products
d produced; &
obsolete, excess, quantities
unusable
inventory

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EXECUTION: Inventory
Objective, Error, Procedure

Objective Error
Procedure Circumvent
Procedures Inventory
for using, existing procedures
transferring procedures; manual for
inventory in stolen, misused control
accord with inventory Restrict
managemen Inventory access to
ts misplaced inventory
authorization

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RECORDING: Inventory
Objectives, Errors, Procedures
Objectives Errors Procedures
Inventory Inventory Recording
recorded at not procedures;
proper recorded; prenumber, control
amounts, inventory, release forms; log
period, CGS inventory
classification misstated movement; periodic
counts
Adjustments Unauthorize Approval for
authorized d adjustments;
adjustments prenumber, control
mean forms
13 misused,
GBW 8th ed., Ch. 15
ACCESS: Inventory
Objectives, Errors, Procedures
Objectives Errors Procedures
Access to Inventory Physical controls;
inventory stolen, lost, employee insurance,
restricted diverted fidelity bonds;
inventory insurance;
segregate handling &
recording
Access to Records Physical controls over
production, misused, forms, records; files
accounting, destroyed, authorized
records lost signatures, periodic
restricted compliance audits
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FIXED ASSET
ACCOUNTING
Detailed records for each asset
Purchase date, cost, depreciation
method, life, salvage,
accumulated depreciation
Reconcile detailed records with
general ledger control accounts
Insurance records fixed assets
Additions, disposals authorized

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AUTHORIZATION: Fixed
Assets Objective, Error,
Procedure
Objective Error
Procedure
Plant Assets Written
additions, purchased, sold procedures
disposals, without additions,
retirement management disposals,
s knowledge retirements
authorized Assets sold at Compare
unfavorable scrap prices
prices received with
published
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EXECUTION: Fixed Assets
Objective, Error, Procedure

Objective Error
Procedure Stolen,
Procedures Establish
for operating, misused, procedures for
using moving misplaced operating,
fixed assets equipment using moving
fixed assets;
restrict access
to movable
assets

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RECORDING: Fixed Assets
Objectives, Errors, Procedures
Objectives Errors Procedures
Additions, Unreported Procedures for
disposals, transactions recording;for disposal
retirements eligibility; detailed
recorded, records; reconcile
classified detailed records with
correctly assets
Depreciation, Depreciation Policies for
amortization miscalculate depreciation
proper d, misstated

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ACCESS: Fixed Assets
Objectives, Errors,
Procedures
Objectives Errors Procedures
Access to Assets lost, Physical
assets stolen controls;
restricted insurance
coverage

Access to Records Physical

records misused, controls over
restricted destroyed, forms, records;
lost periodic
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CONSIDERING INTERNAL
CONTROL: Inventory
Obtain an understanding
Preliminary review
Document system
Perform transaction walk-
through
Determine whether controls
are potentially reliable in
assessing control risk below
maximum
Test controls

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INTERNAL CONTROL
DOCUMENTATION

Internal control questionnaire

Flowchart
Memorandum

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TESTS OF CONTROLS:
Inventory Records

Perpetual records
Cost records

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TESTING CONTROLS:
Raw Materials Perpetual
Records
For sampled raw materials
Compare quantities, unit costs invoice to
records

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TESTING CONTROLS:
Inventory Transfers
For sampled transfers
Raw materials trace to
Approved requisitions, Work-in-process records,
Summary entries in GL
Work-in-process, trace to
Transfers to finished goods records, Summary
entries in GL
Finished goods, trace to
Shipping documents
Summary of CGS, Sales

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TESTING CONTROLS:
Inventory Cost Records
Obtain summaries of charges to
work-in-process
Test direct labor & overhead
Review basis for standard
overhead rates
Determine disposition over-, under-
applied overhead

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CONSIDERING
INTERNAL CONTROLS:
Fixed Assets
Obtain an understanding
Preliminary review
System documentation
Transaction walk-through
Determine whether controls are
potentially reliable in assessing
control risk below maximum
Test controls

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TESTING CONTROLS:
Fixed Asset Records
Reconcile total of detailed
records with GL &
investigate differences
Physically inspect
sampled fixed assets
Review adequacy
insurance coverage

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TESTING CONTROLS:
Fixed Asset Additions
Obtain summary fixed asset additions
Foot summary; reconcile to GL
For a sample
Examine authorization, PO, receiving report,
invoice, etc.
Examine evidence of cash payment & trace
to voucher register
Examine evidence of obligations
Determine classification appropriate

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TESTING CONTROLS:
Fixed Asset Disposals
Obtain summary disposals &
retirements
Foot summary; reconcile to GL
For a sample
Examine authorization, contract, invoice,
etc.
Examine entry cash receipts journal
Examine note receivable;trace to GL
Calculate gain, loss & trace to GL

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TESTING CONTROLS:
Fixed Asset Depreciation
Review depreciation methods by
asset class & policies for life,
salvage
For a sample
Determine whether life, salvage
consistent with policies
Recalculate depreciation expense,
accumulated depreciation

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SUBSTANTIVE TESTS:
Existence, Occurrence
Inventory Fixed Assets
Observe physical Observe asset
inventory additions
Confirm off-premises Test cutoff
inventory
Test cutoff

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SUBSTANTIVE TESTS:
Completeness
Inventory Fixed Assets
Observe physical Observe asset
inventory additions
Confirm off-premises Test cutoff
inventory Perform analytical
Test cutoff procedures
Perform analytical
procedures

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SUBSTANTIVE TESTS:
Rights & Obligations
Inventory Fixed Assets
Confirm off-premises Test additions
inventory Test cutoff
Test cutoff Examine contracts,
Review consignment & documentation
purchase commitments

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SUBSTANTIVE TESTS:
Valuation, Allocation
Inventory Fixed Assets
Test priced inventory Verify accuracy
Review physical recorded fixed assets,
inventory for depreciation
obsolete, slow Test additions,
moving, unsalable disposals
goods

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SUBSTANTIVE TESTS:
Presentation, Disclosure
Inventory Fixed Assets

Compare Compare
presentation, presentation,
disclosures with disclosures with
GAAP GAAP

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SUBSTANTIVE TESTS &
ASSERTIONS: Inventory
1 Existence, Completeness
Observe physical inventory
Existence, Completeness, Rights
Confirm off-premises inventory
Valuation
Obtain records; test mathematical
accuracy

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SUBSTANTIVE TESTS &
ASSERTIONS: Inventory
2 Existence, Occurrence,
Completeness, Rights
Test cutoff & coordinate with sales, A/R
Completeness
Analytical procedures
Presentation, Disclosure
Review for classification, disclosure

37 GBW 8th ed., Ch. 15

SUBSTANTIVE TESTS &
ASSERTIONS: Fixed Assets 1
Valuation
Verify mathematical accuracy
fixed assets, depreciation
Existence, Occurrence,
Completeness, Rights,
Valuation
Test additions, disposals;
physically inspect

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SUBSTANTIVE TESTS &
ASSERTIONS: Fixed
Assets 2
Completeness
Analytical tests
Presentation, Disclosure
Fixed assets, depreciation properly
classified, disclosed

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MANAGEMENT &
AUDITOR INCENTIVES
Management incentives
Income smoothing via big baths
Auditor incentives
Need persuasive evidence of
permanent loss in value

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COMPUTER ASSISTED
TESTS: Inventory, Fixed
Substantive
Assets test Computer task
Verify Foot, cross-foot, test
mathematical extensions
accuracy
Compare details Compare quantities
master file, perpetual file
Perform price Compare prices final
tests inventory with invoices
Merge physical Update & print
counts, perpetual exceptions
records
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