- 20 Marks
AA – L2 – Q45 – Audit Evidence
Question
You are the audit manager in the firm of Amoah & Partners, an audit firm with ten national offices. One of your clients, Pearl & Stone, purchases diamond jewellery from national manufacturers. The jewellery is then sold from Pearl & Stone’s four shops. This is the only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for Pearl & Stone. Inventory is the largest account on the statement of financial position with each of the four shops holding material amounts. Due to the high value of the inventory, all shops will be visited and test counts performed.
With the permission of the directors of Pearl & Stone, you have employed Crystal Experts, a firm of specialist diamond valuers who will also be in attendance. Crystal Experts will verify that the jewellery is, in fact, made from diamonds and that the jewellery is saleable with respect to current trends in fashion. Crystal Experts will also suggest, on a sample basis, the value of specific items of jewellery. Counting will be carried out by shop staff in teams of two using pre-numbered count sheets.
Required:
(a) List and explain the reason for the audit procedures used in obtaining evidence in relation to the inventory count of inventory held in the shops.
(b) Explain the factors you should consider when using the work of Crystal Experts.
(c) Describe the audit procedures you should perform to ensure that jewellery inventory is valued correctly.
Answer
(a)
| Audit procedure | Reason |
|---|---|
| Perform an overall review with client staff to ensure that they are following the client’s physical count instructions. Specifically ensure that: <br> – Inventory is divided into appropriate sections for recording – perhaps by type of jewellery <br> – Staff are counting in pairs with one person checking the inventory and another recording. <br> – Appropriate checks are in place to ensure that each item of jewellery is only counted once. <br> – The shop is closed during the count. <br> – Count sheets are pre-numbered. | To ensure that the count is conducted in an organised way, thereby ensuring that all inventory is recorded accurately. |
| Obtain a sample of inventory items already recorded on the count sheets and agree to the jewellery inventory. | To check that all inventory is recorded on the count sheets – check for completeness of recording. |
| For a sample of jewellery in the shop, agree to the count sheets. | To ensure that all jewellery physically present is recorded on the count sheets, checking for completeness. |
| Obtain a sample of count sheets, photocopy and place on the audit file. | To check that details on the count sheets are not subsequently amended and for agreement to the final inventory sheets to ensure quantities are recorded correctly. |
| Check all count sheets are returned after the physical inventory count. | Ensures that all sheets are accounted for and inventory is therefore not understated. |
| Obtain last inventory receipt note and sales invoice numbers. | To ensure that cut-off is correct. Subsequent checking should show that goods received notes post physical count are not included in payables for the year, and sales invoices after the physical inventory are not included in revenue for the year. |
| Review the condition of the jewellery with the independent valuer. Ensure that there are no reasons why the inventory could be obsolete (e.g. due to changes in fashion) or damaged. | To check that any inventory which is damaged or unsaleable is correctly valued. |
| Form an opinion regarding the overall accuracy of the physical count. | To confirm that inventory quantities have been correctly recorded. |
(b) Factors to consider using the work of Crystal Experts:
Amoah & Partners need to confirm that they actually need an expert. It is not clear whether Amoah & Partners have the necessary skills in-house. However, given that Pearl & Stone is the only client in the diamond industry, then some assistance would be expected as valuing diamonds is difficult.
Check that the expert has relevant experience in valuing diamond jewellery. Part of the appointment process will include checking the work portfolio of Crystal Experts to show that they have valued diamonds in other situations.
Ensure that Crystal Experts is a member of an appropriate professional body. This will help ensure that Crystal Experts follow the appropriate ethical standards as these will be enforced by their professional body.
Check that Crystal Experts cannot be influenced by the client – for example because they are employed by Pearl & Stone. Being employed by the client would imply less independence and limit the value of the expert’s report.
Check that the report produced by the expert regarding the valuation of the diamonds appears to be reasonable. Although Amoah & Partners do not have any other clients retailing diamonds, basic price comparisons for a given weight of diamond could still be obtained from other shops or Internet site to prove the accuracy of Crystal Experts’ figures.
(c) Audit procedures to ensure that jewellery inventory is correctly valued:
The jewellery inventory should be valued at the lower of cost and net realisable value.
For a sample of jewellery on the final inventory sheets, trace the cost of those items to the original purchase invoice, ensuring that the description of goods on the invoice matches the jewellery.
For jewellery sold after the end of the year, check a sample of sales invoices back to the final inventory sheets ensuring that the sales value exceeds the cost. Where sales value is less than cost, ensure that the jewellery is stated at the realisable value on the inventory sheet.
Review the report of the professional valuer. Ensure that the inventory is genuine. For the items checked by the valuer, agree the valuation to the items of jewellery on the inventory statements. Where there is a difference, for example due to age of the inventory or where it is unlikely to be sold due to changes in fashion, discuss with the client and agree a realistic valuation. In these situations, the value should be that provided by the professional valuer.
Where an item has been in inventory for a long period of time (perhaps over one year), check the valuer’s report to find out whether any allowance is required.
- Topic: Audit Evidence
- Uploader: Samuel Duah