- 20 Marks
AA – L2 – Q62 – Audit Evidence
Question
Your firm is the external auditor of Elite Tableware Ltd, and you recently attended the year-end inventory count at the company’s warehouse. The company manufactures high quality tableware (plates, cups and saucers etc.) and it maintains an integrated computerised system that shows the inventory held at any point in time.
At the year-end inventory count, reports showing the various categories of inventories (but not the quantities) are printed off the system and the quantities of inventories actually counted are inserted annually by the counters. Later the quantities are compared with those per the computer system.
The count instructions were received by both you and the counters the day before the count was due to take place. The instructions consisted of the following five points:
(1) Counters must arrive at 8 am on the morning of the count.
(2) They will work in teams of two people.
(3) Each team will be assigned a specific area of the warehouse to count. They will receive inventory sheets listing the products to be found in their area.
(4) The inventory sheets are pre-numbered.
(5) Once the counters have finished the inventory count, the inventory sheets must be handed to the warehouse manager.
Your notes from the attendance at the count include the following observations:
Many areas in which the count took place were untidy and inventory was sometimes difficult to find because it was not in the allocated area. The same categories of inventories were sometimes found in several different areas and some inventory was incorrectly labelled.
The count was conducted in a hurry in order to close the warehouse before a public holiday and there were insufficient counters to conduct the count properly in the time available. The issue and receipt of inventory sheets (on which the quantities were recorded by counters) was not properly controlled. It was difficult to reconcile the inventory quantities recorded at the count to the computerised records and some significant differences remain outstanding.
Although no finished goods were dispatched during the inventory count, a large delivery of raw materials was received into the warehouse.
Required:
(a) For the inventory count conducted by Elite Tableware Ltd:
(i) Identify and explain FOUR (4) deficiencies in the count.
(ii) Explain the possible implication of each deficiency and
(iii) Provide a recommendation to address each deficiency.
(b) Describe the audit procedures that auditor should perform at the year end to confirm each of the following:
(i) The existence of inventory
(ii) The completeness of inventory
(iii) The valuation of inventory.
Answer
(a)
| Deficiency | Implication | Recommendation |
|---|---|---|
| Planning<br>The inventory count was poorly planned as there were insufficient counters, inventory was untidy, inventory was not in its allocated area and was sometimes incorrectly labelled. | If the inventory count is not conducted in an organised way then inventories could be omitted from the count or items counted twice. Items could also be recorded as the wrong product line if different products are mixed up in the same location. If the inventory is not organised then it may be difficult to identify obsolete or damaged inventory. These factors mean that when the quantities are compared to the computerised records adjustment could be made unnecessarily. This would lead to incorrect quantities of items being recorded both in management’s inventory records and the financial statements. This could lead the business to hold too much/too little of certain inventory lines or to have a material error in their financial statements. | In future, the inventory count should be properly planned and organised. Management should carry out a review of the warehouse a few days before the count is scheduled in order to ensure that the warehouse is tidy, inventory lines are stored together and obsolete or damaged inventory is segregated. Staff should be advised that they should communicate any problems with the inventory count to the manager in charge as soon as they are identified. If there is significant concern over the accuracy of the year end count, then the auditor may need to request that the warehouse is organised and a second count carried out at a later date and a roll-back reconciliation performed. |
| Inventory count sheets<br>The inventory count sheets were not properly controlled. Employees were not required to sign for them and records were not kept of who was working from which sheet. | Inventory sheets may be lost or not used in the count. This could result in inventories being counted and not recorded in the final inventory count, or not counted at all. This means that inventories may be understated in the financial statements. | The pre-numbered inventory sheets should be signed in and out by the manager responsible for overseeing the inventory counts. A record should be kept as to which employees has which inventory sheet. At the end of the count, a sequence check of inventory sheets should be made to ensure they are complete. |
| Segregation of duties<br>There is a lack of segregation of duties concerning the responsibility for the count as the inventory counters must hand the inventory sheets to the warehouse manager at the end of the count. | The warehouse manager has day to day responsibility for the inventory and also has control over the inventory count which is the most important procedure to determine the accuracy of the quantity of inventory at the year end. If there are significant differences between the quantity counted and recorded on the inventory sheets and the quantity recorded in the computerised inventory records then… | Someone other than the warehouse manager should have overall responsibility for the inventory count, for example a supervisor or manager from the finance department. Once the count is completed, the inventory sheets should be reviewed and photocopied by this member of staff before being handed back to the warehouse manager. This will enable any… |
| Receipt of raw materials<br>A large delivery of raw materials was received into the warehouse during the inventory count. | If raw materials are received during the count, there is a risk that these items may be included in the count incorrectly, leading to double-counting or incorrect cut-off. This could result in overstatement of inventory in the financial statements if the materials are recorded in the wrong accounting period. | Management should ensure that no deliveries are received during the inventory count. If unavoidable, any goods received should be clearly segregated and marked as not to be included in the count. The auditor should trace these items to ensure they are recorded in the correct accounting period. |
(b)
Existence
Observe the inventory count in order to determine whether the inventory exists. Enquire of management whether any inventory is held for third parties.
Obtain a copy of the completed inventory sheets. Select a sample of items and physically verify that the products listed on the inventory sheets are in the warehouse.
For the raw materials delivered on the day of the count, discuss with management whether these goods relate to the year being audited, or whether they are to be included in the post year end period. Trace these items through to the final inventory figures to ensure they have been recorded in the correct accounting period.
Completeness
For a sample of product lines in the warehouse, verify that they have been included on the inventory sheets and that the quantity is accurately recorded.
Perform a sequence check of all inventory sheets to ensure that they have all been returned to the warehouse manager at the end of the inventory count, so that all product lines are included in the year-end inventory quantity.
Enquire of management whether there are any items of inventory held off site which have not been included in the inventory sheets.
Valuation
For a sample of finished goods sold post year end, compare the sales price to the current price list or catalogue in order to check items are being sold at a price which is greater than the item’s cost.
For a sample of items classified as work in progress at the year end, ask management how they have determined the percentage completion at the year end. Recalculate the costs incurred to date. Compare this to the future selling price of the completed item less the costs to complete in order to determine the net realisable value of the item. Trace through the final valuation of the item to the financial statements.
Review the inventory movement records to identify any particularly slow moving inventory lines. Discuss the saleability of these items with management and enquire whether any provision has been made in order to write the item down to its net realisable value (also check whether damaged inventory identified by Elite Tableware Ltd during the count has been written down to its net realisable value).
- Tags: Audit Procedures, Completeness, Deficiencies, Existence, Internal controls, Inventory Count, Valuation
- Level: Level 2
- Topic: Audit Evidence
- Uploader: Samuel Duah