AUDIT OF INVENTORIES & COST OF SALES

REF: AP Book of Asuncion, Ngina & Escala

INTRODUCTION
• For some entities, special audit consideration should be applied for those
companies with certain specialized nature of inventories (e.g. oil and gas
or precious metals)
AUDIT PROCEDURES FOR INVENTORIES AND COST OF SALES
• Audit of INV presents the auditors with significant risk because:
1. Observing inventory count and performing test counts;
(1) They often represent a very substantial portion of current assets;
2. Confirming inventories held by others;
(2) Numerous valuation methods are used for inventories;
3. Reconciling inventory summary sheet with G/L;
(3) The valuations directly affects COGS (affects OSD for tax); and
4. Performing purchases and inventory cut-off;
(4) The determination of inventory quality, condition, and value is
5. Checking appropriate valuation in accordance with accounting
inherently complex.
policies;
6. Performing lower of cost and net realizable value test;
AUDIT OBJECTIVES
7. Determining whether any inventories have been pledged and
i. EXISTENCE – amount of inventory balance
reviewing purchase commitment; and
ii. OCCUFRENCE – transactions related to inventory
8. Performing analytical procedures.
iii. COMPLETENESS – complete records
iv. CUT-OFF – record inventory in the proper accounting period
INVENTORY COUNT OBSERVATION & TEST COUNTS
v. VALUATION & ALLOCATION – subsequent measurement should
Existence, Completeness, Rights, Valuation & Cut-Off
be lower of cost and NRV
CLIENT: performs the inventory count
vi. RIGHTS & OBLIGATIONS – are inventories really the entity’s
AUDITOR: observes the inventory count
(consigned goods are not owned by the entity
TEST COUNT: Auditor takes a sample and tests if it exists/complete,
vii. PRESENTATION & DISCLOSURE – proper classification (some
depending on procedures used (verifies existence and completeness).
properties e.g. nca held for sale are presented as inventories for
Normally done at year-end or before year-end.
fast disposal)
PRIMARY CONCERN – Existence of inventory
• Nothing to observe if there is no inventory
Inventory count is the responsibility of the management.
• It matters if the inventory is under PERPETUAL or PERIODIC
method.
• Check policy manual for inventory count and observe if the entity
follows the policy manual.
Inventory count is part of client’s internal control (policy manual).
WHAT TO PERFORM?
(1) Observation of actual inventory count
o Auditor must know the location of each inventory.
 o There are instances where there are 2 warehouses, inventory HOW TO PERFORM?
counts are done simultaneously to cover the deficiencies of the If the inventory held by 3rd parties is significant (no need to confirm if
inventory (inventory from WH1 transferred to WH2). insignificant because it is costly) and can be relied upon, send the
o Determine if the inventory is owned by the entity. confirmation letter requesting for the following:
(2) Test counts (1) Details of inventory on hand at the count date (product descriptions,
A. List-to-floor procedure (verifying existence) 10-15 samples quantities, damaged stocks - can be classified as inventory loss and
o Verify if the inventory in the inventory sheet (record) deducted for tax purposes); and
given to the auditor exists. (2) Details of the last receipt/shipment as at the count date and for
o Get samples and check if the selected is really there. several days prior to and after count date.
o Note any discrepancies in the findings. WHAT IF NO CONFIRMATION REPLIES/RESPONSE?
B. Floor-to-list procedure (verifying completeness) 10-15 samples o Follow up the custodian, send 2nd to 3rd request.
o Inventory from the floor is found in the list. WHAT IF STILL NO RESPONSE AFTER DOING THE FOLLOW UPS?
(3) Reconcile any differences o Perform alternative procedures:
HOW TO PERFORM? Ensure the following: (1) Inspection of shipping docs, public WH receipts, reports of
(1) Compliance with written inventory count procedures. and payments for subsequent consignment sales and
- Any deviation is noted and reported to the client for them correspondence with the 3rd party.
to address. (2) Consider to conduct physical inspection.
(2) Ensure accuracy in counting and recording.
(3) Items belonging to other are accurately counted and recorded RECONCILIATION OF INVENTORY SUMMARY SHEET WITH GENERAL LEDGER
including clear description of non-inventory status. Accuracy & Completeness
- Separate inventory owned by client and not owned by HOW TO PERFORM? Check the following:
client. (1) Footing the reconciliation.
(4) Items excluded form inventory items (obsolete items, non-inventory (2) Investigate significant differences (reconcile and adjust as necessary).
items, items owned by others) are either subject to satisfactory (3) Reviewing the nature of reconciling items.
control and excluded from the counting process. (4) Proposed adjustment if necessary.
(5) Proper cut-off has been established.
(6) Count tags, sheets or records are properly controlled. YEAR-END INVENTORY / PURCHASE CUT-OFF
Existence, Occurrence & Completeness
CONFIRMATION OF INVENTORIES HELD BY OTHERS PURPOSE:
Existence, Completeness and Rights (1) To check that the inventory transactions are recorded in the GL or
Some of the inventories owned by the client held by 3rd parties include: perpetual records in the correct period; and
(1) Inventory in a public warehouse (2) To determine that inventories are not double-counted or missed due
- Entity has no own WH, rents a WH to movements within the plant/WH or movement between entity
(2) Inventories out on consignment; and branches or other parties.
- They are considered sold COMMON CONSIDERATION
(3) Inventory held by suppliers (title to the inventory has passed to the (1) Shipments received but purchase invoice received in the next period
entity prior to delivery) (some entities record when they receive billing); and
(2) Purchase invoice received but merchandise received in the Identifying any significant deviation from expectations and investigate
subsequent period. differences.

VALUATION IN ACCORDANCE WITH ACCOUNTING POLICIES (LCNRV)

Valuation, Accuracy, Presentation & Disclosure
Subsequence measurement of inventories is the lower of cost or net
realizable value (LCNRV).
WHAT TO CONSIDER? Understand the following:
(1) What method of valuation does the client use?
(2) Is the method of valuation the same as that used in prior years?
(3) Has the method selected by the client been applied consistently and
accurately in practice? SUMMARY OF ADUIT PROCEDURES CLASSIFIED PER ASSERTION
HOW TO PERFORM? The following should be observed:
(a) FINISHED GOODS – NRV is generally based on Selling Price (SP) less
estimated cost to dispose the item (based on the latest price
catalog/sales subsequent to the reporting)
(b) WIP – NRV is generally based on SP less any estimated cost to
complete and dispose the item (based on the latest price
catalog/sales subsequent to the reporting)
(c) RAW MATERIALS – NRV is generally based on the replacement cost
(by purchase or reproduction) less ant estimated cost to complete
and dispose the item.

DETERMING WHETHER ANY INVENTORIES HAVE BEEN PLEDGED AND

REVIEW PURHCASE COMMITMENT
Valuation, Presentation & Disclosure
Pledging of inventories can be verified through confirmation made to
banks.
Check the existing purchase commitment and check the commitment
price as against the market value or NRV at year-end as the entity may be
required to make a provision regarding the fall of the MV compared to
the commitment price.

ANALYTICAL PROCEDURES
Completeness, Valuation & Accuracy
Test the reasonableness of the inventories and related items.