procedure of Inventory Verification to be followed by an Auditor
Inventory in one
of the most important and difficult verification problems with which the
auditor is faced. It is commonly the single greatest current asset and is often
the largest asset in the entire Balance Sheet. An error in inventory affects
the net income directly.
Problems of
various types are going to be faced in the verification of Inventory. Some such
problems are as under:
a) Physical
existence and ownership of Inventory;
b) The
quantities included in making inventory extensions;
c) The prices
used in making inventory extensions;
d) The
arithmetical accuracy of extension, footings, forwarding, and final totals.
The most
difficult problem is that of Pricing.
Essentials of
Verification
1) To determine physical existence and to
test quantities:
A) Be present
when physical inventory is taken by company representative.
a) Observe existence of inventory;
b) Observe inventory taking procedure including the efficiency with
which the members of the inventory crews perform their tasks.
c) Make and record test counts of inventory counts;
d) Inventory completeness of count by checking areas and divisions
of inventory from tags or other evidence of count.
B) Trace test
counts into inventory listings to discover whether quantities counted are
properly listed;
C) Trace some of
company’s inventory counts into inventory listing to discover whether counts
are properly listed;
D) Account for
all inventory tags or tickets;
E) Review
purchases and sales cut-off and make tests to discover accuracy or inventory
count with respect to shipments close to the balance sheet date.
2) To determine reasonableness of pricing:
A) Test specific
prices used by the company by comparing them with recent invoice or quoted
prices;
B) Review method
of pricing with intention of determining a generally accepted pricing policy
has been followed:
a) Determine and evaluate general pricing practice;
b) Review composition and application of burden rate;
c) Investigate balances of any standard cost variation accounts of
the disposition thereof;
C) To determine
the quality and grade as reasonable:
a) During observation of physical inventory, determine by
observation and inquiry whether inventory is in merchantable condition;
b) Review detail inventory records for slow moving and obsolete
items;
c) Refer to purchase invoices for major inventory items to determine
whether that grade or quality is handled in the quantities indicated.
3) To discover the degree of clerical
accuracy in the inventory complication:
a) Test
inventory extensions and footings by re-computation;
b) Trace all
page total and sub-total into summaries and into the final inventory amounts.
4. To review accuracy of inventory amount
in general:
A) Obtain an
inventory representation from company officers or employees:
a) Enquire as to any merchandise held on consignment held for
others, or otherwise on hand but not the property of the Co under examination,
and any property belonging to the Co but not available for count;
b) Inquire as to method of determining all quantities and prices
used in compiling inventory total.
B) Apply gross
profits test for its equivalent;
C) Review any production record available and
relate beginning inventory, production sales, and ending inventory on a
quantity basis, if possible.
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