Inventories and Cost of Goods Sold

1. Inventories and Cost of Goods Sold

2. Learning Objectives Describe the nature of inventories and cost of goods sold. Describe the documents, records, and accounts that comprise the purchases and production (conversion) cycles. Identify and explain the fundamental controls over inventories, purchasing, and production. 12-2

3. Learning Objectives Design typical tests of controls used by the auditors to evaluate the effectiveness of the controls over inventories and cost of goods sold. Explain the auditors’ objectives for the audit of inventories and cost of goods sold. Describe the nature of the audit procedures to accomplish the auditors’ objectives for the audit of inventories and cost of goods sold. 12-3

4. 12-4 The Special Significance of Audit of Inventories The valuation of goods on hand and in process often presents complex and difficult issues Determining the quantities of inventories may require specialized techniques Inventories often represent the largest current asset of a company Misstatements of inventories directly affect cost of goods sold and, therefore, net income Management fraud has often involved the fraudulent overstatement of inventories

5. 12-5 Controls Over the Conversion Cycle Segregation of duties over purchases and custody of inventory Use of pre-numbered requisitions, purchase orders, and receiving reports Procedures for authorizing purchase transactions and verifying them for payment General ledger control of inventories and reconciliation to production records Cost accounting controls Analysis of variances from standard costs Use of perpetual records for inventories Use of appropriate procedures for taking inventory Appropriate physical controls over inventories

6. 12-6 Objectives for the Audit of Inventories and Cost of Goods Sold Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to inventories and cost of goods sold. Obtain an understanding of internal control over inventories and cost of goods sold. Assess the risks of material misstatement and design tests of controls and substantive procedures that: Substantiate the existence of inventories and the occurrence of cost of goods sold Establish the completeness of recorded inventories Verify the cutoff of transactions affecting cost of goods sold Determine that the client has rights to recorded inventories Establish the proper valuation of inventories and the accuracy of transactions affecting cost of goods sold Determine that the presentation and disclosure of inventories and cost of goods sold are appropriate

7. 12-7 Figure 12.1 Objectives of Major Substantive Procedures for Inventories and Cost of Goods Sold

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9. 12-9 Relating Controls to Assertions

10. 12-10 Considerations in Planning a Physical Inventory Selecting of the appropriate date Suspending production Segregating obsolete and defective goods Establishing control over the counting process Achieving proper cutoff of sales and purchases Arranging for the services of specialists

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