Inventories and Cost of Goods

Sold

Chapter 12

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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

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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

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Objectives for the Audit of Inventories and Cost of Goods Sold

Determine the existence of inventories Establish the completeness of inventories Establish that the client has rights to the recorded

inventories Determine that the valuation of inventories and cost

of goods sold is in accordance with GAAP Determine that the presentation and disclosure of

inventories and cost of goods sold are appropriate

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Substantive Tests for the Inventories and Cost of Goods Sold

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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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