Auditing INVENTORY - substantive procedures

what's up audit fans dr amanda here and today we're going to be doing a big fan request which is looking at auditing inventory today i'm going to specifically focus on the inventory process um and understanding auditing inventory for wholesalers not for manufacturers for manufacturers i'll get into that in a different video so let's get into it now a big shout out to all of my regular subscribers um especially we've had viewers comment from argentina malaysia india uganda so a big hi to everybody around the world i'd love to hear where you're from drop that in the comments so my name is amanda i do love audit i teach audit to undergrads at a major australian university and today we're digging into auditing inventory this one has been requested a lot so let's jump into my tablet so auditing inventory is really important for businesses that sell something all right if you're a service firm infantry is not such a big deal banks etc but if you sell a physical good uh whether that's phones phone cases umbrellas clothing inventory is going to be really really important and as i mentioned before today i'm going to talk about wholesalers so that is organizations that buy inventory from someone and then resell it so realistically for a wholesaler they have a process of needing to purchase inventory and they do that from the manufacturer all right and so there's a whole lot of costing issues obviously that go into making inventory and then they are going to resell it to other wholesalers uh you know online stores uh so you know these types of organizations are normally selling to retailers all right or potentially you could be reselling it to customers okay so i'm just talking about inventory that's fixed boxed comes already organized so in terms of looking at the controls here controls really come from the controls over the purchasing process and i've certainly looked at processes and auditing around how do we order something so certainly around the purchasing there needs to be some sort of purchase request that usually needs to be approved normally then there will be approved suppliers um there needs to be orders obviously so the approved suppliers often you might have a separate purchasing department that might do all of these types of ordering and other types of tasks associated with purchasing then the goods have to be received by the client so they can come to the warehouse you have to check how many do we have is this something that we've ordered and then after that is going to be a process for payment so when you're auditing purchasing you're going to be auditing i guess the transactional side of inventory because inventory is is really interesting in a way that it hits the financials in terms of transactions because i know that when i sell something i go debit cash or accounts receivable and i go credit revenue but then i also make the transaction that says debit cost of goods sold credit inventory so when i'm auditing other parts of the financials when i'm auditing revenue um then i'm also probably going to be auditing that cost of goods sold side and then i'm going to indirectly be gathering information about inventory so today i'm actually going to focus on really the balance side of inventory and that balance is at the end of the financial year the balance of inventory has to go on to the financial statements bless me sorry that i don't think i took my allergy tablet this morning so this could be really interesting all right so i'm going to be looking at the balance of inventory rather than looking at all of the individual transactions that go into that and you'll be auditing that in other parts of the client so now let's write down all of the assertions that we need that go with inventory okay so here we have our assertions and these are our balance assertions remember these come out of isa 315 i think it's paragraph a128 129 i'll be double sure to check but existence completeness accuracy valuation allocation rights and obligations so we're going to look at each of these in turn so let's start with existence does the inventory really exist is it really there it says it's on the balance sheet so we know that for existence this is normally a procedure where we would use some vouching all right so vouching typically means we need to start at the records the accounting records so we're probably going to vouch a let's say haphazard sample of inventory items from now how the inventory is recorded where it is stored could be in any number of different sort of terminology uh types of places so you could have an inventory listing there could be some sort of register of inventory but it's got to be some sort of recording in your system of all the inventory so i'm just going to write here from the inventory listing but it could have a different name at your specific client or in your specific jurisdiction and match two physical items now of course uh this could be a little bit difficult if you have got software that sort of doesn't really count in that same inventory way i'm thinking about physical goods here so you want to match to the physical item and that might be if it's unique enough there might be some sort of um barcode or serial number now if you're looking at inventory it's something really big like a car or a computer part that has a specific serial number you can do that if it's just tennis balls then that's going to be a little bit different but you want to make sure that the inventory actually exists so there is actually a proper name for this type of process where we check the records and we want to make sure that everything that is actually listed as inventory is really there and so one of those is a stock take all right now when it comes to stock takes sometimes if it's very high value inventory we will count it ourselves if it's diamonds or something else if it's a supermarket chain then the stock make stock take might be a process that you observe all right so you might observe the client staff oops i can't spell there counting inventory all right so again this observation process is sort of a bit of a test of a control where you're going to be you know finding out like what's the plan to test inventory how do you train people how do you make sure everything happens correctly and then you're observing the staff as they're doing the stock take so you could observe staff uh stock taking and counting the inventory now of course there can be some complications inventory that is far away inventory that you might not uh you know might be dangerous to look at i don't know if it might be nuclear fissionable material or something so for us we want to find out where is the inventory held how do we actually count it if it's goods that are individually serialized is there some sort of barcode scanner that we could use here so we want to observe count look at the items one other thing to be really careful of when we're testing existence and something that's come up as a result of covert 19 has been the idea of using live streams that is you know the client staff or at their warehouse they're wearing you know perhaps a gopro or something stuck to their head or strapped to here and you're in contact with them and you can see what they're doing when they're doing the counting when it comes to live streams it's really important that you ask to see inside any boxes all right because and this is you know this is a fraud trick as old as time create a whole lot of boxes and they could be empty or they could just be filled with you know something that's broken or something else and so yeah we have heaps of this particular item so you want to make sure that if it says it's there we're looking at the actual product so that i also mean opening some or checking them to make sure that they're reasonable so now sometimes that's difficult i ordered a company that made steel products and i couldn't necessarily look at like this big roll of steel out in the holding area and go oh yeah this is exactly this particular type of product so sometimes when you're checking the existence of inventory it might also be useful to get advice from an expert especially if it's a highly unique product now some things i could tell a can of baked beans i could tell what a frozen chicken looks like but sometimes with specialist equipment we might need to actually get some specialist advice to make sure that we're checking the existence correctly so existence vouching start from the record make sure that the physical item exists now the other side of that is completeness because remember existence is an overstatement thing companies are more likely to overstate their inventory so the other thing that we need to look for i guess when we're looking at existence is also i'm just going to make some more room here so i just need a tiny bit more is we want to examine for any damaged or broken items all right and that'll link through a little bit later on to our accuracy and valuation well that's a bit of a thick line there i want something thinner because broken items will later on help us oh look this needs to be written off this is overvalued so existence and that valuation tend to go together so now let's dig into completeness when you've stock take if you've stocktaked at a company before you might be given a list of the items as an employee and said count how many and write it down now that is actually a completeness test so that would be tracing so that would be counting items and match to the inventory records now remember we have to do both because we're worried about over statement and understatement so i need to you know count it says there should be 20 i write down 20 and then later on we check it to the records and we find out oh there's should be 25 so we've identified that there's some um overstatement there but also we want to look at items and say look is this item actually on the list now when it comes to supermarkets again it's more likely to be the existence issue than the completeness issue but we want to do both so a stock take involves both start from the list work back to the item and pick a random item in the factory and say oh do i find this on an inventory listing somewhere so you could count an item and match to an inventory record or you could haphazardly select items and match to the inventory record all right and that will help you make sure that if there is something that they made that maybe didn't get recorded in the inventory that somehow you've picked that up now of course when you're looking at completeness and you're looking at items on the floor the other thing to be aware of and i'm going to sort of skip down and then i'll come back to accuracy and valuation is that we actually own them so we have the right we want to make sure that we confirm ownership of the inventory so we need to be really careful there if we have any goods that are on consignment so selling goods on consignment might be that for example uh you know audit junior has this phone he doesn't have a phone but somebody somebody has a phone they say commander i want to put this phone in your shop and i want you to sell it um but you won't own the phone you'll just be holding it for me and then you'll get a commission so if you do find inventory and you think oh okay i don't see it on the inventory listing one of the things to check would be is it on consignment to make sure that you own that inventory the other thing around rights and obligations of course is inventory on order or inventory in transit so when inventory you've ordered it it's on its truck on it on the way to you the question is when do you take ownership so that might mean that you'll need to uh you know record inventory that you physically don't have on premises if you own it as soon as it gets on the truck and it gets to you now of course that's not going to be terribly accurate but you still need to record it the other issue is inventory that has been sold but not delivered yet so sold on the last day of the year we know that the sale doesn't happen until the inventory is delivered to them but we want to make sure that's still we still own that inventory until that point so we need to make sure it's recorded so that's our rights and obligations we don't have too much in the obligation side it's more on the right side so let's go back up now to accuracy valuation and allocation and so ava is it often is abbreviated to is accuracy is the costing of the individual product valuation is the value of the entire account and allocation is going to be do we have any non-current inventory so allocation is going to be current v non-current all right so in times of valuing inventory typically the first thing that we need to think about is the inventory valuation method so you need to check whether the inventory method that's being used is acceptable within your jurisdiction so for example fifo weighted average uh lifo so you have to pick out which one oh look they're using a method that's not appropriate or that is an appropriate method so you have to first understand the inventory valuation method then you're going to need to look at the counts all right so you're going to take um so we're going to need to recalculate oh i can't spell here inventory valuation using audited quantities of inventory items multiplied by audited purchase cost now of course that's really simple assuming that everything was purchased for the same price but you're going to need to figure out what inventory is still in existence that was there how much was it purchased for and is it valued correctly so that's going to be a little bit of management accounting there now i'm just going to make a little bit more space here because there's a few other things that we need to do in terms of accuracy valuation and allocation and that other one is going to be that we need to find out is any inventory damaged is any inventory broken or is any inventory lower in value all right because remember we have to use the idea of lower of cost or net realizable value so you need to look at these things and say if it's a fashion warehouse are this is this particular product still in fashion can we still sell it can we still get the money for it so with the damaged or the broken items that's going to come from a lot of observation you look around oh this item is supposed to be on the inventory list but i find that it's broken that needs to be written off so we need to make sure that damaged and broken inventory is written off and we also have to make sure that for any inventory that is declined in value it's not popular anymore it's out of fashion that we need to write it down now the general retail rule is that you buy something you sell it for at least four times the price so it's pretty rare that inventory is going to go down such a significant amount that you're going to need to write it down in value now when it comes to allocation most of the time inventory is current right you plan to sell it in the next 12 months the only time you might have non-current inventory might be goods that you're holding or things that need to age so sometimes that can include things like wine which know goes into the barrel for you know wine or spirits that might need to uh go into a barrel for 20 years etc i can't actually spell spirits there let me try that again spirits so you're going to need to look at those and say is this you know something that we're holding for a long time um and make sure that any um inventory that you don't plan to sell until more than 12 months time actually sits in a non-current inventory type of situation and that's you know reasonably rare and it only sits within a couple of different uh industries now there was one other test or one other thing that i thought is a really good um substantive analytical procedure that works really well with inventory that helps us identify whether we've got an issue with existence or completeness and it's sort of i guess it doesn't really fit neatly within either of those but this is a a type of analytic that i would do quite often so a substantive analytic would be to use your management accounting information to help you understand whether the numbers look correct so for example opening inventory so let's go opening inventory plus what you buy right less what you sell should give you the closing inventory value all right so if you can make sure that opening inventory if you can confirm that from last year's audit so previous year audit purchase you can audit get that audited from the purchases side you're going to get audited information about sales because you're already gathering that evidence and then you can compare your calculation of what you get for your closing inventory and compare that to the client records all right and then you can say oh okay well i started out with 100 i purchased then 1000 then i sold 800 so that should give me 300 in closing inventory but when you actually go and you do your inspections your stock take might discover that you've only got 200 in the item so the question for us is where did the other 100 items go were they stolen were they broken what has happened so i can also use this substantive analytic procedure to help me identify overall what might be happening i can also use substantive analytics to help me with my accuracy valuation and allocation so if we dig into ava i could do things like uh days in inventory so how long and we would do that per product how long does it take me to sell something and if there's something that's been you know really slow so either days in inventory or inventory turnover because they essentially tell you the same thing just in different calculations so days in inventory or inventory turnover per product if you've got days in inventory and it's very high you might say oh look why are we holding onto this for so long how come it takes so long to sell something if inventory turnover happens to be very low that might be something that is slow moving now of course you need to make sure that you customize this for your industry because if i'm selling aston martin sports cars that's going to have low turnover anyway and if you saw low turnover you'd be like oh yeah that that makes total sense however if you are a supermarket and you're selling chicken um or you know fresh meat fruit and vegetables you'd expect the inventory turnover there to be reasonable and if it was really slow you might think oh something is is going on here so you can actually you know calculate one of these ratios for all of the product lines and then if they're in excel just do a sort um and you'll be able to find what's moving the slowest what's moving the fastest and that can also help you get some insight into auditing that specific account and that can also help you narrow down because remember rather than checking your entire population a really smart idea is to stratify so then you could have potentially high medium and low value items you could stratify based on fast average and slow moving items to help you identify obsolete inventory so work smarter rather than harder here now certainly there are some challenges when it comes to inventory inventory that's located far away inventory that is spread out all across the country you know when it comes to auditing supermarkets for example the auditor can't go to every single supermarket here in the country for a particular chain so then it might be testing internal controls what are the controls around stock take do some sample counts yourself if there is inventory in cities that you don't have an office in you might look at hiring a component auditor somebody who can go to that particular place and gather that particular evidence that you need now that is not a fully comprehensive list of every single audit procedure related to inventory that you could do but here are some examples to help you get started remember you always need to customize your audit procedures to the client the industry the scenario even the year with covert 19 where we've had uh observing infantry through gopros live streaming facetime all sorts of different things if you do have a great audit procedure you'd love to share or you want to check whether it seems like a reasonable procedure drop it in the comments and i'll get back in touch of course if you haven't already i'd really appreciate a like if you haven't click subscribe to get up to date audit content i want everybody to stay safe stay well if you're still learning and studying remotely like my students are here in australia and i'll chat to you next time

Channel: AmandaLovesToAudit

Views: 51,599

Keywords: auditing, assurance, auditor, audit, accounting, audited financial statements, financial reporting, audit evidence, substantive testing, auditing inventory, inventory audit, assertions, substantive evidence, audit testing, inventory

Id: 79BQvrZOgXI

Length: 25min 15sec (1515 seconds)

Published: Fri Nov 06 2020