T8 revision

Purchase
and

Inventory
By

Dream high
Contents
 Purchases and trade payable
Substantive procedures

Detailed
objectives

Whether purchases Do trade accounts

and trade accounts payable represent
payable are the appropriate
recorded in the amounts due by
correct year? company?
(related to cut-off)
Management assertion
Obligation &
right
O

Accuracy A C Completeness

Management
asertion

Existence & E P Presentation &

occurrence disclosures
Audit procedures

Payable listing

Trade creditor confirmation

Search for unrecorded liabilities

Purchase cut-off

Analytical procedures on expenses

Vouch purchase
Payable listing-EAP

E A P

Check arithmetic Agree the total Scrutinize the

correctness of the per list of balance list for
listing to purchase unusual items
ledger account (in the
understanding of
balance business &
comparison with
prior year
experience)
 Trade creditor confirmation-CEA
This procedure is relatively rare in practise.
Positive confirmation may be used where:

1.
1.Vendor
Vendorstatements
statementsare
areunavailable
unavailableand
andincomplete
incomplete

2.
2.Weakness
Weaknessinininternal
internalcontrol
controlmay
maylead
leadto
tomaterial
materialmisstatements
misstatements

3.
3.Doubts
Doubtsabout
aboutthe
thefraudulent
fraudulentreporting
reportingactivities
activitiesover
over
under-statement
under-statementof
ofliabilities
liabilitiesand
andexpenses
expenses

4.
4.Non-routine
Non-routinetransactions/balances
transactions/balances
Search for unrecorded liabilities-C

 Review the outstanding purchases order

=> point out any purchase completed but not yet invoice

 Obtain and review the list of unpaid invoices at the date of audit visit
=> make sure material invoices are taken up in the period under review

 Review significant payment subsequent to the period-end AND make sure

the relating invoices/GDN were recorded in proper accounting period

 Inquire into significant unusual items caused understatement of

liabilities AND review the accrual listing (in the understanding of the
business and comparison with prior year)
 Purchase cut-off-C

Goods Receipt Notes for… Should be recorded in…

Purchases received before The period under audit

the period-end

Purchases received after The period subsequent to the

the period-end one under audit

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Company Logo
Analytical procedures on expenses-CE

Comparison the ratio

analysis on trade Monthly trend
payable turnover day analysis on purchase
with prior period

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Company Logo
 Vouch purchase-EA

 Inspect supporting documents on a sample of

purchases during the audit period

 Verify whether the expenses have been allocated

to the correct purchase ledgers
 Inventory

Substantive
Test of control
procedures

“The most difficult area of the audit”

3 Inventory _ Test of control

IAS2-Inventory
Inventory are assets:
• Held for sales in the ordinary course of business
• In the process of production for such sales
• In the form of materials or supplies to be
consumed in the production process or in the
rendering of services
Cost: all purchase costs + other costs to bring
inventories to their location and condition.
NRV: estimated selling price – estimated necessary
cost to make sale.
Written-down = Cost - NRV
3 Inventory _ Test of control

Objective  Controls  Test of

controls
• Recording:
Movement Segregation  Inspect
custody &recording Inquire
 Reconcile  Inquire
Warehouse dept Re-perform
& a/cting dept records
3 Inventory _ Test of control

Objective  Controls  Test of

controls
• Safeguarding
Exist  Count  Inquire
Observe
( a sample)
Value  Mangt review  Inquire
Re-perform
3 Inventory _ Test of control

Inherent risk

• Define: estimate
The susceptibility
of an assertion to
MM assuming
that there’s no
related internal important Complex

control.
3 Inventory _ Test of control

Inherent risk Inventory

• Quantifying
- Many ranges/ numerous product lines
- The movement between centers
- Whether inventory places in third party?
• Valuing: Nature
3 Inventory _ Test of control

WIP
• Valuing:
- Value: material
- Valuation: complex
Involve: - Allocation of direct costs
- Absorption of OHs
Ensure correctly reflecting in closing
valuation.
3 Inventory _ Test of control

Questions

• Reasons why inventory should be valued at NRV

• Tests to determine NRV
- Find actual selling prices from the lastest sales invoice. (slow
moving or obsolete items allowance)
- Estimate marketing, selling, distribution exps in the past  use
reasonableness test.
- Discuss with mangt : selling price if there is little past evidence.
- Discuss any large differences.
- Value any damaged invetory = 0
- Conclude what inv at cost, what at NRV.
4 Inventory_ substantive procedure

Procedures C E A V O P

Review consistency of accounting X

policies

Attend physical inventory count X X X X X

Price testing X

Cut-off test X

Assess net realizable value X

4 Inventory_ substantive procedure

itie s
b il
on si
sp
Re
c ou n ts
d s of
Metho
Physical
inventory Before the count
count
During the count
Click to add Title
After
th e c
ount
4 Inventory_ physical inventory count

Responsibilities

Management Ensure inventory figure in accounts

• Represents inventory that exists
• Includes all inventory owned
Ensure accounting records include statements of
physical inventory count
Auditors Obtain sufficient audit evidence about inventory from:
• Inventory records
• Inventory control systems
• Results of Physical inventory counts
•Test counts by auditors
Attend physical inventory count
4 Inventory_ physical inventory count
Methods of counts

Count at the end of the

1
financial year The length of time between inventory
count and the end of financial year
2 Count before/after the Internal control system
end of the financial year
Quality of records of inventory
movement

All inventory lines are counted at least

once a year
Perpetual/ continuous
3 Maintains adequate inventory records
inventory
Has satisfactory procedures for
inventory counts and test-counting
Investigates and corrects all material
differences
4 Inventory_ physical inventory count
Before the count

Before the count

Planning the count Review of count instruction

Gain Assess Plan Organization Counting Recoding

understand key procedures Of count
factors
4 Inventory_ physical inventory count
Key tasks
1. Observe whether the client’s staff
are following instruction
2. Make test counts to ensure
procedures and internal control are
working properly
3. Ensure that the procedures for
identifying damaged, obsolete and
slow-moving inventory operate
properly
4. Confirm that inventory held on
behalf of 3rd party is separately
identified and accounted for
5. Conclude whether the count has
been properly carried out
6. Consider whether any amendment is
necessary to subsequent audit
procedures.
During the count
Working papers
a. Details of their observations and
tests
b. The manner in which points that
are relevant and material
c. Instances where the client’s
procedures have not been
satisfactorily carried out
d. Items for subsequent testing
e. Details of the sequence of
inventory sheets
f. The auditors’ conclusions
 4 Inventory_ physical inventory count
After the count

• Trace items that were test counted to final inventory sheets

• Check all count records have been included in final inventory sheets

• Check final inventory sheets are supported by count records

• Ensure that continuous inventory records have been adjusted
• Confirm cut-off by using details of the last serial number of goods

• Check replies form 3rd parties about inventory held by them

• Confirm the client’s final valuation of inventory

• Follow up queries and notifying problems to management

• Consider whether attendance at the inventory count
has provided sufficient reliable audit evidence
4 Inventory_ substantive procedure

Cut-off

The importance of Audit procedures on

cut- off cut-off

•Particular points • At theinventory count

•Purchase invoices • During the final audit
• Sales cut-off
• Physical inventory
count
4 Inventory_ cut -off test
The importance of
cut- off

Cut-off is the most critical to the accurate recording of transactions in a manufacturing

entity at particular points in the accounting cycle

Particular points The point of purchase and receipt of

goods and services
The requisitioning of raw materials
The transfer of completed WIP to
finished goods
The sale and dispatch of finished goods

Purchase invoices Should be recorded as liabilities only if the

goods were received prior to the inventory
count
Sales cut-off Invoices for goods dispatched after the
count should not be recognized as revenue
for the current period
Physical inventory count Management should to make arrangement
for cut-off to be properly applied.
4 Inventory_ cut-off test
At the
count
Record all movement notes relating to
the period, including:
•All interdepartmental requisition
numbers
•The last goods received noted and
despatch note prior to the count
•The first goods received noted and
despatch note after to the count
Observe whether corrects cut-off
procedures are being followed in the
despatch and receiving areas
Discuss procedures with company staff
performing the count to ensure they
understood
Ensure that no goods finished on the
day of count are transferred to the
warehouse
Audit procedures on
cut-off
During
the final
audit
Match up the GRN with purchase
invoices to ensure the liability has been
recorded in the correct period
Match up the GDN to sales invoices
to ensure the income has been
recorded in the correct period
Match up the requisition notes to the
WIP figures for receiving department
to ensure correctly recorded.
4 Inventory_ substantive procedure
Price testing/ valuation procedures

The auditors must

 Understand how the company determines the costs of an item for inventory valuation
purposes
Make sure the company is applying the method consistently and that the method used
gives a fair estimation to cost.

Key tests

Raw materials •Inspect the valuation of raw materials to invoices and price list
•Confirm appropriate basis of valuation is being used
•Confirm correct quantities are being used when calculating raw
material value in WIP and finished goods
Labour cost •Check labour costs to wage records
•Review standard labour costs in the light of actual costs and
production
•Check labour hours to time summaries
Overhead Verify the appropriateness of the management’s basis to make
sure that it is consistent with prior years and calculated on the
normal level of production activity
4 Inventory_ substantive procedure
Assess net realizable value

Review and test the client’s system for identifying slow-moving, obsolete or damaged
inventory
Make sure that such items identified at the inventory count are written down to
NRV
Inspect inventories records to identify slow-moving items
Examine the prices at which finished goods have been sold after the end of the
period to identify any finished goods items need to be written down to NRV
Review quantities of goods sold after the year end to determine that inventory at the
year end has been or will be realised
Consider the need to make appropriate provision for significant goods unsold or
sold at lower price subsequent to the period-end
Compare ultimate selling price with carrying value of WIP plus costs to be incurred to
bring the WIP to a finished stage
 Questions
&
exams

Dec June Dec June Dec June Dec June Dec June
2010 2010 2009 2009 2008 2008 2007 2007 2006 2006

Purchase x x

Inventory x x x x x
 Purchase - Test of control

• Objectives of having internal control in

purchase system(6/04 ; 6/07)

• Control activities regard to the purchases

of goods(6/07)
Inventory _ Test of control
•Reasons why inventory should be valued at NRV
•Tests to determine NRV
- Find actual selling prices from the lastest sales invoice. (slow
moving or obsolete items allowance)
- Estimate marketing, selling, distribution exps in the past  use
reasonableness test.
- Discuss with management : selling price if there is little past
evidence.
- Discuss any large differences.
- Value any damaged inventory = 0
- Conclude what inv at cost, what at NRV.

Inventory_ Substantive procedure

• Compare continuous inventory count and year-end inventory count
(6/03)
•Planning the audit coverage of the inventory count (6/03)
•Audit firm’s responsibilities for the accuracy of the inventory(6/05)
• Test sales cut-off(6/05)
•Inherent risks associated with the inventory and WIP(12/08)
•Objective and key procedures of attending the physical count (12/08)