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    Audit of Inventory

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    Joneric Ramos
    PAS 2 provides guidance on accounting for inventories. It defines inventories as assets held for sale, in production, or in the form of materials or supplies. Inventories must be measured at the lower of cost or net realizable value, with cost determined using methods like FIFO or weighted average. Net realizable value is the estimated selling price less costs to complete and sell. Inventories must be written down if cost is not recoverable. Strong internal controls over inventories include centralized control, trained personnel, physical security, perpetual inventory records, and identification of slow-moving items.

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    Audit of Inventory

    Uploaded by

    Joneric Ramos
    55 views10 pages
    PAS 2 provides guidance on accounting for inventories. It defines inventories as assets held for sale, in production, or in the form of materials or supplies. Inventories must be measured at the lower of cost or net realizable value, with cost determined using methods like FIFO or weighted average. Net realizable value is the estimated selling price less costs to complete and sell. Inventories must be written down if cost is not recoverable. Strong internal controls over inventories include centralized control, trained personnel, physical security, perpetual inventory records, and identification of slow-moving items.

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    PAS 2 provides guidance on accounting for inventories. It defines inventories as assets held for sale, in production, or in the form of materials or supplies. Inventories must be measured at the lower of cost or net realizable value, with cost determined using methods like FIFO or weighted average. Net realizable value is the estimated selling price less costs to complete and sell. Inventories must be written down if cost is not recoverable. Strong internal controls over inventories include centralized control, trained personnel, physical security, perpetual inventory records, and identification of slow-moving items.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    55 views10 pages

    Audit of Inventory

    Uploaded by

    Joneric Ramos
    PAS 2 provides guidance on accounting for inventories. It defines inventories as assets held for sale, in production, or in the form of materials or supplies. Inventories must be measured at the lower of cost or net realizable value, with cost determined using methods like FIFO or weighted average. Net realizable value is the estimated selling price less costs to complete and sell. Inventories must be written down if cost is not recoverable. Strong internal controls over inventories include centralized control, trained personnel, physical security, perpetual inventory records, and identification of slow-moving items.

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    of 10

    PHILIPPINE ACCOUNTING STANDARDS 2 (PAS 2 INVENTORIES)

    Scope

    Applies to all inventories except:


    • work in progress arising under construction contracts (PAS 11)
    • financial instrument (PAS 31, PFRS 9); and
    • biological assets related to agricultural activity (PAS 41)

    Does not apply to the measurement of inventories held by:


    • producers of agricultural and forest products, agricultural produce after harvest, and minerals
    and mineral products, to the extent that they are measured at net realizable value in accordance
    with well-established practices in those industries
    • commodity broker-traders who measure their inventories at fair value less costs to sell

    Inventories, defined

    Inventories are assets


    (a)held for sale in the ordinary course of business;
    (b)in the process of production for such sale; or
    (c)in the form of materials or supplies to be consumed in the production process or in the
    rendering of services.

    Inventories encompass:
    • goods purchased and held for resale
    • finished goods produced, or work in progress being produced, and include materials and
    supplies awaiting use in the production process
    • in the case of a service provider, the costs of the service for which the entity has not yet
    recognized the related revenue (see IAS 18 Revenue)

    Measurement of Inventories

    Inventories should be measured at the lower cost and net realizable value

    Cost of Inventories
    • Cost is the total expenditure that has been incurred in bringing the product or service to its
    present location and condition
    • General categories of expenditure considered as cost:
    -Costs of purchase
    -Costs of conversion
    -Other costs incurred in bringing the inventories to their present location and condition

    General Categories of Expenditure

    1. Costs of Purchase include:


    • purchase price,
    • import duties and other taxes,
    • transport and handling costs,
    • other costs directly attributable to the acquisition of finished goods, materials and services
    • discounts, rebates and other similar items are deducted

    2. Costs of Conversion include direct labor cost and overhead


    • Allocation of overhead needs to be based on the enterprise’s normal capacity
    • When there is a main product and a by-product and the costs of conversion of each product are
    not separately identifiable, they are allocated between the products on a rational and consistent
    basis.
    • Most by-products are immaterial. Thus, they are often measured at net realizable value and this
    value is deducted from the cost of the main product.
    3.Other costs are included only to the extent incurred in bringing the inventories to their present
    location and condition. Some expenses should not be included in costs of production:
    • Abnormal amounts of wasted material, labor or other production costs;
    • Storage costs (unless necessary in the production process prior to a further production stage),
    • Administrative overheads that do not contribute to bringing inventories to their present location
    and condition, and
    • Selling costs

    * IAS 23 Borrowing Costs, identifies the limited circumstances where borrowing costs are included in
    the cost of inventories

    * An entity may purchase inventories on deferred settlement items. When the arrangement effectively
    contains a financing element, that element, for example a difference between the purchase price for
    normal credit terms and the amount paid is recognized as interest expense over the period of the
    financing.

    Cost of Inventories of a Service Provider


    • Consist primarily of the labor and other costs of personnel directly engaged in providing the
    service, including supervisory personnel, and attributable overheads.
    • Excludes labor and other costs relating to sales and general administrative personnel, and profit
    margins or non- attributable overheads

    ITEMS TO BE INCLUDED IN THE INVENTORY

    1.Goods in transit Whose inventory is it?


    a. FOB shipping point Buyer’s
    b. FOB destination Seller’s
    2.Consigned goods Consignor (seller)
    3.Sales out on approval Seller’s, until buyer’s approval
    4.Sales with buyback agreement Seller’s, not buyers
    5.Sales with high rates of returns Buyer’s, if you can estimate returns
    6.Sales on installments Buyer’s, if you can estimate collectability
    7.Bill and hold Buyers’
    8.Lay away Seller’s until delivery
    9.Segregated goods in the warehouse
    a. Special order goods Buyer’s upon completion
    b. Hold for shipping instructions Seller’s

    Cost Formula
    Some of the principal cost bases are as follows:
    1.Specific identification – appropriate when inventories are not ordinarily interchangeable, are
    segregated for specific projects are not comprised of a large number of homogeneous items that
    are ordinarily interchangeable.

    2.FIFO or Weighted Average – for all other inventories, IAS 2 permits the cost of inventories to
    be assigned using either first-in, first-out or weighted average.

    FIFO AND Weighted Average Method

    • FIFO - Assumes that the items of inventory which were purchased or produced first, and
    consequently the items remaining in inventory at the end of the period are those most recently
    purchased or produced.

    • Weighted average method - the cost of item is determined from the weighted average of
    the cost of similar items at the beginning of a period and the cost of similar items purchased or
    produced during the period.

    Net Realizable Value

    • Net realizable value is the estimated selling price in the ordinary course of business less
    than the estimated costs of completion and the estimated cost necessary to make the sale.
    • Estimates of net realizable value -Are based on the most reliable evidence available at
    the time the estimates are made, and takes into consideration the purpose for which the
    inventory is held.

    Writing down of inventories. The practice of writing inventories down below cost to net realizable
    value is consistent with the view that assets should not be carried in excess of amounts expected
    to be realized from their sale or use.

    Inventories not to be recoverable if:

    -those inventories are damaged,


    -They have become wholly or partially obsolete,
    -their selling prices have declined, or
    -the estimated costs of completion or the estimated costs to be incurred to make the sale have
    increased.

    AUDIT OF INVENTORIES
    The Use of Assertions in Obtaining Audit Evidence

    Assertions about classes of transactions and events for the period under audit: (COCAC)
    • Completeness - all transactions and events that should have been recorded have been recorded
    • Occurrence - transactions and events that have been recorded have occurred and pertain to the
    entity.
    • Classification - transactions and events have been recorded in the proper accounts.
    • Accuracy – amounts and other data relating to recorded transactions and events have been
    recorded appropriately.
    • Cut-off - transactions and events have been recorded in the correct accounting period.
    Assertions about account balances at the end of the period: (RECV)
    • Rights and obligations - the entity holds or controls the rights to assets, and liabilities are the
    obligations of the entity.
    • Existence - assets, liabilities, and equity interests exist.
    • Completeness – all assets, liabilities and equity interests that should have been recorded have
    been recorded.
    • Valuation and allocation- assets, liabilities, and equity interests are included in the financial
    statements at appropriate amounts and any resulting valuation or allocation adjustments are
    appropriately recorded.
    Assertions about presentation and disclosure: (COCA)
    • Completeness - all disclosures that should have been included in the financial statements have
    been included.
    • Occurrence and Rights and obligations - disclosed events, transactions, and other matters have
    occurred and pertain to the entity.
    • Classification and understandability - financial information is appropriately presented and
    described, and disclosures are clearly expressed.
    • Accuracy and valuation - financial and other information are disclosed fairly and at appropriate
    amounts.
    INTERNALCONTROLMEASURES
    1. Authority and responsibility for controlling the inventories should be centralized management
    and in one person.
    2. There should be careful selection of inventory personnel and intensive training of such
    personnel in policies, objectives and system of inventory control.
    3. Adequate physical facilities for handling and storage of inventory should be provided.
    4. Adequate system of procedures, forms and reports related to the management of inventories should
    be developed and implemented.
    5. Quantitative controls through perpetual inventory records; book quantities verified with physical
    counts at least once a year and differences being investigated, promptly adjusted and reported to higher
    authority should be implemented.
    6. Deliveries of materials, finished stock and merchandise should be made only upon specific
    authorizations emanating at authorized levels.
    7. Slow-moving, obsolete and damaged stock should be identified and reported following periodic
    reviews of physical and book records by qualified employees. Valuation on the basis of approved cost-
    mark-down methods should be reviewed.
    8. Safeguards against that action of the element and inaccuracies in recording receipts and issues
    should be adopted. Example – Maintaining adequate insurance coverage.

    SUBSTANTIVE AUDIT OF INVENTORIES


    Inventory Balances
    Existence: Recorded inventory exist
    1. Before the client takes the physical inventory, review and approve the client’s written plan for
    taking it.
    2. Observe the client personnel physically counting inventory.
    3. Confirm inventories on consignment and held in public warehouses.
    Completeness: All inventory of the entity recorded
    4. Obtain a copy of prenumbered inventory tags used by the client in taking inventory and reconcile
    the tags to the listing.
    5. For selected items, trace from tags to listing.
    6. Perform cutoff procedures. Obtain the receiving report number for the last shipment received
    prior to year- end and determine that the item is included in inventory. Also, identify the last
    shipping document and determine, based on shipping terms, whether the item was properly
    recorded in sales or inventory.
    7. Perform analytical procedures.

    Rights and obligations: Inventory is owned by the entity


    8. Determine that consigned inventory has been excluded from inventory and that inventory
    pledged has been properly disclosed. Examine confirmations from financial institutions and
    read minutes of the board of directors’ meetings.
    Valuation and allocation: Recorded inventory is valued in accordance with GAAP
    9. Considering the method, the client uses for inventory valuation, examine invoices for inventory
    on hand or trace prior year’s inventory listing to verify cost.
    10. For selected items, determine net realizable value (NRV) of the inventory and apply the lower
    of cost or NRV.
    11. Verify computations in the inventory listing.
    12. Review the obsolescence of the inventory by:
    a. being alert while observing inventory being taken for damaged, slow-moving, or scrap
    inventory.
    b. Scanning perpetual records for slow-moving items and discussing their valuation with
    client.
    Presentation and disclosure: Inventory is classified and disclosed in accordance with GAAP
    13. Determine whether accounts are classified and disclosed in the financial statements in
    accordance with GAAP.

    Purchases
    Completeness: Purchases that occurred are recorded
    Trace a sequence of receiving reports to entries in the voucher register. Test cutoff. Account
    for a sequence of entries in the voucher register.
    Occurrence: Recorded purchases are for items that were acquired
    Examine underlying documents for authenticity and reasonableness. Scan voucher register for
    large or unusual items. Trace inventory purchased to perpetual records. Scan voucher register
    for duplicate payments.
    Classification: Purchase transactions have been recorded in the proper accounts
    For a sample of entries in the purchases journal, verify the accuracy of account coding.
    Accuracy (Valuation): Purchases are recorded at proper amounts
    Recompute invoices and compare invoice price to purchase order.

    Production
    Completeness: All production transactions that occurred are recorded

    Account for a sequence for production reports.


    Occurrence: Recorded production transactions occurred
    For selected transactions, examine signed materials requisitions, approved labor tickets, and
    allocation of overhead.
    Classification: Production transactions have been recorded in the proper accounts
    For a sample of entries, verify the accuracy of account coding.
    Accuracy (Valuation): Production transactions are recorded at proper amounts
    Test cost records by tracing to underlying documents, such as bill of materials, labor tickets,
    authorized labor rates, and standard overhead rates. Review variances.
    1. Inventory
    2. Accounts Payable
    3. Net Sales
    4. Net Purchases
    5. Net Income
    1. Sales for the year 4. Inventory
    2. Purchases for the year 5. Accounts Payable
    3. Accounts Receivable
    1. How much is the adjusted Inventory as of July 1, 2005?
    2. How much is the adjusted Purchases for the fiscal year ended June 30, 2006?
    3. How much is the adjusted Inventory as of June 30, 2006?
    4. How much is the adjusted Cost of Goods Sold for the fiscal year ended June 30, 2006?
    5. The necessary compound adjusting journal entry as of June 30, 2006 would include a net
    adjustment to Retained Earnings of:

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