Workshop on Stock in Trade – Physical Stock Taking & Valuation

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Workshop on Stock in Trade –Physical Stock Taking & Valuation

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Inventories

The following topics will be covered during the workshop:• Definitions• Financial statements assertion• Methods of obtaining audit evidence• Understanding of inventory system• Physical inventories• Valuation of inventories• Presentation and disclosures• Quiz and multiple choice questions

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Definitions

Inventories are assets • Held for sale in the ordinary course of business;• In the process of production for such sale; or• In the form of materials or supplies to be consumed in

the production process in the rendering of services.

Net realizable value

Is the estimated selling price in the ordinary course of business less the estimated costs of completion and estimated costs necessary to make the sale.

Fair value

Is the amount for which an asset could be exchanged, or a liability settled between knowledgeable, willing parties in an arm length transaction.

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Financial statements assertion

Assertions about account balances at the period end

Assertions about class of transactions and events

for the period under audit

Assertions about presentation and

disclosure

•Occurrence—transactions and Events that have been recorded

have occurred and pertain to the entity

•Completeness—all transactions and events that should have been recorded have been

recorded •Accuracy—amounts and other data

relating to recorded transactions and events have been recorded

appropriately. •Cutoff—transactions and events

have been recorded in the correct accounting period

•Classification—transactions and events have been recorded

in the proper accounts

•Existence—assets, liabilities, and equity interests exist

•Rights and obligations—the entity holds or controls the rights to assets, and liabilities are the

obligations of the entity •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

•Occurrence and rights and Obligations—disclosed

events, transactions, and other matters have occurred

and pertain to the entity. •Completeness—all disclosures that should have been included

in the financial statements have been included.

•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

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Audit procedures of obtaining audit evidence

Audit procedures of obtaining audit evidence

Objective

The auditor obtains audit evidence to draw reasonable conclusions on which to base the audit opinion by performing audit procedures:

Methods– Inspection of records or documents– Inspection of tangible assets– Observation– Inquiry– Confirmation– Recalculation– Re performance– Analytical procedures

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Yes Approval

ApprovalFinance / Store

Copy to

Report to Finance / Store

Additions

Purchase Requisition

Store Department

Purchase Order

Quality Control

Invoice

INVENTORY SYSTEM

Description - Date of delivery - Quality

Warehouse

Sale Order

Goods Receipt Note Prepared at store for issuance to nextdepartment

Goods Issued to relevantdepartment (process)

Process

Packing

Delivery Note Finance / warehouse

Goods issued to finished goodsdepartment

Labor and overheads

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• Objective of physical attendance• Need for physical stock taking• General audit procedures for stock take• Audit procedures for physical stock taking• Specific areas

Physical inventories

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Objective of physical attendance

• The attendance at the client’s physical inventory is now regarded as a compulsory procedure.

• The purpose of observing inventory is to

determine that the client’s procedure result in accurate count.

• The auditor will himself observe test count.

• The auditor will extract certain cut-off information.

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Need for physical stock taking

When inventory is material to the financial statements, the auditor should obtain sufficient appropriate audit evidence regarding its existence and condition by attendance at physical inventory counting unless impracticable.

If unable to attend the physical inventory count on the date planned, take or observe some physical counts on an alternative date and, when necessary, perform audit procedures on intervening transactions.

Where attendance is impracticable, due to factors such as the nature and location of the inventory, the auditor should consider alternative procedures.

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General Considerations for Stock Taking

In planning attendance at the physical inventory count or the alternative procedures, the auditor considers the following:– The risks of material misstatement related to

inventory.– The nature of the internal control related to inventory.– Whether adequate procedures are expected to be

established and proper instructions issued for physical inventory counting.

– The timing of the count.– The locations at which inventory is held.– Whether an expert’s assistance is needed.

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Audit procedures for physical stock taking

After stock take

During the stock take

Before stock take

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Audit Procedures Before Stock Take

Responsibility

The client has primary responsibility for planning and conducting the physical inventory. The presence of Auditor during this phase is important because of participation in the physical count.

The auditor may carry out the following procedures before the stock take:– Date and time of inventory in consultation with client– Locations of inventory in consultation with client– Stocks held in bonded ware houses– Methods of counting and recording– Instructions to employees– Determine materiality– Need for expert– Provisions for the following:

• Receipts and dispatch of inventory during the count• Segregation of inventory held for third party• Physical arrangement of inventory

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Audit procedures during stock take

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The main task is to ensure that the client’s staff are carrying out their duties effectively. The auditor should:

• obtain cutoff numbers (last receiving number and last dispatch number)

• determine extent to which client counts would be tested.• make two-way test counts from floor to sheet, and from stock sheets

to floor.• compare count with appears on inventory tag, sheet, bin cards, and

also compare serial number and description, of the tags, sheets, bin cards.

• Make notes of all tags, sheets, bin cards that represents damaged stocks and slow moving items.

• examine source of stock sheet generation• for work in process discuss with knowledgeable employee to review

the estimated cost to complete related to labor and factory overheads.

• Make sure that inventory not owned by the client is not included in the stock sheets.

• If experts are used than observe the procedures performed by him.

Audit Procedures During Stock Take

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Following are the procedures

• The sheets shall be signed by all persons who were involved in the physical stock taking

• Ensure all inventory sheets are accounted for

• Ensure rough inventory sheets are retained

• Cut off testing of receiving and dispatch of documents

• Prepare reconciliations in order to reach at year end stock, if the physical stock tacking is performed before or after year end

• Document/ Inquire the observations/ discrepancies between physical and sheets provided noted during the course of physical stock take

Audit procedures after stock take

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Specific Areas

Stocks held at third party

1. Obtain direct confirmation

• As to the quantities.• As to the condition of inventory.

2. Depending on materiality of this inventory the auditor would also consider the following:

• The integrity and independence of the third party.• Observing, or arranging for another auditor to observe, the physical

inventory count.• Obtaining another auditor’s report on the adequacy of the third party’s

internal control for ensuring that inventory is correctly counted and adequately safeguarded.

• Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts, or obtaining confirmation from other parties when such inventory has been pledged as collateral.

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Specific areasStock in transit– The auditor should verify through reviewing purchase invoices

and subsequent status. – Considerations to quarantine inventories

Stock in bonded ware houses1. Auditor obtain direct confirmation in writing, from custodian.2. The auditor should also apply one or more of the following

additional procedures:– Review and test client’s procedures for investigating the

warehouseman and evaluating his or her performance.– observe physical counts of goods, if applicable.– if warehouse receipts have been pledge as collateral, confirm

details of pledged receipts with lenders.

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Audit of Inventory valuation

Topics to Cover:

- Definition of Inventories (Detailed)

- Initial Recognition of Inventories

- Implications of ISA-500 (Audit Evidence) on audit of Inventories

- Subsequent Measurement of Inventories including different methods of Inventory Valuation

- Other Matters which include Retail and Standard Cost Method of Inventory Valuation and special considerations related to Joint and By Product Costs.

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Definition of Inventory

Inventory includes:

Inventories of Manufacturing Concern

- Assets held for sale in the ordinary course of business (finished goods);

- Assets in the production process for sale in the ordinary course of business (work in process); and

- Materials and supplies to be consumed in the production process (raw materials) or rendering of services. [IAS 2.6].

Inventories of Service Provider

In the case of service provider, inventories include the costs of the services which consist primarily of the labor and other costs of personnel directly engaged in providing of the service, including supervisory personnel and attributable overheads for which the entity has not yet recognized the related revenue (see IAS 18 Revenue)

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Initial Recognition

Cost should include all: [IAS 2.10] - Costs of purchase (including taxes, transport, and handling) net of trade

discounts received;- Costs of conversion (including fixed and variable manufacturing

overheads); and- Other costs incurred in bringing the inventories to their present location

and condition.

Inventory cost should not include: [IAS 2.16-2.18] - Abnormal waste;- Storage costs;- Administrative overheads unrelated to production;- Selling costs;- Foreign exchange differences; and- Interest cost.

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Cost Formulae

- For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory. [IAS 2.23]

- For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25]. The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the enterprise. For groups of inventories that have different characteristics, different cost formulae may be justified. [IAS 2.25]

- The standard cost and retail methods (For Commercial Importers and Traders) may be used for the measurement of cost, provided that the results approximate actual cost. [IAS 2.21-22]

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Subsequent Measurement

• Any write-down to NRV should be recognized as an expense in the period in which the write-down occurs.

• Any reversal should be recognized in the income statement in the period in which the reversal occurs. [IAS 2.34]

What is NRV:

NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6].

NRV = Estimated (selling price–cost to complete– cost necessary to make sale)

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Audit Tick Slow Moving/ Audit TickParticulars Location Quantity Physical Damage/ Slow Moving/

of Item Held Count Obsolete Damage/ obsolete

Item - A W1-A 10,232 P 205 SItem - B 7,685 P 154 SItem - C 567 P 11 DItem - D 7,898 P 158 OItem - E 3,455 P 69 DItem - F 5,692 P 114 SItem - G 9,843 P 197 OItem - H 15,468 P 309 DItem - I 8,756 P 175 SItem - J 1,938 P 39 OItem - K 8,762 P 175 DItem - L 1,450 P 29 SItem - M 617 P 12 O

82,363 1,647

Audit Tick for Physical Verification P

Audit Tick for Slow Moving Stock SAudit Tick for Demaged Stock DAudit Tick for Obsolete Stock O

Activity Based Costing LimitedFinished Goods Physical Stock Sheet

As at June 30 2005

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Estimated Estimated Estimated Net Lower ofParticulars Quantity Average Total Selling Completion Selling Realizable Total Cost/

Held Cost Cost Price Cost Cost Value NRV NRV

Item - A 10,232 102.5 1,048,780.00 117.88 - 2.36 115.52 1,181,975.06 1,048,780.00 Item - B 7,685 345.32 2,653,784.20 397.12 - 7.94 389.18 2,990,814.79 2,653,784.20 Item - C 567 85.47 48,461.49 98.29 - 1.97 96.32 54,616.10 48,461.49 Item - D 7,898 1257.63 9,932,761.74 1,265.70 - 25.31 1,240.39 9,796,568.63 9,796,568.63 Item - E 3,455 628.82 2,172,555.83 723.14 - 14.46 708.67 2,448,470.41 2,172,555.83 Item - F 5,692 419.21 2,386,143.32 482.09 - 9.64 472.45 2,689,183.52 2,386,143.32 Item - G 9,843 314.41 3,094,713.02 361.57 - 7.23 354.34 3,487,741.58 3,094,713.02 Item - H 15,468 251.53 3,890,604.17 245.35 - 4.91 240.44 3,719,172.32 3,719,172.32 Item - I 8,756 209.605 1,835,301.38 241.05 - 4.82 236.22 2,068,384.66 1,835,301.38 Item - J 1,938 179.66 348,183.85 206.61 - 4.13 202.48 392,403.20 348,183.85 Item - K 8,762 104.80 918,279.51 120.52 - 2.41 118.11 1,034,901.00 918,279.51 Item - L 1,450 69.87 101,309.08 80.35 - 1.61 78.74 114,175.34 101,309.08 Item - M 617 52.40 32,331.57 60.26 - 1.21 59.06 36,437.68 32,331.57

82,363 28,463,209.15 30,014,844.29 28,155,584.20

Activity Based Costing LimitedFinished Goods Stock Valuation Sheet

As at June 30 2005

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Slow Moving/ AmountParticulars Demage/ Average of

Obselence Cost Provision

Item - A 205 102.5 20,975.60 Item - B 154 345.32 53,075.68 Item - C 11 85.47 969.23 Item - D 158 1257.63 198,655.23 Item - E 69 628.82 43,451.12 Item - F 114 419.21 47,722.87 Item - G 197 314.41 61,894.26 Item - H 309 251.53 77,812.08 Item - I 175 209.605 36,706.03 Item - J 39 179.66 6,963.68 Item - K 175 104.80 18,365.59 Item - L 29 69.87 2,026.18 Item - M 12 52.40 646.63

1,647 569,264

Activity Based Costing LimitedProvision for slow moving/ demaged/ obsolete stock

As at June 30 2005

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Slow Moving/ Audit TickParticulars Location Quantity Physical Demage/ Slow Moving/

of Item Held Count Obselence Damage/ obsolete

Item - RM - A W1-A 5,116 P 102 SItem - RM - B 3,467 P 69 SItem - RM - C 635 P 13 DItem - RM - D 7,475 P 150 OItem - RM - E 3,258 P 65 DItem - RM - F 5,936 P 119 SItem - RM - G 9,254 P 185 OItem - RM - H 12,655 P 253 DItem - RM - I 7,536 P 151 SItem - RM - J 1,675 P 34 OItem - RM - K 8,265 P 165 DItem - RM - L 1,923 P 38 SItem - RM - M 715 P 14 O

67,910 1,358

Audit Tick for Physical Verification P

Audit Tick for Slow Moving Stock SAudit Tick for Demaged Stock DAudit Tick for Obsolete Stock O

Activity Based Costing LimitedRaw Material Physical Stock Sheet

As at June 30 2005

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AmountParticulars Quantity Average of

Held Cost Valuation

Item - RM - A 5,116 51.25 262,195.00 Item - RM - B 3,467 172.66 598,612.22 Item - RM - C 635 42.74 27,136.73 Item - RM - D 7,475 628.82 4,700,392.13 Item - RM - E 3,258 314.41 1,024,339.64 Item - RM - F 5,936 209.61 1,244,215.28 Item - RM - G 9,254 157.20 1,454,763.50 Item - RM - H 12,655 125.76 1,591,530.77 Item - RM - I 7,536 104.80 789,791.64 Item - RM - J 1,675 89.83 150,466.45 Item - RM - K 8,265 52.40 433,096.33 Item - RM - L 1,923 34.93 67,178.40 Item - RM - M 715 26.20 18,733.45

67,910 12,362,451.52

Activity Based Costing LimitedRaw Material Valuation

As at June 30 2005

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Slow Moving/ AmountParticulars Demage/ Average of

Obselence Cost Provision

Item - RM - A 102 51.25 5,243.90 Item - RM - B 69 172.66 11,972.24 Item - RM - C 13 42.74 542.73 Item - RM - D 150 628.82 94,007.84 Item - RM - E 65 314.41 20,486.79 Item - RM - F 119 209.61 24,884.31 Item - RM - G 185 157.20 29,095.27 Item - RM - H 253 125.76 31,830.62 Item - RM - I 151 104.80 15,795.83 Item - RM - J 34 89.83 3,009.33 Item - RM - K 165 52.40 8,661.93 Item - RM - L 38 34.93 1,343.57 Item - RM - M 14 26.20 374.67

1,358 247,249.03

Activity Based Costing LimitedProvision for slow moving/ demaged/ obsolete stock

As at June 30 2005

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Activity Based Costing LimitedAs at June 30 2005

Stock in Trade: 2005 2004

Finished goods 28,155,584 26,344,876 Work in progress 14,556,654 16,765,489 Raw material 12,362,452 10,982,345

55,074,690 54,092,710 Less: Provision 569,264 -

54,505,426 54,092,710

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Presentation and Disclosure of Inventories under Fourth Schedule and IAS-2

IFRS- Accounting policy for inventories. - Carrying amount, generally classified

as merchandise, supplies, materials, work in progress, and finished goods

- Carrying amount of any inventories carried at fair value less costs to sell

- Amount of any write-down of inventories recognized as an expense in the period

- Amount of any reversal of a write-down to NRV and the circumstances that led to such reversal

- Carrying amount of inventories pledged as security for liabilities

- Cost of inventories recognized as expense (cost of goods sold)

Fourth Schedule- Stock in trade distinguished between

appropriate classifications.- Provision, if any, made for diminution

in the value of or loss shall be shown as a deduction from the gross amount.

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Multiple Choice Questions

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Which of the following analytical procedures is most applicable to inventory?

a. Comparison of sales of current and prior years.b. Comparison of gross profit ratios of current and

prior years.c. Comparison of marketing expense with budget.d. Comparison of ratios of sales to accounts

receivable of current and prior years.Solution

bReason Because the amount shown for inventory affects

cost of sale and the gross profit ratio, fluctuations in this ratio are investigated in connection with the audit inventory.


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The inventory observation provides least evidence ofa. Presentation c. Valuationb. Existence d. Rights

Solution A

Reason Observation of inventory on hand provides little evidence about the classification of inventory.


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The observation of inventories is a(n)

a. Generally accepted auditing standard.

b. Generally accepted auditing procedure

c. Alternative auditing procedure.

d. Optional auditing procedure.

Solution

b

Reason

Observation of inventories is a procedure, i.e., an act to be performed.


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During an inventory observation auditors normally record certain of their test counts to

a. Be used in compiling the client’s inventory.b. Check the accuracy of the client’s account.c. Compare with the final inventory listing.d. Test the client’s counting procedure.

Solution cReasonRecorded test counts are compared with the client’s final inventory listing to provide assurance that the client’s counts were not changed between the time they were made and the time the final inventory listing was prepared.


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During an inventory observation an auditor may detect absolute items by all of following except

a. Observing unusual amounts of rust or dust.b. Observing items with prior year inventory tags.c. Computing gross profit ratios.d. Inquiry of plants personnel.Solution

CReason

The gross profit ratio will not detect absolute goods in inventory although other ratios such as inventory turnover will.


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To test the receiving cut off auditors record the last several numbers of documents used prior to the taking of the inventory. These documents are

a. Vendor invoices.

b. Purchase orders.

c. Receiving reports.

d. Purchase requisition

Solution

c

Reason

Receiving reports are used to test the receiving cut off.


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In performing an inventory receiving cut off test, an auditor determines that an item was received and counted on 12/31/X3 (the audit date), but the purchase was not recorded until 1/4/X4. The effect of this to

a. Overstate inventory and accounts payable.b. Understate inventory and accounts payable.c. Overstate inventory and understate accounts payable.d. Overstate net income and understate accounts payable.

Solution dReason The inventory count generated an entry debiting inventory (because inventory was physically on hand but not recorded on the books) and crediting cost of sales (inventory overage). The credit to cost of sales should have been to accounts payable.


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In which of the following types of inventories would an auditor be least likely to need the assistance of a specialist to determine existence?

a. Baked goodsb. Coal Pilec. Precious gemsd. Art workSolution

aReason

The auditor could evaluate baked goods, but would need a surveyor for the coal pile and appraisers for the gems and art work.


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The most important objective in the audit of current liabilities is

a. Existenceb. Completenessc. Valuationd. Presentation and disclosure.Solution

c Reason

Unrecorded items constitute the auditor’s man risk when auditing current liabilities.


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In determining which accounts payable to select for confirmation, an auditor is most likely to pick

a. Accounts with the largest balances to obtain dollar coverage.b. Major vendors and suppliers regardless of the amount of the

balances.c. Accounts with debit balances.d. Any account with zero balance.Solution

bReason

Because the auditor is primarily concerned with the completeness assertion, he or she sends confirmations to vendors that should have large balances (the major vendors).


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The review of subsequent disbursements covers the period ending on thea. Audit Date

b. Bank cut off statement.

c. Last day of field work.

d. Day of delivery of audit report

Solution

c

Reason

The auditors are in the client’s office through the last day of field work, and this is the date trough which the review of subsequent disbursements is performed.


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In the audit of accrued liabilities an auditor finds that the only recorded accrual is for payroll. This suggests that another accrual is needed for

a. Vacation pay

b. Profit sharing

c. Executive salaries

d. Payroll taxes

Solution

d

Reason

The client should have accrued payroll taxes applicable to the accrued payroll.


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An auditor testing pricing of inventory for a client that uses a job-order cost system would review

a. Categories of cost flowing through the control accounts.

b. Accumulations of cost by cost centre.

c. Standard cost buildups.

d. Variation between actual and projected cost.

Solution

a

Reason

The auditor would review costs in the direct labor, material, and overhead control accounts.


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Goods were received on December 29 and counted during December 31 physical inventory. The transaction to record the purchase was recorded January 3. Which of the following entries will the auditor purpose?

a. Debit inventory and credit accounts payable.b. Debit inventory and credit purchases.c. Debit cost of sales and credit accounts payable.d. Debit cost of sales and credit inventory.Solution

cReason

Cost of sales was credited in the entry to record the physical inventory counts, but the entry should have been to accounts payable.


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True and False

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• The taking of an accurate physical inventory is a generally accepted auditing procedure.F The observation of the physical inventory is a generally accepted auditing procedure.

• Before the start of the inventory, the auditor should review the client’s inventory instructions.T

• The auditor tests a client’s inventory cut off to determine that physical items and their related costs are treated in a consistent manner.T

• The objective of a receiving cut off test is to determine whether items that are received near the end of the year and included in inventory also are recorded as purchases and accounts payable.T

• The test of inventory pricing in a job-order cost system usually involves a review of the flow and accumulation of costs by cost centre for the major products.F The review of costs by cost centre is performed when auditing a process cost system

True and False

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• If a product is counted quarts and priced in gallon, inventory will be understated.F Inventory will be overstated, not understated.

• The auditor would perform more extensive inventory cut off procedures where there is a separate receiving department and renumbered receiving reports are used ten where such controls do not exist.F

The auditor would perform less extensive inventory cut off procedure in this case.

• The auditor seldom finds amounts recorded as liabilities that are not liabilities, but unrecorded liabilities are not unusual.T

• Confirmation of accounts payable is a generally accepted auditing procedure.F Although confirmation of accounts payable is common practice, it has not been designated as a generally accepted auditing procedure

• An account payable confirmation may shown an amount different from the client’s books, but both may be correct.T

• An advantage of using the review of subsequent disbursements in the audit of accounts payable is that provides much broader account coverage than would be practicable with confirmations.T

• A good starting point in a search for unrecorded accrued liabilities is the client’s expense accountsT

True and False

Workshop on Stock in Trade – Physical Stock Taking & Valuation

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Transcript of Workshop on Stock in Trade – Physical Stock Taking & Valuation