Auditing Inventories and

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Chapter 12 Auditing Inventories and Property,
Plant and Equipment
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Audit objectivesInventories

• Overall, the audit objectives in respect of
  inventories is to ensure they actually exist, are
  owned and are properly valued

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Analytical procedures

• Audit Procedures
• The auditor reviews industry experience and
  trends
• The auditor must understand the business and in
  practice, auditors often specialise in industry
  sectors

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• Examines inventory turnover and relationship to
  gross profit
• Reviews relationships of inventory balances to
  recent purchasing, production and sales activities

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Tests of details of transactions

• Audit Procedures
• Tests entries in inventory records to and from
  supporting documentation
• Tests the cut-off of purchases, inventory
  transfers and sales

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Tests of details of balances

• Audit Procedures
• The auditor attends the entitys stock-take
• evaluates the adequacy of the entitys
  inventory-taking plans
• observes physical inventory count and tests
  compliance with prescribed procedures

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• makes test counts
• looks for indications of slow-moving, damaged or
  obsolete inventory
• accounts for all inventory tags and count sheets
  used in the physical count
• records cut-off data

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• The auditor also tests the clerical accuracy of
  inventory listings
• recalculates totals and extensions of quantities
  times unit prices
• traces test counts from the stock-take to
  listings
• compares physical counts with perpetual inventory
  records

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• The auditor also tests inventory pricing
• involves verifying the cost of inventory and the
  net realisable value of the items
• also involves considering whether other items,
  whose net realisable value may be below cost,
  need to be written down
• Thus, this testing by the auditor relates to the
  valuation assertion

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Other procedures

• There are also cut-off procedures to be
  undertaken by the auditor to ensure there is no
  inadvertent double counting of inventory and
  sales
• Other tests include inventory turnover that gives
  an indication of any obsolescence in the
  inventory on hand

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• When inventories are stored with third parties,
  the auditor should obtain evidence as to the
  existence of the inventory by direct
  communication with the custodian
• Goods on hand may be held for customers, at their
  request, after a sale has occurred, and goods
  belonging to others may be held on consignment

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• Management is requested by the auditor to
  segregate goods not owned during the physical
  count
• In addition, the auditor usually requests a
  written assertion on ownership of inventories in
  the management representation letter

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Property, Plant And Equipment

• Property, plant and equipment are non-current
  tangible assets intendedto be retained for use
  in the entitys operations
• The main related profit and loss accounts are
  depreciation expense, repairs expense, finance
  charges on finance leases and rent on operating
  leases

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Audit objectivesProperty, plant and equipment

• The auditor is concerned that
• the property plant and equipment actually exist
• are owned
• are properly valued with adequate provision for
  depreciation

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Audit Procedures

• Calculation of ratios such as a comparison of the
  depreciation charge with the cost or written-down
  value
• Analysis of ratio results relative to
  expectations based on previous years results,
  industry data, budgeted amounts or other data
• e.g. repairs and maintenance expense with that
  for previous years or with net sales

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Tests of details of transactions

• These substantive procedures cover three types of
  transaction related to property, plant and
  equipment
• additions
• disposals
• repairs and maintenance

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• Audit procedures include
• Comparison of asset additions and disposals with
  supporting documentation
• Review of repairs and maintenance and rental
  expenses

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Substantiating additions

• The auditor needs first to ascertain managements
  policy with regard to the distinction between
  capital and revenue expenditure
• Most entities specify a cut-off value below which
  purchases are expensed, regardless of their nature

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• Auditor must ensure that additions are properly
  capitalised and that a consistent policy is
  followed
• The recorded amounts should be vouched to
  supporting documentation in the form of
  authorisations in the minutes, suppliers
  invoices and contracts
• The auditor should physically inspect major
  items, ensuring that details of the asset
  inspected (description and the manufacturers
  serial number) agree with the documentation

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• Also needs to inquire about leases for property,
  plant and equipment entered into during the
  period
• The auditor should review any lease agreements to
  determine its proper accounting classification in
  accordance with AASB 117 Leases
• The auditor should do some recalculations to
  verify the accuracy of the entitys determination
  of the present value of the lease liability

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Substantiating disposals

• Evidence of sales, disposals and trade-ins
  should be available to the auditor in the form of
  cash remittance advices, written authorisations
  and sales agreements
• Such documentation should be examined carefully
  to determine the accuracy of the accounting
  records, including the recognition of any gain or
  loss

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• In determining whether all disposals have been
  recorded, the following procedures may be carried
  out
• analysis of the miscellaneous revenue account for
  proceeds from sales of property, plant and
  equipment
• investigation of the disposition of facilities
  associated with discontinued product lines and
  operations

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• tracing of disposal authorisations to recording
  in the accounting records
• reviewing insurance policies for termination or
  reductions of coverage
• inquiring of management to ensure all disposals
  have been properly accounted for

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Tests of details of balances

• The main tests of balances relate to valuation
  and disclosure
• These test the accumulated depreciation, the need
  for provision for impairment, and the
  appropriateness of any revaluation
• Also, the auditor may examine documentary
  evidence as to the existence and rights and
  obligations assertions of the recorded balance

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• Audit procedures include
• Examination of title documents and contracts
• e.g. the auditor may establish ownership of
  vehicles by examining registration certificates
  and insurance policies
• Review of provisions for depreciation
• e.g. the auditor determines the reasonableness of
  accumulated depreciation by considering such
  factors the remaining useful lives of existing
  assets

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• The auditor must also determine whether the
  methods in use are consistent with those used in
  the preceding year
• The auditor verifies the accuracy of depreciation
  through recalculation
• This is done on a selective basis by
  recalculating the depreciation on major assets
  and testing depreciation on additions and
  disposals during the year

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• Consideration of the possibility of impairment
• The auditor needs to ensure that the carrying
  value of property, plant and equipment does not
  exceed the greater of their realisable value or
  value in use
• This is done in accordance with AASB 136
  Impairment of Assets

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• Inquiry into the valuation of property, plant and
  equipment
• Management may choose to revalue property, plant
  and equipment so as to reflect more fairly their
  value to the business
• The auditor would need to be satisfied as to the
  skill, competence, objectivity and independence
  of the valuer