Part Eight

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• Part Eight
• Production Cost Audit

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Structure of Seminar

• 1. Inventory
• 2. Payroll

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1. Inventory

• 1) Introduction to auditing inventory
• The key assertions relating to inventory are
• ?? Existence
• ?? Completeness
• ?? Rights and obligations
• ?? Valuation
• ?? Cut-off

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Inventory

• 2 ) Accounting for inventory
• The valuation and disclosure rules for inventory
  are laid down in IAS 2 Inventories. Inventory
  should be
• valued at the lower of cost and net realisable
  value.
• Production costs (costs of conversion)
  include
• (a) Costs specifically attributable to
  units of production
• (b) Production overheads
• (c) Other overheads attributable to
  bringing the

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Inventory

• product or service to its present location
  and condition
• 3) Audit procedures for inventory
• Audit objectives
• (1) completeness
• (2) existence
• (3) right and obligation
• (4) valuation and allocation
• (5) cut-off
• (6) accuracy
• (7) occurrence and right and obligation

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Inventory

• 4) The physical inventory count
• ISA 501 Audit evidence specific considerations
  for selected items provides guidance to auditors
  on attending the physical inventory count to
  obtain evidence regarding the existence and
  condition of inventory
• It states that where inventory is material,
  auditors shall obtain sufficient appropriate
  audit evidence regarding its existence and
  condition by attending the physical inventory
  count (unless this is impracticable)

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Inventory

• to do the following
• Evaluate managements instructions and
  procedures for recording and controlling the
  result of the physical inventory count.
• ?? Observe the performance of the count
  procedures.
• ?? Inspect the inventory.
• ?? Perform test counts.
• Factors to consider when planning attendance at
  the inventory count include the following

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Inventory

• The risks of material misstatement of
  inventory
• ?? Internal controls related to inventory
• ?? Whether adequate procedures are expected to be
  established and proper instructions issued for
  counting
• ?? The timing of the count
• ?? Whether the entity maintains a perpetual
  inventory system
• ?? Locations at which inventory is held
  (including materiality at different locations)
• ?? Whether the assistance of an auditors expert
  is required

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Inventory

• (1) The inventory count
• A business may count inventory by one or a
  combination of the following methods.
• (a) Physical inventory counts at the
  year-end
• (b) Physical inventory counts before or
  after the year-end
• (c) Perpetual (or continuous) inventory
  where management has a programme of
  inventory-counting throughout the year
• If perpetual inventory counting is used, auditors
  will verify that management
• (a) Ensures that all inventory lines are
  counted at least once a year

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Inventory

• (b) Maintains adequate inventory records
  that are kept up-to-date.
• (c) Has satisfactory procedures for
  inventory counts and test-counting.
• (d) Investigates and corrects all
  material differences.
• (2) Planning attendance at inventory count
• Before the physical inventory count the
  auditors should ensure audit coverage of the
  count is appropriate, and that the client's count
  instructions have been reviewed.

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(3) Attendance at inventory count
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Inventory

• The auditors' working papers should include
• ?? Details of their observations and tests
• ?? The manner in which points that are relevant
  and material to the inventory being counted or
• measured have been dealt with by the client
• ?? Instances where the client's procedures have
  not been satisfactorily carried out
• ?? Items for subsequent testing, such as
  photocopies of (or extracts from) rough inventory
  sheets
• ?? Details of the sequence of inventory sheets
• ?? The auditors' conclusions

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Inventory

• (4) After the inventory count
• After the count the auditors should check that
  final inventory sheets have been properly
  compiled from count records and that book
  inventory has been appropriately adjusted.
• (5)Inventory held by third parties
• Where the entity has inventory that is held by
  third parties and which is material to the
  financial
• statements, the auditor shall obtain
  sufficient appropriate audit evidence by
  performing one or both of the following

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Inventory

• Direct confirmation from the third party
  regarding quantities and condition (in accordance
  with
• ISA 505 External confirmations)
• ?? Inspection or other appropriate audit
  procedures (if third partys integrity and
  objectivity are
• doubtful, for example)
• The other appropriate audit procedures referred
  to above could include the following
• ?? Attending, or arranging for another auditor to
  attend, the third partys inventory count

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Inventory

• ?? Obtaining another auditors report on the
  adequacy of the third partys internal control
  for ensuring
• that inventory is properly counted and
  adequately safeguarded
• ?? Inspecting documentation in respect of third
  party inventory (e.g. warehouse receipts)
• ?? Requesting confirmation from other parties
  when inventory has been pledged as collateral

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2. Payroll

• 1) Tests of control
• Test sample of time sheet , clock cards for
  approval by responsible official
• ? Observe wages distribution to ensure right
  person collect right pay
• ? Test authorization of payroll amendments
• ? Examine evidence of checking payroll
  calculation
• ? Examine evidence of approval
• ? Examine evidence independence checks of payroll
  
• ? Test controls over unclaimed wages
• ? Examine explanation for variance

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Payroll

• 2)Substantive tests
• Substantive tests in respect of payroll focus
  primarily on whether or not expenses have been
  overstated as a result of
• ? Payments being made to fictitious employees
• ? Genuine employees being paid for hours they
  have not worked
• ? Inappropriate rate

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Payroll

• The main tests are as follows
• 1. analytical review
• ? compare with production level, sales level
• ? Compare levels of payroll throughout the year
  on a month-by-month basis
• ? Check leavers and joiners, changes in the rates
  of pay
• 2. test cast and calculation
• 3. test samples of personnel records for rate of
  pay, authorization of changes, leavers and
  joiners detail

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Payroll

• 4. Cut-off test
• 5. select sample check to time records, test to
  personnel records, test cast and calculations
  with reference to tax
• 6. test posting of payroll to general ledger
  account
• 7. test total cheques to net pay(PAYE)