a) The case for carrying out risk analysis during an audit
i) Potential errors may he reduced by reducing the need to combine large quantities of
data in one's head.
ii) A direct linkage can be provided between the administrative structure and budget of
the internal audit department and the characteristics of individual audit units, this
linkage emphasizes the integrated nature of administrative and operational activities.
iii) New data can be more easily incorporated into the analysis as it becomes available.
iv) Consistency may be enhanced since it may be easier to set operational guidelines for
quantitative risk assessment methods than for more global qualitative risk judgments.
v) Quantitative methods may be more easily defended; e.g., to audit committees, external
parties, etc.
vi) Quantitative judgments of risk can be incorporated into other methods to help ensure
the appropriate intensity of auditing commensurate with the risk profile of the audit
unit. This can help reduce the possibility of over auditing or under auditing.
vii) Review and consultation are facilitated.
viii) Decisions may be easier to explain and justify, especially in the future when the
auditor's memory of the circumstances fades.
b) Procedures for audit of inventories
1) Cutoff analysis.
The auditors will examine your procedures for halting any further receiving into the warehouse
or shipments from it at the time of the physical inventory count, so that extraneous inventory
items are excluded. They typically test the last few receiving and shipping transactions prior to
the physical count, as well as transactions immediately following it, to see if you are properly
accounting for them.
ii) Observe the physical inventory count.
The auditors want to be comfortable with the procedures you use to count the inventory. This
means that they will discuss the counting procedure with you, observe counts as they are being
done, test count some of the inventory themselves and trace their counts to the amounts recorded
by the company's counters, and verify that all inventory count tags were accounted for. If you
have multiple inventory storage locations, they may test the inventory in those locations where
there are significant amounts of inventory. They may also ask for confirmations of inventory
from the custodian of any public warehouse where the company is storing inventory.
iii) Reconcile the inventory count to the general ledger.
They will trace the valuation compiled from the physical inventory count to the company's
general ledger, to verify that the counted balance was carried forward into the company's
accounting records.
iv) Test high-value items.
If there are items in the inventory that are of unusually high value, the auditors will likely spend
extra time counting them in inventory, ensuring that they are valued correctly, and tracing them
into the• valuation report that carries forward into the inventory balance in the general ledger.
v) Test error-prone items.
If the auditors have noticed an error trend in prior years for specific inventory items, they will be
more likely to test these items again.
vi) Test inventory in transit.
There is a risk that you have inventory in transit from one storage location to another at the time
of the physical count. Auditors test for this by reviewing your transfer documentation.
vii) Test item costs.
The auditors need to know where purchased costs in your accounting records come from, so they
will compare the amounts in recent supplier invoices to the costs listed in your inventory
valuation.
viii) Review freight costs.
You can either include freight costs in inventory or charge it to expense in the period incurred,
but you need to be consistent in your treatment - so the auditors will trace a selection of freight
invoices through your accounting system to see how they are handled.
ix) Test for lower of cost or market.
The auditors must follow the lower of cost or market rule, and will do so by comparing a
selection of market prices to their recorded costs.
x) Finished goods cost analysis.
If a significant proportion of the inventory valuation is comprised of finished goods, then the
auditors will want to review the bill of materials for a selection of finished 1.00ds items. and test
them to see if they show an accurate compilation of the components in the finished goods items,
as well as correct costs.
xi) Direct labor analysis.
If direct labor is included in the cost of inventory, then the auditors will want to trace the labor
charged during production on time cards or labor routings to the cost of the inventory. They will
also investigate whether the labor costs listed in the valuation are supported by payroll records.
Kavungya answered the question on May 14, 2019 at 13:52
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