UDIT PROGRAM FOR INVENTORIES

OVERVIEW

Observe Inventory
Plan inventory observation (1-10).
Observe physical inventory (11-18).

Establish Proper Cutoff

Examine shipping and receiving activity near
period-end (19)
Test inventory received after period-end and items in
transit (20).
Review fluctuations in sales, purchases and returns
(21).

Test Inventory Summarization

Obtain or prepare a comparative summary (22).
Obtain detailed priced inventory listing(s) (23).
Review inventory adjustments (24).
Determine completeness of detailed priced inventory
listing (25).
Identify inventory in the custody of other divisions
(26).
Trace test counts to/from detailed inventory listing
(27-28).
Test raw material and purchased items costs (29).
Trace unit costs to/from detailed priced inventory
listing (30).
Understand work-in-process and finished goods costing
(31).
Determine that cost allocations are appropriate (32).
Test cost buildup (33).
Review standard cost variances (34).
Determine that inventory pricing is consistent (35).
Trace unit prices to/from detailed priced listing
(36).
Test mathematical accuracy of detailed priced listing
(37).

Test Inventory Valuation

Review the need for valuation provisions (38).
Make or test work-in-process valuation provisions
(39).
Make or test finished goods valuation provisions (40).
Consider valuation provisions for subassemblies and
parts (41).
Evaluate obsolete, slow-moving, scrapped or damaged
items (42).

Additional Procedures
Obtain information for disclosure (43).
Perform procedures when early tests are performed
(44).
Review inventory valuation provisions at period-end
 (45).
Confirm inventory held by third parties (46).
Account for inventory owned by other divisions
(47-48).
Review accounting for internal and intercompany
profits (49).

AUDIT PROGRAM
INVENTORIES

Observe Inventory

PLAN INVENTORY OBSERVATION (1-10).

1. Determine the dates of observations.

2. Determine the location of and method adopted by the division for

testing the existence of each category of inventory (e.g., raw
materials, work-in-process, finished products, consignments).

3. Determine the extent to which physical inventory counts are to be

observed.

4. Review the division's written inventory instructions for adequacy

and clarity. Suggest changes as deemed necessary. Determine
whether the instructions are reviewed and approved by a responsible
official and effectively communicated to persons participating in
the count.

5. Obtain lists of or identify the inventory count teams and determine

whether they include:

a. Persons able to identify the nature and quality of the items.

b. Persons from departments that have no responsibility for the

custody, movement, or recording of the inventory.

If both (a) and (b) are not present, it may be necessary to revise
the extent of work performed to ensure that a complete and accurate
count is achieved and that slow-moving, obsolete, and damaged
inventory is adequately identified.

6. Determine whether information needed for proper identification of

the inventory and subsequent tracing of the test counts to the
inventory listings exists in usable form (e.g., that it
differentiates the various stages of work-in-process).

7. Determine whether procedures are adequate to control the use of

inventory tags or sheets by the count teams (e.g., by using pre-
numbered tags or sheets and accounting for all such tags or sheets,
both used and unused) and consider the division of duties between
persons responsible for tag or count sheet control, counting
 inventory and inputting completed tags or count sheets to inventory
records.

8. Determine whether procedures are established to ensure proper

cutoff.

9. Ask about the procedures that will be used to control movements of

inventories during the count. Evaluate such procedures (which
should cover incoming goods, outgoing shipments, and internal
transfers) to determine their impact on the nature, timing, and
extent of other substantive procedures.

10. Inquire whether there are inventories owned by the division in the
custody of others or inventories owned by others on the division's
premises. Determine the extent to which inspection and confirmation
of these inventories is necessary.

Done by Date
..../../..

GUIDANCE:

When determining locations of inventory the auditor should consider the

nature of the division's business. For example, divisions with delivery
operations may have inventories in various vehicles used for this
purpose; also, consider the existence of goods-in-transit and items that
may be at another division.

OBSERVE PHYSICAL INVENTORY (11-18).

11. Inspect the premises to determine whether:

a. The arrangement of inventory is such that an accurate count is

possible.

b. Scrap, obsolete, and damaged goods are adequately identified and

segregated.

c. Inventory owned by other divisions is adequately identified and

segregated.

d. Inventories appear to be adequately safeguarded against access by

unauthorized persons and protected against deterioration.

12. In observing physical inventory counts, determine whether:

a. The counts are carried out under proper supervision.

b. Quantities and descriptions and, in the case of work-in-process,

stages of completion are properly entered on the inventory tags
or sheets.

c. The methods used to determine quantities are reasonably

accurate.
 d. There are adequate procedures for determining quantities of goods
not susceptible to direct physical counting (e.g. certain
ingredients).

e. Count totals are adequately checked by persons other than the

original counters.

f. There are adequate procedures to ensure that all inventory (other

than that on the company's premises owned by others) is counted
and that no inventory is counted more than once.

g. Inventory on the division's premises owned by others has been

appropriately identified and counted.

h. Tags or count sheets are signed by individuals carrying out the

count, or other suitable means of identifying individuals
carrying out the count have been established, such as assigning
tags or count sheets to count teams.

13. Select items from the inventory tags or sheets and perform an
independent count. Perform other counts of inventories and compare
the results with those recorded on the inventory tags or sheets by
division personnel. Follow up any differences noted in the counts.
Record selected items counted for subsequent comparison with priced
inventory listings.

14. Determine that procedures for accounting for all inventory tags and
count sheets are followed and that all such tags and sheets have been
accounted for, including used and unused tags and sheets, and that
they are secured against alteration.

15. Determine whether slow-moving, obsolete, and damaged items are

identified and recorded by the count teams.

16. Considering the procedures established for determining cutoff

(step 8), visit the receiving and shipping departments and note the
last receiving and shipping document numbers before the count. If
the division's procedures are not based on prenumbered documents,
then prepare a list of shipping and receiving documents for a period
immediately before and after the end of the period. Include
documents for returns to suppliers and from customers, if different
documents are used.
17. Determine that procedures established to control inventory
movements during the count are followed (see step 9).

18. Prepare a memorandum to document inventory observation procedures

performed, and their results (see our inventory observation
checklist).

Done by Date
..../../..

GUIDANCE:

Judgment should be exercised in determining the number of test counts

to be made considering, among other things, inventory with special
characteristics such as high value or susceptibility to theft, the
adequacy of the division's controls over counting and the expertise
and diligence of individuals making the counts. Sampling is not
appropriate for determining the extent of tests because the auditor does
not intend to project an error.

Establish Proper Cutoff

EXAMINE SHIPPING AND RECEIVING ACTIVITY NEAR

PERIOD-END (19)

19. Using information obtained at the physical inventory observation and

data from the sales cutoff procedures and the search for unrecorded
liabilities, determine whether a proper inventory cutoff has been
made:

a. Examine sales transactions and supporting documentation for a

period before the physical inventory and determine that goods
shipped before the physical inventory have been included in sales
and cost of sales, and that goods included in inventory are not
included in sales and cost of sales.

b. Select receiving reports for goods received before the physical

inventory and determine that all goods received before the
inventory have been included in inventory and liabilities.

c. Review supporting documentation for goods not included in the

physical count but included in the general ledger inventory
control account (e.g., inventory in transit, duty and freight,
returns) and determine that the goods are properly included in
inventory.

d. Examine purchase and sales transactions and detailed supporting

documents for the period after the physical inventory to
determine that they have been reflected in the proper period.

e. Review records of returned goods and claims against suppliers and

related debit (credit) memoranda for periods before and after the
cutoff date to determine that returns and claims against
suppliers made after the cutoff date have been entered in the
appropriate period.

Done by Date
..../../..

GUIDANCE:

The auditor usually performs substantive tests directed to the cutoff

objective. In large divisions the auditor should consider whether the
risk of cutoff errors could have a material effect on the financial
statements. The control environment should also be considered,
particularly the risk that management would deliberately override
established cutoff procedures.

INVENTORIES-3
This step requires a decision on the extent of testing. The auditor use
judgment in determining the extent of tests after considering the
assessments of control risk, special procedures such as nonroutine review
and supervision of shipping and receiving activities near the cutoff date,
movements of inventories during the physical count, the type and frequency
of errors in prior periods and assurance expected from other tests,
particularly the review of key performance indicators and other management
information.

TEST INVENTORY RECEIVED AFTER PERIOD-END AND ITEMS IN

TRANSIT (20).

20. Determine that inventory received after period-end for which title
had passed as of the balance sheet date was reflected in inventory
in transit and in accounts payable. Determine that recorded
inventory in transit was received after period-end.

Done by Date
..../../..

REVIEW FLUCTUATIONS IN SALES, PURCHASES AND RETURNS

(21).

21. Consider key performance indicators and management information that

would indicate unusual fluctuations in sales, purchases and returns
patterns before and after period-end and, if present, review for
possible cutoff errors.

Done by Date
..../../..

Test Inventory Summarization

OBTAIN OR PREPARE A COMPARATIVE SUMMARY (22).

22. Obtain or prepare a comparative summary of inventory balances.

Trace the totals to the general ledger and the previous audit's
working papers.

Done by Date
..../../..

GUIDANCE:

Divisions may use a number of different summarization methods; this

program should be tailored to reflect the particular division's
circumstances.
OBTAIN DETAILED PRICED INVENTORY LISTING(S) (23).

23. Obtain detailed priced inventory listings. Trace totals from the
detailed priced inventory listings to the totals of the summary
obtained in step 22. Trace significant reconciling items to
supporting documentation.

Done by Date
..../../..

INVENTORIES-4

REVIEW INVENTORY ADJUSTMENTS (24).

24. Review adjustments to the general ledger and, if appropriate, the

detailed inventory records resulting from the physical inventory.
Investigate the reasons for significant adjustments.

Done by Date
..../../..

DETERMINE COMPLETENESS OF DETAILED PRICED INVENTORY

LISTING (25).

25. Ascertain that all inventory tags and count sheets have been
included in the detailed priced inventory listings.

Done by Date
..../../..

GUIDANCE:

The objective of this test is to ascertain that all inventory amounts

that ultimately will be reflected in the accounts in the general ledger
are entered in the records. Errors disclosed by this test should alert
the auditor to potential completeness problems with inventory
summarizations.

IDENTIFY INVENTORY IN THE CUSTODY OF OTHER DIVISIONS

(26).

26. Determine whether any inventory is in the custody of other divisions

based on your knowledge of the division's business, inquiries of
management, and review of purchase orders, receiving reports,
purchase invoices, shipping records, or other documentation.
Ascertain that such inventory has been included in the detailed
priced inventory listings. Also consider further tests of inventory
owned by other divisions (steps 47 and 48).

Done by Date
 ..../../..

TRACE TEST COUNTS TO/FROM DETAILED INVENTORY LISTING

(27-28).

27. Trace quantities of selected items included in the detailed priced

inventory listings to inventory tags or count sheets and investigate
discrepancies.

28. Trace the test counts recorded during the physical inventory
observation (see step 13) to the detailed priced inventory
listings.

Done by Date
..../../..

TEST RAW MATERIAL AND PURCHASED ITEMS COSTS (29).

29. Obtain and document an understanding of methods and procedures for

costing raw material and purchased items and perform audit
procedures to ensure that the inventory costs are appropriate; when
necessary refer to suppliers' invoices.

Done by Date
..../../..

INVENTORIES-5

GUIDANCE:

When testing costs by reference to the latest invoices, the auditor should
ensure that these costs relate to the inventory units actually on hand.

If the auditor plans to examine invoices to test costs of raw materials

and purchased items, a decision on the extent of tests should be made.
The auditor should use judgment in determining the extent of tests after
considering the adequacy of the division's procedures, the type and
frequency of errors in prior periods and management's use of the
information in the operation of the business. These tests should be
coordinated with the test in step 33, relating to pricing work-in-process
and finished goods inventories, if that test is planned.

TRACE UNIT COSTS TO/FROM DETAILED PRICED INVENTORY

LISTING (30).

30. Trace unit costs of raw materials and purchased items to and from
the detailed priced inventory listing.

Done by Date
..../../..

GUIDANCE:
This step requires a decision on the extent of testing. The auditor
should use judgment in determining the extent of tests after considering
the adequacy of the division's procedures, the type and frequency of
errors in prior periods and management's use of inventory information in
the operation of the business.

UNDERSTAND WORK-IN-PROCESS AND FINISHED GOODS COSTING

(31).

31. Obtain and document an understanding of the methods and procedures

for recording material, labor and overhead costs, and allocating
these costs to work-in-process and finished goods inventories.

Done by Date
..../../..

DETERMINE THAT COST ALLOCATIONS ARE APPROPRIATE (32).

32. Determine that the methods and procedures ensure that material,
labor, and overhead costs used in recording work-in-process and
finished goods cost allocations are appropriate and complete. For
partly completed work-in-process that has been credited with the
costs of completed items, determine whether the remaining costs can
be reasonably attributed to the balance of work-in-process on hand.

Done by Date
..../../..

TEST COST BUILDUP (33).

33. Test cost buildup and appropriateness of allocations to

work-in-process and finished goods units by reference to suppliers'
invoices, properly established pay rates, and overhead cost
records.

Done by Date
..../../..

INVENTORIES-6

GUIDANCE:

This step requires a decision on the extent of testing. The auditor

should use judgment in determining the extent of tests after considering
the adequacy of the division's procedures, the type and frequency of
errors in prior periods and management's use of inventory information in
the operation of the business. These tests should be coordinated with the
test in step 29 relating to pricing raw materials and purchased parts
inventory, if that test is planned.
REVIEW STANDARD COST VARIANCES (34).

34. Determine that standard costs approximate actual costs.

Where there are significant unfavorable variances, determine whether

they resulted from inefficiencies or abnormalities that would not
require adjustment to the inventory valuation, or from unrealistic
standards that do not reflect normal operations and that may require
an adjustment to inventory costs. Determine whether appropriate
adjustments have been made.

Where there are significant favorable variances, determine the

underlying reasons for them and determine whether appropriate
adjustments to the inventory costs have been made.

Done by Date
..../../..

GUIDANCE:

The auditor usually determines that standard costs approximate actual

costs by reviewing:

a. When standards were last updated.

b. Whether they are still appropriate in the light of any changes in

specifications or production methods since the standards were last
updated.
c. Relevant variances.

DETERMINE THAT INVENTORY PRICING IS CONSISTENT (35).

35. Determine whether the method of inventory pricing (including

by-products) is consistent with the prior period.

Done by Date
..../../..

TRACE UNIT PRICES TO/FROM DETAILED PRICED LISTING

(36).

36. Trace unit prices of work-in-process and finished goods to and from
the detailed priced inventory listing.

Done by Date
..../../..

GUIDANCE:

INVENTORIES-7
This step requires a decision on the extent of testing. The auditor
should use judgment in determining the extent of tests after considering
the adequacy of the division's procedures, the type and frequency of
errors in prior periods and management's use of inventory information in
the operation of the business.

TEST MATHEMATICAL ACCURACY OF DETAILED PRICED LISTING

(37).

37. Test the mathematical accuracy of the detailed priced inventory

listing.

Done by Date
..../../..

GUIDANCE:

The auditor commonly performs this test because inventory reports may be
run infrequently or only at period-end and therefore there may be a risk
that the computer program has been altered since its last use. The
auditor should consider the reliability of the system generating the
inventory report. It is often appropriate also to scan the listing for
unusual quantities, prices and extensions.

Test Inventory Valuation

REVIEW THE NEED FOR VALUATION PROVISIONS (38).

38. In light of the accounting policies used by the company (appropriate

to the division) consider whether any provisions are required, or
whether provisions made are adequate, against inventories due to:

a. increased costs of purchases or production (including

adjustments of standard cost variances) that have not been fully
reflected in the selling prices;

b. falling selling prices;

c. any decisions, as part of the company's marketing strategy, to

manufacture and sell products at a loss;

d. replacement or reproduction prices below cost.

Done by Date
..../../..

GUIDANCE:

Inventory valuation procedures should be performed at the physical

inventory date and updated to period-end when appropriate. In making
valuation judgments the auditor should consider the knowledge obtained
about the division's business and industry, the control environment,
financial and other operating information, and other appropriate
information that could affect the valuation of inventories; for example:

a. Processing advances that may render inventories obsolete;

b. The sufficiency and reliability of management information for

valuation tests;

c. New product lines and future marketing forecasts and plans;

d. The company's competitive position in the marketplace for its

products;

INVENTORIES-8

e. Economic conditions;

f. Regulatory trends; and

g. Other matters that may have an effect on inventory valuation

decisions.

MAKE OR TEST WORK-IN-PROCESS VALUATION PROVISIONS

(39).

39. For items of work-in-process, compare costs to date and estimated

costs of completion and disposition with order values or selling
prices and determine whether provisions have been made for any
expected losses on completion.

Done by Date
..../../..

MAKE OR TEST FINISHED GOODS VALUATION PROVISIONS (40).

40. Compare carrying values of finished goods with expected selling

prices and determine whether a provision is necessary.

EVALUATE OBSOLETE, SLOW-MOVING, SCRAPPED OR DAMAGED

ITEMS (42).

42. Determine whether slow-moving, obsolete, scrapped or damaged items

have been adequately identified by:

a. obtaining and reviewing a schedule of items that have shown

little or no recent movement;

b. reviewing detailed inventory records, bin cards, etc.;

c. reviewing periodic reports to management concerning such

information;

d. discussing with management quantities held in the light of

 current production requirements, sales orders received and
future marketing forecasts; examine documentation including,
where appropriate, aged listings of inventory balances,
substantiating the information obtained;

e. discussing with management whether any substantial inventory

amounts may not be realizable because of major delays or
disputes, defective work, marketing difficulties, etc.

Review the pricing of such stocks and determine whether they are
priced in excess of net realizable value.

Done by Date
..../../..

Additional Procedures

REVIEW INVENTORY VALUATION PROVISIONS AT PERIOD-END

(45).

45. Review the adequacy of inventory valuation provisions by:

a. considering changes in inherent risk conditions,

INVENTORIES-9

b. inquiring of management as to significant changes in the

status of slow-moving, obsolete, scrapped or damaged
inventories, marketing strategies and selling prices from the
previous substantive test date.

c. performing analytical procedures as feasible and appropriate.

Done by Date
..../../..

ACCOUNT FOR INVENTORY OWNED BY OTHER DIVISIONS

(47-48).

47. Inquire of management as to the existence of any inventory in which

the passage of title is contingent on a future event.

48. If inventory counted on the division's premises is owned by

others:

a. Determine that the inventory has not been included on the

detailed priced inventory listing.

b. Confirm the nature and quantity of the inventory with the owners
or examine reports to see that the liability is properly
recorded.

Done by Date
 ..../../..

REVIEW ACCOUNTING FOR INTERNAL AND INTERCOMPANY

PROFITS (49).

49. Determine whether profit on interdivisional transfers of products or

materials is eliminated from the inventories and that relevant
details of intercompany profits are obtained for consolidation
purposes.

Done by Date
..../../..