Auditing inventory - Part 4 - Tests of internal controls

Summary

This video covers the process of testing internal controls over inventory in an auditing context. It highlights the importance of understanding a client’s internal controls for inventory-related processes, such as purchasing, receiving goods, and inventory movement. Key points include categories of internal controls, like purchasing and manufacturing controls, and the design of tests to ensure compliance with these controls. The speaker emphasizes the need for customized audit procedures tailored to each client’s unique inventory management system, ensuring effective control testing and maintaining accurate financial reporting.

Takeaways

• 😀 Understanding the internal controls over inventory is crucial for ensuring accurate data and helping businesses make informed decisions.
• 😀 The first step in testing internal controls is identifying the specific controls within the inventory process, such as purchasing, receiving, and inventory movement.
• 😀 In the purchasing process, important controls include approval processes, ordering quantities, pre-approved suppliers, and discounts for early payment.
• 😀 When receiving goods, controls include knowing who receives them, how the systems are updated, and ensuring that only ordered goods are received.
• 😀 For manufacturing businesses, controls extend to monitoring production budgets and potential risks like budgetary slack.
• 😀 Inventory movement involves controlling the recording of inventory updates, particularly in relation to sales, and matching these updates with sales documents.
• 😀 Periodic inventory systems may require stock counts and reconciliation processes to manage inventory movement and verify accuracy.
• 😀 Monitoring controls are critical for ensuring that other controls are functioning as intended and include activities such as warehouse security, unique product IDs, and variance analysis.
• 😀 The process of inventory write-offs should include approval from a responsible manager to prevent fraudulent activity.
• 😀 Testing internal controls involves using detailed, client-specific audit procedures, such as inspecting supporting documents, verifying signatures, and ensuring procedures are followed.
• 😀 Each client is unique, so auditors must customize their tests to match specific client controls and situations, ensuring detailed and tailored audit procedures.

Q & A

What is the purpose of testing internal controls over inventory?

Testing internal controls ensures that the business follows its policies and procedures correctly, which in turn helps in preparing accurate financial statements for decision-making by investors, shareholders, and other stakeholders.

What are the key areas of inventory controls that auditors typically focus on?

Auditors focus on controls over purchasing, receiving goods, inventory movement, manufacturing processes, and monitoring of inventory. These controls ensure that inventory is accurately recorded, managed, and safeguarded.

What should auditors consider when testing the control over purchasing inventory?

Auditors should consider who can order stock, whether there's an approval process in place, if there are pre-approved suppliers, and how the inventory system is updated, especially in terms of receiving goods.

How do periodic and perpetual inventory systems differ, and why is this important for auditors?

A perpetual inventory system continuously updates inventory records, while a periodic system updates inventory at set intervals. Auditors need to understand which system is in use to design appropriate testing procedures for inventory records and movements.

Why is it important for auditors to understand the production budget in manufacturing settings?

The production budget determines how much inventory needs to be ordered and produced, which is critical for understanding inventory flow. Auditors must ensure the budget is accurate, and that purchasing and production are aligned with it.

What role does variance analysis play in monitoring inventory?

Variance analysis helps in identifying discrepancies between expected and actual inventory use, costs, and other related factors. This allows businesses to detect inefficiencies or errors in the inventory process, which auditors can monitor.

What are monitoring controls, and why are they important in an inventory audit?

Monitoring controls ensure that all other controls are functioning correctly. They include things like warehouse security, variance analysis, and stock takes, which help auditors ensure that inventory management processes are being followed properly.

How should auditors test the control over inventory write-offs?

Auditors should select a random sample of inventory write-offs and vouch them to the original supporting documents. They should check for appropriate approvals, such as the warehouse manager’s signature, to ensure the write-off process is properly controlled.

What is the significance of using client-specific details in audit procedures?

Using client-specific details ensures that the audit is tailored to the client's unique operations, processes, and documentation. This customization helps auditors design more accurate and relevant tests that align with the client's actual practices.

Why is it important for auditors to use detailed audit procedures?

Detailed audit procedures demonstrate a clear understanding of the client’s operations, ensuring that tests are relevant and effective. This helps avoid generic procedures that may miss specific issues within the client's inventory management process.