INVENTORY

MANAGEMENT
 INVENTORY :
• The assets that are:-
– Held for sale in the ordinary course of
business; or
– In the process of production for such a sale;
or
– In the form of materials or supplies to
be consumed in the production
process; or
– In the rendering of services.
• Relevance : Trading concern &
Manufacturing unit.
• Loose tools v/s spares.
 TYPES OF INVENTORY…

Work in
process

Vendors Raw Work in Finished Customers

Materials process goods
Work in
process
 …….TYPES OF INVENTORY

• Raw Materials – Basic inputs that are converted into

finishedproductthroughthemanufacturing process.
• Work-in-progress – Semi-manufactured products that
needsomemoreworkbeforetheybecome finishedgoodsfor
sale.
• Finished Goods – Completely manufactured products
readyfor sale.
• Supplies – Office and plant cleaning materials that do not
directly enter production but are necessary for production
processanddonot involve significantinvestments.
 INVENTORY MGT
 The act or manner of managing, handling,
directing or controlling the flow of inventory.
 NEED :-
• Demand related:-
– Meet unexpected demands.
– Smooth seasonal or cyclical demands.
• Pricing related:-
– Hedge against price increases.
– Take advantage of quantity discounts.
• Process and supply surprises related:-
– Internal – upsets in parts of or our own processes.
– External – delays in incoming goods.
 OBJECTIVES: INVENTORY MGT

• To maintain an optimum size of inventory for efficient

and smooth production and sales operations.

• To maintain a minimum investment in inventories to

maximize the profitability.

• Effort should be made to place an order at the right

time with right source to acquire the right quantity
at the right price and right quality.
 INVENTORY SYSTEMS

Factor Periodic Inventory System Perpetual Inventory System

BASIS OF ASCERTAINING BY ACTUAL PHYSICAL ON THE BASIS OF RECORDS

INVENTORY COUNT

Calculation ofinventory Directly by applying Closing Inventory =opening

the method of inventory+ purchases – cost of
valuation of goodssold
inventories

Calculation of cost ofgoods Cost of goods sold =opening Directly calculated byapplying the
sold inventory +purchases – closing method of valuation of inventories
inventory

LostGoods Cost of goods sold includes Cost of closing inventory includes

cost of lost goods (if any) cost of lost goods (if any)
 METHODS OF VALUATION

An inventory valuation allows a company to provide

a monetary value for items that make up its inventory.

Methods:-

• First In First Out (FIFO) Method.

• Last In First Out (LIFO) Method.

• Weighted Average Cost/price Method.

 FIFOMETHOD
• Based on the assumption that the goods that are received
first are issued first.
• For purpose of assigning costs and not exactly for purpose
of physical flow of goods.
• Goods sold, thus, consist of earliest lots and are valued
at the price paid for such lots.
• The ending inventory consists of latest lots and is valued at
the price paid for such lots.
• Balance sheet shows ending inventory costed as per approx
market price.
 LIFOMETHOD
• Based on assumption that goods that are received last are
issued first.
• Assumption made for purposes of assigning costs and not for
actual physical flow of goods.
• Flows of goods and costs may not coincide.
• Goods sold, thus, consist of the latest lots and are valued at
the price paid for such lots.
• The ending inventory consists of the earliest lots and is valued
as such.
• Balance sheet has an inventory costed at old prices.
 WEIGHTED AVERAGE PRICE METHOD

• Based on the assumption that each issue of goods consists of

a due proportion of the earlier lots and is valued at weighted
average price.
• Weighted average price is calculated by dividing the total cost
of goods in stock by the total quantity of goods in stock.
• This weighted price is used for pricing the issues until a
new lot is received when a new weighted average price
would be calculated.
• This method evens out the effect of widely varying prices of
different lots that make up stocks.
 CLASSIFICATION OF INVENTORY

• ABCClassification(consumption)(25/80+15/15+70/05)
• XYZClassification(valuestored)(Hi,Med,Low)
• HML Classification(unit-valuestored) (Hi,Med,Low)
• VEDClassification(spareparts mainly) (Vital,Essential,Desirable)
• FSNClassification(consumption)(Fast, Slow, Non)
• SOSClassification(agriculture)(Seasonal,Non)
• SDFClassification(availability) (Scarce, Difficult, Easy)
• GOLFClassification (source of supply) Govt, Ordinarily
available, Local andForeign)
AUDIT OF THE INVENTORY AND
WAREHOUSING CYCLE
WHAT IS THE SEQUENCE OF FUNCTIONS IN THE

INVENTORY AND WAREHOUSING CYCLE?

1. An employee recognizes a
need for a purchase; completes a requisition and
sends it to purchasing.

Ace Company PURCHASING

PURCHASE DEPARTMENT
REQUISITION
The production
dept. needs 200
kgs. of dry #4
solvent.
authorized
employee
2. Purchasing procures for the appropriate
quality at the best price, then prepares a
purchase order.

Ace Company
PURCHASE BIG
PURCHASING
DEPARTMENT ORDER Chemical Co.
To: Big Chemical Co.
Please ship 200
kgs. of dry #4 sol-
vent by 6/2/04
Price $38.40/kg.
purchasing agent
3. When goods arrive from the
vendor, the receiving dept.
inspects, counts, and prepares a
receiving report.

Ace Company
RECEIVING
BIG RECEIVING REPORT
Chemical Co. DEPARTMENT Received 200
kgs. of dry #4
solvent on 6/1/04.
Condition: OK

BIG receiving employee

Chemical Co.
4. Goods are moved from receiving to
a warehouse; perpetual inventory is
updated.

RECEIVING WAREHOUSE
DEPARTMENT

perpetual inventory
description $$
6/1/04-dry #4
solvent-200 kgs.7680
5. When needed, goods are moved from
the warehouse to production; perpetual
inventory and cost accounting records
are updated.

WAREHOUSE PRODUCTION
DEPARTMENT

perpetual inventory cost acctg. system

description $$ description _ $$ _
6/1/01-dry #4 June 8, 2017
solvent-200 kgs.7680 Raw mat’l added
6/8/04-trans.200 - dry #4 solvent
kgs.to prod. -7680 (200 kgs.) 7680
6. When finished, goods are moved from
production to the warehouse; perpetual
inventory and cost accounting records
are updated.

WAREHOUSE PRODUCTION
DEPARTMENT

cost acctg. system

perpetual inventory description _ $$ _
description $$ 6/9/04-trans.
6/9/04-fin.goods 50 litres of
50 litres x7g 9680 finished x7g
to warehouse 9680
7. When sold, goods are shipped
and perpetual inventory records are
updated.

A Ace Co.
C
E
perpetual inventory
description $$
6/9/04-fin.goods
50 litres-x7g 9680
8/5/03- sold 30
litres-x7g -5808
WHAT IS THE PRIMARY AUDIT

OBJECTIVES WITH REGARD TO INVENTORY?

WHAT ARE THE PRIMARY AUDIT
OBJECTIVES WITH REGARD TO INVENTORY?

- existence
- accuracy
- realizable value
WHAT IS THE PRIMARY AUDIT
PROCEDURE WITH REGARD TO
INVENTORY?
WHAT IS THE PRIMARY AUDIT
PROCEDURE WITH REGARD TO
INVENTORY?

Observe the client’s

inventory-taking
procedures.
WHEN DO CLIENT INVENTORY-
TAKING PROCEDURES OCCUR?
WHEN DO CLIENT INVENTORY-
TAKING PROCEDURES OCCUR?
December
If the client has a
periodic inventory
system, the
physical inventory
count determines
the balance in
inventory accounts and will probably
occur on the balance sheet date.
WHEN DO CLIENT INVENTORY-
TAKING PROCEDURES OCCUR?
If the client has a June
perpetual inventory
system, the
physical inventory
count may occur
any time during
the accounting period.
Whenever the count occurs, the auditor
is required to observe.
SOME CLIENTS USE STATISTICAL
SAMPLING IN THEIR INVENTORY
METHODS .

why?
SOME CLIENTS USE STATISTICAL
SAMPLING IN THEIR INVENTORY
METHODS.

reduces
the need to count
every inventory item
(sample results can be
statistically extended
to the population)
SOME CLIENTS USE STATISTICAL
SAMPLING IN THEIR INVENTORY
METHODS.

What are the

auditor’s
concerns?
SOME CLIENTS USE STATISTICAL SAMPLING
IN THEIR INVENTORY METHODS.

The auditor is concerned that

the statistical inventory plan:
- has statistical validity
- is properly applied
- achieves reasonable results
SHOULD THE AUDITOR TEST
BEGINNING INVENTORY BALANCES?

January
SHOULD THE AUDITOR TEST
BEGINNING INVENTORY BALANCES?
When the auditing firm has not audited
beginning balances, the auditors must
satisfy themselves as to the appropri-
ateness of beginning balances, if they
are satisfied as to the current balances.
SHOULD THE AUDITOR TEST
BEGINNING INVENTORY BALANCES?
When the auditing firm has not audited
beginning balances, the auditors must
satisfy themselves as to the appropri-
ateness of beginning balances, if they
are satisfied as to the current balances.

how?
When the auditing firm has not audited
beginning balances, the auditors must
satisfy themselves as to the appropri-
ateness of beginning balances, if they
are satisfied as to the current balances.

how?
analytical review of prior tests of inventory
inventory transactions and
procedures documents
count records
HOW SHOULD THE AUDITOR TEST INVENTORY HELD
AT A PUBLIC WAREHOUSE?
- direct written confirmation with the
public warehouse

Are additional
procedures
necessary?
HOW SHOULD THE AUDITOR TEST INVENTORY HELD
AT A PUBLIC WAREHOUSE?
- direct written confirmation with the
public warehouse

Confirmation, alone, will not be

sufficient if inventory quantities held
at the warehouse
are significant.
HOW SHOULD THE AUDITOR TEST INVENTORY HELD
AT A PUBLIC WAREHOUSE?
- direct written confirmation with the
public warehouse
- if inventory held at the public ware-
house is significant:
~ review client’s procedures for
investigating and evaluating the
warehouse
~ obtain report from warehouse’s
auditor regarding internal controls
~ observe warehouse’s physical
counts (if practical)
SOME LARGE MERCHANDISERS USE OUTSIDE INVENTORY-
TAKING COMPANIES THAT SPECIALIZE IN COUNTING
INVENTORY.
SOME LARGE MERCHANDISERS USE OUTSIDE INVENTORY-
TAKING COMPANIES THAT SPECIALIZE IN COUNTING
INVENTORY.

What are the

auditing
implications?
SOME LARGE MERCHANDISERS USE OUTSIDE INVENTORY-
TAKING COMPANIES THAT SPECIALIZE IN COUNTING
INVENTORY.

- since the inventory-taking company

is a third party, their work has greater
reliability than the client’s
SOME LARGE MERCHANDISERS USE OUTSIDE INVENTORY-
TAKING COMPANIES THAT SPECIALIZE IN COUNTING
INVENTORY.

- since the inventory-taking company

is a third party, their work has greater
reliability than the client’s
- the auditor still should observe the
physical inventory count
SOME LARGE MERCHANDISERS USE OUTSIDE INVENTORY-
TAKING COMPANIES THAT SPECIALIZE IN COUNTING
INVENTORY.

- since the inventory-taking company

is a third party, their work has greater
reliability than the client’s
- the auditor still should observe the
physical inventory count
- the auditor must test the effectiveness
of the inventory-taking company’s
procedures
INVENTORY AUDIT PROCEDURES

perform
analytical
procedures
to test inventory
reasonableness
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
Review the client’s plan for counting
the physical inventory. Attend
client count planning
meetings.
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
Observe the physical inventory count.
Determine whether client’s counting methods
are effective.
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
Observe the quality and condition of the
inventory. Consider obsolescence.
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
On a random basis:
- select a sample of inventory items from the
warehouse floor, count them, trace the
quantity to client count records
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
On a random basis:
- select a sample of inventory items from the
client count records, find them in the
warehouse, count them
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
On a random basis:
- select a sample of inventory items from the
client count records, trace them to the
perpetual inventory records
4/30/x7 Physical
4/30/04 Physical
Inventory
Inventory
4/30/04 Physical
perpetual inventory
Inventory
description qty
widgets - red 87
18# widgets widgets - green 4
18# widgets
- purple widgets - purple 18
18# widgets
- purple
- purple
INVENTORY AUDIT PROCEDURES
regarding the client physical inventory count:
On a random basis:
- select a sample of inventory items from the
perpetual inventory records trace them to
the client count records
4/30/x7 Physical
4/30/04 Physical
Inventory
Inventory
4/30/04 Physical
Inventory perpetual inventory
description qty
widgets - red 87
18# widgets
18# widgets widgets - green 4
- purple
18# widgets
- purple widgets - purple 18
- purple
INVENTORY AUDIT PROCEDURES
Enquire of client management
regarding the existence of consigned
inventories.

consignments “R” us
ACE
INVENTORY AUDIT PROCEDURES
Enquire of client management
regarding the existence of consigned
inventories:

- if a consignee holds a portion of the

client’s inventory, confirm that amount
with the consignee
- if a client consignee holds a portion of
a consignor’s inventory, confirm that
amount with the consignor
INVENTORY AUDIT PROCEDURES
Test the client’s
application of their
inventory valuation
method (FIFO, LIFO) and
the lower-of-cost-or-
market rule.
INVENTORY AUDIT PROCEDURES
For manufactured
inventories:
test the cost accumulation
process as it affects
valuation of ending
inventories and COGS