Inventory Substantive Audit Procedures - Case Study Example

April 17, Auditing_ Case_Study Introduction The audit process adds credibility to the financial reports. The paper delves on the heightened risk audit of Indus Gas Ltd Company of United Kingdom. The paper focuses on the substantial procedures on one of heightened risk financial accounts. The audit procedure helps ensure the clients’ financial reports are correct and true. Table 1 Indus Gas Ltd Current Assets Inventories The above table 1 shows the current assets portion of Indus Gas Ltd’s balance sheet (Indus, 2014). Based on the quantitative analysis shown in the above table, the above three accounts qualify as heightened audit risks. For 2014, the £ 9.33 million inventories amount represents 48 percent of the total current assets figure, £ 19.29 million. For the year 2013, the £ 5.97million inventories amount represents 25 percent of the total current assets figure, £ 23.72 million. The high inventories amount percent, 48 percent of total current assets, qualifies it as a heightened risk audit priority. There is a high probability that the inventories figure may be materially wrong or the amount may be materially fraudulent. Such errors or fraudulent amounts are material enough to affect the decisions of the company’s management, current and future investors, and other affected parties (Rittenberg, 2011). Further, the internal controls will influence the heightened audit risk of the inventories amount. Strong internal control reduces the heightened audit risk issue of the inventories amount. Poor internal control may increase the heightened risk of the inventories amount. Internal control of inventories includes requiring purchase requisition documents for each inventory release from the company’s warehouses. The security guards or warehouse personnel will not apply the release of inventories without the purchase requisition papers (Hightower, 2008). Further, inventory errors and frauds affect the company’s revenue and cost of revenue amounts. An inventory count will indicate unrecorded revenues. The sales personnel may collect the customers’ cash payments and pocket the amount. The fraudulent employees perfect the fraudulent theft act by not recording the amount paid by the customers as part of the day’s revenues. The fraudulent employees do not issue an official receipt for the customers’ paid purchases (Arwinge, 2012). Trade_Receivables For 2014, the £ 7.85 million trade_receivables amount represents 41 percent of the total current assets figure, £ 19.29 million (Indus, 2014). For the year 2013, the £ 9.93million trade_receivables amount represents 42 percent of the total current assets figure, £ 23.72 million. The high trade_receivables amount percent, 41 percent of total current assets, qualifies it as one of the heightened risk audit priorities. There is a high probability that the trade_receivables figures may be materially erroneous or fraudulent. Such errors or fraudulent amounts will significantly affect the decisions of the company’s high ranking officers, present and future investors, and other concerned parties (Chambers, 2011). Internal controls will affect the heightened risk issue of the trade receivables. Strong internal controls will reduce the trade_receivables heightened risk issue. Poor internal controls will increase the trade_receivables heightened risk topic. Strong internal controls include requiring the issuance of official receipts for all cash collections from the trade_receivables customers. Next, all collections from the trade receivables customers must be deposited in the bank. Surprise cash counts of the collection personnel will show whether the collection personnel are issuing official receipts for all collected amounts. Likewise, a deposit slip attached to the official receipts will show that the amounts collected were deposited to the company’s authorized banks (Arens, 2011). Cash For 2014, the £ 0.98 million cash amount represents five percent of the total current assets figure, £ 19.29 million (Indus, 2014). For the year 2013, the £ 7.55million cash amount represents 32 percent of the total current assets figure, £ 23.72 million. The high inventories amount percent, 48 percent of total current assets, qualifies it as a heightened risk audit priority. There is a high probability that the cash amount may contain significant error or fraudulent portions. Such errors or fraudulent amounts are material enough to influence the decisions of the company’s officers, current and later investors, and other entities (Whittington, 2011). Internal controls will affect the heightened risk issue of the cash amount. Strong internal controls will reduce the cash heightened risk issue. Poor internal controls will increase the cash heightened risk environment. Cash counts will indicate whether the day’s cash in the collection personnel’s possession have the same amount as the amount shown in the day’s official receipt record. If the cash count is less than the amount shown in the official receipt, the difference indicates the collection officer stole the cash amount (fraud) or amount recorded in the official receipt is erroneous (Louwers et al., 2012). Part B: Inventory Substantive audit_procedures A. Disclosure & Presentation. The audit procedure focuses on terms as well as conditions of the purchased inventory items, the price and terms of payment of the purchased items. The audit procedure will include determining whether some of the inventory items are pledged to cover payable and other liability amounts. The auditors must determine whether the items located in the company’s warehouses or locations are owned by the company or held on consignment. Consignment means the company does not own the inventory held by the company in its warehouses or other locations. When the items are not sold within the accounting period or expired, the unsold inventories are returned to the company’s suppliers (Cascarino, 2010). B. Allocation or Valuation The audit procedure includes determining whether the fair market value, lower of cost or market or other cost methods were used. The audit determines whether the inventory end value using the recognized cost accounting standard, full absorption_costing method. The auditor inspects the inventory items to determine quality of the products, quality inspection means determining whether the inventory are of poor quality, high quality, damaged, deformed, expired, or complies with the company’s prescribed quality, model, brand, and quantity standards. The auditing procedure includes determining the inventories are correctly valued in the balance sheet, eliminating any mathematical errors and fraud amounts. The audit procedure may include hiring inventory experts to determine whether the value, type, and quality of the inventory items presented in the financial statements are true and fair. The audit procedure includes vouching if the prices shown in the accounting records are correct. The auditor inspects the products displayed in the warehouses and other locations to determine if the records’ pricing of the inventories are the same as the prices billed by the suppliers (Johnston, 2012). C. Completeness The audit procedure includes determining the inventory sales, sales_returns, or purchases are recording in the proper accounting period. Unsold inventory items received by the company within the accounting period will be included in the balance sheet’s inventory end. Likewise, all inventory not yet leaving the company’s premises and send to the customers should be included in the company’s inventory end amount. The audit process includes comparing the inventory count and the inventory general ledger records. The inventory count results will be used to correct the accounting records. The audit process includes determining whether some inventory transactions were not recorded within the proper accounting period. The auditor must reconcile the inventory count against the perpetual records, if used. Furthermore, an inventory count may indicate overstated revenues and cost of revenues. The sales or marketing personnel may overstate the revenues. The inventory count will show that the overstated sales figure should be reduced to the actual amounts. Similarly, the inventory count will lead to including the unrecorded inventory items sold within the correct accounting period (Leitch, 2012). (Chambers, 2011). D. Occurrence or Existence The audit procedure includes physically observing the client company perform the year -end inventory counts. The auditor must send confirmation requests to public warehouses, other warehouses, and other locations to confirm whether the inventory records correctly represent the actual inventories counted by the warehouse personnel. The auditor must confirm whether inventory records truly present the company’s consignment stocks held by the company in its many warehouses and other locations. For all inventories received, the warehouse or receiving departments shall make a daily report of all received inventory items. The purchase order documents and /or the material requisition documents must tally with the receiving personnel’s inventory count. Internal controls include inventory counts. Any discrepancies between the receiving personnel’s inventory counts will be indicated in the purchase order documents, receiving report documents, and other related documents (Arwinge, 2012). (Johnston, 2012). E. Obligations or Rights The auditor must determine whether the company owns the inventories currently held in its warehouses and other locations. This can be done by inspecting the purchase order documents, suppliers’ billing statements, inventory staff’s receiving records, and other related documents. The auditor must review the company’s board_of directors’ minutes _of_the_meeting records in order to determine whether the company owns the currently held inventory stocks. The company must inspect the suppliers’ billing and other invoice documents to determine whether the company is liable for the inventory amounts. The auditor must examine the company’s purchase_commitments to determine whether the company is liable for the inventory amounts shown in the financial records (Chambers, 2011). Conclusion Summarising the above auditing discussion, the audit process adds reliability to the financial statements. The paper shows the heightened risk audit of Indus Gas Ltd Company of United Kingdom focuses on the inventory amounts, trade_receivables amount, and cash amount. The paper shows the substantial procedures on the financial reports’ balance_sheet inventory amount will help spot and correct errors and fraudulent amounts. Evidently, the audit procedure assure the users of the financial reports that the heightened risk accounts reduced to allowable levels, ensuring the clients’ financial reports are correct and true. References: Arens, A. (2011). Auditing & Assurance Services. London: Prentice Hall Press. Arwinge, O. (2012). Internal Control. London: Springer Press. Cascarino, R. (2010). Auditors Guide to IT Auditing. London: J. Wiley & Sons. Chambers, A. (2011). The Operational Auditing Handbook. London: J. Wiley & Sons . Hightower, R. (2008). Internal Controls Policies & Procedures. London: J. Wiley & Sons Press. Indus Gas Ltd, 2014. Financial Statements. Retrieved 17 April, 2015 from < http://www.hl.co.uk/shares/shares-search-results/i/indus-gas-ltd-ord-gbp0.01/financial-statements- and-reports > Johnston, K. (2012). Auditing. London: Cengage Learning. Leitch, M. (2012). Intelligent Internal Control. London: Gower Press. Louwersetal. (2012). MP Auditing & Assurance Services. London: McGraw-Hill Press. Rittenberg, L. (2011). Auditing. London: Cengage Learning Press. Whittington, R. (2011). Principles of Auditing & Other Assurance Services. London: McGraw- Hill Press. Read More