Sales audit procedures for inventory

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what's up audit fans welcome to the last video in the series on inventory auditing so far we've looked at substantive procedures we've looked at the roll forward and roll back mechanism when we can't actually do the audit right on smack bang on the end of the financial year i've talked about the management accounting and costing impacts when we're auditing inventory and the complexities associated there and today we're going to wrap up this series by looking at testing internal controls over inventory remember internal controls are there to make sure that everybody in the business is following the policies and procedures so that we have accurate data so that businesses can make the right decisions as they're going through their financial year and so that then the management accountants and the financial accountants can prepare the financial statements for investors shareholders and other interested parties to look at so today we're looking at testing internal controls let's get into it [Music] to be able to test internal controls over inventory first we have to have an idea of what those controls are and so i've sort of broken down the processes around inventory into a couple of different subgroups so the first subgroup number one here is controls that we would expect to see around purchasing so you know when you're still auditing the purchasing and the accounts payable function then you would expect to see controls over ordering who can order stock or raw materials so for ordering the questions are going to be who is there some sort of approval process there might be some sort of e o q so economic reordering quantities or some sort of automated process there and you also want to ask questions about are there any pre-approved suppliers because you might not be able to buy from anyone having a process of pre-approving suppliers making sure that they have suitable credit terms for your payments uh suitable quality returns etc that can all be really important in that purchasing and ordering process discounts for early payment etc so there's sort of the the purchasing part which is ordering and then i like to think of the receiving of goods as part of that process as well so again it's the who receives them where do they receive them um we want to know how systems are updated because obviously and that that will depend on what sort of inventory system you have to so the first question to ask probably even before you get into this would be what is the inventory system is it periodic or is it perpetual and you'd probably find that most businesses are using perpetual systems now with so many movements in inventory so when we're receiving goods who receives them how are systems updated how do we count the quantity of goods received and is there a process so that we can only receive goods that were ordered that way we can't actually receive something that wasn't officially ordered and approved now when it comes to this purchasing here i'm talking about purchasing of inventory if we are purchasing just you know stock you know that could be hair brushes or anything else well i have a hair brush on my desk you know what i know why um the other option here is that these purchases could also be for raw materials if you make something or components and these processes you would expect to see regardless of what type of purchasing it is now for those entities that are also manufacturing you'd expect to see some controls over the manufacturing process alright so if you've done introductory accounting you'll know that you'll have a sales budget and from that sales budget there will be generated a production budget all right and that production budget will say we need to make this many by this time i will need to order these resources so that the whole process of having these production budget sales budgets um is actually you know a really important part of the process and with those budgets we want to know who prepares the budget who approves the budget all right and also you know this is management accounting so there's also the risk of budgetary slack coming in there in that section so you know once we have these budgets then you know that loops back up here i guess a little bit into um the purchasing budget process because once we know how much we need to produce that's going to link back in to the whole ordering how much do we order does that come from a budget so that's really important there when it comes to manufacturing we also need to monitor things like wastage but i'm going to include monitoring controls as a slightly sort of separate area so purchasing manufacturing um the next thing i've sort of put it under the area of inventory movement what do i mean by inventory movement you know inventory moves around we buy it we sell it so you know around inventory movement we're going to be looking at recording inventory movement as part of understanding the sales process all right sell something goods get delivered we want to find out when our updates made as a result of having these sales doesn't want to make a sale when is the update to inventory made how is it made how do we confirm that process so that's usually sort of hooked in with the sales process and this is why audit is quite interrelated because all the parts fit together because of double entry bookkeeping so we've got an inventory movement the other thing that if you have an entity that's using a periodic system is that there's going to be some form of stock count to help manage inventory movements there might also be some sort of reconciliation processes as well so those reconciliations might be you know at the end of every day ing to our inventory movements we saw 500 units go out ing to our sales documents is that or delivery documents you know does that match up so there could be some reconciliation processes to help sort of monitor that process so we've got an inventory movement and then the last sort of area i guess where i think about controls is about the monitoring process and you know it's important to have controls as part of processes and doing things but it's also important to have monitoring controls because those monitoring controls if you think about the internal control structure pyramid those are really important because the monitoring controls make sure that the other controls are all working so those monitoring controls could include things like is there warehouse security you might have products with ids product ids that might be unique so for example every car has a unique vehicle identification number or an engine number the microphone that i'm using right here you can't see in my shot has its own unique serial number that i registered so you know that's part of a monitoring process also and this is more from a operational standpoint do you remember from management accounting looking at variance analysis so there would also be variance analysis conducted on a regular basis about materials and labor and looking at those variances in terms of price and usage or efficiency all right i do teach management accounting at the introductory level but i'm not going to go into that now but there's certainly plenty of good videos out there about you know management accounting and variances there so monitoring we've got the warehouse unique product ids you know matching up product ids to sale variance analysis they might also do some sort of basic management accounting um what would we call them analytical procedures analytical procedures yeah and that's using that basic idea for example that if you're looking at your inventory then your opening inventory plus whatever your production is minus whatever your sales is should equal closing inventory all right and this way you can sort of work backwards a little bit so you might say okay i can confirm my sales and i can confirm my production and i know my opening you know let's do that to calculate closing or if i have opening production and closing i can work backwards to find out sales and then do some triangulation compare this inventory movement data to your sales data to make sure that everything looks okay that nothing unusual is going on now another monitoring control here is also the stock take or the stock count all right and that's just to make sure for their own uh processes you know what happens if we find out that there's some items missing at the end of the month or things don't quite um match up right in terms of numbers now as well as all of this i guess probably we might have something maybe up here in inventory movement i just realized i forgot one thing is that we'd also need to think about some way to make sure that we have a process for riding off damage writing off damaged stock so you know something breaks you need to have a process to write it off um and that also might feature in your monitoring reports so you know some sort of management monitoring system to make sure that you know all stock write-offs have been approved etc so with writing off of damaged stock i'm going to add a little arrow in here you want to make sure that it has to be approved by somebody so we have all of these different types of controls and remember the thing that's going to be really important when you're doing this at a client or in a scenario is that every client is different all right even businesses that are in the same industry make the same product might have different processes so every client is different you need to make sure that you customize your procedures to match the client's controls so that first step is identify what what are these controls do you actually see at your client and then you have to do design a test to actually figure out whether it's working or not okay so with any of these tests and i'm not going to write a procedure for every single one of them because that just sort of is not really what i want you to be able to do what i want you to be able to do is take the basic principles about testing the internal control um that i'm you know setting out here in the structure and then be able to apply that to every single unique situation that you come across um i you know we've recently had our exams i marked a lot of students on their tester controls where they just wrote a generic test that didn't take into account the every client is different customized to the client's specific circumstances policies procedures documents whatever there is in the process so let's say here for an example that we're going to use is that we're going to look at the one that uh about stock being written off so the control might be that every time we need to write off stock or inventory that it needs to be approved by the warehouse manager so that it was really broken and it wasn't just somebody stealing an item and then writing it off as damaged all right so what we're going to need to do is we're going to need to follow my four rules i've talked about my four rules before so rule number one is you need to use an audit procedure name all right and this is really about demonstrating that you can talk audit language to us so that you can you know use am i inspecting something am i vouching am i tracing my reperforming so use an order procedure name number two use client specific details okay so whatever the client calls something is what you call that item as well number three is that with client-specific details sorry after the client-specific details is that you need to make sure that you use lots of detail in your procedure and then number four it needs to be fit for purpose it needs to be the right type of test for what you're doing so in applying this example what we need to do is we need to design a procedure that meets the four rules so that we can test the control of somebody properly authorizing inventory write-offs that the approval process is happening correctly so what i need to do is i'm going to use an order procedure name first so actually maybe i'll combine them so i'm going to select a haphazard i always try and include the sampling method there because it helps um you know especially if you're doing cutoff you know block is really good in substantive mode but we want to i usually use haphazard or random for most uh tests of control select a haphazard sample of uh journals journal entries for inventory write-offs and vouch to the original supporting document prepared by the warehouse now i say supporting document it will have a proper name and you should insert the proper name there inspect the let's call it the right off approval approval and look for proof of the i'm running out of room here warehouse manager's signature all right and if you wanted to be really specific ensure the signature is authentic if you're worried that perhaps you know maybe there's multiple people who could sign um here so in this one i've used audit terminology all right so i've said that i'm selecting my sample i've used my sample i'm vouching so i'm starting at the journal and i'm going back to look for that document and i'm inspecting the write-off approval so i've done the first part which is using an audit procedure name the second one let's do this in a different color said use client specific details so i've called it here what did i call it the write-off approval so there i'm talking about you know using client specific documents then the next step was to use lots of detail so i've been very specific i've talked about that i want to start at the journal entries oops i want to start with the journal entries and then i want to make sure that i'm looking look for proof of the warehouse manager's signature so i'm very very specific about what to do now the last one is about purpose and purpose is about making sure i'm testing the control and the control in this instance is the manager's signature all right that is the thing that acts as the control i'm not checking that the amount was correct the write-off was processed correctly i'm checking that the control of having the manager approve is being done and that is probably the most common mistake i see in any audit exam is when i ask students to write a test of control they write a substantive procedure instead and it's not the test for that specific purpose okay if i was going back to any of these others like that let's say we have the variance analysis and let's say that variance analysis has to be approved reviewed monthly by the operations manager and the purchasing manager for example then i would need to get a haphazard or a random sample of those variance analysis analyses and then look for proof of that review you know they stamp it they sign it they date it sometimes it might go through internal mail it might be an email trail it might be an electronic system but there i'm testing the control i'm not looking at the numbers to make sure that those variances match up with what sort of variances are written off as journal entries but i'm testing the internal control so my reminder every single client is different you need to make sure you understand the client this is why isa asa 315 is so so so important understand the client so that then you can design the tests of controls you can pick out the control activities right the things that make sure that you know inventory stays where it's supposed to be we're recording it correctly transactions are being recorded appropriately and then design a test that meets these four rules custom designed so that you're giving the examiner or your client the or your audit juniors so you know you've got auditors working for you you're not giving them a really vague test that says yeah test some inventory write-offs to make sure they're approved what documents do i need to look at how many do i need to select now here you'll notice i haven't talked about uh here my sample number all right i haven't said 50 10 100 because i know that in most audit firms they will have a specific methodology for sampling numbers i would expect in in my instances and what i see in exams is just the general description of the procedure but notice how this is really quite detailed um if you compare this to a lot of auditing textbooks they will say things like um you know inspect approval documents for write-offs and here i would always say be more specific being this specific shows the examiner or shows the client that you understand their business that you can integrate all of this information that you're getting in the audit and you're able to apply it specifically because that is what the auditing standards say the audit standards say be specific design something that is customized that is unique to this client and this set of circumstances so hopefully that was useful to you and that wraps up our series on auditing around inventory because we've covered substantive procedures we've covered manufacturing and the costing sort of issues for manufacturers to roll forwards and roll backs and now we've covered tests of controls and the sorts of controls that you'll expect to see and how to design one of those tests yourself i haven't gone through and written an entire lot of procedures for you but i've given you the scaffolding to learn how to do that yourself this is the whole idea of you know teach you know give them a person a fish they eat for a day teach a person to fish then they feed themselves for life and that's what i want to foster in all of my viewers out there the independence the knowledge the scaffolding to be able to do this yourself so thank you for watching big shout out to wherever you are this is our last video for 2020 boy what a year it's been um there'll be plenty more to come in 2021 i know that you know you've had requests about covert and doing other things um related to covert and covert audit and i've got so some great stuff coming up sort of summarizing wirecard it's a break there's a great new case called freedom foods which is happening here in australia the ceo and a few other people were whistleblowers about some accounting misstatements and accounting fraud that was signed off by deloitte so i have lots of ideas for 2021. of course if there's anything burning that you want to see in 2021 pop it in the comments i always love to hear from you and i hope you have a really great safe and happy festive season socially distanced of course if you can um and i will catch you all in 2021 thank you so much for your support in 2020 i really really appreciate every single comment every single viewer who lets me know where they're from that you've passed exams that you've got the job um i'm really proud of every single one of you so thank you so much for a roller coaster 2020 and i look forward to seeing you next year bye