Chapter 23: Inventory

Q1 Some organizations conduct inventory counts once a year and external auditors attend those counts. Other organizations have
perpetual systems (i.e. they conduct continuous inventory counting) and do not conduct a year- end count.

(b) Describe audit procedures you would perform in order to rely on a perpetual inventory system in a large, dispersed organization
(4 marks)

(ACCA, F8 Level – June 2003, Q.#2b)

A1 (b) Perpetual inventory system
• The purpose of a perpetual inventory system in practice is to control inventory. Such a system involves cyclical counting procedures
during the year. Such procedures avoid the need for reliance on a year-end count. If auditors wish to rely on the records rather than a year-
end count for the purposes of the financial statements, they must ensure that the cyclical counting procedures are adequate and are
being properly and consistently applied, particularly in a large dispersed organization.
• I would ensure that all inventories had been counted at least once a year and that the records had been kept up to date and were
promptly corrected for any discrepancies discovered as a result of counting.
• I would assess the risk attaching to the different locations and seek to visit those locations where the value or volume of inventory is
substantial, and where controls are weak (i.e. where risk is greater).
• It may be necessary to involve other offices of my firm, or to engage staff from another firm to attend counts, and to co-operate with
internal audit, who may wish to conduct their own counts (on which I may wish to rely), or who may lend staff to my firm.
• If using other firms of external auditors, and relying on internal audit work, it is particularly important that I am satisfied with the quality
of that work and that my involvement is sufficient for my firm to be able to justify its audit opinion.
• My firm may perform visits on a rotational basis throughout the year to ensure adequate coverage of all locations.

Examiners’ Comments

Part (b) of the question dealt with audit procedures required where continuous stock counting procedures are in place. Many
answers to this part did not deal with audit procedures, but the continuous stock counting procedures themselves.

Q2 You are an audit manager in Ron & Co. One of your audit clients, MistiRead Co, is a specialist supplier of crime fiction with over 120,000
customers. The company owns one large warehouse, which contains at any one time about 1 million books of up to 80,000 different
titles. Customers place orders for books either over the Internet or by mail order. Books are dispatched on the day of receipt of the order.
Returns are allowed up to 30 days from the dispatch date provided the books look new and unread.

Due to the high inventory turnover, MistiRead maintains a perpetual inventory system using standard ‘off the shelf’ software. Ron & Co has
audited the system for the last five years and has found no errors within the software. Continuous inventory checking is carried out by
Misti Read’s internal audit department.
You are currently reviewing the continuous inventory checking system with an audit junior. The junior needs experience in auditing
continuous inventory checking systems and some basic knowledge on ACCA’s Code of Ethics and Conduct.
Required:

(a) Explain the advantages of using a perpetual inventory system. (4 marks)

(b) List the audit procedures you should perform to confirm the accuracy of the continuous inventory checking at MistiRead Co. For
each procedure, explain the reason for carrying out that procedure. (6 marks)

(10 marks)
(ACCA, F8 Level –June 2007, Q.#6a,b)
A2 (a) Advantages of perpetual inventory systems
• There is no disruption caused by an annual inventory count.
• There is more accurate and regular inventory counting, which enables errors and slow moving or damaged inventory to be identified
earlier.
• Actual inventory balances are known at any time, allowing re-ordering of best selling books to take place on a timely basis. There will
also be fewer causes of inventory reaching zero causing stockouts with orders not being fulfilled.
• Increased control over storekeepers because inventory is being reviewed regularly; this should decrease any pilferage.
• Auditors can rely on the computerized inventory system, reducing substantive audit tests of inventory during the year and at the year
end.
(b) Audit procedures

Audit procedure – Physical count Reason for procedure

Arrange a meeting with the internal audit department. Determine the extent to which reliance can be placed on the work
Discuss the procedures carried out and review working of the internal audit department.
papers produced during the continuous inventory checks.
For any errors identified, ensure that appropriate
adjustments were made to the perpetual inventory
system.
Visit the warehouse and obtain a sample of inventory To ensure that the inventory recorded on the computer system
items already recorded on the perpetual inventory system actually exists.
and agree to the book inventory.

For a sample of books in the warehouse, obtain details and To ensure that all inventory is recorded on the inventory
agree perpetual computer system records. computer system – and there is completeness of recording.

Review the condition of the books, taking details of any To confirm that any inventory which is damaged or unsaleable is
which appear to be old or damaged. correctly valued.
Form an opinion regarding the overall accuracy of the To confirm that inventory quantities have been correctly
perpetual inventory system. recorded.
Ensure all inventory lines are counted at least once per To confirm that all inventory is counted regularly.
year in discussion with the internal audit department.

Q3 The management of Redburn Co have told you that inventory is correctly valued at the lower of cost and net realizable value. You have
already satisfied yourself that cost is correctly determined.
Required:

(i) Define net realizable value; (2 marks)

(ii) State and explain the purpose of FOUR procedures that you should use to ensure that net realizable value of the inventory is at
or above cost. (8 marks)
(10 marks)
(ACCA, F8 Level – Dec 2009, Q.#1e)

A3

(i) Net realizable value is defined in IAS 2 Inventories as: ‘the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.’
(ii) Appropriate procedures to determine that net realizable value of book inventory is above cost would include:

(1) Assessment of estimated proceeds from the sale of items of inventory. Sales price in the period following the year-end is one
important element of net realizable value. Procedures to determine sales prices include:
• Obtain actual sales prices by reference to invoices issued after the year-end and determine that the sales were genuine by
vouching sales invoices to orders, dispatch notes and subsequent receipt of cash.
 • If actual sales prices are not available, the auditor should obtain estimated sales prices from management. It would be
necessary to assess how reasonable these estimated prices were. The auditor might be aided in this respect by reviewing
the reports from sales staff backed up by discussions with management.
• Particular attention should be paid to sales prices of books identified as slow-moving. (Tutorial note: Slow- moving books
might be identified by obtaining lists of sales made in the preceding (say) six months and reviewing reports from sales staff.
The sales statistics would also be useful in this respect.)
• For damaged books disposal price may be nil or very low and the auditor should examine records of disposal of such books
in the past. (Tutorial note: Damaged books should have been identified during the inventory count.)
(2) Determine estimated costs to completion. These costs represent another important element of net realizable value. Relevant
procedures include:
• Some books may still be in production and will initially be included in inventory at cost to date; for example, they may have
been printed but not bound. The auditor should examine production budgets and actual costs (for binding, for example) to
determine actual costs to completion. (Tutorial note: It is not uncommon for publishers to print books but leave them
unbound until sales in the immediate future are expected.)
• Books returned may incur extra costs before they can be made ready for resale and the auditor should examine cost records
to obtain a reasonable estimate of such costs.
(3) Determine costs to be incurred in marketing, selling and distributing directly related to the items in question.
• In general terms the auditor may determine the percentage relationship between sales and selling and distribution
expenses.
• However, the distribution costs of heavy books are likely to be higher than for (say) light paperback books and the auditor
should assess whether the cost weighting is reasonable.
(4) All of the above matters should be discussed with management bearing in mind that, although they represent an internal
source of evidence, they are the most informed people regarding the sale ability of books on hand and regarding
determination of the various elements of net realizable value.
(5) Discuss with management the need for an inventory provision for slow moving and/or obsolete books.

Examiner’s Comments:

Part (e) for 10 marks had two sub requirements, part (i) required a definition of net realizable value (NRV) and part (ii) four procedures
to ensure NRV of inventory is above cost.

It was pleasing to see that a significant proportion of candidates could clearly provide the definition of NRV from IAS 2 Inventories.
However there were a large number of candidates who did not understand what NRV was. Common errors included:

• Confusing NRV with net book value and stating that NRV was cost less depreciation
• Giving the IAS 2 definition of how inventory should be valued i.e. lower of cost and NRV but not actually answering the question asked
of what NRV was
• Stating that NRV was market value of goods less the costs of sale, this is the definition of gross profit and not NRV.
It is unsatisfactory that candidates cannot use their accounting knowledge gained in F3 Financial Accounting and apply it to an audit
question. This is assumed knowledge for F8 and candidates must be prepared to apply this in an audit question where required.

The second part of this question was not answered well. Perhaps due to the misunderstandings over what NRV involved, many
candidates could not provide any relevant procedures let alone the four required by the question. In addition although the question clearly
stated that cost has already been determined satisfactorily a significant proportion of answers contained procedures to verify the cost of
inventory. Again, candidates must read the question clearly, as it was obvious that standard lists of inventory tests had been learnt and
so were written in their answers even though many were irrelevant.

Some of those candidates who did attempt to provide relevant NRV procedures unfortunately did not give sufficient detail in their
answers to receive the 2 marks available per procedure, and many tests were too vague such as ‘check the sales prices’. Candidates must
be able to provide detailed audit procedures in order to be successful in this paper.
Q4 One of your audit clients is Tye Co a company providing petrol, aviation fuel and similar oil based products to the government
of the country it is based in. Although the company is not listed on any stock exchange, it does follow best practice regarding
corporate governance regulations. The audit work for this year is complete, apart from the matter referred to below.
As part of Tye Co’s service contract with the government, it is required to hold an emergency inventory reserve of 6,000 barrels of
aviation fuel. The inventory is to be used if the supply of aviation fuel is interrupted due to unforeseen events such as natural
disaster or terrorist activity.
This fuel has in the past been valued at its cost price of $15 a barrel. The current value of aviation fuel is $120 a barrel. Although the
audit work is complete, as noted above, the directors of Tye Co have now decided to show the ‘real’ value of this closing inventory
in the financial statements by valuing closing inventory of fuel at market value, which does not comply with relevant accounting
standards. The draft financial statements of Tye Co currently show a profit of approximately $500,000 with net assets of $170
million.
Required:

(a) List the audit procedures and actions that you should now take in respect of the above matter. (6 marks)
(ACCA, F8 Level – June 2009, Q#5a)

A4 Valuation of aviation inventory

• Review GAAP to ensure that there are no exceptions for aviation fuel or inventory held for emergency purposes which would suggest
a market valuation should be used.
• Calculate the difference in valuation. The error in inventory valuation is $105 * 6,000 barrels or $630k, which is a material
amount compared to profit.
• Review prior year working papers to determine whether a similar situation occurred last year and ascertain the outcome at that stage.
• Discuss the matter with the directors to obtain reasons why they believe that market value should be used for the inventory this
year.
• Warn the directors that in your opinion, aviation fuel should be valued at the lower of cost or net realisable value (that
• is $15/barrel) and that using market value will result in a modification to the audit report.
• If the directors now amend the financial statements to show inventory valued at cost, then consider mentioning the issue in the weakness
letter and do not modify the audit report in respect of this matter.
• If the directors will not amend the financial statements, quantify the effect of the disagreement in the valuation method
• the sum of $630,000 is material to the financial statements as Tye Co’s income statement figure is decreased from a small loss to a loss
of $130,000 although net assets decrease by only about 0·3%.
• Obtain a management representation letter from the directors of Tye Co confirming that market value is to be used for the emergency
inventory of aviation fuel.
• If the directors will not amend the financial statements, draft the relevant sections of the audit report, showing a qualification on
the grounds of disagreement with the accounting policy for valuation of inventory.

Examiner’s Comments:
5a
Candidates were required to list audit procedures and actions in respect of the director’s decision to revalue some inventory to a
potentially unrealistic amount.
The question was worth 6 marks. As the requirement verb was list, then including 6 relevant procedures in the answer would
obtain full marks.
This question proved to be a fairly good discriminator with many candidates struggling to obtain more than 3 marks overall. The
majority of answers explained the need to discuss the matter with the directors, the effect on materiality and the need to modify
the audit opinion to obtain these marks. Some answers went on to mention other points such as representation letters and
reviewing the proposed policy against GAAP to see if it actually was valid.
The main weakness in many answers concerned the apparent need to go back and audit inventory from the beginning of the audit,
even though the question requirement clearly stated that audit was complete apart from this issue. Audit procedures regarding
existence (seeing the inventory), obtaining the government contract to determine the need to hold 6,000 barrels of oil, etc were
therefore not relevant to the answer. A minority of candidates also treated the issue as an event after the reporting period and
moved on to discussing the going concern status of the company. As no inventory had actually been destroyed, these comments
were again treated as not relevant.
Q5 Introduction and client background

You are an audit senior in Staple and Co and you are commencing the planning of the audit of Smoothbrush Paints Co for the year ending 31
August 2010.

Smoothbrush Paints Co is a paint manufacturer and has been trading for over 50 years, it operates from one central site, which includes the
production facility, warehouse and administration offices.
Smoothbrush sells all of its goods to large home improvement stores, with 60% being to one large chain store Homewares. The company has a
one-year contract to be the sole supplier of paint to Homewares. It secured the contract through significantly reducing prices and offering a
four-month credit period, the company’s normal credit period is one month.
Goods in/purchases

In recent years, Smoothbrush has reduced the level of goods directly manufactured and instead started to import paint from South Asia.
Approximately 60% is imported and 40% manufactured. Within the production facility is a large amount of old plant and equipment that is
now redundant and has minimal scrap value. Purchase orders for overseas paint are made six months in advance and goods can be in transit
for up to two months. Smoothbrush accounts for the inventory when it receives the goods.
To avoid the disruption of a year-end inventory count, Smoothbrush has this year introduced a continuous/perpetual inventory counting
system. The warehouse has been divided into 12 areas and these are each to be counted once over the year. The counting team includes a
member of the internal audit department and a warehouse staff member. The following procedures have been adopted;
1. The team prints the inventory quantities and descriptions from the system and these records are then compared to the inventory physically
present.
2. Any discrepancies in relation to quantities are noted on the inventory sheets, including any items not listed on the sheets but present in the
warehouse area.
3. Any damaged or old items are noted and they are removed from the inventory sheets.
4. The sheets are then passed to the finance department for adjustments to be made to the records when the count has finished.
5. During the counts there will continue to be inventory movements with goods arriving and leaving the warehouse.
At the year-end it is proposed that the inventory will be based on the underlying records. Traditionally Smoothbrush has maintained an
inventory provision based on 1% of the inventory value, but management feels that as inventory is being reviewed more regularly it no longer
needs this provision.
Finance Director

In May 2010 Smoothbrush had a dispute with its finance director (FD) and he immediately left the company. The company has temporarily
asked the financial controller to take over the role while they recruit a permanent replacement. The old FD has notified Smoothbrush that he
intends to sue for unfair dismissal. The company is not proposing to make any provision or disclosures for this, as they are confident the claim
has no merit.

Required:

(c)List and explain suitable controls that should operate over the continuous/perpetual inventory counting system, to ensure the
completeness and accuracy of the existing inventory records at Smoothbrush Paints Co.

(10 marks)
(d)Describe THREE substantive procedures the auditor of Smoothbrush Paints Co should perform at the year end in confirming
each of the following:
(i) The valuation of inventory; (3 marks)
(ACCA, F8 Level – June 2010, Q.#1c,d(i))
A5 Controls over the perpetual/continuous inventory system.

Control Explanation
The inventory count team should be independent of the Currently the team includes a warehouse staff member and
warehouse team. an internal auditor. There should be segregation of roles
between those who have day-to-day responsibility for
inventory and those who are checking it. If the same team are
responsible for maintaining and checking inventory, then
errors and fraud could be hidden.
Timetable of counts should be regularly monitored. The warehouse has been divided into 12 areas that are each
due to be counted once over the year. All inventory is
required to be counted once a year; if the timetable is not
monitored then some areas could be missed.
Movements of inventory should be stopped during the Goods will continue to move in and out of the warehouse
counts. from the designated areas during continuous/perpetual
inventory counts. Inventory records could be
under/overstated if product lines are missed or double-
counted due to movements in the warehouse.
Inventory counting sheets should be pre-printed with a The inventory sheets produced for the count have the
description or item code of the goods, but quantities should quantities pre-printed; therefore, a risk arises that the
not be pre-recorded. counting team could just agree with the record quantities,
making undercounting more likely, rather than counting the
inventory lines correctly.
A second independent team should check the counts By counting the lines twice this should help to ensure
performed by the inventory count team. completeness and accuracy of the counts, and hence that any
inventory adjustments are appropriate.
Inventory checks should be performed from inventory in Currently the team is comparing the records to the inventory
the warehouse to the records. physically present in the warehouse. If the count is performed
from the records to the warehouse, this will only ensure
existence or overstatement. To ensure completeness, the
inventory in the warehouse must be compared to the records
as this will identify any goods physically present but not
included in the records.
Any damaged or obsolete goods should be provided against Damaged or obsolete goods should be written down or
to ensure they are stated at the lower of cost and NRV. moved to a designated area, where a responsible official then
inspects them. It should not be removed from the sheets. This
assessment should only be performed by a suitably trained
member of the finance team, not the inventory count team.
After the count, the inventory count sheets should be At the year-end the inventory of Smoothbrush will be based
compared to the inventory records; any adjustments on the records maintained. Hence the records must be
should be investigated and, if appropriate, updated complete, accurate, and valid. It is important that only
promptly by an authorized person. individuals authorized to do so can amend records.
Senior members of the finance team should regularly review
the types and levels of adjustments, as recurring inventory
adjustments could indicate possible fraud
(b) Substantive procedures to confirm valuation of inventory
• Select a representative sample of goods in inventory at the year end, agree the cost per the records to a recent purchase
invoice and ensure that the cost is correctly stated.
• Select a sample of year end goods and review post yearend sales invoices to ascertain if NRV is above cost or if an adjustment
is required.
• For a sample of manufactured items obtain cost sheets and confirm:
• raw material costs to recent purchase invoices
• labour costs to time sheets or wage records
• overheads allocated are of a production nature.
• Review aged inventory reports and identify any slow-moving goods, discuss with management why these items have not been
written down.
• Compare the level/value of aged product lines to the total inventory value to assess whether the provision for slow moving
goods of 1% should be reinstated.
• Review the inventory records to identify the level of adjustments made throughout the year for damaged/obsolete items. If
significant consider whether the yearend records require further adjustments and discuss with management whether any
further write downs/provision may be required.
• Follow up any damaged/obsolete items noted by the auditor at the inventory counts attended, to ensure that the inventory
records have been updated correctly.
• Perform a review of the average inventory days for the current year and compare to prior year inventory days. Discuss any
significant variations with management.
• Compare the gross margin for current year with prior year. Fluctuations in gross margin could be due to inventory valuation
issues. Discuss significant variations in the margin with management. Substantive procedures to confirm completeness of
provisions or contingent liability
• Discuss with management the nature of the dispute between Smoothbrush and the former finance director (FD), to ensure that
a full understanding of the issue is obtained and to assess whether an obligation exists.
• Review any correspondence with the former FD to assess if a reliable estimate of any potential payments can be made.
• Write to the company’s lawyers to obtain their views as to the probability of the FD’s claim being successful.
• Review board minutes and any company correspondence to assess whether there is any evidence to support the former FD’s
claims of unfair dismissal.
• Obtain a written representation from the directors of Smoothbrush confirming their view that the former FD’s chances of a
successful claim are remote, and hence no provision or contingent liability is required. Credit will be awarded for any
substantive procedures which test for additional provisions or contingent liabilities of Smoothbrush.

Examiner’s Comments

Part (c) for 10 marks required an identification and explanation of controls over the continuous/perpetual inventory counting
system in order to ensure completeness and accuracy of the inventory records. This question proved to be challenging for a number of
candidates and there were some unsatisfactory answers. Many identified controls, such as “the inventory team should be independent of
the warehouse staff” but failed to then explain these controls, this would have restricted their marks to ½ mark per control as opposed to the
1½ marks available for an identification and explanation.

As noted above for question 1a, many candidates identified inventory risks in 1a, but then did not consider the controls required to
address these risks for question 1c, and hence missed out on available marks.
In addition, despite the question asking for controls a significant minority of candidates provided substantive procedures the auditor
would perform at an inventory count. Candidates must read the question carefully. Also many candidates failed to appreciate that the
controls required were in relation to the perpetual inventory system only and not for the whole inventory cycle, hence controls in relation
to goods received notes and purchase invoices were not relevant.
Part (d) for 6 marks required three substantive procedures each to confirm the valuation of inventory and the completeness of
provisions or contingent liabilities.
Performance was mixed for this question; candidates were generally able to provide adequate substantive procedures for provisions
or contingent liabilities. However candidates are reminded that procedures such as;
• obtain management representations,
• discuss with management, or
• read board minutes
are only likely to score ½ mark unless there is an explanation of what the management representation should contain, what the
management discussions should cover, or what the minutes are being reviewed for. Substantive procedures must be sufficiently
detailed otherwise at best only ½ marks rather than 1 mark can be obtained.
The requirement to consider valuation of inventory, which is a topic which is regularly examined, was on the whole inadequately
answered. Candidates seemed to ignore the requirement to consider valuation and often structured their answers with headings such
as existence or rights and obligations. Clearly many failed to read the question properly. In addition despite substantive procedures being
required, many started with a definition of net realizable value, this scored no marks.

Q6 Describe substantive procedures you should perform to obtain sufficient appropriate evidence in relation to:

(i) Inventory held at the third-party warehouses; and

(ii) Use of standard costs for inventory valuation. (4marks)

(ACCA, F8 Level – Dec 2011, Q.#3C)

A6 (i) Procedures to confirm inventory held at third party locations

• Send a letter requesting direct confirmation of inventory balances held at year end from the third-party warehouse providers used by
Abrahams Co regarding quantities and condition.
• Attend the inventory count (if one is to be performed) at the third-party warehouses to review the controls in operation to ensure
the completeness and existence of inventory.
• Inspect any reports produced by the auditors of the warehouses in relation to the adequacy of controls over inventory.
• Inspect any documentation in respect of third-party inventory.
(ii) Procedures to confirm use of standard costs for inventory valuation
• Discuss with management of Abrahams Co the basis of the standard costs applied to the inventory valuation, and how often these are
reviewed and updated.
• Review the level of variances between standard and actual costs and discuss with management how these are treated.
• Obtain a breakdown of the standard costs and agree a sample of these costs to actual invoices or wage records to assess their
reasonableness.

Examiner’s Comments:

Part (c) for 4 marks required substantive procedures to obtain evidence in relation to (i) inventory held at third party warehouses
and (ii) standard costs used for inventory valuation. This question was answered unsatisfactorily by most candidates, especially
(cii).

Many candidates had a reasonable attempt at part (ci) on third party warehouses, suggesting obtaining a confirmation from these
warehouses or attending an inventory count. However, part (cii) on standard costs was inadequately attempted. Candidates
seemed to see “inventory valuation” in the requirement and so produced generic tests for verifying that inventory should be at the
lower of cost and NRV. This was not what the question required. Candidates did not seem to understand that standard costing was
an acceptable option for calculating the cost of inventory and hence they needed to test how close an approximation to actual cost
standard cost was.
Q7 Describe the procedures to be undertaken by the auditor DURING the inventory count of Lily Window Glass Co in order to
gain sufficient appropriate audit evidence. (6 marks)
(ACCA, F8 Level – Dec2012, Q.#1b)

A7. Procedures during the inventory count

• Observe the counting teams of Lily to confirm whether the inventory count instructions are being followed correctly.
• Select a sample and perform test counts from inventory sheets to warehouse aisle and from warehouse aisle to inventory sheets.
• Confirm the procedures for identifying and segregating damaged goods are operating correctly.
• Select a sample of damaged items as noted on the inventory sheets and inspect these windows to confirm whether the level of damage
is correctly noted.
• Observe the procedures for movements of inventory during the count, to confirm that no raw materials or finished goods have been
omitted or counted twice.
• Obtain a photocopy of the completed sequentially numbered inventory sheets for follow up testing on the final audit.
• Identify and make a note of the last goods received notes (GRNs) and goods dispatched notes (GDNs) for 31 December in order to
perform cut-off procedures.
• Observe the procedures carried out by the warehouse manager in assessing the level of work-in-progress and consider the
reasonableness of any assumptions used.
• Discuss with the warehouse manager how he has estimated the raw materials quantities. To the extent that it is possible, re-perform the
procedures adopted by the warehouse manager.
• Identify and record any inventory held for third parties (if any) and confirm that it is excluded from the count.

Examiners’ Comments:

Part (b) for 6 marks required procedures the auditor should undertake during the inventory count of Lily. Performance was
unsatisfactory on this part of the question.

The requirement stated in capitals that procedures DURING the count were required; however, a significant proportion of candidates
ignored this word completely and provided procedures both before and after the count. Many answers actually stated “before the count…”,
candidates must read the question requirements properly.

Those candidates who had read the question properly often struggled to provide an adequate number of well described points. The
common answers given were “to observe the inventory counters” although candidates did not make it clear what they were observing
for; or “undertake test counts” but with no explanation of the direction of the test and whether it was for completeness or existence.
Some candidates provided all possible inventory tests, in particular focusing on NRV testing. This demonstrated that candidates had
learnt a standard list of inventory tests and rather than applying these to the question set just proceeded to list them all. This approach
wastes time and does not tend to score well as of the six answers provided very few tended to be relevant.

Q8 (a) (i)Identify and explain FOUR financial statement assertions relevant to account balances at the year-end; and
(ii) For each identified assertion, describe a substantive procedure relevant to the audit of year-end inventory. (8 marks)
(ACCA, F8 Level – June 2012, Q.#4a)

A8 (a) Financial statement assertions and inventory substantive procedures for balances at the year end.
(i) Existence
Assets, liabilities and equity interests exist.
Substantive procedures
During the inventory count select a sample of assets recorded in the inventory records and agree to the warehouse to confirm the
assets exist.
Obtain a sample of pre year-end goods dispatch notes and agree that these finished goods are excluded from the inventory records.
(ii) Rights and obligations
The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
Substantive procedures
Confirm during the inventory count that any goods belonging to third parties are excluded from the inventory records and count.
For year-end raw materials and finished goods confirm title belongs to the company by agreeing goods to a recent purchase invoice
in the company name.
(iii) Completeness
All assets, liabilities and equity interests that should have been recorded have been recorded.
Substantive procedures
Obtain a copy of the inventory listing and agree the total to the general ledger and the financial statements.
During the inventory count select a sample of goods physically present in the warehouse and confirm recorded in the inventory
records.
(iv) Valuation and allocation
Assets, liabilities and equity interests are included in the financial statements at appropriate amounts and any resulting valuation
or allocation adjustments are appropriately recorded.
Substantive procedures
Select a sample of goods in inventory at the year end, agree the cost per the records to a recent purchase invoice and ensure that
the cost is correctly stated.
Select a sample of year-end goods and review post year-end sales invoices to ascertain if net realisable value is above cost or if an
adjustment is required.

Examiner Comments:

Part (a) was for 8 marks in total and in (ai) required four financial statement assertions relevant to year end account balances and
part (a)(ii) required an example substantive procedure for each assertion relevant to the audit of inventory. This question was
unrelated to the scenario and was knowledge based, and candidates’ performance was on the whole unsatisfactory.
Financial statement assertions are a key element of the F8 syllabus and so it was unsatisfactory to see that a significant minority of
candidates do not know the assertions relevant to account balances; with many giving incorrect assertions of accuracy and cut-off
which are relevant to classes of transactions rather than account balances. Where candidates did correctly identify the assertions,
they often failed to explain them adequately or did so with reference to transactions rather than assets and liabilities.
A number of candidates provided example procedures which were not related to inventory, but instead focused on non-current
assets or receivables. This can only be due to a failure to read the question requirement properly. In addition, many example
procedures were not relevant to the linked assertion, for example giving an existence test for confirming valuation. Also, many of
the procedures were vague such as “check inventory is valued at the lower of cost and net realizable value” without explaining how
we would confirm this.

Q9 Describe substantive procedures the audit team should perform to obtain sufficient and appropriate audit evidence in
relation to the following three matters:
(i) The treatment of the $5 million expenditure incurred on improving the factory production process;
(ii) The release of the $1·5 million allowance for receivables; and
(iii) The damaged inventory.
Note: The total marks will be split equally between each part. (9 marks)
(ACCA, F8 Level – Dec 2013, Q.#1D)

A.9 Substantive procedures

(i) $5 million expenditure incurred on improving the factory production process
• Obtain a schedule of the $5 million expenditure and cast to ensure accuracy.
• For those items treated as capital and included with property, plant and equipment, agree to purchase invoices and ascertain
whether they are in fact of a capital nature.
• For capital items, agree to the non-current assets register to ensure that they are correctly included.
• For capital items, recalculate the depreciation charged to ensure it has been appropriately time apportioned.
• For items treated as repairs, agree to invoices to ensure they are not of a capital nature and that they have been correctly
expensed to the statement of profit or loss (income statement).
(ii) Release of $1·5 million allowance for receivables
• Discuss with the finance director his rationale for not providing against any receivables.
• Review the aged receivable ledger to identify any slow moving or old receivable balances, discuss the status of these balances
with the credit controller to assess whether they are likely to pay.
• Review whether there are any after date cash receipts for slow moving/old receivable balances.
• Review customer correspondence to identify any balances which are in dispute or unlikely to be paid.
• Review board minutes to identify whether there are any significant concerns in relation to payments by customers.
• Calculate the potential level of receivables which are not recoverable and assess whether this is material or not and discuss
with management.
(iii) Damaged inventory
• Obtain a schedule of the $1 million damaged cola products and cast to ensure accuracy.
• During the inventory count identify the quantity of the damaged goods and agree to the schedule.
• Discuss with management their plans for disposing of these goods, whether they believe these goods have a net realizable value
(NRV) at all or if they will need to be scrapped.
• If any of the goods have been sold post year end, agree to the sales invoice to assess NRV.
• Agree the cost of the inventory to supporting documentation to confirm the raw material cost, labour cost and any overheads
attributed to the cost.
• Quantify the level of adjustment required to value inventory at the lower of cost and NRV and discuss with management.

Examiners’ Comments:
Part (d) for 9 marks required substantive procedures the auditor should perform on three areas; the treatment of $5 million spent
on improving the production process, the release of the opening allowance for receivables and the damaged inventory.
Performance on this question was disappointing.
Candidates were unable to tailor their knowledge of general substantive procedures to the specific issues in the scenario. Many
identified the account balances being audited of PPE and repairs expense, receivables and inventory and proceeded to list all
possible tests for these areas. This is not what was required and hence did not score well. The scenario was provided so that
candidates could apply their knowledge; however it seems that many did not take any notice of the scenario at all.
As addressed in other examiners reports candidates must strive to understand substantive procedures. Learning a generic list of
tests will not translate to exam success as they must be applied to the scenario. For example in 1dii on the release of the allowance
for receivables, the scenario clearly stated that there was no longer an allowance, yet many candidates provided tests on
“recalculating the allowance”, or “comparing it to last year” these scored no marks. In addition the damaged inventory in 1diii had a
different taste due to an error in the mixing process; many candidates suggested “inspecting the damaged inventory to assess the
level of damage” this is impossible as the problem was the taste of the cola not the physical condition.
Common mistakes made by candidates were:
• Giving objectives rather than procedures “ensure that inventory is valued at the lower of cost and NRV”, this is not a substantive
procedure and so would not score any marks.
• Lack of detail in tests such as “agree the expenditure on the production to invoices”, this would score few marks as it does not
address what we should be looking to agree on the invoice.
• Believing that “obtaining a management representation” is a valid answer for all substantive procedure questions.
• Providing controls tests rather than substantive procedures.
• Not providing enough tests, candidates should assume 1 mark per valid procedure.
The requirement verb was to “describe” therefore sufficient detail was required to score the 1 mark available per test. Candidates
are reminded yet again that substantive procedures are a core topic area and they must be able to produce relevant detailed
procedures.
Q10 Recorder Communications Co (Recorder) is a large mobile phone company which operates a network of stores in countries
across Europe. The company’s year end is 30 June 2014. You are the audit senior of Piano & Co. Recorder is a new client and you
are currently planning the audit with the audit manager. You have been provided with the following planning notes from the audit
partner following his meeting with the finance director.

Recorder purchases goods from a supplier in South Asia and these goods are shipped to the company’s central warehouse. The
goods are usually in transit for two weeks and the company correctly records the goods when received. Recorder does not
undertake a year-end inventory count, but carries out monthly continuous (perpetual) inventory counts and any errors identified
are adjusted in the inventory system for that month.
During the year the company introduced a bonus based on sales for its sales persons. The bonus target was based on increasing the
number of customers signing up for 24-month phone line contracts. This has been successful and revenue has increased by 15%,
especially in the last few months of the year. The level of receivables is considerably higher than last year and there are concerns
about the creditworthiness of some customers.
Recorder has a policy of revaluing its land and buildings and this year has updated the valuations of all land and buildings.
During the year the directors have each been paid a significant bonus, and they have included this within wages and salaries.
Separate disclosure of the bonus is required by local legislation.
Required:
(a) Explain the audit procedures you should perform in order to place reliance on the continuous (perpetual) counts for
year-end inventory (3 marks)
(ACCA, F8 – June 2014, Q#3b)

A10 Audit procedures for continuous (perpetual) inventory counts

• The audit team should attend at least one of the continuous (perpetual) inventory counts to review whether the controls over the
inventory count are adequate.
• The audit team should confirm that all of the inventory lines have been counted or are due to be counted at least once a year by
reviewing the schedules of counts undertaken/due to be undertaken.
• Review the adjustments made to the inventory records on a monthly basis to gain an understanding of the level of differences
arising on a month by month basis.
• If significant differences consistently arise, this could indicate that the inventory records are not adequately maintained.
• Discuss with management how they will ensure that year-end inventory will not be under or overstated.
• Consider attending the inventory count at the year end to undertake test counts of inventory from records to floor and from floor to
records in order to confirm the existence and completeness of inventory.

Examiner’s Comments:

Part (b) for 3 marks required procedures the auditor should perform in order to place reliance on the continuous counts for inventory.
Candidates’ performance was disappointing.

Many candidates provided lengthy answers on procedures to be carried out when attending a year-end inventory count or procedures to
verify valuation or completeness/existence of inventory, suggesting that a significant proportion of candidates do not understand
continuous inventory counts, the risks associated with this and therefore the areas the auditor needs to focus on. A small proportion of
candidates correctly identified that it was important to confirm if all inventory items were counted at least once a year and also to
assess the level of adjustments made during these counts.

Inventory is a key element of the financial statements and candidates need to be able to provide relevant procedures for both full
year-end counts as well as continuous counting.
Q.11 (i) Andromeda Industries Co (Andromeda) develops and manufactures a wide range of fast moving consumer goods. The
company’s year end is 31 December 2015 and the forecast profit before tax is $8·3 million. You are the audit manager of Neptune &
Co and the year-end audit is due to commence in January. The following information has been gathered during the planning
process:
Inventory count

Andromeda’s raw materials and finished goods inventory are stored in 12 warehouses across the country. Each of these
warehouses is expected to contain material levels of inventory at the year end. It is expected that there will be no significant work
in progress held at any of the sites. Each count will be supervised by a member of Andromeda’s internal audit department and the
counts will all take place on 31 December, when all movements of goods in and out of the warehouses will cease.
Required:

(a) Describe audit procedures you would perform during the audit of Andromeda Industries Co:
(i) BEFORE and DURING the inventory counts; and (8 marks)
(ACCA, F8 Level –Dec 2015, Q.#6)

A.11 (b) (i)Inventory count procedures Before the count

• Review the prior year audit files to identify whether there were any particular warehouses where significant inventory issues
arose last year.
• Discuss with management whether any of the warehouses this year are new, or have experienced significant control issues.
• Decide which of the 12 warehouses the audit team members will attend, basing this on materiality and risk of each site.
• Obtain a copy of the proposed inventory count instructions, review them to identify any control deficiencies and if any are noted,
discuss them with management prior to the counts.
During the count
• Observe the counting teams of Andromeda to confirm whether the inventory count instructions are being followed correctly.
• Select a sample of inventory and perform test counts from inventory sheets to warehouse aisle and from warehouse aisle to inventory
sheets.
• Confirm the procedures for identifying and segregating damaged goods are operating correctly, and assess inventory for evidence of any
damaged or slow-moving items.
• Observe the procedures for movements of inventory during the count, to confirm that all movements have ceased.
• Obtain a photocopy of the completed sequentially numbered inventory sheets for follow up testing on the final audit.
• Identify and make a note of the last goods received notes and goods dispatched notes for 31 December in order to perform cut-off
procedures.
• Discuss with the internal audit supervisor how any raw materials quantities have been estimated. Where possible, reperform the
procedures adopted by the supervisor.

Q.12. Elounda Co manufactures chemical compounds using a continuous production process. Its year end was 31 July 20X6 and the
draft profit before tax is $13·6 million. You are the audit supervisor and the year-end audit is due to commence shortly. The
following matters have been brought to your attention.
(i) Inventory valuation

Your firm attended the year-end inventory count for Elounda Co and ascertained that the process for recording work in progress
(WIP) and finished goods was acceptable. Both WIP and finished goods are material to the financial statements and the quantity
and stage of completion of all ongoing production was recorded accurately during the count.

During the inventory count, the count supervisor noted that a consignment of finished goods, compound E243, with a value of
$720,000, was defective in that the chemical mix was incorrect. The finance director believes that compound E243 can still be sold
at a discounted sum of $400,000. (6 marks)
(ACCA, F8 Level –Sep 2016, Q.#17aii)
A.12 Substantive procedures for inventory valuation
• Obtain a schedule of all raw materials, finished goods and work in progress (WIP) inventory and cast to confirm completeness
and accuracy of the balance and agree to trial balance and financial statements.
• Obtain the breakdown of WIP and agree a sample of WIP assessed during the count to the WIP schedule, agreeing the percentage
completion as recorded at the inventory count.
• For a sample of inventory items (finished goods and WIP), obtain the relevant cost sheets and confirm raw material costs to
recent purchase invoices, labour costs to time sheets or wage records and overheads allocated are of a production nature.
• For a sample of inventory items, review the calculation for equivalent units and associated equivalent unit cost and recalculate
the inventory valuation.
• Select a sample of year-end finished goods and review post year-end sales invoices to ascertain if net realizable value (NRV) is
above cost or if an adjustment is required.
• Select a sample of items included in WIP at the year end and ascertain the final unit cost price, verifying to relevant supporting
documentation, and compare to the unit sales price included in sales invoices post year end to assess NRV.
• Review aged inventory reports and identify any slow-moving goods, discuss with management why these items have not been
written down or if an allowance is required.
• For the defective chemical compound E243, discuss with management their plans for disposing of these goods, and why they
believe these goods have a NRV of $400,000.
• If any E243 has been sold post year end, agree to the sales invoice to assess NRV.
• Agree the cost of $720,000 for compound E243 to supporting documentation to confirm the raw material cost, labour cost and
any overheads attributed to the cost.
• Confirm if the final adjustment for compound E243 is $320,000 (720 – 400) and discuss with management if this adjustment has
been made; if so follow through the write down to confirm.
• Review the financial statements disclosures relating to inventory and WIP to ensure they comply with IAS 2 Inventories.