AUDIT CECKLIST FOR MANUFACTURING
The audit for a manufacturer is nearly identical to the audit of any other business enterprise, except for the additional procedures around the company's inventory balances. Auditors are required to obtain reasonable assurance that a company's financial statements are free of material misstatement, whether caused by error or fraud. As such, auditors design specific procedures to test inventory balances for manufacturers. Understanding some of the more common procedures can help you prepare for your audit.
Generally accepted auditing standards require auditors to physically observe the company's inventory count procedures and make their own independent tests of the physical count of inventory. This requirement is in response to the multitude of accounting frauds that have been perpetuated through falsification of inventory records. Often, when the auditor tests the inventory count, she will use a technique called "floor-to-sheet" and "sheet-to-floor." Floor-to-sheet is when the auditor selects items from the inventory warehouse and makes sure that they are included on the count sheet. This demonstrates that the count sheet is complete. Then, the auditor selects items from the count sheet and ensures that they are in the warehouse, which tests for the existence of inventory.
The inventory balance on the company's financial statements is a function of the quantity of inventory on hand and the value of the inventory. While the inventory observation tests the quantity, price testing tests the cost of the inventory. Generally accepted accounting standards require that inventory is held in the financial statements at the lower of cost or market price. Price testing is the verification of the cost that the company paid for the materials, labor and overhead that goes into the production of inventory. To perform price testing, the auditor will select items from the company's inventory on a test basis and verify, through the analysis of original documentation, such as invoices and time cards, that the inventory's cost is carried in the company's financial records accurately.
Often, the auditor will test the internal controls around the inventory cycle when auditing a manufacturer. The extent of control testing depends on the materiality of the inventory balance, the extent that the auditor wishes to rely on controls to reduce audit testing and other risk factors involving the cycle. However, auditing standards require that auditors at least obtain a general understanding of the internal controls related to the inventory accounting system and use this knowledge to plan and perform the audit.
Inventory Reserve Testing
For companies that hold inventory that may spoil or become obsolete, inventory reserve testing can be an important part of the manufacturer's audit. Because of the lower of cost or market assumption that generally accepted accounting principles prescribe, testing must be conducted to ensure that the market value of inventory does not exceed the cost verified during price testing. Auditors will likely assess the risk of obsolete inventory during the testing of internal controls. In addition, spoiled food or dusty boxes during an inventory count observation may cause auditors to pursue testing in this area more aggressively.
Daniel Cullinane CPA
25 Plaza 5 25th fl Jersey City NJ phone 732-516-1648 fax 732-516-9778
2500 Plaza 5 25th fl Jersey City NJ 07311 phone 732-516-1648 fax 732-516-9778
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