 In this presentation, we will discuss the Auditing of Inventory, so we're going through the auditing process. We are looking specifically to the inventory management process at this time. When we consider the inventory management process, we want to think about the idea of where inventory management lies with regards to first a word from our sponsor. Well, actually, these are just items that we picked from the YouTube shopping affiliate program, but that's actually good for you, because these aren't things that were just given to us from some large corporation which we don't even use in exchange for us selling them to you. These are things that we actually researched, purchased, and used ourselves. Bayer Dynamic? Not sure if I said that right, but this is the DT770 Pro 250 OHM Studio Reference Closed Back Headphones. I wear headphones basically every day for a large part of the day. They are important to me, therefore, I've gone through many different kinds of headphones. 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As we build the audit plan, we want to keep this in consideration so we can consider when we audit something like purchasing, how much of the inventory management process will be audited, how much of that bucket of information of evidence can we fill up with regards to inventory management as we audit the purchasing process as we do the inverse as well. When we go to the inventory management process, how much can we then apply out to the purchasing process so we can efficiently plan this information. Now we'll consider documentation with relation to inventory management started with the production schedule. So the production schedule note, of course, would be involved if we're in the production of the inventory. So we're considering production process there. If we're in the purchasing and selling of inventory, then we wouldn't have the production type components depending on the type of industry that we are in. We want to build an expected demand for the business's products. If we have a normal expected demand, as we'll see when we think about the risks involved with the inventory section, if we have a normal demand, then we can have more assurance about the inventory process and the production schedule. If the demand is a lot more volatile, then we have some more risk involved in terms of the production schedule. And then we have the receiving report records the receipt of goods from the vendor. So the receiving report is going to be what is recording the goods that we're going to receive from the vendor. We discussed this in the purchasing process because of course the purchase of inventory is one of the things that we may purchase through the purchasing process. The receiving report we could think about basically on the warehouse. If we're in the warehouse, we're receiving the goods. If we purchased it, say, from like China, we're here in the US, we purchased something from China. It comes to us, then we're imagining ourselves in the warehouse and we have then that's the point we put together the receiving report. Then we have the materials requests, requisition that is, materials requisition tracks material during the production process. So the material requisition is going to be an internal form internal to the organization and that's going to be tracking the materials and we could think of it if you think of like a job cause system and we're making the inventory, then the materials requisition form may be the form that is used to move the materials, say for making guitars, we're moving the wood from the inventory, the raw goods, to the work in process. That's going to be an internal type of documentation, transferring possibly from one account to another one inventory account to another raw materials, possibly to work in process, which will finally be produced into the format of finished goods, finished inventory. And then we have the inventory master file has information related to the businesses inventory, including the perpetual inventory records. This is going to give us that the perpetual inventory records kind of like the subsidiary type ledger that we might think of with regards to accounts receivable and accounts payable given us basically that detail that will be involved that we're going to need with regards to inventory documents continued production data information has information about the transfer of goods and related cost incurred at each stage of production. So as again, we're thinking about as producing inventory in this case, production data has information about the transfer of goods and related cost incurred at each stage of that production level cost variance report. So now we have the variance report material labor and overhead costs will be charged to inventory during the manufacturing process. So when we make the goods for making the inventory, we've got material labor and overhead those are the three components that we're going to have to consider in inventory if we produce the inventory. This is going to compare the actual cost to the standard or budgeted cost. So when we think about this, we're going to have a budget to the production process, often using something like standard costs, which are kind of like budgeted costs. And then we can take a look at the variance report the difference report between what was budgeted for these components and of course, what actually happened. And then we have the inventory status report has it's going to include or has the type and amount of products on hand. So the inventory status report the types and the type and amount of products on hand. And then the shipping order, the shipping in order used to remove goods from the perpetual inventory records. So when we think about the shipping order, we're thinking about the orders that are basically going out. So we have the shipping order. And that means if it's going out, possibly we sold it. And therefore it's no longer something that should be on our books. Therefore this is the this is going to be the form that triggers the transaction that's going to be removing it from typically the inventory on the businesses books. Now we're going to take a look at the primary functions related to inventory. First we have the inventory management so inventory management primary function authorization of production activity and maintenance of inventory at appropriate levels issuance of purchased requisitions to the purchasing department. So then we have the primary function of raw materials stores that involves the custody of the raw materials issuance of raw materials to the manufacturing department. Of course, as we go through these functions, we want to consider these functions and you're considering what will be the risks involved in these functions, the inherent risk, what internal controls might be put in place for them, how can we test for the internal controls as the auditor and then of course the test of internal controls that we will do with regards to the auditing of them and then the substantive procedures that we can test related to these as well. Then we have the manufacturing the primary function of manufacturing that's going to be the production of goods. Then we have the finished goods storage. So the storage of the finished goods, which of course involves the custody of finished goods issuance of goods to the shipping department. Then we have the cost accounting cost accounting team is the maintenance of the cost of manufacturing. So we have to account for the maintenance of the cost of manufacturing inventory and cost records. We want to make sure the inventories and the cost records then we have the general ledger. The general ledger is of course the accumulation classification summarization of inventory and related costs in the general ledger. Now we'll think of the segregation of duties with relation to inventory. So remember this is going to be one of the major internal controls. When we think about internal controls, we have the segregation or separation of duties. That meaning that the key components we're going to separate and therefore if there's going to be something like theft or fraud that's going to take place, it would have to involve something called collusion where multiple people would have to get involved and plan in order to basically commit fraud. So this is going to be one of the major internal controls, separation, segregation of duties that should come to mind anytime we think of internal controls with basically any type of system. Also note of course as we consider these internal controls, as always, that we're going to have more separation of duties, more segregation of duties that can be done as companies are larger. If you go to a smaller type of companies, the question is what type of separation or segregation of duties will be appropriate given the size and the maintenance or the people that are involved within that organization. All right, segregation of duties. Inventory management function is segregated from the cost accounting function. So inventory management separate from the cost accounting. Why? If they weren't segregated, production and inventory costs can be manipulated. So if you have the same person that's going to be involved in the inventory management function and is also doing the cost accounting function, then the production of inventory costs can't be manipulated. And again, this is kind of the interesting factor for most people to actually think about where could fraud take place. And then for us as the auditor, we've got that kind of skeptical viewpoint that we have to have basically when we're designing or thinking about internal controls or auditing them, where could fraud take place? And then what can we do in order to set up internal controls to reduce it? And how can we test for those controls? So this may result in an over or understatement of inventory and net income. Then we have the next segregation. Inventory stores function is segregated from the cost accounting function. So inventory stores function segregated from the cost accounting function. If they weren't segregated, under authorized shipments can be made. So that wouldn't be good. We can have the unauthorized shipments if we have the one person involved of those two items. And the theft of goods can be covered up. Obviously inventory is something that's not as liquid as cash, but it's something that is fairly liquid. And it depends on what type of inventory we have. So it's something that could be subject to theft. And we want to make sure that we have the proper safeguarding and controls over the inventory as well. And that, of course, includes segregation or separation of duties. Then we have cost accounting function is segregated from the general ledger function cost accounting separates from the general ledger. If not segregated, it is possible to conceal unauthorized shipments. If that wasn't the case, it's possible for one person in charge of both things to conceal unauthorized shipments. And again, as you think of these things, you might say, well, one person wouldn't do that. I know the person involved. I know everybody involved in this. But notice as the companies grow, we don't possibly know everybody personally involved in the situation. And maybe that's good to some degree because we want to have basically some kind of checks and balances, some separations within basically the systems, the larger systems, you know, are going to have that separation of duties, you got to have it. And also, if we don't have the separation of duties, remember that if they're not separated, the likelihood for someone to just realize that they could have the opportunity to commit fraud and not be caught if they once you once that's being realized. And if that's coupled with a problem situation for individuals, they're more like financial problems or something, they're more likely to commit fraud. We would rather not have the temptation even be involved there. And therefore, you want to make sure to have the separation of duties and the fraud prevention in place, the good controls. So cost accounting function is separated from the general ledger function. If it wasn't, it is possible to conceal unauthorized shipment. This can result in the theft of goods causing overstatement of inventory. Then we have the responsibility of supervising or supervising physical inventory. So we're supervising the physical emperor inventory separate from the inventory management and inventory stores function. So if they weren't segregated, it's possible that the inventory shortages will be covered up through the adjustment of the inventory records to the physical inventory. So notice once again, responsibility for supervising the physical inventory is separate from the inventory management and inventory stores function. Because if it's not, it's possible that the inventory shortage will be covered up through the adjustment. You can adjust the inventory records to the physical inventory. This could result in an overstatement of inventory. So here we have our segregation of duties. Now we're going to post this out in a table type of format. So we have the function over here. And then we've got the area that will be involved, including inventory management, raw materials, finished goods, storage, cost accounting, IT. These are different areas that of course we'll be doing different things. That's the point. So we have the function of making of production schedules. That's going to be in the inventory management, the making of the production schedules, then the issuing materials requisition, that's going to be the in the raw materials stores. So that's a different area. And then we have the update cost records with the materials, labor and overhead usage. That's within cost accounting often helped by IT as needed. And then we have the updating inventory records. That's going to be in cost accounting and IT as needed release of goods to the shipping department. So now we got the goods released to the shipping department, finished good stores. So that's going to be a separate location. And then the approval and issuance of the purchase requisition that done in the inventory management.