Inventory

9-1
Chapter 9
Production Cycle
“There is one rule for industrialists and that is: Make the best
quality of goods possible at the lowest cost possible, paying the
highest wages possible.”—Henry Ford
9-2
Presentation Outline
I. Files and Reports in a Production System
II. Production Control Application System
III. Control Risk Assessment
IV. Substantive Procedures
9-3
I. Files and Reports in a Production

System
A. Production Order
B. Bill of Materials
C. Master Operations List
D. Materials Requisitions
E. Job Time Cards
F. Resource Availability Reports
G. Production Status Reports
9-4
A. Production Order We are ready to
begin this
order.
Production control issues

production orders to
authorize production
departments to make
certain products.
9-5
B. Bill of Materials
What
materials do
we need to
make this A bill of materials is a
product? listing of the
ingredients that go
into making a product.
It lists of all the
required parts and
their descriptions.
9-6
C. Master Operations List
A master operations list

specifies the
sequencing of all labor
and/or machine
operations that are
necessary to produce a
product.
9-7
D. Materials Requisitions
Production control
prepares materials
requisitions to
authorize the release
of raw materials from
inventory for use in
production.
9-8
E. Job Time Cards
Job time cards are used

to document the
amount of labor time
that is spent on each
production order or
job.
9-9
F. Resource Availability Reports
We have the materials, but
may have to schedule some
overtime for this job.
 Inventory status reports

detail the material
resources available in
inventory for production.
 Factor availability reports
communicate the
availability of labor and
machine resources for
production.
9-10
G. Production Status Reports
Production status reports

detail the work completed
on individual production
orders as they move
through production.
Open production orders
are monitored and
departmental production
schedules are revised as
necessary.
II. Production Control 9-11
Application System
A. The Role of Production Control

B. Accounting for the Factors of Production
C. Completion of the Production Order
D. Overview of Production Cycle Control
Procedures
A. The Role of Production Control 9-12
Production Production Inventory Cost General
Control Departments Control Accounting Ledger
Inventory Inventory
Status Status
Report Report
Finished Goods
Raw Materials
1
1 Production
Production 2 2 Order
Order 3 Production
Order
N
Factor Factor
Availability Availability
Report Report
1 1
Production 2 Production
Schedule Schedule
D
B. Accounting for the Factors of Production
9-13
1 1
1 Materials 2 Materials
Materials 2 Requisition Requisition
Requisition 3
Post to WIP
N Records
N
Journal Journal
Voucher Voucher
Materials Placed
in Production
Job Time Cards Job Time Cards
Post to WIP
Records
Journal Journal
Voucher Voucher
Conversion Costs
Production Production
Status Status
C. Completion of the Production Order
9-14
1
1 Production
Production 2 2 Order
Order 3 Production
Order
Completed 2 Completed 2
N Production Production
Order Order
Post to Inventory Summarize

Records Production
Journal Journal
Voucher Voucher
Cost of Goods
Completed Manufactured
Production
Cost Report
To Management
D. Overview of Production Cycle 9-15
Control Procedures
• Physical Controls
– Production Order and Materials Requisition.
– Physical inventories reconciled to perpetual inventory records.
– Restrict access to inventories
• Segregation of Duties
– Authorization
– Recording
– Custody
– Reconciliation
• Performance Reviews
– Scrap reports
– Variance analysis
9-16
III. Control Risk Assessment
In the event that control risk is deemed to be high, an

auditor could lower detection risk by:
Sampling more inventory production reports for
valuation calculations
Scheduling inventory observation closer to year end
Making a larger number of test counts
9-17
IV. Substantive Procedures

A. Analytical Procedures
B. Physical Inventory Observation
C. Pricing and Compilation
D. Purchase Cutoffs
E. Accounting Firm Tips
9-18
A. Analytical Procedures
• Verify REASONABLENESS of COGS
– Gross Profit Margin
– Compare to prior year, industry averages
• Verify REASONABLENESS of ending inventory
– Days Sales in Inventory
– Inventory Turnover
9-19
B. Physical Inventory Observation
1. A Required Procedure
2. Client Count Instructions
3. Inventory Count and Measurement
Challenges
4. Audit Program for Inventory Count
5. Inventory Count Sheet
9-20
1. A Required Procedure
• “…it will always be necessary for the auditor to
make, or observe, some physical counts of the
inventory and apply appropriate tests of
intervening transactions" (AU 331.12).
• May make test counts at a time other than year-
end.
– test roll-forward.
9-21
2. Client Count Instructions

• Names of client personnel and dates and times of count
• Instructions for recording inventory descriptions and
counts (measuring physical quantities)
• Noting obsolete or worn items
• Tag control—compilation of counts
• Shutting down production to avoid double counting
• Controlling movement
• Making changes and corrections to counts
• Review and approval of supervisory personnel
9-22
3. Inventory Count and

Measurement Challenges
Examples Challenges/ Special procedures.
Lumber Problem identifying quality or grade. /Employ a specialist
Piles of sugar, coal, scrap steel Geometric computations, aerial photos./ Employ a specialist
Items weighed on scales Accuracy of scales./Examine certification.
Bulk materials (oil, grain, Measuring volume, ensuring composition of content/Climb the
liquids in storage tanks) tanks Dip measuring rods. Sample for assay or chemical
analysis.
Diamonds, jewelry Identification and quality determination problems/ Hire a
specialist.
Pulp wood Quantity measurement estimation/Examine aerial photos.
Livestock Movement not controllable/Use chutes to control animals.
9-23
4. Audit Program for Inventory

Count
9-24
5. Inventory Count Sheet – Exhibit 9.6
6. Observation Considerations 9-25
• Control tags or count sheets

• Be wary of "hollow squares" and "empty boxes”
• Tour shipping and receiving areas
• Watch for OBSOLETE and SLOW-MOVING
inventory
• CONFIRM inventory on CONSIGNMENT and
at other locations
• Consider the use of SPECIALISTS
• Confirm inventory in transit.
9-26
C. Pricing and Compilation Tests

• Valuation (Price Tests)
– VENDOR INVOICES
– COST FLOW ASSUMPTION (FIFO, LIFO,
average, specific identification)
– LOWER OF COST OR MARKET for
inventory
• Check Extensions and Footings.
• Agree to G/L
9-27
D. Purchase Cutoffs
• Verify CUT-OFFs for purchases and sales
– Examine Receiving Reports and Vendor Sales
Invoices occurring around year-end.
– Examine bills of lading and sales invoices
– Agree to inclusion/exclusion from inventory
9-28
E. Accounting Firm Tips

• Focus test counts on high value items.
• Advise client as late as possible about
locations for inventory observation and do
not be predictable about approach.
• Be skeptical of large test count differences.
• Beware of client interest in procedures and
test counts.
• Be alert for slow moving or obsolete
inventory.
9-29
Summary
• Documents in Production Cycle
• Segregation of Duties in Production Cycle
• Control Risk Assessment
• Substantive Procedures including
Observation of Physical Inventory

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9-1

I. Files and Reports in a Production

Production control issues

C. Master Operations List

A master operations list

E. Job Time Cards

Job time cards are used

 Inventory status reports

Production status reports

A. The Role of Production Control

Post to Inventory Summarize

In the event that control risk is deemed to be high, an

IV. Substantive Procedures

B. Physical Inventory Observation

2. Client Count Instructions

3. Inventory Count and

Lumber Problem identifying quality or grade. /Employ a specialist

Items weighed on scales Accuracy of scales./Examine certification.

4. Audit Program for Inventory

• Control tags or count sheets

C. Pricing and Compilation Tests

E. Accounting Firm Tips

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