Stock and Work in Progress in the audit of asset

Stock
and work in progress is often a key item in the financial statement and its
verification is a common examination question.
It
cannot be stressed too much that it is the directors’ responsibility to ensure
that:
·        
Stock and work in progress are correctly identified

·        
Physical quantities are correctly ascertained and recorded and condition
assessed
·        
Valuation on proper bases is correctly identified
·        
Proper disclosure is made in the financial statement.
There
is an auditing guideline which has a specific relevance to stock and that is
ISA 501 Audit Evidence-Additional Considerations for specific items.
Students
should also be aware of the disclosure requirement of 2 SSAP 9 stock and long
term contracts and, where appropriate, IAS 2 Inventories.
Categories of Stock
A
categorisation, which follows the broad disclosure requirement in the financial
statements, is into:
·        
Finished goods and goods purchased for resale
·        
Raw materials and components purchased for incorporation into products
for sale and consumable stores (oil, fuels, spare parts etc.).
·        
Work in progress
·        
Payment on account
Stock may be:
·        
Verified assessed by periodic physical counts, particularly at the
period end;
·        
Recorded on a rolling or continuous inventory system.
Cost and Net Realisable Value
The
accounting standard requires that stock and work in progress should be valued
at the lower of cost and net realisable value.
This
means:
·        
Cost-includes cost of the actual item plus any cost related to brining
it to its present location and condition so can include import duties,
transport costs, handling costs, etc.
·        
Net realisable value-is the estimated selling price of those goods in
the ordinary course of business. This can be calculated after deduction of a
proportion to cover selling and distribution costs if this is appropriate.
Auditors need to review selling price of stock items after the year end-the
market price may be less than cost.
Note this really only applies to finished goods-it may be the case that
raw materials and consumable have a selling price less than cost but this
wouldn’t justify writing down stock values.
Valuation
Cost
has to be based on:
·        
For individual items, i.e. ‘one-off’ items, e.g. a car in a motor
dealership-the actual cost for the individual item.
·        
For interchangeable items-e.g. boxes of welding rods in a store cost
calculated on a First in First Out (FIFO) or on a average cost basis. The same
method must be used for similar items of stock.
Production Overheads
One
of the problems is valuing stock and work in progress is the allocation of
overheads as part of the cost. These are overheads incurred in the manufacture
of the items-obviously this does not include any element of selling or
distribution overhead.
Production
overheads can be either fixed or variable. The calculation of the level of
overheads to be apportioned should be based on the normal level of activity. Where
overheads are allocated using an absorption costing basis, which includes some
element of non-production overheads, it is necessary to attempt to exclude
these from the valuation.
This
might require either recalculating the absorption basis or making an estimate
of the non-production overheads and excluding this proportion from the stock
valuation.
Stocktaking Procedures
In
small companies stocktaking may occur on only one day a year, other companies
have more regular counts and yet others carry out stick checks on a continuous
or rolling count basis.
Stocktaking
is essentially a part of the internet control system.
A
good set of procedures will have the following characteristics:
·        
Good planning so that the work is carried out carefully and
systematically-early issue of stocktaking instructions with consideration of
feed back from staff.
·        
Division of the stock take into manageable areas for control purposes.
·        
Identification of stocks and especially of high value items.
·        
Nomination of people responsible for each aspect of the count. These
should, ideally, be persons independent of those normally responsible for the
control over stock items. This is based on the internal control principle of
segregation of duties-separating those responsible for control of stock from
those responsible for counting it.
·        
Written instruction to counters for counting, weighing, measuring
checking should be issued and all counters must ensure they are familiar with
them.
·        
Control to ensure all stock is counted and once only.
·        
Proper control over the issue of blank stock sheets by numbering them
and the control over the return of completed and unused stock sheets. These
ensure none are mislaid or lost.
·        
Control of stock movement during the count- no goods in or out.
·        
Cut-off arrangement-we look at this in more detail later.
·        
Arrangement for identification of defective, damage, obsolete, and
slow-moving stock.
·        
Identification of stock on the premises owned by third parties and of
client’s stock held by outside parties.
·        
Appropriate treatment for sealed containers, dangerous goods, and goods
with special problems.
Stocktaking-the Auditor’s Duties
As
mentioned above ISA 501 Audit Evidence-Additional Consideration for special
items now requires the auditors to attend stock taking.
It
says:
“Where
inventory (stock) is material to the financial statement the auditors should
obtain sufficient appropriate audit evidence regarding its existence and condition
by attendance at physical inventory counting, unless impractical”.
The
purpose of attendance is not only to gather evidence to support the audit
opinion but also as part of the auditors work on the internal control of the
business. In particular:
·        
The physical count will validate (or otherwise of course) the book stock
records;
·        
It will provide evidence of the operation of internal control over
stocks, including the client’s stocktaking procedures;
·        
It provides substantive evidence for the auditors of a material balance
sheet and profit and loss account figure.
The
auditors must satisfy themselves as to the validity of the amounts attributed
to stock and work in progress in the financial statement. They do this by first
considering the client’s system of internal control. This applies to
stocktaking as it does to all areas of audit enquiry. It is essential for
students to understand that stocktaking procedures are part of stock take.
The
auditor’s duties are usually divided into three part-before, during and after
the stock take.
Before the Stock take-Planning
·        
Review the previous year’s working papers and discuss with management
any significant change from the previous year.
·        
Discuss stocktaking arrangement with management.
·        
Familiarise themselves with the nature and volume of stocks and
especially with high volume items.
·        
Consider the location of stocks (e.g. at branches) and the problems that
caused for the client and the auditors.
·        
Consider likely points of difficulty, e.g. cut off.
·        
Consider internal audit involvement and if reliance can be placed upon
it.
·        
Arrange to obtain from third parties confirmation of stock held by them.
·        
Establish whether expert help may be needed from a third party (e.g.
pubs, clubs and restaurants in the licensing trade use specialist valuers,
advice may be required with regard to the valuation of specialised stock, e.g.
gems, contract work in progress).
·        
Evaluate the client’s stocktaking instructions, especially that they:
·        
Include stock held in all locations;
·        
Plan to use staff from those concerned with the stock on a day basis;
·        
Make arrangement for suspending the delivery of goods into the stores
and the taking of goods out of stock-there should be no movement of goods
during the count;
·        
Are discuss with, and adequately communication to stocktaking staff;
·        
Include arrangement for stock-takers to count in pairs so counts can be
verified as they go around;
·        
Include arrangement for marking stock counted so it isn’t counted twice;
·        
Include arrangement for identifying old, obsolete or damaged stock.
·        
Ensure that all audit teams have a copy of the client’s instructions
(and have read and understood them).
During the Stock take
Remember
that the purpose of the attendance is not to take stock or to supervise the
stock take but observe the client’s internal control system in action.
·        
Observe the stocktake to ascertain that the client’s employees are
carrying out their instructions.
·        
Check the count of a selected number of lines. This must be done by
selecting some items found to be present in the stores and some items recorded
on the stock sheets.
Note
for follow up:
·        
Detailes of items for cut-off purpose. These will consist of recording
the details of the last delivery note number for good inwards and the last
goods outward note number.
·        
Form an impression of the magnitude of stock held for comparison with
the account.
·        
Record fully the work done and impressions of the stocktake in the
working papers.
·        
High value items should be given special attention.
·        
Details of the sequence of stock sheet should be verified.
After the Stock-take
·        
Check the cut-off with details of the last number of goods inward and
goods outwards notes during the year and after the tear end.
·        
Test that the final stock sheets have been properly prepared from the
count records. In particular the record of stock count sheet issued and
returned must be checked.
·        
Follow up any notes at the attendance.
·        
Check final stock sheets for pricing, extensions, additions, Summarising
and officials’ signatures.
·        
Inform management of any problems encountered in the stock-take for
action in subsequent counts.
If
it is not practicable to attend the stock-taking, for example if the client has
stock-take remote or overseas location, the auditors must still attempt to
gather evidence concerning the physical existence, ownership and value of
stocks. They can be done by;
·                    
Arranging for the stock-take to be at the earlier and reconciling count
with the year end figure.
·                    
Appointing agent, e.g. for overseas locations.
·                    
Examining continuous stock-take records and carrying out sample test.
None of these solutions is wholly satisfactory and the auditors must
make very extensive enquires before they give a clean report. 
Continuous Inventory
            Many organization and supermarkets are perhaps the
most accessible to do so. Instead they practice a continual stock-taking
procedure where every item of stock is checked to the book stock records at
least once in the year and probably more than once in a systematic and orderly
manner.
The
records of such checking should demonstrate concurrence between the actual
stock and the records. In this case what the auditor has to do is;
·                    
Attend physical inventory count when they are being carried out by
client’s staff on more than one occasion.
·                    
Examining the book stock listing at the year end and examine records of
counts near the year-end date.
·                    
Examine reconciliation between counts and the book stock records and
ensure the client has procedures in place o follow up any discrepancies during
counts and adjust book stock records as appropriate.
This
last point is probably the most important because, in the absence of an
independent physical count at the year end, the auditor has to ensure that the
client has sufficient controls in place to maintain the book stock records
accuracy.
Stock-take other than at year end
ISA
501 states that stock-taking carried out before or after the year end may be
acceptable for audit purposes provides records of stock movements in the
interning period are such that the movements can be examined and substantiated.
The greater interval the more difficult this will be. Acceptability depends
also on the auditors being satisfied that there is a good system of interval
control and satisfactory stock records.
Work in progress
All
that has been said about stock applies equally to work in progress but this
item presents even greater problems of ascertainment and valuation to the
directors and to the auditors.
This
category relates primarily to long-term work in progress i.e. work which will
cover more than one, and sometimes several, accounting periods.
With
short-term work in progress it is relatively easy to value the work done as the
contract may be completed before the audit is signed off and the auditors can
evaluate its outcome, but for longer-term contract the future may be more
uncertain. This requires an exercise of judgement and sometimes, the
involvement or opinion of an expert valuer, such as a quantity surveyor.
The
auditor’s investigation will include:
·        
Examination of contract to ensure that features such as timescales and
penalty clauses are known.
·        
Enquiry into the costing system from which work in progress is
ascertained.
·        
Enquiry into the qualifications and experience of any valuers who are
certifying valuations of completed work.
·        
Any losses identified on contract in progress must be recognised
immediately in the valuation. This is to reduce the valuation of work in
progress to its estimate realisable value. Auditors have to review not only the
cost already included in the calculation of work in progress but also the cost
to complete the particular contract. This requires them to form a judgement on
the assumptions used by management to calculate such costs.
·        
Where items such as buildings and plant are constructed internally, it
is important for the auditor to make sure that if such items are under
construction at the year end they are not included twice, i.e. in fixed assets
and work in progress.
Auditors
should, where possible, inspect the works in progress in order to familiarise
themselves with the scale and nature of the projects, and to provide basic
evidence that the project exists.
They
may also have to consider the use of experts in connection with the valuation
of work in progress and legal advice in connection with any dispute which may
be taking place over the contract.
Analytical Review
While
detailed work on stock and work in progress is imperative in an audit, there
are number of analytical review procedure which the auditors should carry out
in order to provide additional, substantive, evidence.
These
could include:
·        
Reconciliation of change in stock at successive year ends with records
of movement, e.g. purchases and sales.
·        
Comparison of quantities of each kind of stock held at year end with
those held at previous year ends and with purchases and sales.
·        
Consideration of gross profit ration with that of previous year, other
companies, and budgeted expectations.
·        
Consideration of rate of stock turn with previous years, etc.
·        
Comparison of stock figures with budgets for stock, sales and purchases.
·        
Consideration of standard costing records and the application of
variance in the valuation of stock and work in progress.
Valuation of Stock and Work in Progress
Remember
that stock and work in progress should be valued in accordance with the
provision of SSAP 9 (or IAS 2) which state that they must be valued at the
lower of cost and net realisable value.
Net
realisable value is the value the stock would achieve in the open market in its
present condition.
The audit
tests could include detailed substantive test such as:
·        
Ascertain accounting policies adopted for valuing stock and ensure they
have been consistently applied.
·        
Test the stock sheet or continuous stock record with relevant document
such as invoices and costing records to determine if ‘cost’ has been correctly
arrived at.
·        
Examine and test the inclusion of overheads, as outlined above.
·        
Test the arithmetical accuracy of calculations.
·        
Consider the adequate of the description used in the account and
disclosure of the accounting policies adopted.

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