auditor’s primary objectives when he or she is observing the client’s annual
physical inventory is to verify the existence of inventory, evaluate the
condition of the inventory, obtain a list of inventory, observe compliance with
management’s instructions for the count, and obtain audit evidence about the
reliability of the count procedures. Key inventory audit procedures are reconciling
the inventory count to the general ledger, cut-off analysis, observing the
physical inventory count, testing high-value items, testing error-prone items,
testing inventory in transit, testing item costs, reviewing freight costs, testing
for lower of cost or market, finished goods cost analysis, direct labor
analysis, overhead analysis, work-in-process testing, inventory allowances,
inventory ownership, and inventory layers.
audit procedures that might have prevented Nashwinter from successfully
overstating the 1980 and 1981 physical inventory of the Gravin’s Division are
observing the physical inventory count, inventory ownership, and inventory
layers. Observing the physical inventory means that they would have accounted
for and verified inventory tags, the counting method, and receive inventory
confirmations from staff. Inventory ownership means that the auditors will
review the purchase records to verify that the inventory in the warehouse is
inventory that is actually owned by the company. Inventory layers means that
the auditor needs to know what type of inventory valuation system is being
used, whether it is LIFO or FIFO, so that it can be tested.
inventory turnover was approximately one-half that of comparable divisions
within the firm. This should have affected the planning for the 1981 audit
because during the audit that should have set off a red alert for the auditors.
The auditors already knew that the internal controls for inventory had a number
of weaknesses so when the inventory turnover rate turned up abnormal they
should have done a more detailed search of Gravin’s inventory financial statements.
The internal controls inventory procedure should have been observed and updated
so that it would have less weaknesses and problems when auditors came to check.
assess two types of risks when planning for an audit, the two types of risk
that they assess are inherent risk and control risk. If the auditors knew that Nashwinter
was under considerable pressure to improve operating results of his division they
would have brought it up as a possible risk issue. Pressure is one of the parts
of the fraud triangle. Pressure to improve operating results of Nashwinter’s
division would have been considered an inherent risk because he was a manager, managers
usually have enough to power to create fraudulent documents with ease. It could
have also be seen as a control risk because managers control most of the
documents in a business and his division’s internal controls had a lot of
weaknesses. If the fact he was under pressure was known to auditors, the
auditor would have been more detailed and intense because of the increased
chance of control risk and inherent risk.