1. Chapter 16
Auditing Inventories and
property, plant and
equipment
Prepared by Dr Phil Saj
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2. Learning objectives
1. Identify the audit objectives applicable to
inventories.
2. Explain the nature of inventory records.
3. Describe procedures to be followed at an
inventory count.
4. Discuss considerations relevant to determining
the audit strategy for inventories.
5. Describe procedures to be followed when
observing an inventory count.
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3. Learning objectives
6. Explain the audit procedures for verifying
inventory pricing.
7. Identify the audit objectives applicable to
property, plant and equipment.
8. Discuss considerations relevant to determining
the audit strategy for property, plant and
equipment.
9. Design a substantive audit program for
property, plant and equipment.
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4. Audit objectives - Inventories
Overall, the audit objectives in respect of
inventories are:
to ensure they actually exist;
are owned by the client; and
are properly valued.
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5. Audit Objectives - Inventories
Transaction objectives
Occurrence (OE) Recorded purchase transactions represent inventories
acquired during the period (OE1)
Recorded transfers represent inventories transferred
between locations or categories during the period (OE2)
Recorded sales transactions represent inventories sold
during the period (OE3)
Completeness
(C)
All inventory receipts during the period have been recorded
as purchases (C1)
All transfers of inventories between locations or categories
during the period have been recorded (C2)
All inventory dispatched during the period have been
recorded as sales (C3)
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6. 6
Transaction objectives
Accuracy AV) Inventory transactions are properly (accurately) recorded
(AV1)
Cut-off (CO) Inventories received before the period-end are recorded
as purchases in the current period and those received
after the period end are included in the next accounting
period (CO1)
Inventories dispatched before the period-end are
recorded as sales in the current period and those
dispatched after the period-end are included in the next
accounting period (CO2)
Classification (PD) Inventory transactions are recorded in the correct
accounts (PD1)
Audit Objectives - Inventories
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7. Audit Objectives - Inventories
Balance objectives
Existence (OE) Inventories recorded represent items on hand at
the end of the reporting period (OE4)
Rights and
obligations (RO)
The entity has rights to the inventories included in
the balance sheet (RO1)
Completeness (C) Inventories include all materials, products and
supplies on hand at the end of the reporting period
(C4)
Valuation and
allocation (AV)
Inventories are properly stated at the lower of cost
and net realisable value, determined in accordance
with applicable accounting standards (AV2)
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8. Analytical procedures
Audit Procedures
The auditor reviews industry experience and trends.
Auditors often specialise in industry sectors.
Examines inventory turnover and relationship to
gross profit.
Reviews relationships of inventory balances to
recent purchasing, production and sales activities.
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9. Tests of details of transactions
Audit Procedures
Tests entries in inventory records to and from
supporting documentation.
Tests the cut-off of purchases, inventory transfers
and sales.
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10. Tests of details of balances
Audit Procedures
The auditor attends the entity’s stock-take:
evaluates the adequacy of the entity’s inventory-
taking plans.
observes physical inventory count and tests
compliance with prescribed procedures.
makes test counts.
looks for indications of slow-moving, damaged
or obsolete inventory.
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11. Tests of details of balances
Audit Procedures
The auditor attends the entity’s stock-take (cont.):
accounts for all inventory tags and count sheets
used in the physical count.
records cut-off data.
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12. Tests of details of balances
Audit Procedures
The auditor also tests the clerical accuracy of
inventory listings:
recalculates totals and extensions of
quantities times unit prices.
traces test counts from the stock-take to listings.
compares physical counts with perpetual
inventory records.
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13. Tests of details of balances
Audit Procedures
The auditor also tests inventory pricing:
Involves verifying the cost of inventory and the
net realisable value of the items.
Also involves considering whether other items,
whose net realisable value may be below cost,
need to be written down.
Thus, this testing by the auditor relates to the
valuation assertion.
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14. Other procedures
There are also cut-off procedures to be
undertaken by the auditor to ensure there is no
inadvertent double counting of inventory and sales.
Other tests include inventory turnover that gives
an indication of any obsolescence in the inventory
on hand.
When inventories are stored with third parties, the
auditor should obtain evidence as to the existence
of the inventory by direct communication with the
custodian.
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15. Other procedures
Goods on hand may be held for customers, at
their request, after a sale has occurred, and goods
belonging to others may be held on consignment.
Management is requested by the auditor to
segregate goods not owned during the physical
count.
In addition, the auditor usually requests a written
assertion on ownership of inventories in the
management representation letter.
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16. Property, Plant And Equipment
Property, plant and equipment are non-current
tangible assets intended to be retained for use
in the entity’s operations.
The main related profit and loss accounts are
depreciation expense, repairs expense, finance
charges on finance leases and rent on
operating leases.
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17. Audit objectives
Property, plant and equipment
The auditor is concerned that:
recorded items of property plant and
equipment actually exist;
are owned by the client; and
are properly valued with adequate provision
for depreciation.
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18. Audit Objectives
Property, Plant & Equipment
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Transaction objectives
Occurrence (OE) Recorded additions represent property, plant and
equipment acquired during the period under audit
(OE1)
Recorded disposals represent property, plant and
equipment sold or scrapped during the period
under audit (OE2)
Completeness (C) All additions that occurred during the period have
been recorded (C1)
All disposals that occurred during the period have
been recorded (C2)
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19. 19
Transaction objectives
Accuracy (AV) Additions are correctly journalised and posted (AV1)
Disposals are correctly journalised and posted (AV2)
Cut-off (CO) Additions and disposals of property, plant and
equipment before the period end are recorded in the
current period and those after the period end are
included in the next accounting period (CO1)
Classification
(PD)
Additions and disposals of property, plant and
equipment are recorded in the correct accounts (PD1)
Audit Objectives
Property, Plant & Equipment
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20. 20
Balances objectives
Existence (OE) Recorded property, plant and equipment assets
represent productive assets that are in use at the
end of the reporting period (OE3)
Rights and
obligations (RO)
The entity owns or has rights to all recorded
property, plant and equipment assets at the end of
the reporting period (RO1)
Completeness
(C)
Non-current asset balances include all applicable
assets used in operations at the end of the reporting
period (C3)
Valuation and
allocation (AV)
Property, plant and equipment are stated at cost or a
valuation less accumulated depreciation (AV3)
Audit Objectives
Property, Plant & Equipment
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21. 21
Presentation and disclosure objectives
Occurrence and
rights and
obligations
Disclosed property, plant and equipment transactions have
occurred and pertain to the entity (PD2)
Completeness Disclosures as to:
• Depreciation methods and useful lives of each major class
• The pledging as collateral
• The major terms of finance lease contracts of property,
plant and equipment assets are adequate (PD3)
Classification and
understandability
The details of additions and disposals of property, plant and
equipment support their classification and disclosure in the
financial statements (PD4)
Accuracy and
valuation
Property, plant and equipment transactions are disclosed
accurately and at appropriate amounts (PD5)
Audit Objectives
Property, Plant & Equipment
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22. Audit Procedures
Calculation of ratios such as a comparison of
the depreciation charge with the cost or written-
down value.
Analysis of ratio results relative to expectations
based on previous year’s results, industry data,
budgeted amounts or other data:
e.g. repairs and maintenance expense
with that for previous years or with net
sales.
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23. Tests of details of transactions
These substantive procedures cover three types of
transactions related to property, plant and equipment:
additions;
disposals; and
repairs and maintenance.
Audit procedures include:
Comparison of asset additions and disposals
with supporting documentation; and
Review of repairs and maintenance and rental
expenses.
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24. Substantiating additions
The auditor needs first to ascertain management’s
policy with regard to the distinction between capital
and revenue expenditure (most entities specify a cut-
off value below which purchases are expensed,
regardless of their nature).
Auditor must ensure that additions are properly
capitalised and that a consistent policy is followed.
The recorded amounts should be vouched to
supporting documentation in the form of authorisations
in the minutes, suppliers’ invoices and contracts.
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25. Substantiating additions
The auditor should physically inspect major items, ensuring
that details of the asset inspected (description and the
manufacturer’s serial number) agree with the documentation.
Also needs to inquire about leases for property, plant and
equipment entered into during the period
The auditor should review any lease agreements to
determine its proper accounting classification in
accordance with AASB 117 Leases.
The auditor should do some recalculations to verify the
accuracy of the entity’s determination of the present value
of the lease liability.
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26. Substantiating disposals
Evidence of sales, disposals and trade-ins
should be available to the auditor in the form of
cash remittance advices, written authorisations
and sales agreements.
Such documentation should be examined
carefully to determine the accuracy of the
accounting records, including the recognition of
any gain or loss.
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27. Substantiating disposals
In determining whether all disposals have been
recorded, the following procedures may be carried
out:
analysis of the miscellaneous revenue
account for proceeds from sales of property,
plant and equipment.
investigation of the disposition of facilities
associated with discontinued product lines and
operations.
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28. Substantiating disposals
Tracing of disposal authorisations to recording
in the accounting records.
Reviewing insurance policies for termination or
reductions of coverage.
Inquiring of management to ensure all
disposals have been properly accounted for.
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29. Tests of details of balances
The main tests of balances relate to valuation
and disclosure.
These test the accumulated depreciation, the
need for provision for impairment, and the
appropriateness of any revaluation.
Also, the auditor may examine documentary
evidence as to the existence and rights and
obligations assertions of the recorded balance.
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30. Tests of details of balances
Audit procedures include:
Examination of title documents and contracts,
e.g. the auditor may establish ownership of
vehicles by examining registration certificates
and insurance policies.
Review of provisions for depreciation,
e.g. the auditor determines the
reasonableness of accumulated depreciation
by considering such factors as the remaining
useful lives of existing assets.
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31. Tests of details of balances
The auditor must also determine whether the
methods in use are consistent with those used in
the preceding year.
The auditor verifies the accuracy of depreciation
through recalculation.
This is done on a selective basis by recalculating
the depreciation on major assets and testing
depreciation on additions and disposals during
the year.
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32. Tests of details of balances
Consideration of the possibility of impairment.
The auditor needs to ensure that the carrying
value of property, plant and equipment does
not exceed the greater of their realisable
value or value in use.
This is done in accordance with AASB 136
Impairment of Assets.
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33. Tests of details of balances
Inquiry into the valuation of property, plant and
equipment.
Management may choose to revalue property,
plant and equipment so as to reflect more fairly
their value to the business.
The auditor would need to be satisfied as to the
skill, competence, objectivity and independence
of the valuer.
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