Efficient Tests of Balances Series—No. 16: Obtaining Substantive Evidence from Analytical Procedures for Inventories
- Compare account balances in purchases, inventories and costs of good sold accounts with the preceding year or years. Investigate significant changes in amounts or deviations from trends.
- Consider computing the following ratios and comparing to the prior year or years to evaluate the reasonableness of all assertions:
- Inventory classifications (raw materials, work-in-process, finished goods) as a percent of total inventory.
- Gross margin at the financial statement level and by product line.
- Inventory turnover at the financial statement level and by product line.
- Making inquiries for all unusual matters. Even a small variance in expectations revealed in analytical procedures or a small unidentified entry in purchases, costs of goods sold or inventories accounts, for example, could lead to a material error or fraud.
- Evaluating and clarifying management’s responses to inquiries and communicating the responses to an engagement supervisor when such responses may indicate error or fraud (or when the staff assistant doesn’t know if it indicates error or fraud!).
- Carefully evaluating client data and records, particularly inventory physical count records, for the possibility they could be erroneous or fraudulent.
- Paying attention to discussions and activities of client personnel during the inventory observation and at other times that may raise suspicion about error or fraud.
by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs. He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms. Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations. He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.