Apr 3rd 2012
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As it is with all tests of balances procedures, the risk of material misstatement (RMM) at the assertion level should drive the nature, extent and timing of auditing procedures. Here are a few tips on how the assessed level of RMM related to physical inventory taking can create efficiencies and time savings when auditing inventories.
Tip No. 1: Observing the taking of physical inventories.
RMM for physical inventory observations is directly related to management’s planning, instructions and training of personnel for inventory taking. When management is diligent in performing these activities, and when supervisory personnel are present and responsible for determining the inventory taking instructions are being followed by count personnel, RMM may be assessed at moderate or low. With these entity-level controls in place, the auditor’s observation of supervisors’ carrying out their control procedures are sufficient tests of these pervasive, entity-level controls. With positive results from these observation procedures and the planned test counts, the extent of an auditor’s observation procedures can be substantially reduced.
Tip No. 2: Pricing and clerical tests.
Again, the assessed level of RMM at the assertion level will determine the extent of the pricing and clerical tests. When inventories are determined by physical counts, the pricing and extension of inventory quantities are usually performed manually or by spreadsheet or other software applications. When multiple persons are assigned these tasks, RMM will usually be determined by the nature and extent of the supervision and checks of the results of each person’s procedures. For example, when all pricing and clerical procedures are double-checked and corrected by a supervisor or another person RMM may be moderate to low. On the other hand, if there are no double-checks, RMM will ordinarily be high. Moderate or low RMM permits fewer tests of the client’s pricing and clerical procedures. High risk, of course, results in more such tests.
Tip No. 3: Transferring count results to a spreadsheet for pricing or compiling.
From the above comments we can see the simplicity of the risk rule: When management of an entity plans, supervises and double-checks procedures carried out by its personnel, RMM will likely be assessed at some level less than high. This is also true for the process of transferring counts to a spreadsheet or entering them into other software for pricing and compiling. An auditor creates efficiencies by changing the nature of procedures to lesser reliable ones and/or by reducing the extent of the procedures.
My Basic Staff Training Series of webcasts and self-study courses for performing tests of balances procedures contains information on “how to audit” all major financial statement classifications. You can download syllabuses and register by clicking the applicable box on the left side of my home page at www.cpafirmsupport.com.