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- 12 Marks
Question
Your firm is the external auditor of The Ceramicz Company, and you recently attended the year-end inventory count at the company’s warehouse. The company manufactures high-quality tableware (plates, cups, and saucers, etc.) and maintains an integrated computerised system that shows the inventory held at any point in time.
At the year-end inventory count, reports showing the various categories of inventories (but not the quantities) are printed off the system, and the quantities of inventories actually counted are inserted manually by the counters. Later, the quantities are compared with those per the computer system.
The count instructions were received by both you and the counters the day before the count was due to take place. The instructions consisted of the following five points:
Counters must arrive at 8 am on the morning of the count.
They will work in teams of two people.
Each team will be assigned a specific area of the warehouse to count. They will receive inventory sheets listing the products to be found in their area.
The inventory sheets are pre-numbered.
Once the counters have finished the inventory count, the inventory sheets must be handed to the warehouse manager.
Your notes from the attendance at the count include the following observations:
Many areas in which the count took place were untidy, and inventory was sometimes difficult to find because it was not in the allocated area. The same categories of inventories were sometimes found in several different areas, and some inventory was incorrectly labelled.
The count was conducted in a hurry in order to close the warehouse before a public holiday, and there were insufficient counters to conduct the count properly in the time available. The issue and receipt of inventory sheets (on which the quantities were recorded by counters) were not properly controlled. It was difficult to reconcile the inventory quantities recorded at the count to the computerised records, and some significant differences remain outstanding.
Although no finished goods were dispatched during the inventory count, a large delivery of raw materials was received into the warehouse.
Required:
a) For the inventory count conducted by the Ceramicz Company:
i. Identify and explain FOUR (4) deficiencies in the count.
ii. Explain the possible implication of each deficiency and
iii. Provide a recommendation to address each deficiency.
(12 marks)
Answer
| Deficiency | Implication | Recommendation |
|---|---|---|
| Planning: The inventory count was poorly planned as there were insufficient counters, inventory was untidy, inventory was not in its allocated area and was sometimes incorrectly labelled. | If the inventory count is not conducted in an organised way, then inventories could be omitted from the count or items counted twice. Items could also be recorded as the wrong product line if different products are mixed up in the same location. If the inventory is not organised, then it may be difficult to identify obsolete or damaged inventory. These factors mean that when the quantities are compared to the computerised records, adjustment could be made unnecessarily. This would lead to incorrect quantities of items being recorded both in management’s inventory records and the financial statements. This could lead the business to hold too much/too little of certain inventory lines or to have a material error in their financial statements. | In future, the inventory count should be properly planned and organised. Management should carry out a review of the warehouse a few days before the count is scheduled to ensure that the warehouse is tidy, inventory lines are stored together, and obsolete or damaged inventory is segregated. Staff should be advised that they should communicate any problems with the inventory count to the manager in charge as soon as they are identified. If there is significant concern over the accuracy of the year-end count, then the auditor may need to request that the warehouse is organised and a second count carried out at a later date, and a roll-back reconciliation performed. |
| Inventory count sheets: The inventory count sheets were not properly controlled. Employees were not required to sign for them and records were not kept of who was working from which sheet. | Inventory sheets may be lost or not used in the count. This could result in inventories being counted and not recorded in the final inventory count, or not counted at all. This means that inventories may be understated in the financial statements. | The pre-numbered inventory sheets should be signed in and out by the manager responsible for overseeing the inventory counts. A record should be kept as to which employees have which inventory sheet. At the end of the count, a sequence check of inventory sheets should be made to ensure they are complete. |
| Segregation of duties: There is a lack of segregation of duties concerning the responsibility for the count, as the inventory counters must hand the inventory sheets to the warehouse manager at the end of the count. | The warehouse manager has day-to-day responsibility for the inventory and also has control over the inventory count, which is the most important procedure to determine the accuracy of the quantity of inventory at the year-end. If there are significant differences between the quantity counted and recorded on the inventory sheets and the quantity recorded in the computerised inventory records, then the warehouse manager has the opportunity to conceal these errors. This could lead to inaccurate information regarding inventory quantities and/or fraud going undetected. | Someone other than the warehouse manager should have overall responsibility for the inventory count, for example, a supervisor or manager from the finance department. Once the count is completed, the inventory sheets should be reviewed and photocopied by this member of staff before being handed back to the warehouse manager. This will enable any subsequent changes to the inventory sheets to be monitored. |
| Procedures over the movement of inventory: There are no formal procedures regarding the control of inventory movements whilst the count is being conducted. There were no goods dispatched during the count, but goods were received while the count was ongoing. It is not clear whether these items were included in the count or not. | If there is no stipulation made regarding the cut-off of inventory, then inventory could be recorded in the wrong accounting period. | Ideally, there would be no movements of inventory in and out of the warehouse whilst the count is being conducted. However, if goods must be dispatched during the count, then they should be separated from the other inventory lines and not included in the year-end count. Goods received during the count should also be segregated and recorded in the year-end count. This process should be overseen by the finance supervisor/manager. |
- Tags: Audit Procedures, Deficiencies, Inventory Count, Recommendations
- Level: Level 2
- Uploader: Dotse