Inventory Management System: Deficiencies, Recommendations, And Audit Procedures

Part I

The inventory management system is a procedure that is maintained with the computer software or manually that tracks the inventories. Physical counts of the inventory are carried out for assuring that the inventory management system of the company is accurate and will assure that the items are not stolen or lost. Generally the detailed count for inventory is taken before entering the amount in the balance sheet to assure that the entity reports the levels of inventory for the company accurately.

• All the count staffs were selected from the stores only– here in the given case, the count staffs are responsible for the counting of inventories. Therefore, chances are there that there may be temptation for hiding the missing inventories or the errors that may be removed by them illegally. Further, the count staffs will try to avoid counting the bay where the errors are already known to them (Chandren, Nadarajan and Abdullah 2015).  
• Count sheet not signed by staffs that were carrying out count procedure– non-signing makes it tough for raising the queries with respect to the items that were counted as the original staffs involved in the counting are unknown. Further, on account of any issues one employee can blame another and the auditor will not be able to recognize the actual employee in fault as no signature is there.
• The count sheets for the inventory count were not pre-numbered and were numbered at the time while using– chances are there that additional sheets for the inventory could be lost which in turn will lost all the control on the sheets used at the time of counting the inventory. Further, as the sheets were not pre-numbered, loss of sheets will not be traced. Further, if in the place of original sheet any other sheet is inserted that deletes any name of the items that is already been stolen or misappropriated will not be recognizable (Kalelkar and Khan 2016).
• Count teams were in the decision making place regarding which bays are to be counted– danger involved there with regard to the fact that the teams will omit the inventory under count or may count the same inventory twice owing to the lack of clear instructions regarding where to count the inventories. Further, chances are there that the count staff may put the figures against the items in the inventory sheet without even counting the items. If this happens, there will be no use of inventory counting.
• Inventory sheets mentioned the item quantity for the items that are expected to find in store– It is obvious that the focus for the count teams will be more likely on finding that item numbers that makes the inventory under counting. Further, they will stop further counting after exact numbers of items are found and will write the exact figures against items even if there are any shortages (Knechel and Salterio 2016).

• All the count staffs were selected from the stores only– count teams shall involve the persons who are not involved in the inventory in any ways for providing independence and honest counting. Further, if the counting staffs shall not have the knowledge regarding where there is error and misappropriations so that the counting can be performed in honest way.
• Count sheet not signed by staffs that were carrying out count procedure– all the sheets for counting actually involved in the inventory counting of individual items must sign the sheets. Signing will minimize the error that may take place due to lost of a sheet and inclusion of wrong sheet. Further, signing the sheets will make the person involved responsible for his work and in case of any issue the particular person can be charged with or questioned.
• The count sheets for the inventory count were not pre-numbered and were numbered at the time while using– all the sheets for the inventories including the sheets for additional inventory shall be pre-numbered. With proper numbering the auditor will be able to minimize the risk of misplacing of any sheets or addition of any other sheets. Therefore, the chances of misappropriation will be less which in turn, will assist is accurate counting (Cianci et al. 2016).
• Count teams were in the decision making place regarding which bays are to be counted– each of the team shall be allocated the precise area under the store for the purpose of counting. The allocation of bay to the counting staff must be done by the audit team well before the initiation of the counting procedure. Further, the counting staff staff shall not have any control on the selection procedure of the bay (Balsam, Jiang and Lu 2014).
• Inventory sheets mentioned the item quantity for the items that are expected to find in store– the items shall be included in the inventory sheet only at the time while counting the particular inventory and shall be properly monitored by the audit team member. Count sheets shall not mention the item quantity so that the counting will not be pre-judged with the aspect that how many units can be found. In this way the inventory counting will be carried out in fair way and chances of error will be minimized (Grimm and White 2014).

The test of control is the audit procedure for testing the effectiveness of the control used by the client organization for detecting or preventing the material misstatement. On the basis of the results of the test, the auditors may decide to rely on the control system of the auditor as the part of auditing activities. For the purpose of inventory audit, the auditor shall investigate the procedures for entering any inventory in the stock and issuing procedure and authorization properly (Krishnan, Krishnan and Song 2016). The auditor may prefer to test the controls if they want to rely on the test of control or get the information from the entity on which they want to rely while making recommendations in the letter to the management. The main objective of the auditor is to assure that no material errors are there at the level of assertion with regard to the financial statement of the client company. If the above mentioned recommendations for the deficiencies are applied by the management, the following test of controls will be carried out –

• All the count staffs were selected from the stores only– duties of counting shall be segregated properly so that on one person is involved in counting of two bays. Further, make and observe the inquiries regarding the performance of the different functions.
• Count sheet not signed by staffs that were carrying out count procedure– count sheets shall be checked to verify that is is signed. Further, it shall be examined that the count sheet is signed by the same person who was responsible for taking the inventory count (Putnam, Hatchew and Anthony 2014).
• The count sheets for the inventory count were not pre-numbered and were numbered at the time while using– make enquiries and observe regarding the usage of the pre-numbered documents and examine the evidence with regard to accounting for the purpose of the sequences.
• Count teams were in the decision making place regarding which bays are to be counted– make enquiries and observe regarding the selection of bays for the purpose of counting. Further, the reconciliations, authorizations and comparing the details of re-computing the amount of inventories must be carried out properly (Robert Knechel, Vanstraelen and Zerni 2015).
• Inventory sheets mentioned the item quantity for the items that are expected to find in store– sheets for the inventories must be properly checked to assure that the sheets do not include the quantity of the items before the counting procedure gets completed for the particular item.

Substantive tests or the substantive procedures are the activities carried out by the auditors for detecting the frauds or material misstatements at the level of assertion. It analyses financial statements and the associated documents to identify whether it include any errors or not. The substantive tests are required as the evidence for supporting the assertions that financial records of the entity are accurate, valid and complete.  The substantive procedure for accruals and trade payables will be as follows –

• Compute the days for trade payables of Sohar and compare it with the prior years, identify and investigate about any significant difference and particularly any decrease during the current year
• Discuss with the management regarding the procedure it has taken for quantifying the understatement or overstatement of any trade payables owing to error involved in cut-off procedure and considering the materiality for the errors
• Compare total amount of trade payables and the list of accruals as compared to the prior year and examine the significant variance, if any.
• Discuss with the management whether there are any journal entries for corrections that has been included for the purpose of overestimate or underestimates.
• The balance shall be confirmed with the creditors and the management shall be questioned if any variances found in the balance with the creditor’s book and the balance in the company’s book.

Computer assisted audit technique is a software that is specifically designed for the purpose of audit. Various off-the-shelf packages under CAAT are available and the auditors also have the option of tailor made system. This software is used for processing the data of the client company with regard to check that the amounts are correct. Therefore, it can carry out the substantive procedure for all the data. Various activities those can be performed with CAAT are as follows –

• Extract the sample as per the specified criteria
• Compute the ratios and identify those falling outside the requirement
• Read the files from the computers, perform the calculations, create the data files and print the reports in the specified format by auditor.

The procedures for auditing the accruals and trade payables under CAAT will be as follows –

Field number	Field Title
1	Creditor’s number
2	Creditor’s name
3	Creditor’s address
4	Credit limit
5	Outstanding balance
6	Balance < 30 days
7	Balance 30 – 60 days
8	Balance > 60 days
9	Total value if transaction in the current year
10	Date of the last transaction

Performance required –

State how auditors may utilise the software for aiding the verification of valuation and existence from the master file of the creditor.

Solutions –

• It is the crucial way in which the existence is verified by the auditor for undertaking the creditor’s confirmation process of identifying the subsequent payments to the creditors. These techniques involve the auditor’s selection for the outstanding balance of the auditor that requires testing. Therefore, the auditor will use the sampling technique for the software. In testing the valuation assertion, the auditor requires to identify the accounts where the difficulty for payment may arise. This will include the auditor for using exceptions regarding the reporting function for the audit software (Curtis and Payne 2014). Exception report may include the following –
• Accounts with the outstanding balance that is greater than the credit limit
• Accounts with the outstanding amounts > 60 days
• Accounts where the amount of transaction is < the outstanding balance

If these accounts are recognized, these can also be included in the creditor’s confirmation process or review of the subsequent receipts.

• Prepare and obtain the lead schedule for bank balance
• Trace the balance of the previous year with the working papers
• Check the arithmetical accuracy for the schedule
• Review the long outstanding items
• Account for the cheques issued during the last month of accounting year
• Review the changes in the bank balances during the accounting year and ascertain the reasons for the unusual items
• Inspect the financial reports for checking the bank and cash balances that have been disclosed, described and classified as per the IFRS and complies with the statutory requirements.
• Details of the amounts that are accrued but not credited or changed as on the closing date, for instance, commitment fees, bank charges, interest or mark up
• Full titles for all the accounts that includes the overdrafts and finances under the mark-up arrangements along with the details of account numbers and the balances including the zero balances, if any (Black, Black and Christensen 2014).
• details of the loans, leasing facilities, overdrafts, credit facilities and guarantees for that, indemnities, unused facilities, interest terms, mark ups, overdue rentals, instalments in case of overdrafts or term loans, repayment date or the review date.

• To assure that the directors are paid the salaries as they are entitled to. For this, the monthly salary of each director shall be matched with the name of the director and their entitlement. Further, if any of the directors is absent for long time, the provision for deducting the salaries must be checked. With regard to the bonus entitlement, the attached conditions must be checked properly and it shall be confirmed that only the directors entitled to get the bonus are paid the amount for bonus (Young and Moyes 2014)
• To assure that all the remuneration are properly authorised by the CEO of the company or the remuneration committee.
• To assure that the directors get the remuneration as fixed by the Articles of association or decided by the shareholders in the general meeting

Further, the documents required to be verified under the substantive procedure for director’s remuneration are as follows –

• Agreements with the managing director
• Articles of association (Arens et al.2016).
• Minutes of the board of directors and the meetings of shareholders related to the appointment and reappointment of the directors.
• Receipts obtained from managing director regarding the acknowledgement of the remuneration.

Conclusion 

From the above discussions it is concluded that the internal control over the inventory management of the company plays crucial role in tracking the inventories and preparing the annual report. It has been identified with regard to Sohar Company that there are various deficiencies with regard to the internal control with regard to the purchase or disposal of the non-current assets like the count staffs were selected from the stores only, count sheets were not signed by staffs that were carrying out count procedure and the count sheets for the inventory count were not pre-numbered.

Reference

Arens, A.A., Elder, R.J., Beasley, M.S. and Hogan, C.E., 2016. Auditing and assurance services. Pearson.

1. Curtis, M. and A. Payne, E., 2014. Modeling voluntary CAAT utilization decisions in auditing. Managerial Auditing Journal, 29(4), pp.304-326.

Balsam, S., Jiang, W. and Lu, B., 2014. Equity incentives and internal control weaknesses. Contemporary Accounting Research, 31(1), pp.178-201.

Black, D.E., Black, E.L. and Christensen, T.E., 2014. The effects of executive compensation contracts and auditor effort on pro forma reporting decisions.

Chandren, S., Nadarajan, S. and Abdullah, Z., 2015. Inventory Physical Count Process: A Best Practice Discourse. International Journal of Supply Chain Management, 4(3).

Cianci, A.M., Houston, R.W., Montague, N.R. and Vogel, R., 2016. Audit Partner Identification: Unintended Consequences on Audit Judgment. Auditing: A Journal of Practice and Theory.

Grimm, S.D. and White, S.W., 2014. A Simulation Study of the Influence of PCAOB Regulatory Guidance on the Internal Control Audit Process: An Analysis of Relationships, Risk and Information Sharing. In Research on Professional Responsibility and Ethics in Accounting (pp. 33-67). Emerald Group Publishing Limited.

Kalelkar, R. and Khan, S., 2016. CEO Financial Background and Audit Pricing. Accounting Horizons, 30(3), pp.325-339.

Knechel, W.R. and Salterio, S.E., 2016. Auditing: Assurance and risk. Taylor & Francis.

Krishnan, J., Krishnan, J. and Song, H., 2016. PCAOB international inspections and audit quality. The Accounting Review.

Putnam, D., Hatchew, G. and Anthony, C.A., PICO Eenterprises, Inc., 2014. System and method for monitoring an in-progress inventory audit. U.S. Patent Application 14/515,842.

Robert Knechel, W., Vanstraelen, A. and Zerni, M., 2015. Does the identity of engagement partners matter? An analysis of audit partner reporting decisions. Contemporary Accounting Research, 32(4), pp.1443-1478.

Young, R. and Moyes, G.D., 2014. An examination of the effectiveness of test-of-controls audit procedures for detecting fraud. International Journal of Auditing Technology, 2(1), pp.22-36.