Manufacturing product involve the physical flow of goods and the cost that related with those goods at different stage production of product such as buying raw material of inventory and make payment to the creditor who have supplies the inventory. In manufacturing activities, there were production cycles activity during which inventories are being turned by the company into finished goods.
The auditor have to obtain knowledge about control procedure and the auditor must be familiar with the cycle activities and specific document and record that related to manufacturing operations. Besides, the auditor also must obtain knowledge of the internal control structure by performing a walk through test which is the one of several material transfer to trace from raw material s to work in process to finished goods perpetual record. Then, the nature of walk-through tests such are they not provide sufficient appropriate audit evidence to support a control risk assessment.
For the internal control objective and control procedure, the function of this control is to control the inventory. It is because, control is very important and can strength by the effectiveness system of detailed record-keeping and by a well-designed cost accounting system. In inventory record-keeping, there are two method we can use. Firstly, periodic inventory method which mean this method can count quantities on hand and can be determined by a physical count. Second method, perpetual inventory method is used to records maintained documenting all items on hand, raw material issued to production and finished goods sold. Compare this two methods, usually manager used the second method which is perpetual inventory methods because it is more reliable buts it also depend on the existence internal control structure (Standars of Internal Control, April 2007). In production system, the auditors must know with the physical flows of material and labour in the manufacturing process and the way to categorize the cost that accumulated and standards are set, in order to understand how a particular cost system operates.
However, an auditor have to makes a preliminary assessment of control risk for the financial report that related to the production transaction. This action will take after obtaining an understandings of the internal control structure to plan the inventory audit like performing a walk-through test. The auditor must evaluates the effectiveness of an entity’s internal control structure in prevent or detect and correcting material misstatement pertaining to that assertion. The preliminary assessment of control risk will be high if the auditor cannot identify if any internal controls relevant to specific financial report assertion, which likely to preventing or detecting and correcting material misstatement. In this case, the auditor should obtaining audit evidence from manufacturing transaction, inventory balance and analytical procedures (Statement of Auditing Standards, January 1997).
The main purpose of test control is to evaluate the effectiveness design and operation of internal control structure policies and procedure which will help an auditor to made up of substantive tests of manufacturing transaction, substantive test of inventory account balance including analytical review procedure. Examples of internal control procedures and test of control for inventory and production cycle are as follows (Inventory and Production Cycle, July 26, 2013):
Assertions Internal Control Procedures Test of control
1. Existence • Use appropriate segregation of duties and physical control of inventory to prevent fake inventory.
• Use renumbered and/or properly approved receiving reports and materials requisitions for inventory transfers • Observe and evaluate appropriate segregation of duties and test procedures for transfer and issuing inventory.
• Review authorized production schedules and the test procedures for establishing inventory levels and inventory internal control.
2. Rights and obligations • Recorded inventory is approved by suppliers invoices and goods received notes. • Check the recorded inventory against suppliers invoices and goods received notes.
3. Completeness • Purchase requisition, purchase order, receiving report and vouchers are renumbered and accounted
• Procedures to include goods out on consignment and exclude goods led on consignment. • Check sequential controls over purchase of requisition, purchase order, receiving report and vouchers from suppliers
• Test the control procedures for the consignment goods or inventory
4. Cut-off • All receiving reports and delivery notes from another parties should be processed daily. • Check dates of receiving reports and delivery notes the dates to record the inventory movements in perpetual inventory records.
5. Accuracy • Review of cost accumulation, standard costs, or expenses and variance reports by person of appropriate level. • Examine and test procedures for taking physical inventory, accumulating costs, or expenses and developing standard cost.
6. Valuation and allocation • Inventory management personnel review inventory for obsolete, slow-moving, or excess quantities.
• Periodic or annual comparison of goods on hand with perpetual inventory record. • Discuss with management and test procedures for identifying obsolete and slow-moving items.
7. Classification • Material requisitions and production data used to classify inventory into raw materials, WIP, and finished goods. • Check that the classification of inventory is in compliance with accounting standard and company accounting policies.
8. Presentation and disclosure • Inventory is properly classified, disclosed and presented at fair value. • Review inventory items are properly classified, disclosed and presented at fair value in the financial statements.
Besides, for the substantive tests of inventory account balance, there were few reason that particular important which are inventory usually forms a major in balance sheet and it is will reflect a significant part of a firm’s working capital. Current asset normally converted into cash or other assets through the operating cycle of a firms and it will effects a firm’s liquidity. Next, inventory also is a component in the computation of COGS and directly effects the subsequent determination of profit. Then, there were variety of available methods for valuing inventory used by a client because it is based on different types of inventory.
The assertion that should an auditor audit of inventory account balanced are from these perception. Existence of inventory should show in the financial report, right and obligation that all the inventory items pertain to the entity, completeness all the inventory items that have been recorded, valuation and allocation of the inventory that valued at the lower cost and net realisable value and lastly presentation and disclosure whether the inventory categorize properly disclosed in accordance with Malaysia accounting disclosure requirement. The faster the company is able to run the production turn inventories into finished goods, the more efficient its production process is (Finstanon.com , n.d.)
Figure1: Overview of production cycle
Finstanon.com . (n.d.). Retrieved from Finstanon.com : https://www.finstanon.com/ratios-dictionary/119-production-cycle
(July 26, 2013). Inventory and Production Cycle.
(April 2007). Standars of Internal Control.
(January 1997). Statement of Auditing Standards.