AUDITING ASSURANCE SERVICES PAPER

Part B: Inventory Management System and Internal Control Process

AdoreU carries four ranges of stock as shown in the table below. The company uses a perpetual inventory system and adopts FIFO (first in and first out) method to estimate the inventory cost. Inventory level is managed and monitored by FlowRight, an inventory management system.

There are two central warehouses. One is located in Auckland, New Zealand and the other is in Melbourne, Australia. The warehouses dispatch clothes to all retail stores within its respective country. All stores in Ireland receive stock from the warehouse in Australia. On the balance date, the two central warehouses hold 20% of total inventory and all retail stores hold 80% of total inventory.

INVENTORY AT YEAR END

Nature of the range	Label	Age	Value $000
Infants	Cuties	0-2	8,431
Young children	Cool monkeys	2-5	18,654
School-aged children	Fun kids	5-12	10,765
Maternity wear	Comfort	Adults	4,473
Total			42,323
Closing balance of inventory			41,230
Provision for inventory write-offs			1,093

RETAIL STORES

Location	Number of stores
New Zealand	25
Australia	61
Ireland	6
Total	92

FLOWRIGHT - INVENTORY MANAGEMENT SYSTEM

FlowRight, the companys inventory management system has a central server. It records information on inventory item code, item description, cost price per item, selling price per item, and the available quantities. It also tracks the available quantities of inventory in each warehouse and store. Reorder point was not set up in FlowRight because the designs of clothes are changing for each season. Instead, the order quantities are based on an anticipated sales level.

Since some designs sell quicker than others, Adoreu has a policy of providing 30% discounts for inventories that have been on the shop floor for more than six weeks and 50% discount after ten weeks. New inventory normally arrives in the store every six weeks. The discounts are automatically applied to the inventories based on their arrival dates in the stores, by using a Sales Register System AccurateSale.

ACCURATESALE THE SALES REGISTER SYSTEM

AccurateSale links to FlowRight (the companys inventory management system); and the terminals for the sales system are located in each store. AccurateSale records cash and credit card sales, calculate discounts, sales tax and produces Daily Sales Report (DSR) for each store. The DSR records the items and quantities sold on that day, and the sales and cost prices of those items. The AccurateSale system automatically updates inventory levels in FlowRight at midnight daily, after which it also exports information on the DSR to the general accounting system (a separate software) for the recording of sales.

SUPPLIERS AND SHIPPING OF INVENTORY

AdoreU designs the clothes carried in their stores. The completed designs are assigned a prenumbered Purchase Order (PO) which records inventory item code, item description, and quantities ordered. The PO together with the completed designs are then sent to their Chinese suppliers for production. The Chinese suppliers source the different fabrics used for manufacturing clothes from their local Chinese markets. The Chinese suppliers give AdoreU an estimate of production time and costs. The payment arrangement agreed between AdoreU and the Chinese suppliers are as follows: (1) 40% of total costs as a deposit at the time when the completed design and the PO are sent to the suppliers. (2) Once the completed garments are made and shipped, AdoreU has 30 days to pay the remaining balance 60%. The suppliers provide a Bill of Lading as proof that the garments are shipped, its ownership transfers to AdoreU at the time of shipment. When the inventory is shipped (AdoreU receives a copy of the Bill of Lading via email), the accounting department records a journal entry to recognise both inventory-in-transit and account payable, but the actual inventory level in FlowRight is not updated until the inventory arrived at the warehouse. The journal entry made by the accounting department is:

DR: Inventory in transit

CR: Accounting payable

CR: Prepaid Deposit

RECEIVING INVENTORY

The shipment of the garment arrives at the central warehouses packed in cartons. The barcodes and the quantities of inventory items shipped are printed on the outside of the cartons. A Packing Slip is attached to each shipment. Each barcode printed on the carton contains information on the inventory item code and item description.

For each shipment that arrives, the warehouse assistant prints off the relevant pre-numbered PO. The warehouse assistant using a scanning device reads each barcode printed on the outside the cartons and compares it with the information on the PO. When the information agrees, the warehouse assistant ticks and signs the PO. He then logs into the FlowRight system to click on the received box on the PO filed in the system, after which the FlowRight system updates the inventory levels and also prints out a Receiving Report (RR). At this point, FlowRight also sends a copy of the Receiving Report to the accounting department regarding the arrival of the inventory. The accounting department then initiates a journal entry to reverse inventory-in-transit and to increase inventory. The warehouse assistant is authorised to alter the quantities received in FlowRight to reflect the actual received quantities when there is a discrepancy in the information between the PO and the barcodes printed on the cartons. The Receiving Report and suppliers Packing Slip are filed in the warehouse. The signed PO and a copy of the Receiving Report are handed to the inventory manager for inventory distribution.

DISTRIBUTING INVENTORY TO RETAIL STORES

The inventory manager is responsible for distributing inventory to the retail stores. The inventory distribution is usually based on the size and turnover of the retail store. When the new inventories arrive, the inventory manager uses FlowRight to allocate inventory to each retail store. FlowRight generates and prints a pre-numbered Distribution Report which displays the inventory item code, item description and quantities and the location of the store. Two copies of the Distribution Report go to the warehouse for packing and then shipping via an external carrier. The warehouse files one copy of the Distribution Report and the other copy goes with the inventory to a retail store. When the inventories arrive at the retail store, the shop manager logs into the FlowRight system. She identifies the relevant shipment by checking its reference number on the Distribution Report and then confirms receipt of the inventories by clicking the arrived in store box, after which the shop manager and/or sales assistants unpack the inventory.

AdoreU carried out an annual inventory count on the 31 December 2016 at 6 pm local time. During the inventory counts, the stores were shut. Each store manager has access to FlowRight. They can read and print out inventory reports, but they cannot edit the inventory levels in FlowRight. For the stock take the store manager prints out a list of inventories held in store, which shows the item code, description and quantities. Two staff members and the manager count the stock and write down the numbers counted next to each inventory item on the list. They take note of any differences. At the end of the inventory count, the store manager uses AccurateSale to prepare an Inventory Count Report, which notes the differences. AccurateSale adjusts the inventory level in FlowRight at midnight to reflect the results from the inventory count. A copy of the Inventory Count Report from each store is sent to the accounting department, where all reports are aggregated based on item codes. The accounting department then adjusts the inventory level accordingly in the accounting system.

Required:

1. Identify four control weaknesses in the inventory system. Explain how each weakness may affect the financial statements and identify the audit procedures to verify the relevant accounts impacted by the weakness. (12 marks)

You are required to present your answers according to this format:

Identify a control weakness

How the weakness may affect the financial statements

Audit procedures to verify the accounts.

2. Identify five control strengths in the inventory system. For each control strength, explain why each control is a strength and identify audit procedures to test the effectiveness of control. (15 marks)

You are required to present your answers according to this format:

Identify a control strength

Why it is a strength

Audit Procedures to test the control

3. Assuming the control risk is medium, explain substantive audit procedures for verifying inventory at year end. The substantive procedures should address the following assertions, and explanation should be given for the procedures. (33 marks)

You are required to present your answers according to this format: Account receivable Assertions Audit procedures Details and rationale of each procedure Existence Completeness Cut-off Accuracy Valuation You are required to present your answers according to this format: Account receivable Assertions Audit procedures Details and rationale of each procedure Existence Completeness Cut-off Accuracy Valuation