Steadfast Wholesaling Company purchases a line of approximately 42,000 different items and wholesales to a variety of industries. The company utilizes an elaborate EDP perpetual inventory system as a basis for its operations (promising deliveries, etc.) as well as financial reporting.

You have been newly assigned as supervisor on the account, and during your initial meeting with management, you discover that the company has been troubled by a “large number” oPunexpected stockouts. Your review of prior years’ inventory tests of compliance reveals that several errors were detected in recording issues and receipts to stock.

Curious about how this problem was resolved, you turn to the year-end inventory workpapers and discover that no physical inventory was taken; rather, the audit team counted the 200 most expensive parts as determined from a client listing. Large numbers of errors were noted from this exercise, in both over- and understatement directions. However, because the net overstatement of inventory was only \($4,219\) compared to the total inventory of \($17\) million, the difference was passed and no further work was done.

You are troubled by the degree and nature of that testing and discuss the matter with Peter Pleistocene, the audit partner. Pleistocene has been on the engagement for 17 years and will not concede that there is a possible problem.

You propose to Pleistocene that a complete physical inventory be taken this year. Pleistocene laughs and explains that this is the way the inventory has been evaluated for the past 17 years and that the client would not stand for a full physical. However, he gives you permission to talk to the controller. Unfortunately, the meeting goes exactly as Pleistocene indicated.

Ultimately, you decide that by using a statistical test, you will be able to satisfy your own objectives of quantifying the possible error in the perpetuals while avoiding the full physical inventory to which the client objects. Accordingly, you return to Pleistocene with your ideas.

Pleistocene surprises you by getting very defensive; he indicates that he knows very well how to audit Steadfast’s inventory and that his method has worked for years.

Required :

a. What sort of problems can you see with Pleistocene’s approach ?

b. What arguments can you muster in support of your position to convince the controller and Pleistocene?