Observing the client's physical inventory is required for all audits in which inventory is a material item. Using Figure 12-15 as a guide, describe why the auditor's key responsibilities for inspecting inventory are important for auditing inventory related transactions and accounts (e.g., what management assertions do they help test?).

Figure 12-15

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Preliminary 1. Review client's inventory procedures prior to the date of the inventory. Tour facilities where inventory is stored. Determine if all inventory locations are to be counted. Be sure that the following controls are used during the conduct of the inventory count: Count teams should consist of two people to ensure accurate counts. Count teams should have clearly delimited areas of responsibility. Prenumbered, two-part tags for entering counts should be used and attached to inventory that has been counted. A separate review (by supervisor) should be performed to ensure that all inventory is counted and tagged. Movement of inventory and personnel should be limited during counts. Arrangements should be made for specific handling of shipments made or received during the count process. Conduct of Inventory Inspection 2. Observe the client's personnel in the execution of the inventory counts. By observ- ing the client perform inventory counts-a test of control-the auditor can justify performing less inspection of actual inventory-a substantive test. 3. Randomly select a sample of completed tags and verify the accuracy of the item description and quantities. (These tags should be noted for follow-up when the inventory listing is prepared.) 4. Inspect inventory on hand and note any indications that inventory is obsolete, to be scrapped or on consignment. 5. Assess reasonableness of percentage completed or stage of completion assigned to work-in-process. 6. Survey areas where counts have been completed to ensure that all inventory has been counted and tagged. Only then does the client personnel return to pull the tags. 7. After tag pulling is complete, survey areas to ensure that all tags have been pulled. 8. Note the sequence numbers of all tags used in the count process at each location. 9. Note the number of the last receiving and shipping reports used for subsequent follow-up in cutoff tests. Test of Inventory Compilation 10. Obtain a complete list of inventory quantities listed by tag number and test its accuracy. 11. Trace inventory tags observed during test counts to proper inclusion in the inventory listing. 12. Verify completeness and validity of tags listed in the compilation report against tag numbers used in actual observation. 13. Compare quantities per inventory listing to quantities per perpetual inventory records and note disposition of any inconsistencies. 14. Perform price tests on items in inventory. 15. Test the accuracy of the compilation and reconcile with the general ledger accounts.