Richland Equipment: Inventory Fraudulent Reporting

Richland Equipment Parts is a wholesale provider of equipment parts for manufactures of conveyer belts and robot machines. It operates in the Northwest states and has large warehouses in three cities (Portland, Denver, and Salt Lake City) with large populations.

Richland's controller, Jake Willson, discussed the company's financial results with the audit manager of your CPA firm and informed him that he is surprised that income before taxes is down significantly from last year even though sales have increased and expenses seem to be in line with expectations. He did mention that the president decided to reduce selling prices because of a new competitor, but Willson felt the increase in sales offset the reduced prices. He is hoping your CPA firm will find any understatements of assets during the audit, especially any related to inventory. Richland intends to expand its operations in the next several months and will need a sizable loan to do so, and management is concerned about the effect of the declining profits on the ability to receive a loan at a favorable interest rate.

The audit manager did some analytical procedures and determined that inventory is lower than in previous years in each location. He therefore assigned an experienced staff person, Rhonda Malroney, to do tests of the inventory.

Inventory is counted at each location as near to year-end as possible. The counts are summarized in an Excel spreadsheet for each location that includes the location, part number, part description, unit of measure, and number of units counted. The counts are compared to the perpetual records in each location. A copy of the inventory counts is sent to the home office in Seattle, where a complete list of the inventory counts is prepared and retained by the controller.

An assistant to the controller enters the unit costs from the perpetual records on a copy of the worksheet and completes the inventory valuation worksheet by extending the price times the quantity and adding the totals for each location and in total using Excel. Willson then compares the unit costs with the perpetual records and rechecks the mathematical accuracy of the calculations to verify they are correct. Willson adjusts the general ledger balances to the priced physical inventory balances from the Excel worksheet.

Malroney has completed the audit of inventory for Richland and Willson has reviewed her inventory work. There were no significant exceptions. She performed the following tests with the results as stated:

1. Made sure that there was an experienced staff person on hand for observation of the physical count of the inventory on the date of the count. Each staff person indicated that the physical count was carefully and accurately taken and recounted using recommended procedures. Tag numbers and counts were included in the work papers for subsequent follow-up.

2. Extensive cutoff tests were performed during the physical count and records were prepared for subsequent follow-up to test for sales and purchases cutoff.

3. Performed cutoff tests of sales and purchases using the information provided in the physical count work papers.

4. Traced all test counts in the work papers to the inventory valuation worksheet and determined that they were the same. She also selected a stratified sample of inventory and recalculated the unit cost times the quantity and refooted two pages of the worksheet and compared the total to the general ledger. She also compared the unit cost for each sample item to the unit cost on the perpetual records and the inventory valuation worksheet.

5. Tested unit costs for a sample of items on the perpetual records and compared them to vendors' invoices. She concluded that the costs were accurate.

6. Performed tests for the lower of cost or market and concluded that there was no need for any adjustment.

7. Did extensive analytical procedures and determined that inventory was less than the previous year but concluded that there was no basis for concluding that inventory was misstated.

You are also assigned to the audit, but primarily have responsibility for auditing property and long-term liabilities, not the audit of inventory. During lunch, you are chatting with Rhonda, and she tells you what she did in the audit of inventory and her findings. You said that what she did seemed reasonable. You offered to use data analytics to validate her work. She agreed to have you do that if it didn't take too much time and you would share what you learned.

She provides you with the following three Excel files that she used in her tests of inventory:

[bl] Richland Inventory Valuation

[bl] Richland-Inventory Count

[bl] Richland Perpetual Inventory

The general ledger totals for each of the three inventory locations:

Portland 269,001.77

Denver 2,191,947.23

Salt Lake City 4,211,834.94

Before you attempt to complete the case requirements, review the information on the following page providing an overview of audit tests of the client's inventory compilation, as well as other helpful hints.

You can perform your tests using Excel, primarily using VLOOKUP, filters, and PivotTables, as well as basic functions. You can also perform the tests using ACL or IDEA audit software.

Overview of Tests of an Inventory Compilation

A priced inventory compilation accumulates all the quantities for each inventory tag for each part number, and prices them using the appropriate unit cost.

The primary file for testing is the inventory valuation file (Richland Inventory Valuation).The first line of this file is reproduced below:

Location	Part No	Part Name	UOM	Unit_Cost	Phy Count	Total Cost	Tag No
Denver	19EL7900	WIRE #16 2/64 INS 19 STRAND MA	FT	1.35	3800	5130.00	6046

The total cost for each item is the amount counted x the unit cost. The sum of the total costs equals inventory in the general ledger. (The priced and compiled inventory will always differ from the amount initially recorded in the client's records. The client records a book-to-physical adjustment to adjust the inventory to the amount that was actually counted.)

The quantities counted come from the inventory count file (Richland-Inventory Count). The perpetual inventory file is actually a master file with the standard cost and unit of measure (UOM) for each product.

You can perform many tests by relating or relating the files. For example, if you want to determine if the quantities in the valuation file equal the quantities in the count file, you need to use a VLOOKUP to obtain the quantity from the count file. The VLOOKUP uses the common information in each file, which is the tag number. Remember that this tests in only one direction. For example, you need one VLOOKUP to test for tags in the priced inventory that are not included in inventory count file (overstatement of inventory potentially due to fictitious tags), and a test for tags that are included in the count file but not in the priced inventory (understatement of inventory due to omitted tags).

Hints:

The amount of misstatement is the difference between the actual and correct amounts. For example, assume 10 springs were counted, but 20 were included in the valuation file at a price of $5 each. The misstatement is (20-10) x $5 = $50.

Be careful not to include a misstatement twice. For example, a fictitious tag will show up in a test for tags not included in the count file, as well as in a test for differences in quantities between the two files.

Case Requirements

1. Summarize your testing and findings, including any misstatements of inventory. Include sufficient information or a printout to describe the misstated item(s), and the amount of the misstatement. If you find any misstatements, indicate the significance of the combined misstatements assuming performance materiality of $200,000. An Excel spreadsheet is provided to help with this analysis.

1. Indicate whether you believe the misstatements are due to error or fraud.

1. Evaluate the effectiveness of the tests performed by Malroney.