Question

You are the auditor from a CPA firm who each year audits a company called ABC Grocers, Inc. ABC Grocers, understandably, has a large amount of their assets tied up in Inventory. Some of their inventory is small such as candy at the check out counters, but some of it is rather large in size and dollar amount such as large amounts of meat that is waiting to be butchered. The inventory is susceptible to spoilage and theft.

During the second quarter of this fiscal year, ABC Grocers uncovered a scheme of employees' stealing produce and meats from the store and selling them at discount to friends and family. Based on their investigation these thefts had been going on for approximately two months before it was discovered.

Based on this information, evaluate which financial statement accounts are at risk of being misstated. Also, explain what you would do as the auditor to ensure that the Inventory account is valued properly and that all losses from the theft have been accounted for

Answer 1

1

Merchandising company can prepare accurate statements of income, retained earnings, and balance sheets only if its inventory is valued correctly. The cost of inventory sold is recorded as cost of goods sold on the income statement and thus affects the company’s net income and also it affects the balance of retained earnings.

In the balance sheet, reported ending inventory and retained earnings are affected by incorrect inventory amounts

· A merchandising company should sure that it has valued its ending inventory properly. Any change in the calculation of ending inventory is reflected in net income, current assets, total assets, and retained earnings.

· Also the company carries forward that misstatement into the next period. Because the ending inventory amount of the current period is the beginning inventory amount for the next period.

· An error in one period’s ending inventory automatically causes an error in next period’s net income in the opposite direction.

2

An effective internal control for inventory includes a company’s plan of organization and all the procedures and actions. These include protect its assets against theft and waste, Compliance assurance with policies and Federal law, personnel performance evaluation and ensure reliable and correct operating data and accounting reports.

Protect of Assets

Company should protect their assets by segregating duties of employees. Means that employee safeguarding the asset must not be the same one for maintaing accounting records for that asset.

Assigning specific duties to each employee, if any problem occurs the company can quickly identify the responsible employee.

Rotating employee job assignments, by this employees realize that if they steal from the company, the other employees assigned to their positions may discover the theft later.

Companies use several mechanical devices such as bar codes scanners to protect their assets.

Reliable and accurate Inventory Records

Companies should maintain accurate and complete accounting records. Company should hire and train competent and honest individuals. Periodically, supervisors evaluate an employee’s performance.

Accounting transactions should be supported by one or more business documents. For proper control, source documents should be serially numbered. Validity of these documents should check from time to time.

Companies should carry adequate casualty insurance on assets.

Inventory management systems

An inventory management system is a series of procedures that tracks assets progression through inventory.

The benefit of inventory management system is that it allows management to be able to know how much inventory it has at any given time.

Physical count of Inventory

Physical inventory counts are a way of ensuring that a company’s inventory management system is accurate and also assures goods are not being lost or stolen.

Inventory cycle Counts

This is to ensure that the information in its inventory management system is correct.