If inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by:

• Attendance at physical inventory counting, unless impracticable
• Evaluation of management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting
• Observation of the performance of management’s count procedures
• Inspection of the inventory
• Performance of test counts.

(2 points for 2 marks)

Where physical inventory counting is conducted at a date other than the date of the financial statements, the auditor shall, in addition to the procedures required as per b) i) above, perform audit procedures to obtain audit evidence about whether changes in inventory between the count date and the date of the financial statements are properly recorded.

The audit objectives of the audit of stocks(inventories) are to ensure:

• Completeness: That all stocks belonging to the client at the balance sheet date have been reported or included in the financial statements.
• Existence: That the stocks were in existence at the balance sheet date
• Rights and Obligation: That the client has title to the stocks or the entity hold or controls the rights to the stocks
• Valuations and allocation: That stocks are included in the financial statements at appropriate amounts and any resulting valuation or allocation and adjustments are appropriately recorded.
• Presentation and disclosure: That stocks are properly classified, presented and adequately disclosed in the financial statements.

Sources of evidence on quantity and value of stocks: Evidence on quantity and value of stocks can be obtained from:

• Observation of stock taking: Careful observation of client stock taking may enable the auditor to form opinion about the quantity and value of client stocks.
• Stock summary sheets and valuation: Examination of the stock summary sheets prepared by the client and comparison with sample evidence taken during stock taking will provide evidence on the stock quantities.
• Checking of the extensions and summary of the stock valuation will provide evidence of the value of stocks.
• Client stock systems: Where the client has an adequate stock system which is maintained on perpetual inventory system, evidence can be obtained from it to substantiate stock quantities and valuation.
• Third party confirmation: Evidence about quantity and value of client stock can also be obtain from confirmation replies from third parties holding client stock.

Stocks present high audit risk because of the following reasons:

• Lack of double entry records: For most clients the stock quantities and value are not obtained from double entry book keeping but through physical stock count and valuation which can be manipulated by management that intends to engage in fraudulent financial reporting
• Materiality of stocks: For most entities stocks represent large proportion of the assets of the company. Materiality of this magnitude is bound to increase audit risk.

Four examples of external confirmations are:
– Debtor’s confirmation letter
– Solicitor letter
– Bank report letter
– Certificate on stock held by third parties.
one example of each assertion only required.
Debtor’s confirmation letter
This letter provides evidence of the existence of the debtor when a reply is returned from that debtor direct to the auditor.
The letter provides evidence on cut-off because sales or cash receipts recorded in the incorrect accounting period will have to be reconciled to the balance provided by the debtor.
The letter does not provide evidence of completeness of the debtor balance because debtors may not query balances which are understated.
The letter does not provide evidence of the valuation of the debtor balance because the debtor cannot be expected to list all outstanding balances and confirmation of the debt does not mean it will be paid.
Solicitor letter
A solicitor letter provides evidence as to the existence of claims at the period end as the solicitor will confirm specific claims.
However, the letter does not necessarily confirm the valuation of claims due to uncertainty about the future or the completeness of any legal claims as solicitors do not normally provide a list of all claims – they prefer to comment only on claims they are actually asked about.
Bank report letter
A bank confirmation letter provides good evidence on the existence of the company’s bank accounts as the bank has confirmed this information in writing.
A bank letter cannot necessarily be relied on to provide complete or accurate information. Most banks place a disclaimer on the letter of ‘errors and omission excepted’ indicating that the auditor must review this evidence against other cash and bank evidence obtained.
Certificate on stock held by third parties
A letter from the third party holding the stock will provide evidence of the existence of that stock because the third party has confirmed this in writing.
However, the letter does not provide evidence regarding the valuation of the stock; confirming something exists does not necessarily mean it is in good condition.

• The extent of the potential misstatement should be considered and therefore a large sample of inventory items should be tested to identify the possible size of the misstatement.
• The potential misstatement should be discussed with Damongo Ltd’s management in order to understand why these inventory differences are occurring.
• The misstatement should be compared to materiality to assess if the error is material individually.
• If not, then it should be added to other errors noted during the audit to assess if in aggregate the uncorrected errors are now material.
• If material, the auditors should ask the directors to adjust the inventory balances to correct the misstatements identified in the 2017 year end.
• Request a written representation from the directors about the uncorrected misstatements including the inventory errors.
• Consider the implication for the audit report if the inventory errors are material and the directors refuses to make adjustments.
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Factors to consider before placing reliance on the work of internal auditors
The external auditors would normally be able to use the work of the internal auditors of Adepaye Ltd provided that:

• They are independent (in this case, of the accounting department and finance director to whom the accounting department reports). It appears that they have reported to the whole board, which would be a factor increasing their independence. It would be even better if they had strong links with the audit committee (if applicable).
• They are competent. Your firm would have formed a view in past years of their reliability by considering the background (including qualifications and experience, particularly as regards forecasting) of the internal audit staff and by examining their reports and working papers. You may also have reviewed some aspects of their work in the current year to the same end.
• Effective communication, whether there is likely to be effective communication between the internal auditors and the external auditor.
• Whether there are established policies for hiring, training and assigning internal auditors to internal audit engagements.
• The internal audit function does not have managerial or operational duties that are outside of the internal audit function.
• They have exercised due professional care, the work would need to have been properly planned including detailed work programmes, supervised, documented and reviewed. The company is experiencing difficulties due to the economic down turn and it requires the loan in order to expand. Management might place pressure upon the internal auditors to present the cash flow forecast in a more favourable light.
  This would impact the independence of the internal auditors.
  You would still take full responsibility for any report that you issue.

• Verify valuation to valuation certificate.
• Consider reasonableness of valuation by reviewing
• Experience of the valuer
• The scope of work
• Methods and assumptions used
• The objectivity of the valuer
• Check that valuation surplus has been correctly calculated
• Consider whether permanent diminution in value of assets has occurred
• Consider the adequacy of depreciation
• Ensure that the valuation surplus has been correctly treated
• Verify tittle to land and building by inspection of
• Title deeds
• Land registration certificate
• Inspect directors minute book to ensure that all tittle deeds, conveyances, tenancy agreement and lease are properly authorized
• Check sample of entries in the fixed assets register and the trace back to source documentation to ensure they are properly stated
• Review company policies for depreciation and ensure appropriate in the light of the life of the building and ensure that land is not depreciated
• Ensure the assets are properly disclosed in the financial statement
• If freehold or leasehold assets are let to third parties , inspect tenancy agreement and performed analytical procedures on rental income
• Physically inspect a sample of assets
• Ensure that the fixed assets register reconcile with nominal ledger

• The audit team should attend at least one of the continuous (perpetual) inventory counts to review whether the controls over the inventory count are adequate.
• The audit team should confirm that all of the inventory lines have been counted or are due to be counted at least once a year by reviewing the schedules of counts undertaken/due to be undertaken.
• Review the adjustments made to the inventory records on a monthly basis to gain an understanding of the level of differences arising on a month by month basis.
• If significant differences consistently arise, this could indicate that the inventory records are not adequately maintained.
• Discuss with management how they will ensure that year-end inventory will not be under or overstated.
• Consider attending the inventory count at the year end to undertake test counts of inventory from records to floor and from floor to records in order to confirm the existence and completeness of inventory.
                                                                                                                                                                                 ( Any 5 points)

• Obtain a schedule of the directors’ remuneration including the bonus paid and cast the addition of the schedule.
• Agree the individual bonus payments to the payroll records.
• Confirm the amount of each bonus paid by agreeing to the cash book and bank statements.
• Review the board minutes to confirm whether any additional bonus payments relating to this year have been agreed.
• Obtain a written representation from management confirming the completeness of directors’ remuneration including the bonus.
• Review any disclosures made of the bonus and assess whether these are in compliance with local legislation.
                                                                                                                                                                                  (Any 5 points)

• Existence
  Assets, liabilities and equity interests exist.
  Substantive procedures
  During the inventory count select a sample of assets recorded in the inventory records and agree to the warehouse to confirm the assets exist.
  Obtain a sample of pre year-end goods dispatch notes and agree that these finished goods are excluded from the inventory records.
• Rights and obligations
  The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
  Substantive procedures
  Confirm during the inventory count that any goods belonging to third parties are excluded from the inventory records and count.
  For year-end raw materials and finished goods confirm title belongs to the company by agreeing goods to a recent purchase invoice in the company name.
• Completeness
  All assets, liabilities and equity interests that should have been recorded have been recorded.
  Substantive procedures
  Obtain a copy of the inventory listing and agree the total to the general ledger and the financial statements.
  During the inventory count select a sample of goods physically present in the warehouse and confirm recorded in the inventory records.
• Valuation and allocation
  Assets, liabilities and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.
  Substantive procedures
  Select a sample of goods in inventory at the year end, agree the cost per the records to a recent purchase invoice and ensure that the cost is correctly stated.
  Select a sample of year-end goods and review post year-end sales invoices to ascertain if net realisable value is above cost or if an adjustment is required.

Substantive procedures
Depreciation

• Review the reasonableness of the depreciation rates applied to the new capital expenditure and compare to industry averages.
• Review the capital expenditure plans of any plans by management to refurnish the restaurant facilities in less than 50 years which means the useful life is less than 50 years.
• Select a sample of building facilities and recalculate the depreciation charge to ensure that the non-current asset register is correct.
• Perform a proof in total calculation for the depreciation charged on the restaurant building facilities, discuss with management if significant fluctuations arise.
• Review the disclosure of the depreciation charges and policies in the draft financial statements.
  Food poisoning
• Review the correspondence from the customers claiming food poisoning to assess whether BDE Co has a present obligation as a result of a past event.
• Send an enquiry letter to the lawyers of BDE Co to obtain their view as to the probability of the claim being successful.
• Review board minutes to understand whether the directors believe that the claim will be successful or not.
• Review the post year-end period to assess whether any payments have been made to any of the claimants.
• Discuss with management as to whether they propose to include a contingent liability disclosure or not, consider the reasonableness of this.
• Obtain a written management representation confirming management’s view that the lawsuit is unlikely to be successful and hence no provision is required.
• Review the adequacy of any disclosures made in the financial statements for any material contingent liabilities.
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• Name of client – identifies the client being audited.
• Year-end date – identifies the year end to which the audit working papers relate.
• Subject – identifies the area of the financial statements that is being audited, the topic area of the working paper, such as receivables circularisation.
• Working paper reference – provides a clear reference to identify the number of the working paper, for example, K5 being the 5th working paper in the audit of cash and cash equivalents (from PCAS).
• Preparer – identifies the name of the audit team member who prepared the working paper, so any queries can be directed to the relevant person.
• Date prepared – the date that the audit work was performed by the team member; this helps to identify what was known at the time and what issues may have occurred subsequently.
• Reviewer – the name of the audit team member who reviewed the working paper; this provides evidence that the audit work was reviewed by an appropriate member of the team.
• Date of review – the date the audit work was reviewed by the senior member of the team; this should be prior to the date that the audit report was signed                                                                                                                                    (Any 3 points).