Reconcile the inventory - general ledger balance, Auditing

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The Tonka Manufacturing Company conducts its annual physical inventory at the end of the calendar year as a result of the auditor's assessment of non-operating internal controls in the Expenditure Purchasing process.  The Company traditionally takes the count on New Year's Eve, and then hosts a large party for employees and friends. The Company has a main warehouse and 6 outside warehouse locations.  The inventory value at each warehouse location as of November 30, 2011 is as follows:

Location                                  Amount    

Minnetonka                            $2,000,000

Bemidji                                      350, 000 

Cook/Tower                                375,000

Brainerd                                      400,000

Winona                                         375,000

Alexandria                                   500,000

Marshall                                       650,000  

Total         $4,650,000

Each manager at an outside warehouse counts the merchandise within his or her own warehouse. The outside warehouse managers are rewarded on their ability to maintain accurate inventory records.  Therefore, it is in their best interest to take an accurate count. The warehouse manager at Tonka's Minnetonka location utilizes count teams to determine the inventory.  Since Tonka maintains perpetual inventory balances, the final physical count for every item can be reconciled to the company inventory records as of year end.  All significant variations between the quantity physically on hand and the perpetual records are re-checked at a later date.

You are the audit senior on the Tonka Manufacturing financial statement audit. The partner and manager have decided that you need to observe the physical count at the Minnetonka location, and two staff assistants will observe the physical counts at the two outside warehouse locations (Bemidji and Cook/Tower).  This decision is based on a careful review of the physical inventory instruction memo distributed to all employees involved with the annual count.  Key sections from the client's memo are included below.

Tonka utilizes a tag system for counting inventory.  Prior to the actual count, the inventory is separated into groups of like items.  Employees then complete and attach a pre-numbered tag to each group.  This tag includes a description of the merchandise and the quantity on hand.  Later, after the entire inventory has been counted and tagged, the lower portion of each tag is detached and returned to the controller's office for data entry.  This list in tag number order provides Tonka with a record of all merchandise presently on hand.  Subsequently, the controller's office enters a unit cost for each of these items.  The total cost is then computed by multiplying the cost by the December 31 quantities on hand in ending inventory.  Tonka still has to review the cutoff information and attempts to remove any errors caused by any January transactions.  The final step is for Tonka's cost accountants to reconcile the physical inventory total to the general ledger balance and resolve any differences.  The final adjusted total will be reported as the value of Tonka's inventory.

You are assigned to observe the physical inventory at the Tonka's central warehouse and perform the appropriate audit procedures during and after the physical count.

AUDIT PROGRAM

Note:  Assertions to be addressed by these tests include Existence, Cutoff, and Completeness. 

1. Use judgmental haphazard sampling techniques to select 10 inventory items.  Record the tag number, description, unit of measure and quantity. Verify that your count agrees with the actual quantity on the tag.  Resolve any tag discrepancies noted during the physical count.

2. Obtain a copy of the client's tag control summary upon completion of the physical inventory.  Also note the last tag number used by client personnel.

3. After the inventory, compare the used tags indicated on the tag control to the client's inventory computer report in tag number order.  Verify unused and void tags are omitted from the listing.  Note any differences and follow up as necessary. 

4. Compare the last tag used during the physical count and compare that to the client's inventory computer report in tag number order.  Note whether any tags have been added after the count.

5. Obtain a copy of the last 5 receiving reports prior to the physical count and the first 5 receiving reports after the count.  Note that the receipts prior to year end are properly recorded in the physical count (e.g., physical count must be greater than or equal to the amount received) and receipts in January are excluded from the physical count.  Any differences should be reflected in the client's book-to-physical reconciliation.

6. Obtain copies of the last 5 bills of lading prior to the physical count and the first 5 bills of lading after the count.  Note that the shipments prior to year end are properly removed from the physical count and shipments in January are included in the physical count.  Any differences should be reflected in the client's book-to-physical reconciliation.

7. Obtain a copy of the client's inventory computer report in tag number order.  Compare the prices used to value the items to the prices shown in the inventory master file price list.

8. Obtain a copy of the client's book to physical reconciliation.  What modifications would you make to the client's analysis?  After you complete your analysis of the reconciliation, write the adjusting entry you would propose the client record in order to properly state its inventory on hand at year end.

Requirements

Refer to the Excel file and complete the audit program noted above.  The end product of your work should be a complete set of workpapers using tickmarks and notes similar to the workpapers we reviewed in class.  In addition to the preparing the audit workpapers, you should also answer the two questions below.

Discussion questions

1. Your partner and manager decided to observe only the central warehouse and two other locations.  Given the materiality of the inventory balance, was this observation scope adequate to opine on the inventory balance?  State your answer and then defend your position.

2. After analyzing the client's book-to-physical reconciliation, what are the internal control implications from the adjustments made to reconcile the inventory general ledger balance with the value of the actual quantities?


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