Weakness in Inventory Internal Control, Audit Risk and Procedures

This article discusses the weakness in inventory internal control, audit risk, and procedures in the context of API. It explores the potential risks and the necessary audit procedures to address them.

Running head: AUDITING
Auditing
Name of the Student:
Name of the University:
Author’s Note

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AUDITING
Memo
To: Mr Wayne of Always Precise Ltd
From: Auditing Manager
Date: 12th May, 2019
Subject: Discussion Regarding Audit risks of API
Purpose and Scope
The process of audit for Always Precise Instruments Pty Limited (API) is being conducted for
the purpose of analysing the financial statement and ensuring that the annual report of the
business is providing a clear view of the financial position of the business. The memo is
provided with explanation relating to the audit risks which is applicable on the ratios computed.
In addition to investigation into the workings of internal control system would also be done to
understand whether the same is working appropriately or not. The discussion regarding the ratios
is presented in the table below:
Ratios Analysis Audit Risks Audit Procedure
Current Ratio This estimate is a
sign for evaluating
the liquidity status of
the business and as
per analysis of the
current ratio of API
ltd for the year 2018,
there is a significant
increase in current
ratio is seen. This
may be because of an
increase in current
assets of the business
or a decrease in
The main risk which
arises from this
particular ratio
discrepancies is
related to
misrepresentation of
the current assets and
liabilities of the
business which would
ultimately affect
accuracy of reporting
of the business
Test of details is the
procedure which the
auditor should
considered while
going through all the
transactions of the
business which are of
immediate nature and
also checking the
values of short term
assets for assessing
whether there is any
risks present in the
same or mot

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current liabilities
might also have the
same effect
Quick Ratio The quick ratio of the
company is quite
similar to current
assets but deals with
more liquid assets
and liabilities. There
has been an increase
in these estimates as
well which might
suggest an increase in
quick assets or
decrease in quick
liabilities
The risk which is
connected with such
assets is risk of
material misstatement
which can affect the
flow of cash and
affect the cash
position of the
business disabling
them from meeting
current obligations.
The auditor must
proceed with test of
details and test of
control while
assessing the
balances of the assets
and liabilities of short
term nature and also
looking out flaws in
internal control
system which can
affect the reporting
framework of the
company.
Return on Equity The return on equity
estimate is shown to
have fallen in
comparison to
previous year but the
same is still lower
than industry average
of the business. This
estimate is considered
as important as
potential investors of
a business relies on
the estimate for
taking major
The main risk which
can be identified with
this estimate is that
the figures of profits
or equity capital
might be
misrepresented which
has a negative impact
on reporting of the
business.
The most accurate
audit procedure
which can be applied
in such a case is Test
of Details which
would help the
auditor to collect
appropriate audit
evidences to confirm
or deny whether the
financial statements
are free from material
misstatement or not
(Byrnes et al., 2018).

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AUDITING
decisions regarding
investments
The auditor needs to
check equity and
profit balances for
making appropriate
estimate regarding
the accuracy of the
financial statement.
Return on Assets The return on assets
estimate is an
important estimate as
the same is
considered by
investors and
therefore the same is
considered to be
important for a
business. The
estimate is shown to
have fallen in
comparison to
previous year
estimate which mat
be due to fall in
profitability or
overvaluation of
assets of the
company.
The risk relating to
audit deals with
material misstatement
in the balances of
income statement or
overvaluation of
assets (Vasarhelyi,
2018). Such kind of
risks would seriously
affect the financial
position of the
business and also the
profit of the business.
Test of details as a
audit procedure needs
to be applied as the
same would assess
every transaction
related to income or
expense items of the
business. The auditor
of the business also
needs to apply
verification practices
for appropriating
assessing the values
of the assets which is
shown in annual
reports (Christensen,
Glover & Wolfe,
2014). The auditor of
the business has an
important role in
assessing whether the
financial statements
are misstated or not.
Gross Profit Margin The gross profit The main risks which The main tests which

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AUDITING
margin represents the
profits which is
generated by the
business from
operations. The
estimate is shown to
have fallen which
may be due to fall in
the sales of the
business or increase
in the costs of the
business.
arises from such a
situation is
misstatement in
income statement
items which may be
related to revenue
generated or expenses
incurred during
process of
production.
can be applied by the
auditor in such a case
is test of details and
test of control (De
Simone, Ege &
Stomberg, 2014).
Substantive audit
procedures can be
applied for
conducting the audit
and at the same time
review the internal
control system and
different ledgers
which includes sales
and cost transactions
information.
Marketing Expenses Market expenses
estimate is depicted
to be higher than the
budget and the same
is also shown to be
greater than industry
average. Any
increase in the
marketing expenses
of the business would
have an negative
consequence on
profits.
Any misstatement in
the marketing
expenses of the
company would give
rise to material
misstatement. It is
suspected that the
marketing expenses
might be slightly
overvalued. This is
considered to be of
material nature as
profit is directly
affected
Test of detail is the
right approach in this
case for assessing
whether the expenses
are appropriate
represented in the
financial statement of
the company. The
auditor needs to
apply vouching
practices so as to
cover the wide range
of transaction which
is covered in the

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AUDITING
financial statement of
the business.
Admin expenses/
sales
As per the estimates
which is shown for
2018, this ratio
experiences a
decrease and the
same is lower than
the benchmark figure
as well. Such
expenses also have
direct impact on the
profits which is
generated by the
business.
Audit risk in such
case is misstatement
in the administrative
expenses which can
result in potential
audit risks. The
situation suggests that
there might be
understatement of the
expenses of the
business.
In such a case, the
test of details is the
accurate approach for
assessing all the
expenses which is
incurred by the
business. The auditor
can also check all the
transactions relating
to expenses of the
business (Elder et al.,
2013). This would
help the auditor to
identify any possible
overstated expenses
of the business.
Times interest earned The ratio reveals a
decline in the
estimate from
previous year and the
same is also shown to
be lower than
industry average.
This implies that the
company is incurring
lower amount of
expenses in
comparison to
previous year figures.
The main risk which
arises from such a
situation is associated
with discrepancies in
the interest expenses
of API and it is very
much possible that
the management in an
attempt to improve
the income statement
presentation has
understated the
interest expenses of
Test of detail and test
of control procedures
are appropriate for
checking the
transactions of the
business related to
interest expenses.
This would result in
identification of
material misstatement
in the financial
records.

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the business.
Days in inventory There is a decrease in
the inventory days
which is a favourable
sign as the
management is trying
to clear the stocks of
the business.
The major
misstatement in such
a case is related to
appropriate valuation
of the inventory costs
of the business. Any
overstatement in
inventory value at the
closing of a year can
lower the profits of
the business.
In such a case, test of
control is the main
audit procedure
which the auditor of
the company should
apply for checking
the policies of
business and
evaluating whether
the same is
competent enough for
appropriate valuation
of the stocks of the
business. This would
help the auditor to
identify material
misstatement in the
accounting records.
Days in accounts
receivable
There is an increase
in the estimate of
account receivable of
API in the current
years which shows
that there has been a
change in the debtor
management policy
of the business.
The misstatement in
the values of debtor
can affect the
financial records of
the business
adversely. There can
be overstatement of
the balances of
accounts receivable
in API in the recent
year due to internal
control weakness or
Test of details and
test of control are the
main procedures
which needs to be
followed by the
auditor. The internal
control of the
business needs to be
assessed so that the
auditor is able to
assess the debtors
valuation process and

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AUDITING
other factors. also ensure that the
value of the debtor is
appropriately
represented or not.
The auditor of the
business also needs to
assess the debtor
management policies
which is followed by
business.
Debt to equity ratio: The estimate shows a
decrease in the ratio
for API in
comparison to
previous year. The
main reason for the
same might be
increase in debts of
the business.
Misstatement in the
value of debts can be
potentially risky for
the business. An
overstatement in the
balances of debt has
resulted in decrease
of the ratio
Test of detail is the
main audit procedure
which the auditor
needs to assess and
the auditor of the
business can also
apply verification
practices in order to
ensure that there is no
material misstatement
in the financial
records.
Weakness in Inventory Internal Control, Audit Risk and Procedures
INTERNAL
CONTROL WEAKNESS
AUDIT RISK AUDIT PROCEDURES
When the company’s raw
material falls below 70% then
the computer will
automatically generate
According to the audit
risk this weakness has an
extensive effect on the
purchase order. It will create
This is an extensive risk
for the audit so it is necessary
for the auditor to test the
internal control. The

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AUDITING
purchase order for the raw
material. This can be termed
as a weakness if by chance
the company’s computer
system have an error or the
system is having any
malfunction then it can lead
to generate dispute purchase
order.
loss for API no matter it is
below the requirement or
above the requirement.
responsibility of the auditor
includes the regular testing of
the computer system and
ensures that this kind of
problem should not arise in
the future (Ruhnke &
Schmidt, 2014). The auditor
should also check that the
computer system should be
updated on regular basis.
As the above case
suggests, one of the weakness
which can be distinguishes is
that the whole process of
producing purchase order is
solely dependent on the
computer system of API. If
the computer persists any
kind of problem then the
whole process will fall down
and hence no production
order can be generated.
The audit risk associated
with it creates a major
problem in terms of the
production process of the
company and hence the
whole process will come
under the risk (Vîlsănoiu &
Buzenche, 2014). Due to this
risk, the company may have
serious problem in
accordance of order of the
raw material because there
might be a situation the
computer may have over
order and under order the raw
material. The date of ordering
the raw material may change
because of the glitch will
provide the adverse effect on
the raw material and finished
goods.
The above-mentioned risk
requires attention from the
auditor in terms of audit
control. The auditor need to
test the control periodically so
that the such problem does
not adhere with the
production order process. The
auditor need to ensure the
system is working and
placing correct order
periodically. It is also
important for the auditor to
see whether the system is
updated properly on a regular
basis.

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AUDITING
The computer system is
responsible for choice of raw
material and finished good
suppliers which is based on
latest price. This is a
weakness as any fraud or
error or even malfunction can
disrupt the operation process.
The case shows that there is a
presence of control risk
which can affect the flow
materials if appropriate
suppliers are not selected
The auditor can apply
substantive audit procedures
for assessing the nature of the
risk and also needs to
evaluate whether the
computer system which is
considered is working
appropriately or not (Eilifsen
& Messier Jr, 2014).
The account clerk is
responsible for filing copy 2
of purchase orders and GRN
and also has access to
password of master file which
can be regarded as one of the
major weaknesses of the
business
The major audit risk arises
when the clerk can materially
affect the entries in the
master file.
The auditor needs to apply
test of details where all
documents needs to be
assesses by the auditor so that
any incident of fraud can be
detected.
The production controller
also can access the master file
and has the responsibility of
printing the production orders
and also making changes in
the master file for updation.
This is a weakness of the
internal control system as the
entries can be manipulated
There is an audit risk which
arises as a single person has
multiple responsibilities and
therefore there is a chance
that he would manipulate the
entries which would affect
the production process of the
business.
In such a situation, the auditor
needs to advice the
management of the company
to segregate the duties of the
employee for avoiding audit
risks (Legoria, Melendrez &
Reynolds, 2013).
The store staff of the business
has access to password
relating to the master file and
is also responsible for both
the orders printing relating to
This is a situation where the
audit risk arises relates
weaknesses of the internal
control setting which can
affect the material and
In this case as well, the
company needs to ensure that
the same person does not
have multiple duties and
segregation of duties must be

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AUDITING
raw materials as well as GRN
printing. This is recognised as
a weakness as there is an
opportunity of fraud in the
business.
production process of the
business thereby attracting
losses for the business.
done.
Orders which are generated to
suppliers and sub-contractors
are based on master file. This
is a weakness since many
people have the access to the
password of the master file
for making amendments. This
would make the situation
susceptible to fraudulent
activities.
This is a weakness as the
whole of the process of the
business would be affected as
there is a high chance of
manipulation in the financial
records of the business. The
whole process of the business
would be disrupted.
The appropriate measure
which can be taken by the
management of the company
is that limited access should
be provided on the password
and this would reduce the
possibility of frauds.
The stock sheet which reports
stock value does not show the
quantity of stocks of the
business which is a weakness
as this would lead to wrong
valuation of stock of the
business.
This type of audit risk is
related to weakness in
internal control which can
affect value of the stocks of
the business. The stocks can
be overstated or understated
in company records
The auditor needs to apply
detail scrutiny of the records
of store ledgers and every
invoices and receipt issued by
store staff. If required the
auditor of the business also
can apply physical stock take
for appropriate quantities of
the stock values.
Sampling Methods
Assertion Which Population Sample Selection
Method
Justification for
Sample Selection
Method
Completeness The completeness The systematic This method is

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AUDITING
assertion states that
all the transactions
and accounts which
are presented in the
financial statements
must be complete.
This assertion is
mainly associated
with understatement
of inventory values. It
is for this reason that
Wayne needs to
collect sample from
finished goods and
raw materials
sampling method
would most suit the
needs of the situation.
The method involves
determination of
uniform intervals
through dividing
whole physical units
from the source
considered to be most
simple from the
perspective of the
auditor. In this
system of sampling
assurance can be
given to Wayne that
even sampling of the
total population
would be done. In
case of API, even
sampling can be done
for raw materials and
finished goods.
Therefore, there is a
chance of detection
of errors and
misstatement
following this
sampling method
(Jones, 2017). This
method includes the
use of random
number tables which
would be useful for
assessment
Existence This assertion is
related to the test of
fact whether the
transaction actually
existed. This is a
The most appropriate
sampling method in
this scenario would
be random sampling
which would allow
The main reason due
to which such a
sampling method is
used is because equal
chance can be given

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crucial assertion for
inventory. There is a
need for selection of
sample from purchase
of materials since
there is a scope of
vouching which
allows the auditor to
assess relevant
documents.
Wayne to select
sample order from
purchases in a
haphazard manner
(Badara & Saidin,
2014). Random
number of tables
needs to be used in
this process.
to each element of the
population of
purchase orders
(Davidson, Desai &
Gerard, 2013). This
method requires
appropriate audit
sampling which
Wayne needs to
perform. The
inventory base of the
business of API is
huge and therefore
random sampling is
the most appropriate.

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AUDITING
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