Question

Case A company provides specialty items to chemical plants in a large metropolitan area. Inventory reorder decisions are based on quarterly sales reports and must be approved by the VP of Sales. The company has a highly motivated and wellpaid sales force.

Often a good salesperson can earn more in commissions than from base salary. Salespeople use laptops and portable devices to enter orders while in the field. As sales orders are entered, all outofstock conditions are noted. Restocking orders are created whenever inventory levels fall below reorder points. The products handled by the company are subject to rapid obsolescence and have little scrap value once obsolescence is reached. The annual inventory count is performed by an inventory audit service outsourced using professional team of counters. All count information is given to the company for entry and balancing. Over the past several years, the company has experienced unusually large writeoffs as a result of its annual physical inventory.
The company hires you, the internal auditor, with an engagement to determine the cause of inventory shortages shown by the physical inventories.
Do you think reviewing the count sheets inventory printouts, and memos from the last inventory count is sufficient to address your audit objective? Why or why not?

Answer 1

Reviewing count sheets and inventory printouts alone is not sufficient to fully understand inventory shortages. A comprehensive assessment including processes, sales forecasting accuracy, and interviews is necessary to identify potential systemic issues or irregularities.

Step-by-step explanation:

Reviewing the count sheets, inventory printouts, and memos from the last inventory count would not be sufficient to address the audit objective regarding the cause of inventory shortages. Since the company's products are subject to rapid obsolescence with little scrap value, it is essential to look beyond the year-end numbers and assess the inventory management processes throughout the year, such as how reorder decisions are made, sales forecasting accuracy, and the effectiveness of the restocking system. Moreover, considering that the sales force is highly incentivized with commissions, it would be prudent to examine the potential for sales order manipulation.

The company's current inventory count performed by an external auditor is a snapshot in time; therefore, it is necessary to establish whether discrepancies are due to systemic issues such as theft, improper record-keeping, or deficiencies in inventory control mechanisms. Continuous monitoring and analysis of inventory trends, as well as interviews with staff, including the VP of Sales and the sales team, could offer valuable insights into inventory turnover, obsolescence rates, and any possible irregularities that may lead to stock variances. This comprehensive approach allows the auditor to ascertain the underlying issues causing the inventory shortages.