AWP 5

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Valuation Case Example: Valuation of Inventory

Context

ABC Manufacturing Company holds significant amounts of inventory, including raw materials, work-in-progress, and finished goods. Given the nature of the electronic components industry, the risk of obsolescence is high, and market demand can fluctuate. Accurately valuing inventory is crucial for presenting a fair view of the company’s financial condition.

Audit Objective

To verify that inventory is appropriately valued at the lower of cost or net realizable value (NRV), in accordance with applicable accounting standards.

Types of Audit Evidence and Documentation for Valuation

1. Review of Valuation Methodologies

• Case: Auditors review the company’s inventory valuation methods, including cost formulas (e.g., FIFO, LIFO) and the approach to determining NRV.

• Documentation: Document analysis of valuation methods, consistency with prior periods, and compliance with accounting standards. Include memos or analyses that discuss the appropriateness of the methodologies used.

2. Analysis of Market Conditions

• Case: Considering the electronic components industry’s volatility, auditors analyze market trends, including demand forecasts and technology advancements, that could affect inventory valuation.

• Documentation: Prepare a report that summarizes market research, interviews with the company’s sales and marketing teams, and any external data used to assess market conditions.

3. Testing for Obsolescence

• Case: Perform specific procedures to test for inventory obsolescence, such as reviewing sales trends for individual products and inspecting items in inventory for physical condition.

• Documentation: Create a detailed schedule of inventory items tested for obsolescence, including the criteria used for testing, results, and any adjustments made or recommended to the inventory valuation.

4. Reperforming Valuation Calculations

• Case: Auditors reperform inventory valuation calculations for a sample of inventory items, comparing cost to NRV when applicable.

• Documentation: Develop spreadsheets or schedules that show the auditors’ calculations side-by-side with the client’s, noting any discrepancies, the investigation into causes, and adjustments made.

5. Engaging Specialists

• Case: If certain inventory items require specialized knowledge to value (e.g., rare components or advanced technology), auditors may engage valuation specialists.

• Documentation: Summarize the specialist’s findings, methodologies, and qualifications. Document how the specialist’s valuation impacts the audit conclusion on inventory valuation.

6. Management Representations

• Case: Obtain written representations from management regarding the completeness and accuracy of inventory valuations.

• Documentation: Include a copy of the management representation letter, highlighting sections relevant to inventory valuation and any related assurances or disclosures from management.

Conclusion

For valuation evidence related to inventory, the auditors compile detailed documentation that captures the processes, analyses, and conclusions related to ensuring inventory is valued accurately. This documentation supports the auditors’ opinion on the financial statements, ensuring stakeholders can rely on the reported financial position and performance of ABC Manufacturing Company.