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Hello sir
I have a doubt
Regarding audit risk
This is part of an answerThe inventory valuation policy has changed with additional overheads to be inckuded within inventory. Inventory days have increased from 58 to 70 days. There is a risk thatinventory is overvalued.
I was thinkng how… the inventory will be overstated .. if inventory days have increased..
I assume like this but i am not sure.. if its true pls correct me if i am wrong..
If inventory days have incresed and there is difficult trading conditions… it means that.. more inventory is sitting in the company not being sold.. so in the financial statements.. these inventory must be valued at lower of cost and nrv.. now since there are lots of inventories sitting in the company and bad trading conditions… they may be selling at discounts.. so.. the value which they get will be lower than the cost.. and the company must have valued tge inventory at cost.. when instead they were supposed to value it at the nrv.
so could that be a reason for risk of overstatement of inventory?
What could be other reasons sir..
I have assumed one more reason for risk of overstatement of inventory..
If the management wants their profit to look high.. they want to overstate their inventory.. so profit looks high.. so.. they would be adding some fake amount calling it production overheads just inorder to make the inventory figures high..
is this a possible reason?..
Also when writing the answer should we write out all these assumptions as to why the inventory could have been overstated.. or the extract from bpp kit which i typed is enough ? Because all these assumptions are in my head so i will be able tk right theanswer but should we write it in the exam because its 1 mark
thank you
sir is it possiblr for you to post this in f8 forum I tried many times and I cant.. I tried through several devices.. sorry for the inconvenienceSorry you couldn’t post to F8 directly.
You are completely correct about the days of inventory risk on inventory valuation. Auditors worry about inventory days increasing because it might be because the inventory will not sell at above cost.
You are also correct that the change of valuation methods might have the same effect ie overstating profits. However, this might be a little more complicated.
Including more overheads will increase the value of inventory. What you have to consider is that this is a change of accounting policy so should be retrospective. This means that opening inventory has to be valued on the new policy. This might not have been done and that would increase profits because opening inventory would have a lower per unit value than closing inventory.
You might also add that if the directors change the accounting policy they have to be able to argue that the new one is more appropriate
What you have to do is to explain your points as fully as you can. Imagine you are explaining to a 16 year-old trainee who doesn’t know much about accounting or auditing theory.
Hope that’s OK
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