Case study 7
a. State briefly what benefit are gained by management from a year-end inventory counting. Why does the auditor observe such inventory counting?
The Companies Ordinance requires companies to keep proper accounting records. Such proper accounting records include statement of physical inventory counting. HKSA 501 also states that management ordinarily establishes procedures under which inventory is physically counted at least one year to serve as a basis for preparation of the financial statements and, if applicable, to ascertain the reliability of the entity’s perpetual inventory system.
1. Difference between carrying amount and actual inventory
The year-end inventory counting is an important aspect of internal control, especially for the annual report, through year-end inventory control, companies can find whether the actual production figure as the same as the reporting data, therefore, provide confirmation to management on the quantity and condition of the company’s inventories. To a certain degree, this is an important factor in the attainment of truth and fairness in financial statements. By year-end inventory counting, managers may notice the carrying error between the carrying amount and actual amount of inventory, overage or shortage.
2. Adjustment of cost
Inventories may be slow-moving or damaged during an accounting year. Based on the consequence of overage or shortage after the year-end inventory counting, accountants should adjust the reporting data in the financial statement, especially in the cost expense.
3. Operation budget for the next year
The quantity and quality of the inventories has a major impact on the continues-operation issue for a company, the company is generally based on the existing inventory in the current year and formulates its production plan as well as operating budget for the next year.
Reasons for why auditors observe such inventory counting