#99- Inventory System - Perpetual vs Periodic

Entity can account for its inventory by using either perpetual method or periodic method.

Under perpetual method:
- the entity record for every single movement of the inventory (i.e. in and out of the inventory)
- at any single point of time, the entity is able to recall the inventory on hand
- frequency of stock-take required is lesser than those accounted using periodic method

Under periodic method,
- every single movement for the inventory (i.e. in and out) is not required to be tracked
- the entity perform a periodic stock-take to ascertain the inventory balance
- inventory on hand can only be recalled after the stock-take is performed
- frequency of stock-take required is higher than those accounted using perpetual method
- cost of sales is computed by using the following formula: Opening Stock+ Cost of Goods Manufactured / Purchase - Closing stock

The above summarize the difference between perpetual inventory method and periodic inventory method.

Ernst & Young sued over Lehman's collapse

Here is the big news that might trigger your interest as an auditor.

One of the Big 4 accounting firms, Ernst & Young is facing a civil lawsuit in the US over the collapse of Lehman Brothers! New York's state attorney Andrew Cumo claims that New York's state attorney Andrew Cuomo claims Ernst & Young "sat by silently" as Lehman Brothers tried to conceal billions of dollars in debt from investors before its implosion. The lawsuit says Lehman ran a "massive accounting fraud".

It is claimed that Ernst & Young approved of Lehman's increasingly frequent use of a device known as Repo 105. The lawsuit alleges: "These Repo 105 transactions had no independent business purpose and were designed solely to enable Lehman to manage the company's financial balance sheet metrics."

The case centres on Lehman's use of an accountancy practice known as Repo 105, which involves temporarily removing money from the balance sheet to give the impression of greater financial strength. Mr Cuomo mentioned that, Ernst & Young should not have approved the accounts, knowing that the practice had been used so widely.

The lawsuit seeks more than $150 million in fees that Ernst & Young received from 2001 to 2008 as Lehman's outside auditor,plus other unspecified damages

Ernst & Young has responded, and claims that the firm is going to "vigorously defend" the lawsuit.

#98- Expectation on FY 2010 inventory level

For audit of year-end 2010 audit, auditors should form an expectations that inventory level has reduced, as compared to previous year. Inventory level can be computed as inventory as % of sales / inventory as % of last 3 month sales. This provide a good guide / benchmark on the inventory level our audit clients are holding.

In view of the recovering business/ economy, inventory turnover are expected to become relatively quicker than prior year. Aged inventory are expected become relatively lesser either.

If the inventory level, as well as aged inventory level, remain relatively constatnt as prior year, this could indicate higher risk of provision for inventory obsolescence. Auditor should discuss this issue with management.

#97- Excess inventory after christmas

We were reading one of the business article online on how to deal with the excess inventory after the christmas sales, especially for retailers.

One of the options suggested was to auction it off online. Companies tend to store higher level of inventory during Christmas season, to meet the demand from customers. Demand from customers are often hard to be projected. Neither historical trend, nor forecast can precisely predict the inventory required. Hence, instead of losing sales resulted from insufficient inventory,Companies tend to store higher level of inventory to meet the demand from customers.

After Christmas sales, Companies are required to reduce the relatively high level (if any) of inventory, considering that the warehouse costs/ inventory holding costs/ liquidity costs could be substantial.

One of the options suggested was to auction the inventories off online. Though the pricing might not be attractive, but auctioning off the inventories allow the Companies to reduce all type of costs mentioned above.

Companies could sell the stocks in all sorts of website, including: e-bay.

#96- Cash audit- internal controls in cash process- cash payment

In our earlies entries in relation to cash audit, we discussed about the audit procedures of auditing unpresented cheques. We will discuss more extensively for audit procedures in auditing cash and bank balances of our audit clients.

Auditors may consider test the internal controls of the client's cash process. For this entry, we will provide an overview of the possible audit procedures to test the internal controls in cash payment process:

(a) select certain number of random samples, and test that payment voucher are properly prepared and authorised

(b) select certain number of random samples, and test that bank reconciliations are properly prepared and reviewed

(c) select certain number of random samples, and test that journal entries are properly posted into General Ledger

(d) select certain number of random samples, and test that payment voucher details match with the corresponding payment details (e.g suppliers' invoices), etc

#95- Auditing Creditors IV

In previous posts in relation to auditing creditors, we mentioned about:

- Review of Creditors' Statement of Account
- Purchase Cut-off testing
- Comparison of current year balance to prior year balance

In addition to the above, it would be good if a creditors' turnover analysis is performed:

Creditors Turnover (day): Purchase/ Average Trade Creditors x 365 [for periodic inventory system]
Creditors Turnover (day): Purchase/ Average Trade Creditors x 365 [for perpetual inventory system]

Auditor can compare the creditors' turnover (day) computed above to general creditor term given by the creditors to assess if the Company has been repaying on time. If the creditors' turnover (day) is significantly longer than the credit term given by suppliers, this might indicate the liquidity issue the Company is facing.

#94- Auditing Creditors III

In our previous entries in relation to auditing creditors and auditing creditors II, we discussed about the audit procedures for trade creditors balances:

(i) Review of Creditors' Statement of Account
(ii)Purchase cut-off testing [ Please also refer to interesting comments posted by our readers

Apart from the procedures mentioned above, auditor should also perform analytical review, by comparing current year creditors' balance to prior year creditors' balance to investigate if there's any unusual fluctuations or absence of expected fluctuations.

For instance, sales volume for ABC company reduced substantially during the year, while the trade creditors balance has increased significantly. We need to understand / analyse the reasons caused the increase in trade creditors' balance while the sales volume has dropped substantially. One of the possible answer is due to the ABC Company is having liquidity issue, and resulted in delaying in repaying its trade creditors.

A good and thorough analytical review give auditor a better understanding of the business.

#93- Auditing Creditors II

In addition, we should perform purchase cut-off test to address the potential risk of misstatement arising from improper cut-off.

As an auditor, we can examine the Goods Received Notes ("GRN") near year-end and after year-end to check that Goods Received Notes details matached with the supplier's delivery order details and supplier's invoices details.

For instance, Auditor Arthur is auditing Company E (whose year end is 30 June 2010) creditor's balance. As part of cut-off testing procedure, Auditor Arthur requested the details of Goods Received Notes near year-end and after year-end. And noted the following sample:

"Goods received notes was generated on 01 July 2010, however, supplier's invoices, supplier's DO indicated the date of 30 June 2010. Further investigation revealed that, supplier generated their internal documents on 30 June 2010, but only delivered the goods to Company E in 01 July 2010. As such, there's no exceptions for Company E"

Cut-off testing is deemed as a compulsory procedure in auditing creditors' balances.

Hewlett Packard CEO Mark Hurd- False Expense Report

Right now, most of the medias is covering the news about Mark Hurd, CEO of Hewlett Packard's resignation. Mark Hurd, CEO of HP, following a sexual harrasment investigation has admitted he had a "close personal relationship" with a former marketing contractor.

HP said that althorugh there was no violation of its sexual harassment policy, Mard Hurd violated the company's standards of business conduct by submitting inaccurate expense reports that covered his relationship with the contractor.

HP further claims that Mark Hurd had "...failed to disclose a close personal relationship he had with the contractor that constituted a conflict of interest, failed to maintain accurate expense reports, and misused company assets. Each of these constituted a violation of HP's Standards of Business Conduct..."

It is evidenced that HP has a strong corporate governance that guide / regulate the behaviour of its mangement, employees, or every single on within the firm.

#92- Auditing Creditors

One of the procedures required to audit trade creditors account is to audit the creditors' statement received from the audit client's suppliers (i.e. external audit evidence).

In normal business circumstances, suppliers will send their monthly Statement of Account to their customers to inform the customers in relation to the outstanding balances. Hence, our audit client will , most likely, receive statement of account from the suppliers.

As part of audit procedure, we can check the suppliers' statement (received by our audit customers) against the creditors' balance recorded in their book. Discrepancies need to be investigated. Statement of account served as an external confirmation to check if our audit client's book has been prepared properly.

However, there are suppliers who do not have practices of sending out Statement of Account to their customers. In this instance, we can send external audit confirmation to the suppliers to confirm outstanding balances.

#91- No depreciation charge on asset held for sale

This is to confirm that if a property is classified as asset held for sale, no depreciation is to be recorded.

To illustrate, Company ABC entered into Sales & Purchase agreement with 3rd party to dispose one of its property. The Sales & Purchase agreement may take months to complete. In this instance, Company ABC re-classified the property from Property, Plant & Equipment to Asset held for Sale upon entering the Sales & Purchase agreement.

Asset held for sale is de-recognised from the balance sheet upon the completion of the Sales & Purchase agreement.

#90- Review of Credit Term

One of the audit procedures to be performed while reviewing trade debtors balance is to review the credit term given to the customers (i.e. debtors).

To illustrate, we can obtain list of trade debtors, including: credit term given to respective trade debtors, and compare the credit term given to the norm of the industry. We would inquire our audit clients, if credit terms given are unusually long.

For instance, the norm of the credit term in industry A is 90 days. ABC company ( our audit client) allows a credit term of 180 days to customer XYZ. We will have to find out the underlying business reason of giving relatively longer credit term, and evaluate the collectibility of amount owing from customer XYZ.

Analyzing credit term given can be used as a useful tool in understanding the credit policy of our audit client.

#89- Accounting treatment for tax penalty

One of our Accounting & Audiitng blog reader inquired us the following:

" How should penalty on late repayment for tax been accounted for?"

Should it be a tax expense? Should it be other expenses?

To clarify: penalty imposed by inland revenue authority on late repayment for tax should not be accounted for as tax expense; it should be accounted for as administrative expense/ other expense.

#88 PWC Singapore issued Disclaimer Audit Opinion for Rickmers Maritime

Recently, PWC Singapore issued Disclaimer Audit Opinion for its client, Rickmers Maritime in view of the Group's uncertainties to continue as a going concern enity.

For our Accounting & Auditing readers, you can find media coverages on this matter via website. For now, let's look at what's a Disclaimer Audit Opinion.

According to Singapore Auditign on Standard (SSA 701),

"13. A disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and accordingly is unable to express an opinion on the financial statements. " (Source: Singapore Auditing Standard)

As above, a disclaimer audit opinion indicates that the auditor is unable to express an audit opinion on the Group's financial statement.

Example of limitation of scope mentioned above is also quoted in SSA 701:


"17. A scope limitation may be imposed by circumstances (for example, when the timing of the auditor’s appointment is such that the auditor is unable to observe the counting of physical inventories). It may also arise when, in the opinion of the auditor, the entity’s accounting records are inadequate or when the auditor is unable to carry out an audit procedure believed to be desirable. In these circumstances, the auditor would attempt to carry out reasonable alternative procedures to obtain sufficient appropriate audit evidence to support an unqualified opinion."

In the case of Rickmers Maritime, due to the doubt on the ability in obtaining waiver for breach of loan covenant and contingent liability arising from unfulfilled capital commitments, PWC has issued a Disclaimer Audit Opinion.