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Statutory Audit Checklist for Manufacturing Companies

The audit for a manufacturer is as identical as other business enterprise audit, except for some additional procedures around the company’s inventory balances. In this article know about Statutory Audit Checklist for Manufacturing Companies.

What is an Audit?

The Audit is the verification activity. It is an inspection or examination of a process or quality system to ensure the compliance requirement. An Audit can apply to an entire organization or specific to a function, process or production system. An Audit can be classified into statutory audit, internal audit, external audit, process Audit, system Audit etc.

The audit is divided into four parts which are Audit preparation, Audit Performance, Audit Reporting, and Audit closure.

Audit normally varies from the organization to the organization. The audit plan is prepared considering the factors like the type of organization, activities involved in, laws applicable to the organizations etc.

Statutory Audit checklist for Manufacturing Company:

Auditors are necessary to get reasonable assurance that a company’s financial statements are free of material misstatement, whether caused by error or fraud. The auditors shall design specific procedures to test inventory balances for manufacturers.

Inventory Observation

As per most of the auditing standards require auditors to physically observe the company’s inventory count procedures and make their own independent tests of the physical count of inventory^[1]. This requirement is in response to the multitude of accounting frauds that have been perpetuated through misrepresentation of inventory records. Every so often, when the auditor tests the inventory count, he/she will use a technique called “floor-to-sheet” and “sheet-to-floor.”

Floor-to-sheet is when the auditor selects items from the inventory warehouse and makes sure that they are included on the count sheet. This demonstrates that the count sheet is complete.

The auditor shall selects items from the count sheet and confirm that they are in the warehouse, which tests for the existence of inventory.

Price Testing

The inventory balance on the company’s financial statements is a purpose of the quantity of inventory on hand and the value of the inventory in a book.

The inventory observation tests the quantity and price testing tests the cost of the inventory.

As per accounting standards inventory is apprehended in the financial statements at the lower of cost or market price. Whereas Price testing is the verification of the cost that the company paid for the materials, labor, and overhead that goes into the production of inventory.

For price testing, the auditor shall select items from the company’s inventory on a test basis and verify, through the analysis of original documentation, such as invoices and time cards, that the inventory’s cost is carried in the company’s financial records accurately.

Control Testing

The auditor shall test the internal controls around the inventory cycle when they are auditing a manufacturer company.

The extent of control testing depends on the materiality of the inventory balance, the extent that the auditor wishes to rely on controls to reduce audit testing and other risk factors involving the cycle.

The auditing standards require auditors to take a general understanding of the internal controls related to the inventory accounting system.

Inventory Reserve Testing

For companies that hold inventory that may spoil or become out-dated, inventory reserve testing can be an important part of the manufacturer’s audit. Since the lower of cost or market assumption that generally accepted accounting principles prescribe, testing must be conducted to ensure that the market value of inventory does not exceed the cost verified during price testing.

Auditors will likely assess the risk of obsolete inventory during the testing of internal controls. The spoiled food or dusty boxes during an inventory count observation may cause auditors to pursue testing in this area more aggressively.

Read our article:What is Procedure for Removal of Statutory Auditor from a Company?