The cost of goods sold testing is conducted at the same time as inventory testing is carried out for purposes of the balance sheet. The cost of goods components can broadly be categorized into two major components.
Firstly, the auditor is supposed to determine the overall amount of inventory sold.
If the auditor has been able to test the amount of inventory that is readily available on hand, in addition to the amount that was available initially, the amount can be calculated by simple addition.
Furthermore, the auditor is also required to calculate the inventory sold on a unit basis. This is mainly completed from making selections from a listing of the items sold by the company on a per-unit basis.
However, in addition to these basic calculations, the auditor is supposed to have a procedure designed to ensure that he can give a true and fair view regarding the overall policies that are in place.
In order to determine the audit procedure for the cost of goods sold, there are a couple of things that should be taken into account.
These issues are concerning the overall procedures that are likely to be followed to ensure that there are no issues that might mitigate the auditor from giving a proper judgment.
When it comes to the cost of goods sold, the auditor has a number of responsibilities and factors that should ideally be taken into account.
First and foremost, they should ensure that there are internal controls sufficiently present over inventories and cost of goods sold.
In the same manner, it is also important to consider the basis for determination for the existence of inventories and the occurrence of transactions that majorly affect the cost of goods sold. The major component for the cost of sales is mainly inventory counting.
It is really important to ensure that inventory-related measures are properly taken care of, essentially because of the tantamount importance, it has, not only on the Income Statement but also on the Balance Sheet.
There are a number of procedures that can be used by the auditor pertaining to the Cost of Goods Sold. These audit procedures are given below:
- Cutoff analysis. This requires auditors to examine the relevant procedures to ensure that the physical inventory count is for the relevant period only. This also includes a process for halting any further receiving into the warehouse or shipments from it at the time of the physical inventory count, so that additional inventory items are already excluded.
- Observe the physical inventory count. Counting inventory can also be one of the most integral parts of the accounting process for many companies. In this regard, the auditors want to be fully aware of the procedures that are used to count the inventory. This requires them to discuss the counting procedure with the accountants, observe the accounting process, and apply random sampling to check for any inconsistencies.
- Reconcile the inventory count to the general ledger. Auditors also ensure that they are able to trace the valuation that is compiled from the physical inventory count to the company’s general ledger, to verify that the counted balance was carried forward into the company’s accounting records.
- Test high-value items. In the case where there are items in the inventory that are of unusually high dollar value, the auditors are most likely supposed to spend some extra time to count them physically in inventory. Therefore, this can ensure that they are valued in a correct manner, and subsequently, trace them into the valuation report that carries forward into the inventory balance in the general ledger.
- Test item costs. When deciding on the audit procedure, it is also fundamentally important to ensure that the purchased costs in your accounting records are physically traceable. This can then be compared with supplier invoices to the costs listed in your inventory valuation.
- Test for lower of cost or market. Cost of Sales involves inventory mainly, it is important to have all the relevant values correctly. Therefore, this requires the auditors to follow the lower of cost or market rule. It should be ensured that inventory items are recorded at lower of cost or net realizable value.
- Direct labor analysis. In the case of manufacturing companies, it should be ensured that if direct labor is included in the cost of inventory, then the auditors will want to trace the labor charged during the production process on time cards or labor routings to the cost of the inventory. This amount should be taken into consideration in order to fully evaluate the overall costs that have been charged under this particular head.
Therefore, in addition to these specific assertions and procedures pertaining to the cost of sales, it is also important fundamentally important to ensure that the other basic assertions are fully taken into account.
These assertions include the following: Accuracy, Completeness, Cut-Offs, Right and Obligations, and Understandability.
Overall, the audit procedures that are designed by auditors keeping in mind the overall presentation and calculation behind the cost of sales is an increasingly integral part, because of the fact that it is something that is often misrepresented or miscalculated by accountants.
Traceability of items in the cost of sales is often a tiring process, which also requires physical verification.
Therefore, the overall chances of error surrounding this particular head are often high.
In this regard, all the procedures that should ideally be designed must include all the relevant elements, which can mitigate the overall chances of fraud or misrepresentation in the Income Statement.
Having said that, it is also really important to realize that the audit procedure for every audit assignment will differ from client to client.
Despite a basic blueprint that can be followed (as mentioned above), there will still be additional factors that should be taken into account depending on the nature of the work itself, and the scope of items that are included in calculating the cost of sales for the respective organization.