Discussion Question #4.1
There are many reasons that the valuation assertion for inventory could be at risk, i.e., the
risk that the inventory is shown at an incorrect value in the balance sheet.
Locking the warehouse would reduce the risk of theft, but does not address all the
the inventory could be physically present in the warehouse, but the valuation is
incorrect because there are errors in the costing procedures used to value
If the client is using FIFO, there could be errors in identifying the inventory
movements and associated costs.
There could be errors in calculating inventory costs because of mathematical
mistakes in the invoices or inventory records.
There could be errors in updating the inventory records so that they misstate the
amount and value of inventory in the warehouse.
There could be inappropriate procedures for identifying obsolete or damaged
inventory so that these items continue to be carried at full cost instead of being
written down to NRV.
There could be errors in cut-off, so that inventory purchases made prior to the end
of the financial year are not recorded in the inventory records as at the end of the
The auditor would need to explicitly address all of the risks to the inventory balance and
how these would be prevented or detected by the client’s controls before concluding that
inventory was not likely to be misstated.
Discussion Question #4.2
The auditor’s preliminary assessment of materiality is made early in the audit and is used
to guide planning of the audit and the audit testing based on the plan. In making this
assessment, the auditor considers the financial statement users and their needs. This is
considered independently from audit risk.
A low preliminary assessment of materiality means that the auditor must plan to detect
misstatements of low materiality. A high preliminary assessment of materiality means
that the auditor plans to detect misstatements that have a high level of materiality. It takes
more audit work to be reasonably sure that smaller misstatements are detected, than the
amount of audit work required to be reasonably sure that larger misstatements are
detected. This is because the lower the materiality level set, the more items will fall into
this definition. In addition, because the auditor will be combining all testing results
together, a lower materiality level is more sensitive to a potential material misstatement.
Page 1 of 3 Discussion Question #4.3
Analytical procedures that could be useful to assess the risk of misstatement of sales
• Comparisons between this year’s sales (inter im or final data) and previous years (for
the same months)
year by year comparison
Trend analysis (across time periods)
Common size statements and analysis (sales to every other item in the accounts)
• Comparison between this year’s actual sales and budgeted sales
• Comparison between sales for this client and industry averages or peers
• Calculation of gross margins for this y ear and comparison with other periods and
entities (year by year, trend analysis, common size analysis)
• Consideration of sales and margins by pr oduct line, region, store (and comparison
with other periods and entities)
• Comparison of sales commissions and reve nues and margins, by entity, region and
Discussion Question #4.4
A gross profit margin is the gross profit divi ded by net sales. Fully understanding this
margin, and the reasons for any change, requ ires an understanding of the components of
Gross profit = sales – cost of goods sold.
If the gross profit margin increases, profit as a proportion of sales increases, whic