An auditor is performing substantive procedures on the client's inventory balance. The client uses the First-In, First-Out (FIFO) method for inventory costing. Which of the following procedures would be most effective in testing the valuation assertion for inventory?
- ATesting the client's cost flow assumptions by comparing vendor invoices to inventory records.
- BObserving the physical inventory count at year-end.
- CTracing a sample of inventory items from the perpetual records to the physical inventory.
- DConfirming inventory held at third-party warehouses.
Show answer & explanationAnswer & explanation
Correct answer: A. Testing the client's cost flow assumptions by comparing vendor invoices to inventory records.
For the valuation assertion, especially when using FIFO, the auditor needs to ensure that the costs assigned to inventory reflect the FIFO cost flow assumption. This involves verifying that the earliest costs are expensed as COGS and the latest costs remain in ending inventory. Comparing vendor invoices (which show actual costs) to inventory records and tracing the flow of these costs directly tests the application of the FIFO method and thus the valuation of inventory.
Why the other options are wrong
- B. Observation primarily tests existence and completeness of inventory, not its valuation under FIFO.
- C. Tracing from perpetual records to physical inventory primarily tests existence. Tracing from physical to records tests completeness. Neither directly addresses FIFO valuation.
- D. Confirmation of inventory at third-party locations primarily tests existence and rights, not the application of a specific costing method like FIFO.
Inventory Valuation (FIFO)
Auditing the valuation of inventory when the client uses the First-In, First-Out (FIFO) costing method, ensuring that costs are assigned to inventory and cost of goods sold according to this assumption.
- Assumes earliest goods purchased are first ones sold.
- Ending inventory reflects most recent costs.
- Auditor verifies proper application of the cost flow assumption.
Memory trick: FIFO valuation: Check the cost flow, not just the count.