CPA Exam — AUDAssessing Risk and Developing a Planned ResponseHard
A client, a large retail chain, is experiencing significant supply chain disruptions due to geopolitical events, leading to unpredictable inventory levels and delays. As part of understanding the entity and its environment, the auditor should primarily consider this situation as increasing the inherent risk related to which financial statement assertion for inventory?
- ACompleteness.
- BExistence.
- CRights and obligations.
- DValuation and allocation.
Show answer & explanationAnswer & explanation
Correct answer: D. Valuation and allocation.
Supply chain disruptions lead to unpredictable inventory levels, potential obsolescence due to delays or changing demand, and difficulty in accurately costing inventory due to fluctuating freight and procurement costs. These factors directly impact the net realizable value and cost allocation of inventory, thus increasing the inherent risk for the valuation and allocation assertion.
Why the other options are wrong
- A. Completeness relates to ensuring all inventory that should be recorded is recorded. While delays might make this harder, the valuation impact is more direct and significant from 'unpredictable levels' and 'delays' affecting cost and obsolescence.
- B. While disruptions could theoretically impact existence if goods are lost, the primary and most pervasive risk from 'unpredictable inventory levels and delays' relates to correctly valuing the inventory that does exist.
- C. Rights and obligations relate to whether the company owns the inventory. Supply chain disruptions do not inherently alter ownership, though they can complicate when title passes.
Valuation and Allocation Assertion (Inventory)
The assertion that inventory is included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.
- Focuses on cost, net realizable value, and obsolescence.
- Affected by factors like market prices, condition, and estimability of costs.
- Highly susceptible to inherent risk from volatile economic conditions or supply chain issues.
Memory trick: Disruptions make inventory's 'VALUE' a 'CHALLENGE'.