Study unit 8

Inventory and
production cycle
Mrs Krysta Heathcote
GEAR111

Auditing Fundamentals 2nd edition

Chapter 8 (page 321 to 356)
 Learning outcomes
After completion of this study unit, you should be able to:
• explain the nature and purpose of the the inventory and production cycle;
• demonstrate an understanding of a typical transaction in the inventory and production cycle;
• identify and describe the major general ledger accounts affected by the inventory and production cycle;
• explain the accounting treatment required for some of the transactions in the inventory and production cycle;
• list the inventory and production cycle’s functional areas;
• describe each of the inventory and production cycle’s functional areas, with specific reference to the purpose, main activities, and
persons involved;
• demonstrate an understanding of the information system used in the inventory and production cycle;
• name and describe the documents and records utilised in the inventory and production cycle and the purpose of each;
• describe the flow of transactions in the inventory and production cycle through the information system, including its relation to
source documents and accounting records and its relation to classes of transactions and events, and balances;
• identify and describe the risks of material misstatement affecting the account balances, classes of transactions and events in the
financial statements in the inventory and production cycle;
• demonstrate a basic understanding of the computer technologies typically applied in the inventory and production cycle;
and
• apply all of the above-mentioned in a case study.
 Content
Nature and purpose
Typical transaction
Major general ledger accounts and accounting
Functional areas
Information system
Documents and records
Flow of transactions
Risk of material misstatement
Computer technologies
 Managing of Safeguarding of
inventory inventory

Controlling the
production process
(manufacturing – not examinable)
Nature and purpose

Business function Accounting function

Safeguard the inventory against theft and damage

Control the movement of inventory

Control the production process itself (manufacturing – not examinable)

Auditing Fundamentals page 322 - 325

 Purchases
and
payments

Inventory
Link to other cycles

and
production

Revenue
Payroll and
and
personnel
receipts
 Retail
Purchase and
payment cycle –
receive
Wholesale

Internal controls
Nature and purpose
Forestry

Manufacturing
– wholesale / retail

Revenue and
receipt cycle –
Resource despatch

Auditing Fundamentals page 322 - 325

 INVENTORY

Order the goods

from the supplier Receive the goods

Storing the goods

Customer orders
the goods Despatch the goods
Typical transaction

Auditing Fundamentals page 325 - 326

 Major general ledger accounts
and accounting

Cost of sales Purchases (periodic) Inventory

IAS2 – assets (HELD FOR SALE ORDINARY COURSE, process of production, materials or supplies consumed in production or rendering of service)

IAS2 – measured at LOWER of cost or net realisable value (NRV)

IAS2 – cost includes purchase costs, conversion costs, other costs location and condition

Auditing Fundamentals page 326 - 327

 Functional areas
Storage of raw Transfer of raw materials to
Production planning
materials (not examinable) production (not examinable)
(not examinable)

Transfer of finished goods

Production Storage of finished
to finished goods
(not examinable) goods
warehouse (not examinable)

Cost allocation and

Maintenance of
updating of inventory
inventory records
records

Auditing Fundamentals page 327 - 330

 Functional areas
Cost allocation and
Storage of finished Maintenance of
updating of inventory
goods inventory records
records

Finished goods Accounting personnel Accounting personnel

warehouse personnel
Warehouse personnel

Auditing Fundamentals page 327 - 330

 Information system
Source documents Journals Ledgers

Financial statements

Cost of sales Purchases (periodic) Inventory

Inventory flows through the

system (buying / selling)

Auditing Fundamentals page 331

 Documents and records
Inventory Master file Inventory
Inventory adjustment
count amendment
sheets tags form
form

General General
journal ledger

Inventory
list

Inventory
listing

Inventory
reconciliation
Auditing Fundamentals page 331 - 333
 Refer to Figure 8.4 in Auditing Fundamentals Chapter 8 for the department
where each activity occurs and the supporting documents created.
Flow of transactions

ONLY RETAIL.
Also refer to page 333 – 336 (next session).

Auditing Fundamentals page 333 - 336

 Financial Misappropriation
reporting risks risks

Risk of material misstatement

Major risk affecting Major risk affecting
COSTS INVENTORY

incorrectly allocated Stolen and/or

to inventory damaged

Auditing Fundamentals page 337

Computer technologies
Barcode scanning

Auditing Fundamentals page 337

 Learning outcomes
After completion of this study unit, you should be able to:
• explain the nature and purpose of the the inventory and production cycle;
• demonstrate an understanding of a typical transaction in the inventory and production cycle;
• identify and describe the major general ledger accounts affected by the inventory and production cycle;
• explain the accounting treatment required for some of the transactions in the inventory and production cycle;
• list the inventory and production cycle’s functional areas;
• describe each of the inventory and production cycle’s functional areas, with specific reference to the purpose, main activities, and
persons involved;
• demonstrate an understanding of the information system used in the inventory and production cycle;
• name and describe the documents and records utilised in the inventory and production cycle and the purpose of each;
• describe the flow of transactions in the inventory and production cycle through the information system, including its relation to
source documents and accounting records and its relation to classes of transactions and events, and balances;
• identify and describe the risks of material misstatement affecting the account balances, classes of transactions and events in the
financial statements in the inventory and production cycle;
• demonstrate a basic understanding of the computer technologies typically applied in the inventory and production cycle;
and
• apply all of the above-mentioned in a case study.
 ©
Copyright © 2024 edition.
Prepared by: Me Rolé van der Merwe
North-West University, Potchefstroom, South Africa.

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