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Carls Computers is a computer hardware and accessories store, which imports

products from overseas and has branches in every capital city such as China,
Japan and Korea. The main administration office and central warehouse is
located in Melbourne. Competition is fierce in the computer hardware industry,
recently, the new products are continuously coming onto the markets and the
competition is getting worse, the company wants to assess their inventory risk in
order to develop their audit strategy to strong their business. This paper will give
the inventory analysis of inherent risk, control risk and comment on materiality
for inventory at Carls Computers.
Inherent risks which could be material, either when aggregated with other
misstatements or individually, are the susceptibility of an assertion to a
misstatement, assuming that there are no related controls. Carls Computers
inherent risk of inventory includes the following risks. First of all is external
factors risk. The rapid change of high technology lead to computer hardware and
accessories obsolete quickly, the business experiences inherent risk as inventory
valuation. The amount could be either overstated or understated. Stock risk
results from competition from aggressive discounters. There is a great risk that
inventory cannot be sold and be hold on hand as stock. The inherent risk is high
as it also affects inventory valuation, could be overstated or understated.
Exchange rate risk is also obvious as Carls Computers imports products from
overseas. Transactions may not be recorded using adequate exchange rates at the
date of each transaction. The value of inventory could be either overstated or
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understated. Misunderstanding risk should be also taken into consideration.
Correct stock will not be received from suppliers due to inability to meet orders,
confusion between Australian importers and foreign suppliers. Also when
purchase orders appeared to be unfilled or incorrectly filled, payment for stock
not received, the inventory could be recorded overstated.
Transportation risk results from dealing with multiple delivery companies with
different transportation, there is a risk that central or branch warehouse would
be not able to receive goods or not on time and easily damage the products. As a
result, the inventory could be recorded overstated. Risk of errors appears as the
wide range of products has different values, which lead to inherent risk that
incorrect calculation of stock on hand. In this circumstance, it could be either
overstated or understated. Fraud or theft risk is involved, as all inventories have
to transport from overseas to central warehouse, then distribute to each branch
by either permanent or casual staffs. So there is a susceptibility risk of fraud or
theft that inventory account overstated.
Such control system included certain strengths and weaknesses. One of the
strength is simplicity. Such manual order system requires less complex computer
software and needs less knowledge to operate. The other strength is Low cost.
Such manual order system can save cost of software and training cost of staffs on
software operation. However, the opportunity cost may eventually balance out
the simplicity and cost of the software. Business performance has been
influenced in result of slow market responds. Inventory control system also posts
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a few weaknesses. Inventory cost will be higher as there are only 3 suppliers to
choose from, thus pricing will be less competitive which will influence the
profitability of store since pricing acts as a main factor in such industry. A wider
net of pricing should be provided. However under such manual system it is hard
to satisfy such need. A computerized pricing net should be installed, as it will
save time and effort to land on the lowest price of supplier. Time delay on
inventory refill is the main factor that affects the business performance. The
inventory is distributed to each branch by request only as mentioned in the
article, managers need to count inventory to see which one goes faster then
request a refill. This traditional process brings down the efficiency in market
responds, as the inventory request will be delay. A computerized system is
advised as the time gap to sense a market trend and place a refill stock will be
shorten therefore quantity of inventory can react to market demand quickly.
Moreover to prevent control risks a computerized system software should be
used therefore the data can be more accurate, as the control system is now
operation under manual order system, it indicates that a high level of control
risks.
Materiality is used to guide audit testing and assess the validity of information
contained in the financial report and the notes to the report. Different
approaches could be taken to set materiality in risk assessment. A appropriate
base to reflect the percentage change on different items should to start with.
Hence, in the risk assessment phase, materiality assessment will guide audit
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planning and testing, and it is a key concept in the auditing.
In general, qualitative and quantitative are usually consider as the two core
factors in materiality. First of all, if some information affects a users
decision-making process for a reason other than its magnitude, it could be a
qualitatively material. In this case, because the computer hardware are facing the
fierce competition, purchasing new products and frequent changing of supplier
would lead to uncertainty about the quality of products, this is a significant
qualitatively material of inventory. In addition, these factors may change Carls
operating and management model, such as launching new advertisement, new
product promotions and other managerial operations, therefore these factors are
affecting the qualitatively material of inventory. Secondly, if information exceeds
an auditors preliminary materiality assessment, it could be considered as
quantitatively material. According to AASB 1031, any item that is 10% or greater
of profit before tax is considered to be material; conversely, less than 5% is
immaterial; between 5% and 10% is a matter for professional judgment.
However, when the base is total assets or revenue, the percentage fall to 0.5-1%;
when the base is equity, the percentage fall to 1-2%. Therefore, in this case,
because the value of inventory products ranges from several thousand dollars to
a few cents, the value of inventory will affect the value of asset, revenue and
equity, especially in different periods. Such factor should be considered as a
quantitatively material when using inventory as a part of asset.
Material balance is a process which to calculate inputs versus outputs. In general,
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inventory cannot represent material balance because some outside factors
effects inventory, such as on the way transport, product presale, inventory
damage and so on. Hence, inventory is not a material balance; it is not a real
number for material balance as well. In this case, Carl purchase items from
different country, it leads that many inventory is on the way transport, in
addition, it has branches in every capital, and the branchs items always transfer
from central warehouse. Therefore, the liquidity of inventory is significant; it
cannot represent material balance.
All items of inventory cannot be audited in the same way. In this case could
clearly see that, there are some different value items in the Carls warehouse, and
this case did not mention that the products were treated differently. For those
expensive (thousands dollars) computer accessories, the security is limited, so
the inherent risk is high for the existence of inventory. The control risk is also
high as there are no controls in place to reduce the identified risk. By assessing
control risk as high, the auditor will adopt a predominantly substantive approach.
Gathering direct evidence that the financial report is free from material
misstatement is the goal of substantive testing procedures. Substantive
procedures are used to acquire direct evidence as to the validity, completeness
and accuracy of data as well the considerate of the estimates and relative
information comprised in the financial report. Substantive procedures include:
inspection, enquiry, observation, confirmation, re-performance, recalculation and
analytical review. Conversely, Carl also sells some cheap (a few cents) computer
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accessories and conducts regular stock counts. For these products, the inherent
risk is low, as a significant number of a few cents computer accessories would
need to be stolen before having a material impact on the amount recorded for
inventory. Simply, as the product is too cheap to impact the amount recorded
inventory. When the control risk is low, the auditor will generally obtain a
detailed understanding of Carls system of internal control as they plan to rely on
that system to identify, prevent and detect material misstatement. In terms of
low risk company, we believe that controls are exists that they should test to
acquire evidence that are controls are implement and designed properly. That is,
when control risk is assessed as low, it is appropriate to test controls. This will
then reduce the need to perform significant amounts of substantive testing.
Those controls that are selected by auditors that will achieve the most efficient
and effective audit. They are critical to their opinion, which only test controls
they believe. Auditors choose to use techniques of combination for testing
control. These include: enquiry, observations, and inspection of physical evidence
and re-performance of the control.
In conclusion, the inherent risk of Carls Computers inventory is high as
computer hardware and accessories could be disvalued, damaged, stolen, and
wrong valuation. Moreover, the opportunity cost of having a low cost simple
inventory system is very high as the profitability and sensitivity of market
reaction has been influenced. The traditional control system has post a control
risks. Last but not least, Carls Computers inventory is not a material balance and
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not a real number for material balance as well. As the liquidity of Carls inventory
is significant, it cannot represent material balance. Furthermore, due to all items
of inventory will lead to different inherent, control, and detection risk, thus, it
cannot be audited in the same way.