Proposed Auditing Standard: Existence and …

1 exposure draft ED 5/05. (August 2005). Proposed Auditing Standard: Existence and valuation of Inventory (Re-issuance of AUS 506). Prepared and Issued by the Auditing and Assurance standards Board Commenting on this exposure draft Comments on this exposure draft should be forwarded so as to arrive by 14 October 2005. Comments should be addressed to: The Chairman Auditing and Assurance standards Board PO Box 204. Collins Street West Melbourne Victoria 8007. AUSTRALIA. E-mail: A copy of all non-confidential submissions will be placed on public record on the AUASB website: Obtaining a Copy of this exposure draft This exposure draft is available on the AUASB website: Alternatively, any individual or organisation may obtain one printed copy of this exposure draft without charge until 14 October 2005 by contacting: Auditing and Assurance standards Board Phone: (03) 8080 7400. Level 4 Fax: (03) 8080 7450. 530 Collins Street E-mail: Melbourne Victoria 3000 AUSTRALIA.

2 Postal Address: PO Box 204. Collins Street West Melbourne Victoria 8007. AUSTRALIA. COPYRIGHT. 2005 Auditing and Assurance standards Board (AUASB). The text, graphic and layout of this exposure draft are protected by Australian copyright law and the comparable law of other countries. The exposure draft may be reproduced in print for the sole purpose of preparing a written submission to the AUASB in respect of the exposure draft . Otherwise, no part of the exposure draft may be reproduced, stored or transmitted in any form or by any means without the prior written permission of the AUASB. except as permitted by law. ISSN 1030-603X. ED 5/05 -2- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506). CONTENTS. PREFACE. AUTHORITY STATEMENT. Paragraphs 1- 2. Operative Date .. 3. 4- 6. Internal Control Structure .. 7- 9. Attendance at Physical Inventory 10- 28. valuation of 29- 31. Conformity with International standards on 32.

3 ED 5/05 -3- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506). PREFACE. Reasons for Issuing ED 5/05. The Auditing and Assurance standards Board (AUASB) is proposing to re-issue Auditing Standard (AUS 506) Existence and valuation of Inventory due to the requirements of the legislative provisions explained below. The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (the CLERP 9 Act) established the AUASB. as an independent statutory body under section 227A of the Australian Securities and Investments Commission Act 2001, as from 1 July 2004. Under section 336 of the Corporations Act 2001, the AUASB may make Auditing standards for the purposes of the corporations legislation. These Auditing standards will be legislative instruments under the Legislative Instruments Act 2003. Main Proposals This Proposed Auditing Standard establishes standards and provides guidance on obtaining sufficient appropriate audit evidence regarding the Existence and valuation of inventory.

4 Proposed Operative Date It is intended that this Proposed Auditing Standard will be operative for reporting periods commencing on or after 1 July 2006. ED 5/05 -4- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506). Main changes from existing AUS 506 (July 2002). The main differences between this Proposed Auditing Standard and the Auditing Standard issued by the former Auditing & Assurance standards Board of the Australian Accounting Research Foundation that it supersedes, AUS 506 Existence and valuation of Inventory (July 2002), is that in this Proposed Auditing Standard: 1. the word shall', in the bold-type' paragraphs, is the terminology used to describe an auditor's mandatory requirements, whereas an auditor's degree of responsibility was previously described by the word should';. 2. the explanatory paragraphs provide guidance and illustrative examples to assist the auditor in fulfilling the mandatory requirements, whereas previously some obligations were implied within certain explanatory paragraphs.

5 Accordingly, such paragraphs have been redrafted to clarify that the matter forms part of the explanatory guidance;. 3. the following implied obligations, previously in AUS 506, have been elevated and re-stated as specific mandatory requirements: (a) if the entity uses procedures to estimate the physical quantity of inventory that is material, the auditor shall design and perform audit procedures to be satisfied with the reasonableness of those procedures (paragraph 19); and (b) the auditor shall perform audit procedures over the final inventory listing to determine whether it accurately reflects actual inventory counts made by the entity (paragraph 27). 4. in exceptional circumstances, the auditor is no longer permitted, to depart from the requirements to attend physical inventory counting in order to more effectively achieve the same objectives; and 5. the auditor is required to take or observe physical counts on an alternative date when planned attendance was not possible due to unforseen circumstances.

6 A Table of Proposed Changes is provided as an attachment to the exposure draft . ED 5/05 -5- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506). Request for Comments Comments are invited on this exposure draft of the Proposed re-issuance of Auditing Standard (AUS 506) Existence and valuation of Inventory by 14 October 2005. The AUASB would prefer that respondents express a clear overall opinion on whether the Proposed Auditing Standard, as a whole, is supported and that this opinion be supplemented by detailed comments, whether supportive or critical, on the major issues. The AUASB regards both critical and supportive comments as essential to a balanced review of the Proposed Auditing Standard. ED 5/05 -6- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506). AUTHORITY STATEMENT. Auditing Standard << >> Existence and valuation of Inventory is set out in paragraphs 1 to 32.

7 The requirements of this Auditing Standard set out in bold-type paragraphs are mandatory. These requirements are to be applied by auditors in conjunction with the requirements of other applicable Auditing standards . The explanatory paragraphs in this Auditing Standard provide guidance and illustrative examples to assist auditors in the application of the mandatory requirements. ED 5/05 -7- exposure draft . Auditing STANDARD. Existence and valuation of Inventory Application 1 This Auditing Standard applies to: (a) an audit of a financial report for a financial year, or an audit of a financial report for a half-year, in accordance with Part of the Corporations Act 2001; and (b) an audit of a financial report for any other purpose. 2 This Auditing Standard also applies, as appropriate, to an audit of other financial information. Operative Date 3 This Auditing Standard is operative for financial reporting periods commencing on or after 1 July 2006.

8 Introduction 4 The purpose of this Auditing Standard is to establish standards and to provide guidance on obtaining sufficient appropriate audit evidence regarding the Existence and valuation of inventory in the financial report. 5 The auditor shall obtain sufficient appropriate audit evidence regarding the Existence and valuation of inventory material to the financial report. 6 Definitions, and the method of measurement regarding inventory, are given in Accounting Standard AASB 102: Inventories and are adopted for the purpose of this Auditing Standard. Although the method of measurement given in AASB 102 does not apply to certain types of inventories, the guidance provided by this Auditing Standard may be suitable for the purpose of obtaining sufficient appropriate audit evidence regarding their Existence and valuation . ED 5/05 -8- exposure draft . Proposed Auditing Standard: Existence and valuation of Inventory (Re- issuance of AUS 506).

9 Internal Control Structure 7 When obtaining an understanding of the internal control structure and making a preliminary assessment of control risk, the auditor ordinarily considers the adequacy of authorisation, custodianship and recording functions relating to inventory (as well as internal controls relating to the determination of quantity and value of inventory for financial reporting purposes) to determine the nature, timing and extent of audit procedures. 8 In obtaining an understanding of the internal control structure, the auditor ordinarily considers the records and internal controls existing over the receiving, storing, returning, utilisation and dispatch of inventory. 9 Records and internal controls ordinarily considered by the auditor regarding a manufacturer may include those relating to the movement of inventory through work in progress to finished goods, and the aggregation of costs through appropriate centres. Attendance at Physical Inventory Counting 10 Management ordinarily establishes procedures under which inventory is physically counted at least once a year to serve as a basis for the preparation of the financial report or to ascertain the reliability of the perpetual inventory system.

10 11 When inventory is material to the financial report, the auditor shall obtain sufficient appropriate audit evidence regarding its Existence and condition by attendance at physical inventory counting unless impracticable. 12 The auditor's attendance serves as a test of controls or substantive procedure over inventory depending on the auditor's risk assessment and planned approach. Such attendance enables the auditor, for example, to inspect the inventory, to observe compliance with the operation of management's procedures for recording and controlling the results of the count and to provide audit evidence as to the reliability of management's procedures. 13 If unable to attend the physical inventory count on the date planned due to unforeseen circumstances, the auditor shall take or observe some physical counts on an alternative date and, when necessary, perform audit procedures on intervening transactions. ED 5/05 -9- exposure draft .