[Amay]

Do you extrapolate inventory observation count errors that were not adjusted by the client among the population? Ideally, there should be no differences in the auditor’s count and the client’s because any differences should be corrected in the system on the date of the count; however the client did not adjust the errors and I am having trouble deciding whether to extrapolate or not, and if so, how to do it.

Option 1: Take the total $ value of errors divided by total $ value of sample (items tested). Multiply the % by the total inventory balance at year-end.

Doing this option, do you use auditor #units counted or client #units counted to come up with the “$ value of items tested.”

Option 2: Take the # of sample items with errors divided by the total sample. Multiply % by an average cost?

Option 3: Do not extrapolate. Propose an entry for a client to adjust the erroneous items in their system.

I was doing option 1 but ran into my question above. I am not sure if the other options make sense for this.

Thanks for your help!

BEC: 73, 81
AUD: 85
FAR: 71, 77
REG: 74, 75...finally DONE! 😀

*This is my 2nd attempt at the CPA exam. For all of you who have failed this exam many times, given up on it, or taken a break like me, remember that it is still possible to finish what you started...failure is the opportunity to begin again more intelligently 🙂

[Anonymous]

Hi Amay, unfortunately I think your answer from me will be “it depends”. In my firm we do not extrapolate errors for 2 reasons. First because errors are required to be fixed while our observers are onsite and we can see them being updated in the final count sheets. If an error was found in the final count sheets to inventory listing reconciliation that would be a control issue as well as an exception. Secondly, we would not be able to extrapolate as our inventory selections are not made randomly so it's not mathematically appropriate to extrapolate results as we make our selections when our counters are on site…so we would have to expand our sample…which is difficult to do after the fact (once the count is over). I'm not sure if you perhaps have other locations that haven't performed inventory counts yet that you could expand to? That might be a viable alternative. Or perhaps your selections were made in a way that would allow extrapolation.

[Anonymous]

I'm not gonna read your options cause I'm lazy but I'll answer your question. Firstly, if the auditor count does not agree with the client count, you extrapolate – EVEN if the client does correct the individual error.

I'm not going to walk you through how to do an extrapolation because I'm sure different firms have different methods of extrapolating – follow your firm's extrapolation workbook/tool.

But I'm gonna give you some advice. Just ask your senior – it's a little weird to be asking on these boards.

@amy: at any inventory observation that I've been too selections were always made either randomly or haphazardly – but I'm sure depending on the industry and warehouse location & product availability some clients are different.

[Mayo]

Expand and extrapolate once your expanded count is done.

Mayo, BBA, Macc

[Amay]

Thank you guys for your responses! I am the Senior. The reason I posted was because there was a debate between the Mgr. and Sr. Manager about whether extrapolation was even necessary. Also, the guidance we looked up was not very persuasive as to which way was the correct way. I was curious to see what others out there have done as I have never encountered this issue before.

The guidance did say that in the case the client does not correct the errors, you don't necessarily project the errors across the population (aka extrapolate) and that you should recount if possible. Expanding the sample or recounting does make sense, way more than extrapolating, but for various reasons, it is not possible for us at this time.

And I don't necessarily agree with extrapolating even if the client corrects the error. Once they have corrected the qty in their system it will produce the accurate results in the books at year-end, so it is not really an exception if it is corrected.

I do agree that if there are too many errors, it is a control issue. Especially if that particular location has more errors than others, or if they consistently have differences during the count each year.

BEC: 73, 81
AUD: 85
FAR: 71, 77
REG: 74, 75...finally DONE! 😀

*This is my 2nd attempt at the CPA exam. For all of you who have failed this exam many times, given up on it, or taken a break like me, remember that it is still possible to finish what you started...failure is the opportunity to begin again more intelligently 🙂

[Anonymous]

‘Expanding the sample or recounting does make sense, way more than extrapolating, but for various reasons, it is not possible for us at this time.'

This is usually the case, which is why most inventory counts have you make many more selections than you actually have to make (just to be safe).

‘And I don't necessarily agree with extrapolating even if the client corrects the error. Once they have corrected the qty in their system it will produce the accurate results in the books at year-end, so it is not really an exception if it is corrected.'

You are not getting it. It is all about sampling (which is why you extrapolate – so unless your firm uses a whacky methodology – this is how you should do it for most accounts). I'll try to illustrate:

Let's say a client has 1,000,000 in inventory in the warehouse.

1. Based on materiality you make 10 selections from the inventory listing (1 item selection for every $100,000 in inventory).

2. You count the 10 items. 2 of the items are 100% overstated (none of the inventory items even exist). Each of these two items have ~$20,000 worth of inventory on the inventory compilation.

Scenario 1: The client does not correct. Based on this you would extrapolate and say that you have a $200,000 overstatement of inventory (representing a $40k factual error and a 160k projected error).

Scenario 2: The client makes an adjustment reducing inventory by $40,000. Then you'd subtract the adjustment/correction from the total extrapolated error. Your total total error would be $160,000 ($200,000 – $40,000). The idea, which you don't seem to agree with, is that even though the client corrects the factual error ($40k) they have not corrected the projected error. Under your methodology, clients could completely lie about their inventory every year but then only have to correct the tiny few number of items that randomly get selected. You can't ignore the fact that your item selected being an error indicates that there are other errors in the population (unless you count 100% of the population).

Scenario 3: The client makes an adjustment reducing inventory by $200k. This could make sense – although hopefully you made enough selections to be comfortable that the extrapolated error estimate (e.g. 200k) is accurate. If so, then you would not have any error (post client-adjustment of $200k).

Like I said this works the same way for most accounts. For example, if you make 50 sales selections, and half of them are 100% wrong/overstated, then your total error would be the 50% of all sales less the client adjustment. So the adjustment better be greater than just the value of 25 incorrect invoices themselves.

Clearly I'm using big numbers for example's sake. In reality for this sales example, you in all likelihood would not extrapolate, you would expand your sample size and make a shit load more selections.

[Amay]

Thanks for your help Annony!

BEC: 73, 81
AUD: 85
FAR: 71, 77
REG: 74, 75...finally DONE! 😀

*This is my 2nd attempt at the CPA exam. For all of you who have failed this exam many times, given up on it, or taken a break like me, remember that it is still possible to finish what you started...failure is the opportunity to begin again more intelligently 🙂

[Author]

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