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EXECUTIVE SUMMARY

Statement of Assurance

This audit engagement was planned and conducted in accordance with the Generally Accepted
Auditing Standards.

Summary of Audit Findings

This report was commissioned to examine whether the companys inventory management is
reliable, and to determine what impact it could have on the companys profitability. Procedures
such as observation, inquiries, and sampling were performed to obtain the needed information.

The report draws attention to the following findings: There was no periodic inventory count for
the last six years which could result to undetected inventory shortages and overages; No clearly
defined inventory monitoring responsibility over the warehouse inventory which makes the
company prone to unidentified errors which could materially misstate accounts; Purchases did
not have established policies and procedures for identifying and disposing of obsolete inventory
items, increasing the costs for storage and maintenance and reducing the recoveries the
company may obtain when these obsolete items are disposed; Purchases did not perform
periodic reviews of its reorder points to determine whether inventory levels were adequate,
making the company prone to emergency buying, thus possibly losing the benefit of volume
discounts; Purchases did not maintain an up to date inventory catalog, increasing the time
and cost required to fill agency requests; The inventory warehouse area was not clean and
organized, resulting to safety and fire hazards that may hinder the efficient operation of the
warehouse.

Summary of Audit Recommendations

Therefore the following recommendations are made: periodic count for its inventory items in
both warehouses and reconciliation of the physical inventory stock with the stock records;
management should establish a system for responsible employees to verify delivery, receipt,
and storage of inventory; The Purchasing Department must establish its own Inventory
Obsolescence Policy through a Material Review Board; evaluation of the inventory stock level
reorder points should be done annually to prevent excess or shortages of inventory supply;
Purchases update its warehouse catalog; Purchasing department should find a way to store
inventory items in an organized manner and maintain the cleanliness of the warehouse (ex.
Inventory layout plan). These recommendations can minimize the problems mentioned above,
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thus aiding the company in terms of adequate controls and proper financial statement account
balances.

Management Action

The TNC Co. is addressing the recommendations in this report. Specific responses to each
recommendation are provided in the body of the audit report.































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INTRODUCTION

Background

TNC Co. was registered with the Securities and Exchange Commission on December 19, 1985
and was incorporated in the Philippines as a stock corporation with SEC Registration No. CEO-
0525 for the primary purpose of engaging in exporting and importing, buying, acquiring,
holding, selling on whole sale basis, or otherwise disposing and dealing in any goods, wares,
merchandise and commodities of all kinds and products, natural or artificial, of the Philippines
or other countries, which are or may become articles of commerce, as may be permitted by
law. The Company also manufactures, improves, amalgamates or joins various goods to form
one product, merchantable goods, or wares, whether of local or Philippine materials, imported
materials or contribution of both, most especially handicrafts and the like products. The
registered office of the Company is located at Kagudoy Road, Basak, Lapu-Lapu City, Cebu,
Philippines.

On November 26, 1999, the Company became a member of the Board of Investments as an
export producer of garden and home products made of fiberglass on a non-pioneer status
under Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987.

Since the commencement of the business, the company has used the perpetual inventory
system and has annually performed a physical inventory count. But for the last six years, the
Company has not conducted the physical count because the records obtained from the
reconciliation of the amounts from the last inventory count with the perpetual record showed
no difference. In short, they were of great accuracy, thus, the Company decided not to conduct
the annual count and just rely on the reconciled records. The Company has low employee turn-
over rate. So, most of the Companys employees are working with the Company for so long.

The Company is also committed to giving their customers the quality products that they
deserve. Thus laborers or employees are compensated on a per output basis and these
completed outputs must be of good quality limiting the number of obsolete inventories. Over
the years, there were only a few obsolete inventories because of this policy and usually the
cause of its obsolescence is not due to the work done by the laborer but due to the raw
material itself that was used in manufacturing such product. Because of this minimal number of
obsolete inventories, the Inventory Control Department has not established a formal policy
with regards to the treatment of these items however, the Company does have a usual practice
wherein they segregate the defective items from the good ones and treat it as a loss.
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The Company has not also reviewed their inventory stock level for the past 20 years because
despite the overwhelming demands from their customers, they have always met these
demands. So far, for the past 20 years they have never experienced shortages of our raw
materials.

The Company was not able to maintain the cleanliness and neatness of the warehouses
because of the busy schedule they had in the past years. There were a lot of orders recently
that they ran short of manpower. The Company was too preoccupied that they have not paid
attention to the physical needs of the warehouse.

Audit Scope

The accountability audit was conducted in accordance with the Generally Accepted Auditing
Standards in the Philippines. It included the test of accounting records, test of reasonableness
of balances, and other auditing procedures that were considered necessary in the
circumstances.

Audit Objective

The objectives of this audit were to determine the existence of the companys inventory items
reflected on its 2013 financial statements and to determine if the companys internal controls
were adequate to safeguard assets and ensure that all inventory receipts and withdrawals were
properly recorded in both the perpetual inventory and accounting records.

Audit Methodology

In order to accomplish our objectives, we visited the two warehouses of the company. We
interviewed some personnel of the company regarding its established inventory management
procedures. We also looked for some obsolete inventory items. Inventory Purchase Orders and
Vendors Invoices were also examined. Additionally, we obtained an understanding of the
policies and procedures used to control the companys perpetual inventory system and
evaluated their adequacy. We tested inventory transactions to determine whether the policies
and procedures were in place during the period January 1, 2013 December 31, 2013. The
results of our audit are detailed in the Findings and Recommendations section included in this
report.



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FINDINGS, RECOMMENDATIONS, AND MANAGEMENT RESPONSES

Periodic Inventory Count
A method of inventory valuation for financial reporting purposes where a physical count of the
inventory is performed at specific intervals. This accounting method for inventory valuation
only keeps track of the inventory at the beginning of a period, the purchases made and the
sales during the same period and is recorded under the asset section of the balance sheet.

With this valuation method, it is much harder to track which individual items were destroyed or
stolen, but a cross-reference can be made with the sales revenue to get a rough estimate of
what was sold versus what was not. Many see this method as being inferior to the perpetual
inventory method, which keeps track of inventory at the point of sale.

Every company must perform a physical inventory of its warehouse stocks at least once in a
fiscal year to balance the stock account. In addition to cycle counting, you can also use the
periodic and continuous inventory procedures. You can perform a periodic inventory in the
form of a complete inventory count or as a sample-based inventory count. In the SAP R/3
System, the term physical inventory refers to the functions used for performing the physical
inventory. You can valuate stocks for balance sheet purposes based on the data counted.

During the periodic inventory (complete inventory count), all of the companys stocks are
physically counted on the balance sheet key date. You must count every material. The whole
warehouse must be blocked at an organizational level for material movements during the
count.
Finding no. 1: There was no periodic inventory count for the last six years.
Consolidation of purchases into 2 warehouses.
Discontinuation of inventory counting and reconciling stock counts of the
companys perpetual inventory records and general ledger
Analysis
Condition Periodic inventory counts in warehouse No. 15 were not
routinely performed.
Cause Since the past six years, the company hasnt periodically
done an inventory count and reconciliation of amounts.
Effect As a result, inventory shortages and overages could occur
and remain understated. Inventory reorder points might be
inappropriate.
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Recommendation
Even though the company has a perpetual inventory system, we recommend that the
management must perform a periodic count for its inventory items in both warehouses and
reconcile the physical inventory stock with the stock records. We also recommend that the
Purchases Dept. should make a well-defined list of inventory count procedures including the
treatment of special kinds of inventory items (consigned, obsolete, and damaged inventory
items). We will also examine the past years financial statements and records to determine
whether there are any material misstatements attributed to the absence of a periodic count.
We will also test the reasonableness of the companys beginning inventory so that any material
misstatement on the companys reported profit will be adjusted.

Management Response
Response Office of Primary
Interest
Timeline
The Chief Executive Officer will issue a
memorandum regarding the establishment of
periodic inventory count policies and
procedures.

The physical inventory count will be conducted
at the end of the next business year.
Chief Executive
Officer, Inventory
Control Head, and
Purchasing Dept.
Head

March 24 31,
2014






Monitoring Responsibility
Inventory management is an important part of an organizations profitability because the faster
the turnover, the more money the organization makes. The inventory manager is mainly
responsible for ensuring that the organization has the right amount of stock to meet customers
needs and also to avoid overstocking certain items, which ties up cash and storage resources.
Order Entry
Monitoring inventory means developing an understanding of what your best-selling
products are, how often you turn over that particular inventory and what you need to
have on hand to satisfy orders. Having the right products in stock allows you to fulfill
orders in a timely manner and develop a loyal customer base. Maintaining inventory
trends of the best-selling products helps you keep those products in stock and allows
you to keep filling orders.
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Product Rotation
Holding on to obsolete stock becomes a drain on your company's productivity. By
monitoring inventory activity, you may track a product from the day it enters your
warehouse up until the time when it can be returned to the manufacturer if it isn't
sold. You can develop product rotation agreements with your suppliers that allow you
to return unsold product for a restocking fee. You can get most of your money back for
the unsold items as long as you monitor your inventory and keep track of those unsold
items that need to be returned.
Purchasing Costs
An accurate inventory monitoring system lets your purchasing department know what
products need to be bought and in what quantities. A comprehensive inventory
monitoring system helps you to only purchase products as needed and reduce the
holding costs of inventory that doesn't sell. An accurate purchasing projection means
that your purchasing costs are kept down and you're not spending money that you
don't need to spend.
Buying in Volume
Understanding the cycles of your inventory through inventory monitoring allows you
to negotiate bulk purchase agreements with some of your vendors and lower your per-
unit costs. For example, if a department store uses inventory control to determine that
it will sell a large number of beach balls just prior to the start of summer, then that
store may negotiate a lower price per unit for a large-quantity purchase of beach balls,
as opposed to buying product in smaller quantities as needed.
Finding no. 2: No clearly defined inventory monitoring responsibility over the warehouse
inventory.
The current system is capable of ensuring that all receipts and withdrawals
are recorded but is prone to errors because of the combination of manual and
automated processes.
Purchasing Department recognizes the need for a fully automated system
and is in the process of procuring an automated requisitioning system.



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Analysis
Condition 1.) Purchasing Department did not adequately monitor
the warehouse inventory activities.

2.) The current Accounting Information Systems is
capable of ensuring that all receipts and withdrawals
are recorded.
Cause 1.) Purchasing Department did not reassign oversight
responsibility.

2.) The system is not fully automated, and thus is prone
to errors.

Effect 1.) The warehouse and inventory control personnel are
operating independently. As a result, after the initial
inventory count, there was a difference of roughly a
million dollars in the recorded and actual inventory
amounts.

2.) There might be unrecognized errors which could
materially misstate the GL amounts

Recommendation
We recommend that the management should establish a system for responsible
employees to verify delivery, receipt, and storage of inventory. Create a paper trail of internal
documentation and cross-check to ensure items received and those on invoice are identical.
Confirm that a system of signing items out of inventory and into sales exists, that it requires
signature authorization and compliance is enforced as policy. Confirm that all shipments of
products are identical to invoiced sales documents. Adopt measures to ensure that inventory is
not reduced in company records until documentation is checked and items are shipped. Make
sure that shipping records are verified and costs for shipping are accounted for in costs of
goods sold. And to further ensure a strong inventory tracking and monitoring system, we also
recommend that the Purchases Dept. continue its effort to fully automate the entire inventory
system. This will enable the management to have a real-time view of the flow of the inventory
items in the company. But this system must be fully integrated with the Accounting Information
System of the company and it must also be accessed by only a limited number of authorized
company personnel.

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Management Response
Response Office of Primary
Interest
Timeline
A management committee meeting will be held
to discuss the full automation of the entire
inventory system. Capital budgeting decisions
will be considered weighing its pros and cons.
A cost-benefit analysis will also be done by the
Internal Audit Department.

The new fully-automated system will be
integrated with the current accounting
information system of the company.
Chief Executive
Officer, and all the
department heads

April 1 5, 2014






Obsolete Inventory Items
Term that refers to inventory that is at the end of its product life cycle and has not seen any
sales or usage for a set period of time usually determined by the industry. This type of
inventory has to be written down and can cause large losses for a company. Also referred to as
"dead inventory" or "excess inventory".

Large amounts of obsolete inventory are a warning sign for investors: they can be symptomatic
of poor products, poor management forecasts of demand, and poor inventory management.
Looking at the amount of obsolete inventory a company creates will give investors an idea of
how well the product is selling and of how effective the company's inventory process is.

Finding no. 3: Purchases did not have established policies and procedures for identifying and
disposing of obsolete inventory items.

Analysis
Condition Purchases did not have established policies and procedures for
addressing inventory obsolescence. On January 31, 2012, a number of
items appeared to be obsolete. There were printed forms and material
that were no longer used by the company.
Cause The company has not done its physical inventory count in the past six
years.
Effect The lack of policies and procedures for identifying and disposing obsolete
inventory increases the costs for storage and maintenance. It also
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ultimately reduces the recoveries the company may obtain when these
obsolete items are disposed.

Recommendation
The Purchasing Department must establish its own Inventory Obsolescence Policy
through a Material Review Board that would guide the company with regards to the timely
recognition of obsolete inventory, the necessary inventory adjustments, and its subsequent
dispositions. This policy shall also establish the departments responsibilities for the strict
conformance of these policies.

Management Response
Response Office of Primary
Interest
Timeline
A management committee meeting will be held
to discuss the formal establishment and
documentation of the companys Inventory
Obsolescence Policy.

The companys Material Review Board will guide
the company with regards to the timely
recognition of obsolete inventory, the necessary
inventory adjustments, and its subsequent
dispositions. It will also establish the
departments responsibilities.
Chief Executive
Officer, and all the
department heads

April 1 5, 2014






Inventory Reorder Points
The reorder point formula allows us to determine the safety stock (SS) needed to achieve a
certain cycle service level. In general, the longer the lead times are, and the greater the
variability of demand and lead times, the more safety stock we will need.



Lead Time- The amount of time that elapses between when a process starts and when it is
completed. Lead time is examined closely in manufacturing, supply chain management and
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project management, as companies want to reduce the amount of time it takes to deliver
products to the market. In business, lead time minimization is normally preferred.

Finding No. 4: Purchases did not perform periodic reviews of its reorder points to determine
whether inventory levels were adequate.

Analysis
Condition The inventory stock level reorder points established 20 years
ago remained unadjusted and unevaluated
Cause Purchases did not perform periodic reviews of inventory-
reorder points
Effect When the inventory supply is insufficient to meet the
Company demands, Purchases must make emergency buys
or agencies may purchase the items themselves without the
benefit of volume discounts.

Recommendation
We recommend that evaluation of the inventory stock level reorder points should be
done annually to prevent excess or shortages of inventory supply which may lead either to an
additional non-value added cost or loss of sale due to customer dissatisfactions. These
procedures must comprise of assessment of lead time demand, safety stock, and required
inventory stock level. The Purchase Department must consider the causes for the shortages and
adjust reorder points.

Management Response
Response Office of Primary
Interest
Timeline
The purchasing department will reevaluate the
inventory stock level reorder points starting at
the end of the next business year. The lead time
demand, safety stock, required stock level and
shortages will also be reevaluated.
Purchasing Dept.
Head, Marketing
Officer, and Inventory
Control Head

Every year starting
on December 31,
2014




Warehouse Catalog
A typical company can have a number of product types. Maintaining such a heterogeneous
inventory can get out of hand if it isn't tracked properly.

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Warehouse Catalogue allows us to get to know instantly all the types of products in the
company and promotes effective product management by tracking who owns which product.

Finding No. 5: Purchases did not maintain an up to date inventory catalog.
The last printing of the Companys inventory warehouse catalog was approximately 6
years ago.
Since that time, the Company has implemented just in time purchasing from a vendor,
and many of the supplies that agencies previously obtained from the warehouse are now
supplied by a vendor.

Analysis
Condition The inventory catalog was not maintained on a current basis.
Cause The last printing of the Companys inventory warehouse
catalog was approximately 6 years ago.
Effect Use of the outdated catalog causes requisitions to be
completed incorrectly, increasing the time and cost required
to fill agency requests.

Recommendation
We recommend that Purchases update its warehouse catalog. Besides, there must be an
implementation and development of management policy requiring an annual update of
inventory catalogs.

Management Response
Response Office of Primary
Interest
Timeline
We have already updated the warehouse
catalog few hours before the start of the exit
conference.
Purchasing Dept.
Head and Inventory
Control Head

Done



Inventory Warehouses
A warehouse is a commercial building for storage of goods. They usually have loading docks to
load and unload goods from trucks. Sometimes warehouses are designed for the loading and
unloading of goods directly from railways, airports, or seaports. They often have cranes and
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forklifts for moving goods, which are usually placed on ISO standard pallets loaded into pallet
racks. Stored goods can include any raw materials, packing materials, spare parts, components,
or finished goods associated manufacturing and production.

Finding No. 6: The inventory warehouse area was not clean and organized.

Analysis
Condition Purchases did not maintain a neat, clean and organized warehouse.
Inventory items were not always consistently labeled with inventory
numbers nor were they stored in an organized manner that would
facilitate an efficient retrieval. The facility lacks painting and has poor
lighting. Surplus property that appeared to be damaged or obsolete were
situated in at the center of the first floor.
Cause The company has not done its physical inventory count in the past six
years.
Effect The poor organization of the inventory and the lack of proper lighting and
storage of inventory items could lead to safety and fire hazards and
hinder the efficient operation of the warehouse.

Recommendation
The Purchasing department should find a way to store inventory items in an organized
manner and maintain the cleanliness of the warehouse, which must be documented in an
inventory layout plan for future reference. In addition, the facility has to be painted and the
lights replaced or improved. These, if implemented, shall promote efficiency and smoothness of
flow in retrieving the inventory, as well as the safe use of the warehouse.

Management Response
Response Office of Primary
Interest
Timeline
The Chief Executive Officer will visit the
Purchasing Departments Office and the
warehouses of the company to discuss possible
facility upgrades and improvements.
Chief Executive Officer
and Purchasing Dept.
Head

March 27 29,
2014





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UEVAS & Co.
CERTIFIED PUBLIC ACCOUNTANTS



Date : March 10, 2014
To : Management
From : Rieland J. Cuevas, Partner
Subject : Audit of the Inventory Department

Attached herewith is a draft of the report we plan to issue based on our findings
on the recent audit of TNC Company. The draft is issued in order to provide you the
opportunity to discuss the findings of our audit, present any additional documentation,
and for you to suggest changes, if any. The exit conference is available as an option
prior to the issuance of the final Audit Report.

If you would like to schedule an exit conference to discuss the contents of the
draft prior to distribution of the final report, please notify me. Otherwise, please provide
a written response by March 17, 2014 to the address provided below, or send it via
email at cuevasri_cpa@yahoo.com. The response should take the form of specific
action taken with respect to each finding and recommendation. If a response is not
received, the final report will be issued with the management responses detailed in the
draft report. A copy of the draft report is being forwarded to the applicable manager
requesting acknowledgement and review of the report.

Upon receipt of the Exit Conference Memorandum, the management may submit
a request for an exit conference.




C
12F Ayala Life FGU Center
Mindanao Ave. cor. Biliran Road
Cebu Business Park
Cebu City, Philippines 6000
+6332 421 9838 main
+6332 421 9837 fax
www.cuevasco.com
cuevas_co@cuevasco.com

BOA/PRC Reg. No. 0811
SEC Accreditation No. 0337-G

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Attachment

Request for an Exit Conference

Date: ______________________

Management Representative(s):
Name: ________________________________________________________________
Phone: _______________________________________________________________
Fax: __________________________________________________________________
Email: ________________________________________________________________

Name: ________________________________________________________________
Phone: _______________________________________________________________
Fax: __________________________________________________________________
Email: ________________________________________________________________

Name: ________________________________________________________________
Phone: _______________________________________________________________
Fax: __________________________________________________________________
Email: ________________________________________________________________

Name: ________________________________________________________________
Phone: _______________________________________________________________
Fax: __________________________________________________________________
Email: ________________________________________________________________

Name: ________________________________________________________________
Phone: _______________________________________________________________
Fax: __________________________________________________________________
Email: ________________________________________________________________

Signature: _________________________________ Date:____________________

Printed Name: __________________________________________________________

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