Chapter 21 Final

Chapter 21 Multiple-Choice Questions 1. easy b

Receipt of ordered materials by the receiving department will generate the completion of a form called the: a. bill of of lading. b. receiving report. c. mate materrials ials requi equisi sittion. ion. d. inven invento tory ry acqu acquisi isitio tion n summa summary ry..

2. easy c

The audit of ______ is often the most difficult and complex part of an audit. a. prop proper erty ty,, pla plant nt and and equ equip ipme ment nt b. cash c. inventory d. prepaid insurance

3. easy d

Inventory is a complex area to audit for all but which of the following reasons? a. Inve Invent ntor ory y is oft often en in in diff differ eren entt locat location ions. s. b. There are several acceptable valuation methods and some entities use different methods for different types of inventory. c. Invent Inventory ory is often often the the larg largest est acc accoun ountt in worki working ng capi capital tal.. d. Inve Invent ntor ory y valua valuatio tion n inclu include dess few est estima imate tes. s.

4. easy b

When labor is a significant part of inventory, verifying the proper accounting of these costs should be tested in the: a. inve invent ntor ory y and and ware wareho hous usin ing g cycl cycle. e. b. payroll and personnel cycle. c. acqu acquis isit itio ions ns and and pay payme ment ntss cycl cycle. e. d. cash cycle.

5. easy a

For retail and wholesale businesses, the most important inventory is: a. merc mercha hand ndis isee avai availa labl blee for for sale sale.. b. work-in-process. c. raw ma materials. d. inve invent ntor ory y held held on on con consi sign gnme ment nt..

6. easy b

The audit procedure “observe the client taking a physical inventory count and test the count” is sufficient to determine all of the following except: a. whet whethe herr recor recorde ded d inven invento tory ry actu actual ally ly exis exists ts.. b. whether recorded inventory was properly valued by the client. c. whethe whetherr record recorded ed inven inventor tory y was proper properly ly count counted ed by the the clien client. t. d. whethe whetherr client client invent inventory ory instr instruct uction ion had had proper properly ly been been followe followed. d.

7. easy d

In most manufacturing companies, the inventory and warehousing cycle begins with the: a. rece receip iptt of a cus custo tome mer’ r’ss o ord rder er.. b. completion of production of a customer’s order. c. initiati initiation on of produc production tion of a cust custome omer’s r’s order. order. d. acquis acquisitio ition n of raw raw materi materials als for for prod product uction ion of of an order order..

8. easy c

The audit tests to verify that the client is using an inventory method which is generally accepted and to verify that physical counts were correctly summarized are performed during the audit of the: a. acqu acquis isit itio ion n and and pay payment mentss cycl cycle. e.

Arens/Elder/Beasley Arens/Elder/Beasley

b. c. d. 9. easy a

payroll and personnel cycle. inve invent ntor ory y and and ware wareho hous usin ing g cycl cycle. e. sale saless and and coll collec ecti tion on cycl cycle. e.

Which of of th the fo following wo would be be an an ap appropriate in initiation of of a purchase re requisition?

a. b. c. d.

One initiated based on a periodic count of raw materials. Yes No Yes No

One initiated by stockroom personnel as raw materials are needed. Y es No No Y es

10. easy a

Almost all companies need physical controls over their assets to prevent loss. Which of the following is not an example of such a control? a. Perp Perpet etua uall inven invento tory ry mast master er file files. s. b. Segregated, limited-access storage areas. c. Custod Custody y of asse assets ts assig assigned ned to specif specific ic respo responsi nsible ble indi individ vidual uals. s. d. Approv Approved ed prenum prenumber bered ed docume documents nts for for authori authorizin zing g movemen movementt of inventory inventory..

11. easy d

Which department within a manufacturing company is often responsible for the review of production and scrap reports? a. Purchasing. b. Accounts Payable. c. Accounting. d. Production.

12. easy b

Handling the receipt of ordered goods is a part of the ________ cycle. a. purchasing b. acquisition and payment c. inventory d. inve invent ntor ory y and and ware wareho hous usin ing g

13. easy b

_________ accumulate costs by individual jobs as material is issued into production and labor costs are incurred. a. Just Just-i -inn-ti time me pro produ duct ctio ion n syst system emss b. Job order cost systems c. Process co cost sy system tems d. Manu Manuffactu acturring ing syst systeems

14. easy c

There must be a periodic physical count by the client of the inventory items on hand: a. only only if the clien clientt use usess the the LIFO LIFO met metho hod. d. b. only if the client uses a lower-of-cost-or-market method. c. regard regardles lesss of the client client’s ’s inve invento ntory ry valu valuatio ation n metho method. d. d. only if the the client client uses uses either either the LIFO LIFO or FIFO FIFO metho method. d.

15. easy d

With regard to the physical count of inventory, necessary control procedures include: a. prop proper er ins instr truc uctio tions ns for for the the phy physic sical al cou count. nt. b. independent third-party verification of the counts. c. third-party third-party reconciliat reconciliations ions of of the physical physical counts counts with with perpetua perpetuall inventory inventory master master files. files. d. countin counting g the the inven inventory tory only on the year-e year-end nd date. date.

16. easy c

If the auditor auditor conclude concludess that that phy physica sicall contro controls ls over over invent inventory ory are so inadeq inadequat uatee that that the inventory will be difficult to count, the auditor should ordinarily: a. with withdr draw aw from from the the eng engag agem emen ent. t. b. issue a qualified audit report.


c. d.

conduc conductt expand expanded ed obser observat vation ion test testss of phys physical ical inventor inventory. y. hire hire a spec specia ialis listt to assi assist st the the aud audito itor. r.

17. easy a

From which of the following evidence-gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories? a. Obse Observ rvat ation ion of of phys physica icall inven invento tory ry cou count nts. s. b. Written inventory representations from management. c. Confir Confirmat mation ion of invento inventorie riess in a publ public ic ware warehou house. se. d. Auditor Auditor’s ’s recom recomput putatio ation n of of inve invento ntory ry extens extension ions. s.

18. easy a

Johnson Co.’s physical count of inventories was lower than the inventory quantities shown in its perpetual records. This situation could be the result of the failure to record: a. sales. b. sales returns. c. purchases. d. pur purchas chasee dis discoun counts ts..

19. easy d

Which of the following is not a function within the inventory and warehousing cycle? a. Process the the goods. b. Store raw materials. c. Ship finish ished go goods. d. Proc Proces esss invo invoic ices es for for shi shipp pped ed good goods. s.

20. easy b

If an auditor were concerned with obtaining evidence about the appropriateness of the value of inventory, which of the following tests would be most appropriate? a. Comp Compil ilaation ion tes tests. ts. b. Price tests. c. Confir Confirmat mation ion of invento inventory ry held held by by outs outside ide parties parties.. d. Phys Physica icall exam examina inatio tion n of the inve invento ntory ry..

21. easy b

Which of the following is the best audit procedure for the discovery of damaged merchandise in a client’s ending inventory? a. Compar Comparee the physica physicall quantitie quantitiess of slow-mov slow-moving ing items items with corres correspon pondin ding g quantitie quantitiess of the prior year. b. Observe merchandise and raw materials during the client's physical inventory count. c. Review Review the manag manageme ement’ nt’ss inventor inventory y repres represent entatio ation n letter letter for accur accuracy acy.. d. Test overa overall ll fairness fairness of inventory inventory values values by compar comparing ing the company’s company’s turnov turnover er ratio ratio with the industry average.

22. medium c

Which of the following controls would be appropriate regarding the release of materials from a stockroom? a. Prod Produc uctio tion n employ employee eess requ reques estt mate materi rial alss be delive delivere red d to thei theirr work work areas areas as they they need need them. b. Stockroom employees deliver materials to work areas throughout the day to maintain acceptable levels of safety stock – no written records are maintained. c. Produc Production tion employ employees ees subm submit it appro approved ved requ requisit isition ion form formss to the the stockr stockroom oom for for mater material ialss needed. d. Prod Produc uctio tion n employ employer er in need need of materi material alss should should perso persona nally lly pick pick up need needed ed mater materia ials ls from the stockroom.

23. medium d

Who should maintain the perpetual inventory master files? a. Prod Produc ucti tion on pers person onne nel. l. b. Inventory storeroom personnel. c. Inve Invent ntor ory y rece receiv ivin ing g pers person onne nel. l. d. Acco Accoun untin ting g depa depart rtme ment nt pers person onne nel. l.


24. medium a

The inventory and warehousing cycle can be thought of as having two separate but closely related systems, one involving the actual physical flow of goods, and the other the: a. related co costs. b. storage of the goods. c. inter interna nall con contr trol ol over over thos thosee goo goods ds.. d. preven prevention tion of waste, waste, obs obsole olesce scence nce,, and and theft. theft.

25. medium c

In any company involved in manufacturing, an adequate cost accounting internal control system is necess necessary ary to indica indicate te the relati relative ve profit profitabi ability lity of the variou variouss produc products ts for manage management ment planning and control and to: a. deter determin minee var varia ianc nces es from from stan standa dard rds. s. b. determine variances from budgets. c. value value inve inventor ntories ies for financ financial ial stateme statement nt purp purpose oses. s. d. value value inv inven entor torie iess for for audit audit ver verif ific icat ation ion..

26. medium c

Master files, worksheets, and reports that accumulate material, labor, and overhead as the costs are incurred are: a. accounting ting sy system tems. b. storeroom documents. c. cost cost ac accoun counti ting ng re record ords. d. finis finishe hed d goo goods ds inven inventor tory y rec recor ords ds..

27. medium b

The main difference between job order and process costing systems is that: a. one accu accumula mulates tes costs costs by by materi materials als issue issued d and the the other other by labor labor incur incurred red.. b. one accumulates costs by individual jobs and the other by particular processes. c. one emphas emphasize izess costs accum accumula ulated ted in complete completed d product productss and the other other emphasiz emphasizes es costs costs associated with work-in-process. d. one emphasi emphasizes zes costs costs adding adding value to the product product and the other other emphas emphasizes izes costs costs incurr incurred ed because of waste, scrap, and obsolescence.

28. medium d

A well-designed computerized system of perpetual inventory master files includes information about the: a. units units o off inve invento ntory ry purcha purchased sed,, sold, sold, and on hand. hand. b. unit costs of inventory purchased, sold, and on hand. c. units units of raw raw mater materials ials,, work-i work-in-p n-proc rocess ess,, and finis finished hed goo goods. ds. d. units units and unit unit costs costs of inve inventor ntory y purcha purchased sed,, sold, sold, and on on hand. hand.

29. medium a

Which of the following following is a significant significant audit concern concern related to the transfer transfer of inventory from one location to another? a. Reco Record rded ed tra trans nsfe fers rs occ occur urre red. d. b. Transfers were properly transported. c. Tran Transf sfer erss were were prop proper erly ly plan planne ned. d. d. Transf Transfers ers repres represent ent efficie efficient nt move movemen mentt of assets assets..

30.

When may auditors observe the physical inventory count?

medium a

31. medium d

a. b. c. d.

At an interim date Ye s No Yes No

At year-end Y es No No Y es

Which of the following is not an aspect of concern when auditing the cost accounting system? a. Unit cost records. b. Physical controls over inventory. c. Docume Documents nts and record recordss for for trans transfer ferrin ring g inven inventor tory. y.


d.

Safegu Safeguard arding ing the the raw mater material ialss from from point point of recei receipt pt to the the storer storeroom oom..

32. medium a

The auditor’s tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods must be restricted to: a. obse obserrvati vation on and and inq inqu uiry iry. b. documentation and observation. c. docu docume ment ntat atio ion n and and conf confir irma mati tion on.. d. docu docume ment ntat atio ion n and and inqu inquir iry y.

33. medium a

It is frequently possible to test the physical inventory prior to the balance sheet date when: a. there there are are accu accurate rate perpet perpetual ual invent inventory ory master master files. files. b. year-end sales are small. c. the interna internall control control system system is no better better at year-en year-end d than than at an an earlier earlier point in time. time. d. the clie client nt coun counts ts inve invento ntory ry at at inter interim im date dates. s.

34. medium d

Tests of the perpetual inventory master files for the purpose of reducing the tests of physical inventory or changing their timing are done through the use of: a. inquiry. b. observation. c. confirmation. d. documentation.

35. medium c

A major difficulty i n the verification of inventory cost records is determining reasonableness of: a. dire direct ct labo labor’ r’ss hou hourl rly y rat rate. e. b. raw materials per unit cost. c. cost alloc location ions. d. numb number er of dire direct ct lab labor or hour hourss appl applie ied. d.

36. medium d

When auditing the inventory and warehousing cycle, the use of analytical procedures is: a. not not imp impor orta tant nt for for thi thiss cy cycle. cle. b. less important than for any other cycle. c. more more impo import rtan antt than than for for any any oth other er cycle cycle.. d. as impo import rtan antt as the their ir use use in in any any othe otherr cycle cycle..

37. medium c

Which one of the following analytical procedures would be most helpful in alerting the auditor to the possibility of obsolete inventory? a. Compar Comparee gross gross margin margin perce percentag ntagee with with prev previou iouss y year ears’. s’. b. Compare unit costs of inventory with previous years’. c. Compar Comparee invent inventory ory turnov turnover er ratio ratio with previou previouss y year ears’. s’. d. Compar Comparee curre current nt year year manufa manufactu cturing ring costs costs with with previ previous ous year years’. s’.

38. medium a c

Which of the following statements is correct regarding the auditor’s responsibility with respect to the year-end inventory procedures of an audit client?

a. b. c. d. 39. medium a

The auditor is responsible for reconciling the physical count with the perpetual inventory matter files. Yes No Yes No

The auditor is responsible for taking and compiling the inventory. No No No Yes

The auditor is responsible for observing the physical counting of inventory. No Yes Y es No

McKesson & Robbins Company is a well-known audit case involving auditor responsibility. What occurred at the McKesson & Robbins Company to change the way in which auditors audit inventory?


a. b. c. d.

The The compa company ny reco record rded ed none nonexis xiste tent nt inve invent ntor ory. y. The auditor did not perform any audit tests of the inventory. The audi auditor tor and and compa company ny collud colluded ed to overs overstate tate inve invento ntory ry balan balances ces.. The comp company any coun counted ted inve inventor ntory y three three month monthss prior prior to to year-e year-end. nd.

40. medium c

When a phys physical ical count of inventory inventory is performed performed at an interim interim date, the auditor observes observes it at that time and t ests the perpetual records for transactions: a. thr throughout the the ye year. b. which are a representative sample of the period under audit. c. from from the the date date of the the cou count nt to year year-en -end. d. d. from from the date date of the count count to the end of the the audit audit fiel field d work. work.

41. medium b

When there are no perpetual inventory files and inventory is material: a. an audit audit cann cannot ot be perf perform ormed, ed, so so the audit auditor or must must issue issue a disc disclaim laimer er.. b. a physical inventory should be taken by the client near year-end. c. the audito auditorr will have have to perfor perform m the invent inventory ory coun countt and deter determine mine valua valuation tion.. d. the audi auditor tor need need not not observ observee inventor inventory y counts counts but but must do do test test counts counts..

42.

Auditor tor tes tests of physica ical co contro trols over raw ma mater terials ials,, work-inin-process, an and fin finiished go goods are performed by:

medium d

a. b. c. d.

Examination Ye Yes No Yes No No

Observation No Yes Ye s No

Inquiry Y es No No Y es

43. medium d

The most important part of the observation of inventory is to determine whether: a. all all cou count ntss are are accu accura rate te.. b. the inventory-takers are qualified. c. obso obsolet letee inve invent ntor ory y has has been been ide identi ntifi fied ed.. d. the physica physicall count count is being taken in accor accordance dance with the the client’ client’ss instructi instructions. ons.

44. medium d

A useful starting point for becoming familiar with the client’s inventory is for the auditor to: a. read read the AICPA AICPA’s ’s Indu Indust stry ry Audi Auditt Guid Guide. e. b. review accounting theory covering special problems, such as gas and oil accounting, or lease-purchase agreements. c. read read the clien client’ t’ss Acc Accou ounti nting ng Manu Manual al.. d. tour tour the the cli clien ent’ t’ss fac facil ilit ity y.

45. medium a

A common inventory observation procedure is to select a random sample of tag numbers and identify the tag with that number attached to the actual inventory item. The audit objective being achieved by this procedure is: a. invento inventory ry as as recor recorded ded on on tags tags actua actually lly exist existss (exist (existenc ence). e). b. existing inventory is counted and tagged (completeness). c. inven invento tory ry is coun counte ted d accur accurate ately ly (acc (accur urac acy) y).. d. invento inventory ry is is class classifi ified ed corr correc ectly tly (cla (classi ssific ficati ation) on)..

46. medium c

If a client intends to count inventory at an interim date, the auditor should expect there to be all of the following except: a. controls controls over over the preparatio preparation n and maintenance maintenance of perpe perpetual tual inventory inventory recor records. ds. b. competent personnel assigned to count the inventory. c. third third-p -par arty ty inven invento tory ry coun countin ting g speci special alist ists. s. d. an adeq adequat uately ely design designed ed plan plan to coun countt the invento inventory ry..

47.

A co common in inventory ob observation pr procedure is is to to be be al alert fo for it items th that ar are da damaged, ru rust- or or


medium c

dust-cover dust-covered, ed, or located located in inappropr inappropriate iate places. places. The balance-re balance-related lated audit objective objective being achieved by this procedure is: a. classification. b. cutoff. c. realiz lizable value. d. rights.

48. medium d

The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been deleted is associated with the audit objective of: a. accuracy. b. existence. c. detail ti tie-in. d. completeness.

49. medium d

The test of details of balance procedure which requires the auditor to perform tests of lower-ofcost-or-market, selling price, and obsolescence is an attempt to satisfy the objective of: a. existence. b. completeness. c. accuracy. d. realiz lizable value.

50. medium a

Most of the audit testing of the storage of finished goods as well as the shipment of merchandise takes place during the testing of the: a. sale saless and and coll collec ecti tion on cycl cycle. e. b. payroll and personnel cycle. c. acqu acquis isit itio ions ns and and pay payme ment ntss cycl cycle. e. d. inven invento tory ry and and ware wareho hous using ing cycle cycle..

51. medium b

The auditor’s main concerns in verifying t ransfers of inventory do not include whether: a. reco record rded ed tran transf sfer erss exis exist. t. b. transfers represent appropriate appropriate uses of company resources. c. all all act actua uall tra trans nsfe fers rs are are rec recor orde ded. d. d. the details details of the the tra transf nsfer er are are acc accura urately tely record recorded. ed.

52. medium c

After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items: a. includ included ed in in the the list listing ing have have bee been n coun counte ted. d. b. represented by inventory tags actually exist. c. repres represent ented ed by inventor inventory y tags tags are are inclu included ded in the the listing listing.. d. includ included ed in the list listing ing are are repr represe esente nted d by inven inventor tory y tags. tags.

53. medium d

Auditors test the quantity of materials charged to work-in-process by tracing these quantities to: a. cost ledgers. b. perpetual inventory records. c. receiving ing re reports. d. mate materrial ial requ requis isit itio ion ns.

54. medium a

Which of the following situations would most likely require special audit planning? a. Inve Invent ntor ory y con consis sists ts of prec precio ious us sto stone nes. s. b. Some items of factory and office equipment do not bear identification numbers. c. Depreciation Depreciation methods methods us used ed on the client’ client’ss tax return return differ differ from from those those used on the the books. books. d. Ass Assets ets costin costing g less than than $500 $500 are expen expensed sed even even though though their their expec expected ted life life exceeds exceeds one one year.

55.

For several years, a clie lient’s physica ical inv inventor tory count has been lower than what was shown on


medium a

the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal control that led to the failure to adjust the accounting records for some: a. purc purcha hase sess retu return rned ed to to vend vendor ors. s. b. sales returns received. c. sale saless d dis isccount ountss all allow owed ed.. d. cash pu purchases.

56.

The physi ca cal co counting of inventory may be performed at which of the following times?

medium a

a. b. c. d.

Interim dates Ye s No Yes No

On a cycle basis during the year Y es No No Y es

57. medium c

When an auditor observes that personnel who are responsible for physically counting inventory are not following the inventory instructions, the auditor should: a. contac contactt a client client’s ’s super superviso visorr in an attem attempt pt to corr correct ect the the probl problem. em. b. modify the client’s physical inventory instructions. c. not discus discusss the problem problem with with client’s client’s supervisor supervisor in order order to maintain maintain independe independence. nce. d. assig assign n audit audit staf stafff to the the inve invento ntory ry coun count. t.

58. medium b

The auditor’s objective during an observation of a client’s physical inventory count is to: a. discover discover whether whether a client client has has counted counted a particula particularr inventory inventory item or or group group of of items. items. b. obtain direct knowledge that the inventory exists and has been properly counted. c. provide provide an appraisal appraisal of the the quality quality of the mercha merchandise ndise on hand hand on the day day of the physic physical al count. d. allow the auditor auditor to supervis supervisee the conduct conduct of the count count so so as to obtain obtain assura assurance nce that that inventory quantities are reasonably accurate.

59. medium a

The audit of year-end physical inventories should include steps to verify that the client’s purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a: a. sale sale in the the curr curren entt per perio iod. d. b. sale in the subsequent period. c. purc purcha hase se in in the the curr curren entt peri period od.. d. purc purcha hase se ret retur urn n in the the sub subse sequ quen entt peri period od..

60. medium b

Which one of the following procedures would not be appropriate for an auditor in discharging his responsibilities concerning the client’s physical inventories? a. Confir Confirmat mation ion of goo goods ds in the hands hands of of publ public ic ware warehou houses ses.. b. Supervising the taking of the annual physical inventory. c. Carryi Carrying ng out phy physic sical al invent inventory ory proc procedu edures res at at an inter interim im date. date. d. Obtaining Obtaining written written representa representation tion from from the the client client as to the the existence existence,, quality, quality, and and dollar dollar amount of the inventory.

61. medium d

Pricing manufactured inventory is difficult. Auditors must evaluate the method of allocating manufacturing overhead for all but which of the following? a. reasonableness. b. computational correctness. c. adhe adhere renc ncee to FAS FASB B pron pronou ounc ncem emen entt d. consistency.

62. medium

If the perpetual inventory master files show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded:


c

a. b. c. d.

63. easy b

Which of the following is not a generally recognized inventory method? a. FIFO b. LOFO c. LIFO d. Spec Specif ific ic ide identif ntific icaation tion

64. medium b

Which of the following control procedures would most likely be used to maintain accurate perpetual inventory records? a. Indepe Independe ndent nt storer storeroom oom count count of goo goods ds receiv received. ed. b. Periodic independent comparison of records with goods on hand. c. Periodi Periodicc indepen independen dentt reconci reconcilia liation tion of contr control ol and subsid subsidiar iary y records records.. d. Independen Independentt matching matching of purchase purchase orders, orders, receivin receiving g reports, reports, and vendor vendors’ s’ invoice invoices. s.

65. challenging c

Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which: a. materia materials ls are are ordere ordered d for purc purchas hasee until until the finis finished hed prod product uct is sold sold.. b. the customer’s order is received until the finished product is shipped. c. raw mater materials ials are are requi requisiti sitione oned d until until the finish finished ed produc productt is sent to stor storage age.. d. raw materia materials ls are requisitione requisitioned d until until the finished finished product product is complete completely ly manufac manufactured. tured.

66. challenging d

In valuing inventory, the auditor must consider all but which of the following factors? a. The valuat valuation ion method method mus mustt be in acco accorda rdance nce with GAAP. GAAP. b. The valuation method must be applied on a consistent basis. c. The inve inventor ntory y must must be valu valued ed at at the lower lower of cost cost or mark market. et. d. All inven inventor tory y must be be valued valued using using the the same same valua valuation tion meth method od under under GAAP. GAAP.

67. challenging c

Controls which provide a means of ensuring that the physical counts are properly summarized, priced at the same amount as the unit records, correctly extended and totaled, and included in the general ledger at the proper amount are known as: a. sta standa ndard cos costt con contr tro ols. ls. b. pricing internal controls. c. comp compil ilat atio ion n inte intern rnal al con contr trol ols. s. d. coun countt quan quantit tity y inter interna nall con contr trols ols..

68. challenging c

Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using first-in, first-out (FIFO). If the most recent acquisition of inventory was for 600 units at $10 per unit and the immediately preceding acquisition was for 700 units at $9 per unit, the inventory item is in error and it is: a. understate tated d $400. b. understated $300. c. overstated $4 $400. d. overstate tated d $700. Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using LIFO. If the most recent acquisition of a layer of inventory was for 600 units at $10 per unit and the immediately preceding layer was for 700 units at $9 per unit, the inventory item is in error and it is: a. understate tated d $700. b. understated $300. c. overstated $4 $400. d. overstate tated d $700.

69. challenging d


sales. sales discounts. purchases. pur purchas chasee dis discoun counts ts..

70. challenging c

When an outside specialist has assumed full responsibility for taking the client’s physical inventory, reliance on the specialist’s report is acceptable if: a. the auditor auditor’s ’s repor reportt contains contains a refer reference ence to the the assumptio assumption n of full responsibility responsibility.. b. the auditor is satisfied through application of appropriate procedures as to the reputation and competence of the specialist. c. the auditor auditor conducted conducted the the same same audit audit tests tests and and procedu procedures res as as would would have have been been applicab applicable le if the client’s employees took the physical inventory. d. circumstanc circumstances es made made it imprac impracticable ticable or impossib impossible le for for the auditor auditor either either to do the work personally or observe the work done by the inventory firm.

71. challenging b

To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditor should review and test the: a. term termss of the the open open purc purcha hase se orde orders rs.. b. purchase cutoff procedures. c. contra contractu ctual al commit commitmen ments ts made made by by the the purch purchasi asing ng depa departme rtment. nt. d. purcha purchase se invoi invoices ces receiv received ed on on or aroun around d year year-end -end..

72. challenging a

Hardy Company mass-produces eight different products. The controller who is interested in strengthening internal controls over the accounting for materials used in production would be most likely to implement a(n): a. perp perpet etua uall inv inven ento tory ry syst system em.. b. job order cost accounting system. c. econ econom omic ic ord order er qua quant ntit ity y syst system em.. d. separa separation tion of duti duties es among among prod product uction ion person personnel nel..

73. challenging d

Which of the following is an internal control weakness for a company whose inventory of supplies consists of a large number of individual items? a. The The cycle cycle basi basiss is used used for for phys physica icall coun counts ts.. b. Supplies of relatively little value are expensed when purchased. c. Perpetual Perpetual invento inventory ry recor records ds are are maintained maintained only for items of signif significant icant value. value. d. The storek storekeeper eeper is respon responsible sible for maintenanc maintenancee of perpetual perpetual inventory inventory records. records.

74. challenging c

When auditing a public warehouse, which of the following is the most important audit procedure with respect to disclosing unrecorded liabilities? a. Obse Observ rvat atio ion n of inve invent ntor ory y. b. Review of outstanding receipts. c. Inspec Inspection tion of recei receiving ving and issuin issuing g proc procedu edures res.. d. Confir Confirmat mation ion of negotia negotiable ble receip receipts ts with with holder holders. s.

Essay Questions 75. easy

What are two factors affecting the complexity of the audit of inventory? Answer: Inventory is often the largest account in the working capital. Inventory is often in different locations. Diverse items in inventory are often difficult to value. Inventory valuation is difficult due to the estimates involved. There There are severa severall accept acceptabl ablee method methodss of valuin valuing g invent inventory ory and som somee entitie entitiess use different methods for different types of inventory. • • • • •

76. easy

The basis for the auditor’s verification of inventory pricing and compilation is the client’s inventory listing. Describe the information that should be included in this listing.


Answer: The inventory listing should include each inventory item’s description, quantity, unit price, and extended value.

77. medium

In pricin pricing g invent inventory ory,, it is necess necessary ary to consid consider er whethe whetherr replac replaceme ement nt cost cost is lower lower than than historical cost. When applying lower of cost or market tests, what basis should auditors use for each of the following categories of inventory: Raw materials Work-in-process Purchased finished goods • • •

Answer: •

•

•

78. medium

Raw materials – the most recent cost as found on vendor invoices from the period subsequent to year-end Work-in-process – all manufacturing costs from production records from the period subsequent to year-end Purchased finished goods – the most recent cost as found on vendor invoices from the period subsequent to year-end and the sales value of these goods

What must auditors do to meet their obligations under professional auditing standards related to the observation of inventory? Answer: Be presen presentt at the time the client client counts counts their their inventor inventory y for determ determinin ining g year-e year-end nd balances. Observe the client’s counting procedures. Make inquiries of client personnel about their counting procedures. Make their own independent tests of the physical counts. •

• • •

79. medium

Discuss the auditor’s responsibilities for inventory maintained in public warehouses or with other outside custodians.

80. medium

Answer: Ordinarily the auditor will confirm inventory held by outside custodians. However, the auditor may perform additional procedures if the amounts involved are significant. These additional additional procedure proceduress may include: include: an investigation investigation of the custodian’ custodian’ss performan performance, ce, requesting an independent accountant’s report on the custodian’s control procedures over the custody of goods, and observing the t he physical count of goods held by the custodian. Discus Discusss the four aspects aspects of the audit of cost cost accoun accounting ting with which which the auditor auditor is mos mostt concerned. Answer: The auditor is most concerned with: Physical controls controls over inventory. inventory. •

Documents and records for transferring inventory. The auditor’s auditor’s primary primary • concerns concerns in verifying verifying the transfer transfer of inventory from one location location to another another are that the recorded transfers exist, the transfers that have actually taken place are recorded, and the quantity, description, and date of all recorded transfers are accurate. Perpetual inventory master files. The adequacy of perpetual inventory master files has a major effect on the timing and extent of the auditor’s physical examination of inventory. Unit cost records. •

•


81. medium

Identify three analytical procedures commonly used when auditing accounts in the inventory and warehousing cycle. Answer: Common analytical procedures for the inventory and warehousing cycle include: Compare gross margin percentage with previous years’. Compare inventory turnover ratio with previous years’. Compare unit costs of inventory wi th previous years’. Compare extended inventory value with previous years’. Compare current-year manufacturing costs with previous years’. • • • • •

82. medium

Discuss the methodology for designing t ests of details of balances for inventory. Answer: The methodology for designing tests of details of balances for inventory is: 1. Set materiality, materiality, and assess assess acceptable acceptable audit risk and inheren inherentt risk for the inventory inventory and warehousing cycle. 2. Assess Assess control control risk for several several cycles. cycles. This risk is assessed assessed for the inventory inventory and warehousing cycle, sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle. 3. Design Design and perfor perform m tests tests of contro controls ls and sub substa stantiv ntivee tests tests of transa transactio ctions ns for several cycles. 4. Design Design and perfor perform m analyt analytica icall proced procedure uress for the invento inventory ry and warehou warehousing sing cycle. 5. Design Design tests of details details of invent inventory ory to satisf satisfy y balanc balance-r e-rela elated ted audit objective objectives. s. Design sample size, timing of tests, items to select for testing, and audit procedures to be performed.

83. medium

The design of tests of details of balances for inventory is affected by audit results from multiple cycles. Identify the cycles, other than the inventory and warehousing cycle that affect the audit of inventory. Answer: Tests of details of balances for inventory are affected by the results of tests of controls and substantive tests of transactions in the sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle, as well as the inventory and warehousing cycle.


84. medium

Discuss the key control procedures relating to the client’s physical count of inventory. Answer: The key control procedures relating to the client’s physical count of inventory include proper instructions for the physical count, supervision by responsible personnel, independent internal verification of the counts, independent reconciliations of the physical counts with perpetual inventory master files, and adequate control over count sheets or tags.

85. medium

Explain Explain why the audit of work-in-pr work-in-proces ocesss and finished goods inventory is generally generally more complex than the audit of purchased inventory. Answer: The need to verify the cost of raw materials, direct labor, and manufacturing overhead in pricing work-in-process and finished goods has the effect of making the audit of work-in process and finished goods inventory more complex than the audit of purchased inventory.

86. medium

What types of tests are available to an auditor who wishes to test the physical control over inventory? Answer: The auditor may either use observation or inquiry to obtain evidence about the physical control over inventory.

87. challenging

State the six functions that make up the inventory and warehousing cycle and, for each function, identify the related documents and/or records t hat would be used by a manufacturing company. Answer: The six functions are: Process purchase orders. Related documents are the purchase requisition and the purchase order. •

Receive raw materials. Related documents are the receiving report and the vendor’s invoice. •

Store raw materials. Related Related record record is the raw materials materials perpetual inventory master file. •

Related documents documents and records are the raw materials materials Process the goods. Related requisition and the cost accounting records.

•

Related record recordss are the finish finished ed goo goods ds perpet perpetual ual Store finished goods. goods. Related inventory master file and the cost accounting records.

•

Related d docume documents nts and recor records ds are the shippi shipping ng Ship Ship finis finished hed goods. goods. Relate document, the finished goods perpetual inventory master file, and the cost accounting records. •


88. challenging

The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor. Answer: The five parts are: Acquire and record raw materials, labor, and overhead. This is tested during the audits of the acquisition and payment cycle, and the payroll and personnel cycle.

•

This is tested tested in the inventor inventory y and Internally transfer assets and costs. This • warehousing cycle. Ship goods, and record revenue and costs. This is tested during the audit of the sales and collection cycle.

•

•

Physically observe inventory. This is tested in the inventory and warehousing

cycle. •

Price and compile inventory. This is tested in the inventory and warehousing

cycle.

Other Objective Answer Format Questions 89. easy b

Auditors have been required to perform physical observation tests of inventory since the early 1990s. a. True b. False

90. easy b

Perpetual inventory records should be maintained b y persons have access to inventory. a. True b. False

91. easy b

Internal controls over the ship finished goods function in the inventory and warehousing cycle are not normally tested by the auditor as a part of performing tests of controls and substantive tests of transactions in the sales and collection cycle. a. True b. False

92. easy b

In the audit of inventory, the auditor and client are jointly responsible for making and recording the count of physical inventory; while the auditor is responsible for drawing conclusions about the adequacy of the physical inventory. a. True b. False

93. easy a

94. easy b

The audit procedure “Perform tests of lower-of-cost-or-market, selling price, and obsolescence” provides assurance mainly for the realizable value objective for inventory pricing and compilation. a. True b. False In process costing systems, costs are accumulated by individual jobs. a. True b. False

95. easy a

In job cost systems, costs are accumulated by individual jobs. a. True b. False


96. easy b 97. easy a

An approved purchase requisition form authorizes shipment of goods to customers. a. True b. False The receipt of raw materials is a part of the acquisition and payment cycle. a. True b. False

98. easy b

When finished goods are completed, they are usually stored in the packing area. a. True b. False

99. easy b

When performing price tests for purchased inventory, the auditor would not be concerned with the most recent vendors’ invoices if the client uses the FIFO valuation method. a. True b. False

100. easy a

A comparison of the current year’s inventory turnover ratio with previous years’ may indicate the presence of obsolete inventory. a. True b. False

101. easy a

To test for proper sales cutoff, an auditor would obtain the number of the last bill of lading issued during the period under audit and verify that the item shipped had been excluded from the inventory listing. a. True b. False

102. easy b

If the perpetual inventory master files show lower quantities of inventory than the physical count, one explanation of the difference might be unrecorded sales. a. True b. False

103. medium a

It is acceptable under generally accepted accounting principles for a company to use different valuation methods for different parts of it s inventory. a. True b. False

104. medium a

Internal controls over the processing of purchase orders function, the receipt of raw materials function, and the storage of raw materials function in the inventory and warehousing cycle are normally tested by the auditor as a part of performing tests of controls and substantive tests of transactions in the acquisition and payment cycle and the payroll and personnel cycle. a. True b. False

105. medium a

The major considerations in evaluating the reasonableness of cost allocations are compliance with GAAP and consistency with prior years. a. True b. False

106. medium a

When verifying the transfer of inventory from one location to another, the audit objectives with which the auditor is primarily concerned are occurrence of recorded transfers, completeness of recorded transfers, and accuracy of recorded transfers. a. True b. False


107. medium b

When the client’s perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date. a. True b. False

108. medium a

When part of the client’s inventory is in a public warehouse or in the possession of other outside custodians, custodians, the auditor does not need to observe a phys physical ical count of the inventory if a written confirmation is obtained directly from the inventory custodians. a. True b. False

109. medium b

The audit procedure “Foot the inventory listing schedules for raw materials, work-in-process, and finished goods” provides assurance mainly for the accuracy objective for inventory pricing and compilation. a. True b. False

110. medium b

The audit procedure “Account for unused tag numbers shown in the auditor’s working papers to make sure no tags have been added” provides assurance mainly for the existence objective for inventory pricing and compilation. a. True b. False

111. medium a

When performing audit tests of pricing and compilation for inventory, the client’s perpetual inventory master file may be used in place of vendors’ invoices if controls over the perpetual inventory master file are adequate. a. True b. False

112. medium b

Production Production personnel personnel should ordinarily ordinarily be responsible responsible for maintaining maintaining perpetual perpetual inventory inventory records. a. True b. False

113. medium a

The extent extent and timing timing of an auditor auditor’s ’s phy physic sical al examina examination tion of invento inventory ry is signif significa icantly ntly influenced by the adequacy of the client’s perpetual inventory records. a. True b. False

114. challenging a

While separate perpetual inventory records are normally kept for raw materials and finished goods, most companies do not use perpetuals for work-in-process. a. True b. False

115. challenging b

Inherent risk is typically assessed at a moderate level for inventory due to the nature of the asset. a. True b. False


Chapter 21 Final

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