Chapter 12 Audit: Inventories and Cost of Goods sold

Which of the following is least likely to be an accurate statement concerning characteristics of an audit? A. An analysis of inventory turnover addresses whether the proper method of determining inventory costs-as contrasted to market values-is being applied. b. Characteristics of the double entry bookkeeping system make it possible to test for overstated sales when tests of accounts receivable are being performed c. The direction of tests of overstated errors is generally directed from the recorded entry to source documents d. Us of a perpetual rather than a periodic inventory system is likely to affect the nature of cutoff errors made at year-end

A. An analysis of inventory turnover addresses whether the proper method of determining inventory costs-as contrasted to market values-is being applied.

The receiving department should accept only goods for which there is an approved purchase order on hand True / False

True

Andy Watson, CPA, is a senior auditor on the audit of Carlson, Inc. Andy is reviewing the results of analytical procedures related to inventory. For results (a), (b), and (c), select the explanation that is most likely to be consistent with the change described. Explanations may be used once, more than once, or not at all. (1) Inventory increased as of year-end. (2) Debt outstanding increased. (3) A larger percentage of sales occurred during the last month of 20X8, as compared to 20X7. (4) Interest expense increased during 20X8 due to the acquisition of new debt. (5) The percentage tax included in the provision for income taxes for 20X8 is less than the percentage used in 20X7. (6) Increases in costs of purchases were not completely passed on to customers through higher selling prices. (7) Owners' equity increased due to retention of profits. (8) Interest expense increased during 20X8. (9) A significant amount of long-term debt became current at the end of 20X8. a. Inventory turnover (as measured by cost of goods sold/ending inventory) went from 7.95 in 20x7 to 10.52 in 20x8. Which of the explanations is consistent with the change in inventory turnover? b. Net income increased in 20x8. Which of the explanations is most consistent with the changes in net income? c. The gross profit percentage (gross profit/revenue) changed from .166 in 20x7 to .154 in 20x8. Which of the explanations is consistent with the change in gross profit percentage?

a. 3 b. 5 c. 6

When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably: a. Want the client to schedule the physical inventory count at the end of the year. b. Insist that the client perform physical counts of inventory items several times during the year. c. Increase the extent of tests for unrecorded liabilities at the end of the year. d. Have to disclaim an opinion on the income statement for that year.

a. Want the client to schedule the physical inventory count at the end of the year.

inventories

1) goods on hand ready for sales, whether the merchandise of a trading concern or the finished goods of manufacturer. 2) goods in the process of production 3) goods to be consumed directly or indirectly in production, such as raw materials, purchased parts, and supplies

Aspects of concern to the auditors include management's assessment of risks related to

1) the availability of a supply of goods, services and skilled labor; 2) the stability of prices and labor rates, 3) the generation of sufficient cash flow to pay for purchases, 4) changes in technology that affect manufacturing processes, and 5) the obsolescence of inventory.

The examination of warehouse receipts is not sufficient verification of a material amount of goods stored in public warehouses. True / False

True

The lower-of-costs-or-market test by the auditors is generally designed to assure that inventories are not valued above their net realizable values. True / False

True

Job time tickets

are prepared to document the labor or machine hours devoted to a particular production job. Each job time ticket should be reviewd and approved by the department supervisor before it is entered into the cost accounting system.

Production orders

are prepared to authorize the production of specific products

Master production schedule

overall production should be controlled with a master production schedule that presents the gross production needs for a particular period. Because the schedule is developed based on forecasts of demand for the company's products, it helps to ensure the company will meet its customers needs, while not overstocking particular products.

Inventory turnover ratio

= average inventory / COGS

A client uses a perpetual inventory system. Would one expect a credit to which of the following accounts at the point of sale? Sale Inventory A. Yes Yes B. Yes No C. No Yes D. No No

A. Option A, yes yes

In verifying credits to perpetual inventory records of a nonmanufacturing firm, the auditor would be most interested in examining the: A. Shipping documents b. Receiving reports c. Purchase orders d. Vendors' invoices

A. Shipping documents

An auditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the inventory summary sheets. Which assertion does this procedure related to most directly? A. Completeness b. Existence c. Legality d. Valuation

A Completeness

Purchase order

A copy of the requisition is sent to the purchasing department to provide a basis for preparing the serially numbered purchase order.

A receiving department compares inventory items received with copies of purchase orders. The purchase orders list the name of the vendor and do not list the quantities of the material ordered. Using the purchase orders, the receiving departments is most likely to detect: A. Deliveries for which no purchase order was issued b. Unapproved sales orders c. Partial deliveries d. Deliveries of a greater quantity of items than those ordereed

A. Deliveries for which no purchase order was issued.

Which of the following audit procedures most likely would provide assurance that a manufacturing entity's inventory valuation is proper? A. Testing the entity's computation of standard overhead rates b. Obtaining confirmation of inventories pledged under loan agreements c. Reviewing a cutoff procedure for inventories d. Tracing test controls to the entity's inventory listing

A. Testing the entity's computation of standard overhead rates

To measure how effectively a client employs its assets, and auditor calculates inventory turnover by dividing the average inventory into: a. Net sales B. Cost of goods sold c. Operating income d. Gross sales

B. Cost of goods sold

The use of a "blind" purchase order is designed to prevent errors by the: a. Purchase department B. Receiving department c. Stores department d. Accounting department

B. Receiving department

Purchase cutoff procedure should be designed to test that merchandise is included in the inventory of the client company, if the company: a. Has paid for the merchandise b. Has physical possession of the merchandise C. Holds legal title to the merchandise d. Holds the shipping documents for the merchandise issued in the company's name

C. Holds legal title to the merchandise

The client's physical count of inventories is lower than the inventory quantities in the perpetual records. This could be the result of a failure to record: a. Purchases b. Purchase discounts C. Sales d. Sales discounts

C. Sales

Which of the following is true about the auditors' observation of the client's physical inventory? a. The auditors should plan the physical inventory b. The auditors should segregate damaged and obsolete goods C. The auditors should evaluated the adequacy of the client's counting procedures d. The auditors should supervise the client's personnel

C. The auditors should evaluate the adequacy of the client's counting procedures

Which of the following would an auditor most likely question included in calculation of the overhead rate for a company that manufactures a product? a. Factory supervisor salary b. Indirect materials c. Miscellaneous expense D. Salaries expense

D. Salaries expense

Material requisitions and move tickets

document the flow of the goods and related responsibility as they progress through the production process.

observation

physical count, or other actual contact with the inventories

The auditors objectives in the audit of inventories and cost of goods sold are to:

1) Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to inventories and cost of goods sold 2) Obtain and understanding of internal control over inventories and cost of goods sold 3) Assess the risks of material misstatement and design tests of controls and substantive procedures that: a) substantiate the existence of inventories and the occurrence of transactions affecting costs of goods sold b) Establish the completeness of recorded inventories c) Verify the cutoff of transactions affecting cost of goods sold d) Determine that the client has rights to the recorded inventories e) Establish the proper valuation of inventories and the accuracy of transactions affecting cost of goods sold f) Determine that the presentation and disclosure of information about inventories and costs of goods sold are appropriate including disclosure of the classification of inventories, accounting methods used, and inventories pledged as collateral for debt.

Which of the following best describes the reason that the auditors record their inventory test counts in the working papers? a. To document every test count B. For subsequent comparison with the completed inventory listing c. To document compliance with generally accepted accounting principles d. For use in subsequent audits

B. For subsequent comparison with the completed inventory listing

Which of the following is an auditor least likely to consider a departure from U.S. generally accepted accounting principles? a. Valuing inventory at cost B. Including in inventory items that are consigned out to vendors, but not yet sold c. Using standard costs as the measure of inventory costs d. Including in inventory items shipped subsequent to year-end, but for which valid orders did exist at year-end

B. Including in inventory items that are consigned out to vendors, but not yet sold

A client uses a periodic inventory system. Would one expect a credit to which of the following accounts at the point of sale? Sales Inventory A. Yes Yes B. Yes No C. No Yes D. No No

B. Option b (Yes No)

A 'bill and hold' scheme is most likely to include: a. Shipment of items to a customer beyond what the customer has ordered B. Recording as sales items that the company retains as of year-end c. Billing of items that are held by customer for future revenue production purposes d. Selling items at substantial discounts near year-end

B. Recording as sales items that the company retains as of year-end

Which of the following is not true relating to the auditors' observation of the client's physical inventory? a. The auditors should evaluate the client's planning of the physical inventory B. The auditors should make certain that consigned items from suppliers are included in the physical inventory totals c. The auditors should evaluate the adequacy of the client's counting procedures d. The auditors should take test counts of the client's inventory

B. The auditors should make certain that consigned items from suppliers are included in the physical inventory totals

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. Supplies of relatively little value are expensed when purchased. b. The cycle basis is used for physical counts C. The storekeeper is responsible for maintenance of perpetual inventory records d. Perpetual inventory records are maintained only for items of significant value

C. The storekeeper is responsible for maintenance of perpetual inventory records

Which of the following is not a procedure that typically is used by the auditors in their examination of a client's goods held in the custody of a public warehouse? a. Confirmation b. Obtaining reports on internal control at the warehouse c. Observation D. Corresponding with the state agency regarding the authenticity of the public warehouse

D. Corresponding with the state agency regarding the authenticity of the public warehouse

Auditors should not review the client's planning of the physical inventory True / False

False

For good internal control over purchase transactions, purchases should be made from approved vendors by the department needing the goods True / False

False

Observation of inventories is a required audit procedure under all circumstances True / False

False

The proper cutoff of inventories is best achieved when the client uses pre-numbered purchase orders True / False

False

When the auditors cannot satisfy themselves as to the accuracy of ending inventory and a material misstatement may exist, they normally may still give an unmodified (unqualified) opinion on the client's income statement True / False

False

Inventories physical functions directly connected with inventories

Purchasing, receiving, storing, issuing, processing, and shipping

Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? a. Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods. b. Determine the existence of inventories and the occurrence of transactions affecting cost of goods sold. c. Establish that the client includes only inventory on hand at year-end in inventory totals. d. Establish the completeness of inventories.

c. Establish that the client includes only inventory on hand at year-end in inventory totals.

Which of the following is not a reason for the special significance attached by the auditors to the verification of inventories? a. The determination of inventory valuation directly effects net income B. The existence of inventories is inherently difficult to substantiate c. Special valuation problems often exist for inventories d. Inventories are often the largest current asset of an enterprise

B. The existence of inventories is inherently difficult to substantiate

Which of the following best describes the reason for the auditors' review of the client's costs accounting system? a. To obtain evidence regarding the quantities of good described as work in process B. To obtain evidence about the valuation of work in process, finished goods, and cost of goods sold c. To obtain evidence about the profit margin on specific jobs d. To obtain evidence about compliance with Cost Accounting Standards

B. To obtain evidence about the valuation of work in process, finished goods, and cost of goods sold

An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all: a. Merchandise received B. Vendor's invoices c. Cancelled checks d. Receiving reprots

B. Vendor's invoices

To assure that all purchases are authorized before payment is made, accounting department personnel should match the vendors invoice to: a. The purchase requisition b. The receiving report C. The purchase order d. The voucher

C. The purchase order

The auditors will usually trace the details of the test counts made during observation of the physical inventory taking to a final inventory schedule. The audit procedure is undertaken to provide evidence that items physically present and observed by the auditors at the time of the physical inventory count are: a. Owned by the client b. Not obsolete c. Physically present at the time of the preparation of the final inventory schedule D. Included in the final inventory schedule

D. Included in the final inventory schedule

In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor would be most interested in examining the: a. Purchase journal b. Purchase requisitions c. Purchase orders D. Vendors' invoices

D. Vendors invoices

Monitoring

Relevant monitoring controls for the purchases cycle include management review of reports of purchases from suppliers, inventory on hand, and accounts payable balances.

An auditor concluded that no excessive costs for an idle plant were charged to inventory. This conclusion is most likely related to presentation and disclosure and: a. Rights. b. Valuation. c. Existence. d. Completeness.

b. Valuation

The use of a tagging system for inventory taking is designed to prevent double counting of goods. True / False

True

To test the clients cutoff of inventories, the auditors will make a record of the serial number of the final receiving and shipping documents used prior to the taking of the physical inventory. True / False

True

purchase requisition

a purchase transaction begins with the issuance of a properly approved purchase requisition by the stores department needing the goods or services. the requisition should include a precise description of the type and quantity of the goods or services desired.

An auditor most likely would analyze inventory turnover rates to obtain evidence about: a. Presentation. b. Valuation. c. Rights. d. Existence

b. Valuation

Which of the following should be included as a part of inventory costs of a manufacturing company? Direct Labor Raw Materials Factory Overhead a. Yes Yes Yes b. Yes No No c. No Yes No d. No No No

a. Yes Yes Yes

Effective internal control for purchases generally can be achieved in a well-planned organizational structure with a separate purchasing department that has: a. The ability to prepare payment vouchers based on the information on a vendor's invoice b. The responsibility of reviewing purchase orders issued by user departments C. The authority to make purchases of requisitioned materials and services d. A direct reporting responsibility to controller of the organization

C. The authority to make purchases of requisitioned materials and services

The auditor's analytical procedures will be facilitated if the client: a. Uses a standard cost system that produces variance reports. b. Segregates obsolete inventory before the physical inventory count. c. Corrects material weaknesses in internal control before the beginning of the audit. d. Reduces inventory balances to the lower of cost or market.

a. Uses a standard cost system that produces variance reports.

An auditor selects items from the client's inventory listing and identifies the items in the warehouse. This procedure is most likely related to: a. Completeness. b. Existence. c. Valuation. d. Rights

b. Existence

Which of the following is the best audit procedure for the discovery of damaged merchandise in a client's ending inventory? a. Compare the physical quantities of slow-moving items with corresponding quantities in the prior year. b. Observe merchandise and raw materials during the client's physical inventory taking. c. Review the management's inventory representations letter for accuracy. d. Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average.

b. Observe merchandise and raw materials during the client's physical inventory taking.

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete inventory to address: a. Existence. b. Valuation. c. Presentation. d. Rights.

b. Valuation

The receiving department is least likely to be responsible for the: a. Determination of quantities of goods received. b. Detection of damaged or defective merchandise. c. Preparation of a shipping document. d. Transmittal of goods received to the store's department.

c. Preparation of a shipping document.

Which of the following is true about the auditors' observation of the clients' physical inventory? a. The count must be made at year-end b. The auditors should supervise the client's personnel C. the auditors' observation addresses the existence assertion d. The auditors' should justify any omission of the observation in the audit report

C. The auditors' observation addresses the existence assertion

The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the: a. Bill of lading. b. Job time shipping. c. Production order. d. Production schedule.

a. Bill of lading.

McPherson Corp. does not make an annual physical count of year-end inventories, but instead makes weekly test counts on the basis of a statistical plan. During the year, Sara Mullins, CPA, observes such counts as she deems necessary and is able to satisfy herself as to the reliability of the client's procedures. In reporting on the results of her examination, Mullins: a. Can issue an unqualified opinion without disclosing that she did not observe year-end inventories. b. Should comment in the scope paragraph as to her inability to observe year-end inventories, but can nevertheless issue an unqualified opinion. c. Is required, if the inventories are material, to disclaim an opinion on the financial statements taken as a whole. d. Should, if the inventories are material, qualify her opinion.

a. Can issue an unqualified opinion without disclosing that she did not observe year-end inventories.

An auditor suspects that certain client employees are ordering merchandise for themselves over the internet without recording the purchase or receipt of the merchandise. When vendors' invoices arrive, one of the employees approves the invoices for payment. After the invoices are paid, the employee destroys the invoices and the related vouchers. In gathering evidence regarding the fraud, the auditor most likely would select items for testing form the file of all: a. Cash disbursements b. Approved vouchers c. Receiving reports D. Vendors' invoices

a. Cash disbursements

During the inventory count an auditor selects items and determines that the proper description and quantity were recorded by the client. This procedure is most closely related to: a. Completeness. b. Valuation. c. Existence. d. Rights.

a. Completeness

The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the: a. Cost Accounting Standards Board. b. Financial Accounting Standards Board. c. Public Company Accounting Oversight Board. d. Securities and Exchange Commission

a. Cost Accounting Standards Board

When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is: a. Existence. b. Completeness. c. Clarity. d. Presentation

a. Existence

Instead of taking a physical inventory count on the balance-sheet date, the client may take physical counts prior to the year-end if internal control is adequate and: a. Well-kept records of perpetual inventory are maintained. b. Inventory is slow-moving. c. Computer error reports are generated for missing prenumbered inventory tickets. d. Obsolete inventory items are segregated and excluded.

a. Well-kept records of perpetual inventory are maintained.

The primary objective of a CPA's observation of a client's physical inventory count is to: a. Discover whether a client has counted a particular inventory item or group of items. b. Obtain direct knowledge that the inventory exists and has been properly counted. c. Provide an appraisal of the quality of the merchandise on hand on the day of the physical count. d. Allow the auditor to supervise the conduct of the count in order to obtain assurance that inventory quantities are reasonably accurate

b. Obtain direct knowledge that the inventory exists and has been properly counted.