Auditing Chapter 12

What do auditors check in a company's cost accounting system?

1- Determining proper allocation of costs for current and future periods 2- This helps give them that internal controls are working over inventories and COGS. 3- Seeing if management is effective in controlling and reducing costs.

When dealing with a receiving report? How many copies should you normally make and who should get one?

3 copies, could be more. 1. For you (receiving department) 2. Accts. Rec Department 3. Purchasing Possibly another one if company is manufacturing.

Define: Production order

A document that authorizes the production of a specific quantity of a product.

The observation of a clients physical inventory is a mandatory auditing procedure when possible for the auditors to carry out and when inventories are material. A. Why is the observation mandatory? B. under what circumstances is observation of physical inventory impossible? C. Why is the auditors review of the clients control of inventory tags important during the observation of physical inventory?

A. it delivers strong evidence that relates to quality and existence of the physical inventories. B. It isn't possible if they hire the client after the inventory had been procured. It would be rare but its possible that auditors couldn't make it because terrains, weather, and other circumstances make it difficult to check. (If in Puerto Rico, you as the Auditor hire some company to check for you) C. Fraud could happen and you need to double check everything

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: The auditor calculated the accounts receivable turnover for the year.

Analytical Procedure

The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the:

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 Mullin, CPA, observes such counts as she deems necessary and is able to satisfy herself as to the reliability of the client

Can issue an unqualified opinion disclosing that she did not observe year-end inventories. ( You rarely have to say specific procedures that you used in your audit)

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:

Completeness

The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the:

Cost Accounting Standard Board

What is meant by a "bill and hold" scheme?

Customer has bought the item and it just hasn't been shipped yet. Goods are held by supplier. The goods must be marked and not counted in physical inventory or it will exaggerate revenue and net income!

Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold?

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

DETERMINE the inherent risk factor and the effect on the company's net income using the following: Risk Factors: 1. Complexity 2. Estimates 3. Industry Circumstances 4. Other external circumstances 5. Susceptibility of asset to theft 6. Volume Effect on Net Income: 7. Overstatement 8. Understatement 9. No effect Question: Gold Miner, Inc. has gold mines in a number of states. To hedge the price of its gold inventory, Gold Miner purchases gold futures contracts.

Estimates, Overstatement

DETERMINE the inherent risk factor and the effect on the company's net income using the following: Risk Factors: 1. Complexity 2. Estimates 3. Industry Circumstances 4. Other external circumstances 5. Susceptibility of asset to theft 6. Volume Effect on Net Income: 7. Overstatement 8. Understatement 9. No effect Question: Joe's Computers provides three-year money back warranties on all laptops. During Year 1, warranty claims decreased significantly and the company has not reduced the warranty reserve.

Estimates, Understatement

An auditor selects items from the client's inventory listing and identifies the items in the warehouse. This procedure is most likely related to :

Existence

When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is:

Existence

DETERMINE the inherent risk factor and the effect on the company's net income using the following: Risk Factors: 1. Complexity 2. Estimates 3. Industry Circumstances 4. Other external circumstances 5. Susceptibility of asset to theft 6. Volume Effect on Net Income: 7. Overstatement 8. Understatement 9. No effect Question: Global Co. imports most of its products from a foreign supplier. During Year 1, a new technology made part of the Global Co. inventory obsolete.

Industry Circumstances, Overstatement.

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: The auditor asked the warehouse manager about whether certain inventory items were becoming obsolete

Inquiry

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: During the physical inventory count, the auditor asked the client to open various boxes of inventory items so she was able to assess the quality of the item.

Inspection of Tangible assets

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: The auditor obtained a copy of the company's accounting manual and read the section on inventory to prepare for the physical inventory observation

Inspection of records or documents

Explain the significance of the purchase order to adequate internal control over purchase transactions.

It needs approval and attestation that confirms all standard procedures have been considered for the following: determining need, getting competitive bids, getting consent to buy

What segregation of duties would you recommend to attain max. internal control over purchasing activities in a manufactoring concern?

Maintain exclusive authority for all kinds of purchases through a separate purchasing department, receiving department, and record transactions in the accounts payable department. If, it is a small company, at least make sure different employees do each of the above.

The controller of a new client company informs you that most of the inventories are stored in bonded public warehouses. He gives you receipts to account for the inventories. Can you just examine the warehouse receipts to verify count of inventory?

No, the review of the warehouse receipts doesn't establish adequate verification. Auditors must treat public warehouses the same as clients. They go in and do a test control to count. Auditors also review client records regarding performance and selection of the warehouse, as well as reports available on int. control of the warehouse.

When perpetual inventory records are maintained, is it necessary for a physical inventory t be taken at the balance sheet date?

No. Physical counts can be performed on any time of the year. There is no need to count the entire inventory again.

What effect, if any, would the inventory certificate of outside specialists have upon the type of report the auditors would render? Would they auditors need to make a special reference to the certificate of the outside specialists on their audit report?

None. No.

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: During a site visit to a construction site, the auditor determined that all employees were wearing proper safety equipment.

Observation

Which of the following is the best audit procedure for the discovery of the damaged merchandise in a client 's ending inventory

Observe marchandise and raw materials during the client's physical inventory taking

What are the purposes of the auditors observation of the taking of the physical inventory?

Observing physical inventory is a key step in meeting the required standard of field work. It also gives information and proof that it was done correctly and numbers are accurate. Auditors check to make sure that inventory is: real, quantity is accurate and it is in usable condition!

The primary objectives of a CPA's observation of a client's physical inventory count is to:

Obtain direct knowlegde that the inventory exists and has been properly counted

The receiving department is LEAST likely to be responsible for the:

Preparation of the shipping document

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: The auditing firm's computer assisted audit specialist obtained an electronic inventory file from the company and checked the accuracy of the extensions and footings.

Reperformance

DETERMINE AUDITING PROCEDURE: - Analytical Procedure - External Confirmation - Inquiry - Inspection of records or documents - Inspection of Tangible assets - Observation - Recalculation - Reperformance Question: The auditor obtained a purchase order from the purchase order file and compared it to the authorized supplier list to determine that the related goods had been purchased from an approved supplier.

Reperformance

If a client employs a separate company to count their inventory, how much reliance can the auditors place on the outside specialists?

Same amount as the employees. they still need to assess the inventory and also internal control of the specialists?

DETERMINE the inherent risk factor and the effect on the company's net income using the following: Risk Factors: 1. Complexity 2. Estimates 3. Industry Circumstances 4. Other external circumstances 5. Susceptibility of asset to theft 6. Volume Effect on Net Income: 7. Overstatement 8. Understatement 9. No effect Question: Metal, Inc. supplies copper pipes to home builders. During Year 1, copper prices doubled.At any given time, a significant amount of inventory is in transit or located at job sites.

Susceptibility of asset to theft , Overstatement

A client company wishes to conduct its physical inventory on a sampling basis. Many items will not be counted. Under what general conditions will this method of taking inventory be acceptable to the auditors.

This is not common but can be possible if.... 1. The sampling plan for inventory valuation should have statistical validity 2. the allowance for sampling risk (confidence) and sampling risk (precision) levels must deliver an estimate that permits a materially correct inventory valuation.

How do the independent auditors use the clients backlog of unfilled sales orders in the examination of inventories?

To determine the net realizable value of goods in process as well as finished goods. They are also used for determining the losses, if any, on firm's sales obligations for which production has not yet started.

For what purposes do the auditors make and record test counts of inventory quantities during their observation of the taking of the physical inventory?

To make sure it is the precise count. You check this data you find with clients physical inventory counts. Another reason for making and recording test counts in the working papers is to provide proof for auditors' tests in the situation that audit procedures are examined at some future date.

Purchase, storage and the use of inventories should be controlled by separate departments. T/F?

True.

The auditor's analytical procedures will be facilitated if the client:

Uses a standard cost system that produces variance reports

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:

Valuation

An auditor most likely would analyze inventory turnover rates to obtain evidence about:

Valuation

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete inventory to address:

Valuation

DETERMINE the inherent risk factor and the effect on the company's net income using the following: Risk Factors: 1. Complexity 2. Estimates 3. Industry Circumstances 4. Other external circumstances 5. Susceptibility of asset to theft 6. Volume Effect on Net Income: 7. Overstatement 8. Understatement 9. No effect Question: Sales orders for an Internet textbook distributor have increased 100% over the last year. Additionally, the company's asset turnover has doubled since the previous year.

Volume, Overstatement

When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably:

Want the client to schedule the physical count at the end of the year

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:

Well-kept records of perpetual inventory are maintained

Which of the following should be included as a part of inventory costs of a manufacturing company?

YES to all Three: Direct Labor, Raw Material, and Factory Overhead

Do auditors play a part in planning the client's physical inventory?

YES! Hugely. They give assistance as far choosing a date, scheduling processes. The independent auditor gives the client approval that their choice of doing it is Good!! That is most important, they kind of sign off on it.

Should the normal review of purchase transactions by the auditors include examination of receiving reports?

Yes. Receiving Reports should have serial numbers on them and auditors can check this with other information to make sure procedures are being accurately followed.

Why do auditors consider the substantiation (providing evidence, truth of) of the figure for inventory to be a more difficult task than the verification of most other items on the balance sheet?

You need to be experienced and skilled to identify and count goods on hand. The possibility of of misstatements are huge with the huge size of most inventories.

Once the auditors have completed their test counts of the physical inventory, will they have any reason to make later reference to the inventory tags used by the client's employees in the counting process? Explain.

tag numbers and test counts are recorded in the working papers and then matched to the inventory summary sheets of the client. if a substantial # of variances are found, the auditors need to re-check the original tags or make a request to the client to recompile the inventory.