Chapter 12

On June 15, 20X0, Ward, CPA, accepted an engagement to perform an audit of the Grant Co. for the year ended December 31, 20X0. Grant Co. has not previously been audited by a CPA and Ward has been unable to satisfy himself with respect to opening inventories. How should Ward report on his audit? a. He would have to disclaim an opinion or qualify his opinion on the December 31, 20X0 balance sheet, but could issue an unmodified opinion on the income statement and the statement of cash flows. b. He must disclaim an opinion on the financial statements taken as a whole. c. He could give an unmodified opinion on the financial statements taken as a whole so long as the change in the inventories from the beginning of the year to the end of the year was not material. d. He would have to disclaim an opinion or qualify his opinion on the income statement and the statement of cash flows, but could issue an unmodified opinion on the December 31, 20X0 balance sheet.

D

When an auditor tests a client's cost accounting system, the auditors' tests are primarily designed to determine that: a. quantities on hand have been computed based on acceptable cost accounting techniques that reasonably approximate actual quantities on hand. b. physical inventories are in substantial agreement with book inventories. c. the system is in accordance with generally accepted accounting principles and is functioning as planned. d. costs have been properly assigned to finished goods, work-in-process, and cost of goods sold.

D

The determination of the value of ending inventory ____ (directly/indirectly) affects net income.

Directly

Tests used to help identify the _____ of controls help to evaluate the client's internal control structure.

Effectiveness

T or F: Auditors may use statistical sampling for their test counts, but the client should never use statistical sampling to estimate the quantities of goods on hand.

False

T or F: Factory overhead is normally assigned to work-in-process immediately as overhead expenses are incurred.

False

T or F: Goods in transit at the balance sheet date should never be included in the client's inventory.

False

T or F: If the auditors are unable to satisfy themselves regarding the fairness of the client's beginning inventories, they will be unable to give an unmodified opinion on any of the financial statements.

False

T or F: Since the employees in the purchasing department order inventory items, they should inspect and receive the items when the goods arrive.

False

T or F: The auditors need never observe inventories stored in legitimate public warehouses.

False

T or F: The auditors' observation of the taking of a client's physical inventory must be done on, or shortly after the balance sheet date.

False

T or F: The receiving department normally sends raw materials received to the production department and obtains a receipt from the supervisor.

False

T or F: To assure that the physical inventory is taken properly, the auditors should prepare and take primary responsibility for the physical inventory instructions.

False

Purchasing and cash disbursements can provide opportunity for ______ by employees.

Fraud

When performing substantive procedures, the auditors will obtain a schedule of listings of inventories that will be reconciled to the __________.

General ledger

In obtaining an understanding of ___________ over inventory, the auditors should become familiar with the procedures for purchasing, receiving, storing, and issuing goods.

Internal control

Internal controls for ___________ affect nearly all the functions involved in producing and disposing of the company's product.

Inventory

A document designed to accumulate the labor and machine time devoted to a particular production order is a _____________ ticket.

Job time

Cost accounting systems record the costs of direct materials and labor, and apply ___________ to the jobs or processes.

Manufacturing overhead

A schedule that illustrates the gross production of each of the company's products is called a ____________.

Master production schedule

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Am I correct that our observation of the counting of inventory primarily addresses the existence of inventory, and not the completeness of the count?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. At the completion of the count, should I leave Jilco Inc. personnel with a copy of my inventory test count to help assure accuracy?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Do I need to count all items in inventory?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Jilco Inc. has inventory at many locations. Do we need to be present for the count at all locations?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Must I document all my test counts in the working papers?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. When I take test counts of items, does this eliminate the need for Jilco Inc. personnel to count those items?

No

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Should Jilco Inc.'s inventory be valued at the lower of standard cost or market?

No (no more than net realizable value)

Inventories with a high risk of ______ may be warranted as a signficant risk.

Obsolescence

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

Order

An inventory system that shows at all times the quantity of goods on hand is called a ___________ inventory system.

Perpetual

__________ of inventories to secure bank loans may be brought to light when bank balances and indebtedness are confirmed.

Pledging

An important step of testing controls is comparing quantity and _______ in the invoice, purchase order, and receiving report.

Price

A contractual obligation to buy goods at fixed prices, entered into well in advance of scheduled delivery dates is a(n) __________ commitment.

Purchase

When testing controls around inventory, auditors are considering the ________transaction cycle.

Purchasing

Audit procedures for consignment inventory could include a comparison of the physical inventory with the client's _________.

Records

A contractual obligation to offer customers goods at fixed prices, entered into well in advance of scheduled delivery dates is a(n) ___________ commitment.

Sales

The auditors assessments of the risk of material misstatement are used to design the ___________ tests for these accounts.

Substantive

T or F: Analytical procedures may reveal conditions indicating that the client has significant amounts of obsolete inventory.

True

T or F: During the auditors' observation of the physical inventory, they often obtain information that may be used to test the cutoff of the client's purchase transactions.

True

T or F: If inventory is material, the auditors should, if practicable, attend the physical inventory counting.

True

T or F: Management representations concerning inventories often include representations regarding purchase and sales commitments.

True

T or F: Perpetual inventory records not only help control theft of inventories, they also generally result in improved production planning.

True

T or F: Proper presentation of inventories includes disclosure of inventory that is pledged as collateral for loans.

True

T or F: Serially numbered purchase orders should be issued for purchases of goods.

True

T or F: Testing the cost accounting system is a major step in determining the appropriate valuation of inventories in a manufacturing business.

True

T or F: The McKesson & Robbins case highlighted the need to directly verify the existence of a client's inventory.

True

T or F: The accounting profession allows numerous alternative methods for valuation of inventories.

True

T or F: The auditors should record the details of their test counts in the audit working papers to be used to test the client's completed physical inventory listing.

True

T or F: The extent of the auditors' test counts of inventory items should be influenced by the inherent risk of the client's inventory and the adequacy of the client's internal control.

True

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Is it correct that, since Jilco Inc. manufactures a product, direct labor and overhead ordinarily became a part of inventory costs?

Yes

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. Is it safe to assume that any inventory items present as "consigned in" should not be included in the client's inventory?

Yes

Auditors often observe the counting of their clients' inventories. You are working in the area of inventory with a new assistant on the audit of Jilco Inc. The assistant has a number of questions concerning inventory and the observation of inventory. Reply "yes" or "no" to answer the following question. With strong internal control, may Jilco Inc.'s inventory count be performed during the year rather than at year end?

Yes

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 the result below, select the explanation that is most likely to be consistent with the change described. 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. 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?

3

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 the result below, select the explanation that is most likely to be consistent with the change described. 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. Net income increased in 20X8. Which of the explanations is most consistent with the changes in net income?

5

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 the result below, select the explanation that is most likely to be consistent with the change described. 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. The gross profit percentage (gross profit/revenue) changed from 0.166 in 20X7 to 0.154 in 20X8. Which of the explanations is consistent with the change in gross profit percentage?

6

*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

*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. Must 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 statement taken as a whole d. Must, if the inventories are material, qualify her opinion

A

*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

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

A

*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

*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

*Which of the following should be included as a part of inventory costs of a manufacturing company? a. Direct Labor, Raw Materials, Factory Overhead b. Direct Labor only c. Raw Materials only d. None of the above should be included

A

A client's materials purchasing cycle begins with requisitions from user departments and ends with the receipt of materials and the recognition of a liability. An auditor's primary objective in reviewing this cycle is to: a. evaluate the reliability of information generated as a result of the purchasing process. b. investigate the physical handling and recording of unusual acquisitions of materials. c. consider the need to be on hand for the annual physical count if this system is not functioning properly. d. ascertain that materials said to be ordered, received, and paid for are on hand.

A

A client'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. purchase discounts.

A

A decreasing rate of turnover suggests __________. a. the possibility of obsolete inventories b. a need to purchase additional inventories c. an increase in profits from inventories

A

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete inventory to address: A. Valuation B. Existence C. Rights D. Presentation

A

For any significant risk related to inventory and COGS, the auditors evaluate the design of the controls and determine if they are: a. implemented b. cost effective c. efficient

A

From which of the following evidence gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories? a. Observation of physical inventory counts. b. Written inventory representations from management. c. Confirmation of inventories in a public warehouse. d. Auditor's recomputation of inventory extensions.

A

Inventories represent an asset with significant inherent risks, including ____________ risks faced by management. a. business b. audit c. environment

A

Purchase cutoff procedures should be designed to test whether purchases recorded near year-end: a. is owned by the company. b. on the year-end balance sheet was carried at lower of cost or market. c. on the year-end balance sheet was paid for by the company. d. is in the possession of the company.

A

The McKesson & Robbins fraud case affirmed the importance of the auditors observation of: a. physical inventories b. sales receipts c. inventory receipts

A

The financial statements should disclose ___________ of valuing inventory, with the dollar effect and justification. a. change in methods b. physical count c. procedures

A

The lower-of-cost-or-market test involves comparing inventory purchase prices to the replacement cost, within the ceiling or floor. In this case, the ceiling represents: a. net realizable value b. net realizable value plus normal profit c. net realizable value minus normal profit

A

The risk of material misstatement of the financial statements is reduced when ___________ evaluates and manages the risk related to purchasing and producing goods and services. a. management b. employees c. customers

A

To strengthen the system of internal control over the purchase of merchandise, a company's receiving department should: a. accept merchandise only if a purchase order or approval granted by the purchasing department is on hand. b. accept and count all merchandise received from the usual company vendors. c. rely on shipping documents for the preparation of receiving reports. d. be responsible for the physical handling of merchandise but not the preparation of receiving reports.

A

When reviewing the completed physical inventory, auditors should trace their ____________ made during the observation of physical inventory counts. a. test counts b. management instructions c. inventory tags

A

Which of the following is an effective control that encourages receiving department personnel to count and inspect all merchandise received? a. Quantities ordered are excluded from the receiving department copy of the purchase order. b. Vouchers are prepared by accounts payable department personnel only after they match item counts on the receiving report with the purchase order. c. Receiving department personnel are expected to match and reconcile the receiving report with the purchase order. d. Internal auditors periodically examine, on a surprise basis, the receiving department copies of receiving reports.

A

Match the inventories functions with the correct statements. a. Receiving b. Storing c. Issuing 1. responsible for the determination of quantities of goods accepted, the detection of damaged merchandise, and the preparation of a receiving report 2. responsible for counting, inspecting, and preparing a receipt for goods; notifies accounting of the amount received and placed in stock 3. requires prenumbered requisitions be issued for all items passing out of its hands to serve as a signed receipt from the department accepting the goods

A - 1 B - 2 C - 3

*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 - management tools

Analytical procedures of inventories and COGS include: (Select all that apply) a. significant changes in inventory accounts b. scanning the general ledger accounts relating to COGS c. compare volume of sales transactions

A, B

Auditors may engage in direct written communication with cosigners to: (Select all that apply) a. disclose client liability for unremitted sales proceeds from inability to collect consignment A/R b. confirm the quantity and value of goods held at the BS date c. review of cosigner's auditors working papers to verify the physical inventory count

A, B

Inspecting inventory reports and examining evidence of follow-up on variances is a test of controls that will verify: (Select all that apply) a. existence and occurrence b. valuation and accuracy c. presentation and disclosure

A, B

When performing tests of controls, auditors may test the key control procedures in the client's purchasing transaction cycle including examination of: (Select all that apply) a. the purchase requisition b. vendor's invoice, receiving report, and paid check c. the dates and times certain transactions are entered d. shipping documents and sales invoices

A, B

Important aspects of the control environment related to inventories and COGS include: (Select all that apply) a. organizational structure and assignment of authority and responsibility b. commitment to competence and HR policies and practices c. integrity and ethical values d. employee bonuses based on exceptional management of inventory costs e. control of inventory transactions by the BOD

A, B, C

Relevant monitoring controls for the purchases cycle include management review of reports of: (Select all that apply) a. purchases from suppliers b. accounts payable balances c. inventory on hand d. wages payable balances

A, B, C

The shipping department will generate a prenumbered shipping document to be: (Select all that apply) a. sent to the billing department b. retained by the shipping department c. enclosed as a packing slip with the goods d. sent to the production department

A, B, C

Inventories include: (Select all that apply) a. goods in process of production b. goods on hand ready for sale c. goods sold to customers d. goods to be consumed in production

A, B, D

Observing and inquiring about the physical control policies and procedures is a test of controls that will verify: (Select all that apply) a. rights and obligations b. cutoff c. presentation and disclosure d. existence and occurrence

A, D

Auditors ordinarily should observe the counting of inventories that are on hand. Use the professional standards to find this requirement and the related guidance. Provide the AICPA AU-C section that includes the guidance.

AU-501

_____ (Before/After) considering information about the client and its environment, the auditors must assess the risks of material misstatement related to assertions about inventory.

After

*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

*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

A contractual obligation to offer customers goods at fixed prices, entered into well in advance of scheduled delivery dates is called a ____________ commitment. a. purchase b. sales c. fixed

B

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 physical inventory sheets. The purpose of this procedure is to obtain assurance that: a. the final inventory is valued at cost. b. all inventory represented by an inventory tag is listed on the inventory sheets. c. all inventory represented by an inventory tag is bona fide. d. inventory sheets do not include untagged inventory items.

B

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. Valuation B. Existence C. Rights D. Completeness

B

From the auditor's point of view, inventory counts are more acceptable prior to the year-end when: a. internal control is weak. b. accurate perpetual inventory records are maintained. c. inventory is slow-moving. d. significant amounts of inventory are held on a consignment basis.

B

It is the __________ responsibility to take the inventory and to control or supervise the taking of physical inventory. a. BOD's b. management's c. auditor's

B

Management should have a formal process for considering recommendations by the ___________ for improvements in the purchasing and production functions and the related control activities. a. customers b. internal auditors c. suppliers d. board of directors

B

Sales commitments are indicated by the client's ___________ sales orders. a. high volumes of invoices b. backlog of unfilled c. completed and filled

B

The audit tests of the client's cost accounting system are designed to determine that the ___________ allocated to specific jobs are appropriately compiled. a. profit b. costs c. income

B

To determine that a client has consistently and accurately applied an inventory pricing method, such as FIFO, the auditor should: a. review sales invoices and shipping documents b. test the pricing of a sample of inventory items c. perform an inquiry of management and BOD

B

When performing substantive procedures, auditors will evaluate the client's planning of a physical inventory and will consider the nature and materiality of the inventories, as well as existing ___________. a. efficiency b. internal control c. cost benefit analysis

B

Identify inherent risks related to inventories: (Select all that apply) a. incorrect inventory valuation can result in higher sales b. valuation of inventory affects COGS and NI c. use of various methods for valuation d. inventory often constitutes a large current liability

B, C

In reviewing final inventory listings, auditors test extensions and watch for two sources of substantial errors including: (Select all that apply) a. missing inventory line items b. incorrect extension of count units by price units c. misplaced decimal points

B, C

To verify cutoff of purchases, auditors can: (Select all that apply) a. review sales invoices and shipping reports b. examine records of the receiving department c. match purchase invoices and receiving reports d. mail confirmation of major purchases to vendors

B, C

In a first-year audit, if the auditors have doubts about the validity of beginning inventory, they will not be able to issue an unqualified opinion on which statements? (Select all that apply) a. balance sheet b. income statement c. statement of cash flows

B, C BS does not reflect beginning inventories

The auditors objectives in the audit of inventories and COGS include: (Select all that apply) a. assess business risk and design test of controls and substantive procedures b. obtain understanding of internal control c. obtain absolute assurance inventory and COGS is not understated d. consider inherent risks, including the risk of fraud

B, D

*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

*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

An audit committee would most likely help prevent which errors or fraudulent activity? a. miscounting of inventory by personnel involved in physical inventory b. accidentally recording purchases of the current period in the subsequent period c. intentional misstatement of production costs assigned to inventory

C

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. Valuation B. Existence C. Completeness D. Rights

C

An auditor most likely would analyze inventory turnover rates to obtain evidence about: A. Existence B. Presentation C. Valuation D. Rights

C

An auditor would be least likely to learn of slow-moving inventory through: a. inquiry of sales personnel. b. inquiry of stores personnel. c. vouching of year-end purchases. d. review of perpetual inventory records.

C

Auditors will test the pricing of goods in process and finished goods by referencing ___________. a. vendor invoices b. receiving reports c. cost accounting records

C

In a first-year audit, the auditors may be able to obtain evidence that the beginning inventories are fairly stated by: a. obtaining assurance from the BOD and the client's internal auditors b. obtaining assurance from management c. reviewing the predecessor firm's working papers

C

When auditing a company that has supply contracts with U.S. government agencies, the auditor should determine whether standards issued by the _____________ were complied with.

Cost Accounting Standards Board

Inventories are often a large _____ asset of a company's balance sheet.

Current

An inventory turnover analysis is useful to the auditor because it may detect: a. inadequacies in inventory disclosures. b. methods of avoiding cyclical holding costs. c. the optimum automatic reorder points. d. the existence of obsolete merchandise.

D