Chapter 21 - Audit

7) The main difference between job order and process costing systems is that A) one accumulates costs by materials issued and the other by labor incurred. B) one accumulates costs by individual jobs and the other by particular processes. C) one emphasizes costs accumulated in completed products and the other emphasizes costs associated with work-in-process. D) one emphasizes costs adding value to the product and the other emphasizes costs incurred because of waste, scrap, and obsolescence.

B) one accumulates costs by individual jobs and the other by particular processes.

3) Which of the following is not a function within the inventory and warehousing cycle? A) process the goods B) store raw materials C) ship finished goods D) process invoices for shipped goods

D) process invoices for shipped goods

4) The test of details of balance procedure which requires the auditor to perform tests of lower of cost or market, selling price, and obsolescence is an attempt to satisfy the objective of A) existence. B) completeness. C) accuracy. D) realizable value.

D) realizable value.

13) The most important part of the observation of inventory is to determine whether A) all counts are accurate. B) the inventory-takers are qualified. C) obsolete inventory has been identified. D) the physical count is being taken in accordance with the client's instructions.

D) the physical count is being taken in accordance with the client's instructions.

10) 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) The company recorded nonexistent inventory. B) The auditor did not perform any audit tests of the inventory. C) The auditor and company colluded to overstate inventory balances. D) The company counted inventory three months prior to year-end.

A) The company recorded nonexistent inventory.

19) Which of the following is an accurate statement regarding inventory and risk? A) Inventory with a high business risk includes products with potential obsolescence. B) Auditors often have a greater concern for misstatements when inventory is stored in one warehouse. C) Inherent risk is generally set at low for manufacturing companies. D) Performance materiality for inventory is determined before assessing client business risk.

A) Inventory with a high business risk includes products with potential obsolescence.

1) You are auditing the inventory account and are concerned about the possibility of an inventory overstatement. What is the best audit procedure to detect damaged inventory? A) Observe the condition of inventory during the client's physical count. B) Compare the condition of inventory from the previous year's count to the current year. C) Compare inventory turnover from the previous year's inventory to the current year's inventory. D) Reconcile the inventory counts to the cost accounting records.

A) Observe the condition of inventory during the client's physical count.

9) Which of the following is a significant audit concern related to the transfer of inventory from one location to another? A) Recorded transfers occurred. B) Transfers were properly transported. C) Transfers were properly planned. D) Transfers represent efficient movement of assets.

A) Recorded transfers occurred.

4) Inventory is often a significant part of a company's current assets. Because of its importance, A) auditors are required by auditing standards to observe the client taking a physical inventory count. B) price tests must be performed to verify whether the physical counts were correctly summarized. C) companies are required to use perpetual inventory systems. D) auditors are required by auditing standards to take the physical inventory for the client.

A) auditors are required by auditing standards to observe the client taking a physical inventory count.

22) When an auditor observes that personnel who are responsible for physically counting inventory are not following the inventory instructions, the auditor should A) contact a client's supervisor to correct the problem. B) modify the client's physical inventory instructions. C) not discuss the problem with client's supervisor in order to maintain independence. D) assign audit staff to the inventory count.

A) contact a client's supervisor to correct the problem.

15) 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) inventory as recorded on tags actually exists (existence). B) existing inventory is counted and tagged (completeness). C) inventory is counted accurately (accuracy). D) inventory is classified correctly (classification).

A) inventory as recorded on tags actually exists (existence).

4) When auditing inventory cost accounting, the auditor is concerned with all of the following except for A) net realizable value. B) unit cost records. C) physical controls over inventory. D) documents and records for transferring inventory.

A) net realizable value.

5) 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) observation of physical inventory counts

2) 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) perpetual inventory master files B) segregated, limited-access storage areas C) custody of assets assigned to specific responsible individuals D) approved prenumbered documents for authorizing movement of inventory

A) perpetual inventory master files

15) In order to strengthen controls over cost accounting information, a company should consider implementing A) perpetual inventory master files. B) a job order cost accounting system. C) an accounting system that keeps separate the records of the accounting department from the records of the production department. D) an economic quantity order system.

A) perpetual inventory master files.

8) 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 costs. B) storage of the goods. C) internal control over those goods. D) prevention of waste, obsolescence, and theft.

A) related costs.

24) 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 in the current period. B) sale in the subsequent period. C) purchase in the current period. D) purchase return in the subsequent period.

A) sale in the current period.

7) It is frequently possible to test the physical inventory prior to the balance sheet date when A) the perpetual inventory records are accurate and related controls operate effectively. B) year-end sales are small. C) the internal control system is no better at year-end than at an earlier point in time. D) the client counts inventory at interim dates.

A) the perpetual inventory records are accurate and related controls operate effectively.

3) You are gathering evidence for the audit objective that existing inventory items are included in the inventory listing schedule. The audit procedure that would provide you with the best evidence to confirm this objective is A) trace from inventory tags to the inventory listing schedule and make sure the inventory on the tags is included. B) trace the inventory totals to the general ledger. C) perform tests of lower-of-cost-or-market. D) account for unused tags shown in the auditor's documentation to make sure no tags have been added.

A) trace from inventory tags to the inventory listing schedule and make sure the inventory on the tags is included.

5) ________ accumulate costs by individual jobs as material is issued into production and labor costs are incurred. A) Just-in-time production systems B) Job cost systems C) Process cost systems D) Manufacturing systems

B) Job cost systems

12) When there are no perpetual inventory files and inventory is material, A) an audit cannot be performed, so the auditor must issue a disclaimer. B) a physical inventory should be taken by the client near the end of the accounting period. C) the auditor will have to perform the inventory count and determine valuation. D) the auditor need not observe inventory counts but must do test counts.

B) a physical inventory should be taken by the client near the end of the accounting period.

26) The auditor generally decides whether the inventory count can be taken before year-end primarily on the basis of A) audit efficiency. B) accuracy of the perpetual inventory master files. C) client convenience. D) audit staff availability.

B) accuracy of the perpetual inventory master files.

2) Handling the receipt of ordered goods is a part of the ________ cycle. A) purchasing B) acquisition and payment C) inventory D) inventory and warehousing

B) acquisition and payment

6) When auditors observe the client counting inventory, they should be careful to do all of the following except A) inquire about items that are likely to be obsolete or damaged. B) calculate the unit cost of the inventory items. C) discuss with management the reasons for excluding any material items. D) observe the counting of the most significant items.

B) calculate the unit cost of the inventory items.

2) The first step in verifying the valuation of purchased inventory is in determining the valuation method used by the client. The next step is A) determining that all inventory that is purchased is expensed through cost of goods sold. B) determining which costs should be included in the valuation of an item of inventory. C) determining that all inventory on hand reconciles to the perpetual inventory records. D) determining that cut-off procedures have been adhered to prior to counting inventory.

B) determining which costs should be included in the valuation of an item of inventory.

18) The audit of cost accounting begins with the internal transfer of assets from raw materials to work-in-process to A) manufacturing overhead. B) finished goods inventory. C) the perpetual inventory master files. D) retail sales.

B) finished goods inventory.

1) Auditor tests of the physical controls over raw materials, work in process, and finished goods are generally limited to A) observation and confirmation. B) observation and inquiry. C) inquiry and reconciliation. D) observation and reconciliation.

B) observation and inquiry.

2) When determining the sample size for the number of items the auditor should count during the physical inventory, A) it is easy to quantify the number of items based on a formula developed by the AICPA. B) one of the key determinants that must be considered is internal control over the physical count. C) one of the key determinants that must be considered is the cost involved. D) generally accepted auditing standards require that at least 80% of the dollar value of the inventory should be included in the sample.

B) one of the key determinants that must be considered is internal control over the physical count.

1) When labor is a significant part of inventory, verifying the proper accounting of these costs should be tested in the A) inventory and warehousing cycle. B) payroll and personnel cycle. C) acquisitions and payments cycle. D) cash cycle.

B) payroll and personnel cycle.

1) 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) compilation tests B) price tests C) confirmation of inventory held by outside parties D) physical examination of the inventory

B) price tests

29) 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) terms of the open purchase orders. B) purchase cutoff procedures. C) contractual commitments made by the purchasing department. D) purchase invoices received on or around year-end.

B) purchase cutoff procedures.

1) Receipt of ordered materials by the receiving department will generate the completion of a form called the A) bill of lading. B) receiving report. C) materials requisition. D) inventory acquisition summary.

B) receiving report.

9) The auditor traces inventory tags identified as non-owned during the physical observation to the inventory listing schedule to make sure these have not been included. This test satisfies the balance-related audit objective of A) cutoff. B) rights. C) accuracy. D) existence.

B) rights.

25) Which one of the following procedures would not be appropriate for an auditor in discharging his responsibilities concerning the client's physical inventories? A) confirmation of goods in the hands of public warehouses B) supervising the taking of the annual physical inventory C) carrying out physical inventory procedures at an interim date D) obtaining written representation from the client as to the existence, quality, and dollar amount of the inventory

B) supervising the taking of the annual physical inventory

23) Auditors need to understand the client's physical inventory count controls before the count of the inventory begins so that A) the auditors can accurately count and tag the inventory for the client. B) the auditors can make constructive suggestions as to the adequacy of the procedures. C) the client will be informed on exactly what items the auditor intends to test count. D) the auditor can communicate any weaknesses directly to the audit committee.

B) the auditors can make constructive suggestions as to the adequacy of the procedures.

1) Which one of the following substantive analytical procedures would be most useful in alerting the auditor to the possibility of obsolete inventory? A) Compare gross margin percentage with that of previous years. B) Compare unit costs of inventory with previous years. C) Compare inventory turnover ratio with previous years. D) Compare current year manufacturing costs with previous years.

C) Compare inventory turnover ratio with previous years.

27) An auditor selects a random sampling of tag numbers and identifies the tag with that number attached to the actual inventory. The purpose of the procedure is to A) obtain proper cutoff information. B) uncover the inclusion of nonexistent items as inventory. C) determine if the client has adequately priced the inventory item. D) verify that the client has not changed the recorded counts after the auditor left the premises.

B) uncover the inclusion of nonexistent items as inventory.

7) Which of the following statements is correct regarding the audit of inventory cost accounting? A) Cost accounting systems and controls are the same for all manufacturing companies. B) All companies that have work-in-process must use a perpetual inventory system. C) Auditors test perpetual inventory master files by examining documentation that supports additions and reductions of inventory amounts in the master files. D) Manufacturing companies keep their cost accounting records separate from the production and other accounting records.

C) Auditors test perpetual inventory master files by examining documentation that supports additions and reductions of inventory amounts in the master files.

8) Which of the following is an accurate statement regarding perpetual inventory master files? A) When perpetual inventory master files are accurate, auditors can test the physical inventory after the balance sheet date. B) It is a difficult procedure for the auditor to test the accuracy of the perpetual inventory master files. C) Auditors test the perpetual records for reductions in finished goods for sale as part of the sales and collection cycle. D) All of the above are accurate statements.

C) Auditors test the perpetual records for reductions in finished goods for sale as part of the sales and collection cycle.

2) Which one of the following substantive analytical procedures would be most useful in alerting the auditor to the possibility inventory and cost of goods sold being overstated or understated? A) Compare extended inventory value with that of previous years. B) Compare unit costs of inventory with previous years. C) Compare inventory turnover ratio with previous years. D) Compare current year manufacturing costs with previous years.

C) Compare inventory turnover ratio with previous years.

2) ________ is normally characterized as a difficult and complex account to audit. A) Property, plant and equipment B) Cash C) Inventory D) Prepaid insurance

C) Inventory

20) The auditor's tour of the client's inventory facilities should be led by A) a member of the audit committee. B) the CFO. C) a plant supervisor. D) the company president.

C) a plant supervisor.

7) 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) standard cost controls. B) pricing internal controls. C) compilation internal controls. D) count quantity internal controls.

C) compilation internal controls.

6) 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) compliance with generally accepted auditing standards D) consistency

C) compliance with generally accepted auditing standards

4) If the auditor concludes that physical controls over inventory are so inadequate that the inventory will be difficult to count, the auditor should ordinarily A) withdraw from the engagement. B) issue a qualified audit report. C) conduct expanded observation tests of physical inventory. D) hire a specialist to assist the auditor.

C) conduct expanded observation tests of physical inventory.

6) Master files, spreadsheets, and reports that accumulate material, labor, and overhead as the costs are incurred are A) accounting systems. B) storeroom documents. C) cost accounting records. D) finished goods inventory records.

C) cost accounting records.

30) Boxes or other containers holding inventory should also be opened during test counts to determine the ________ of the inventory. A) classification B) detail tie-in C) existence D) realizable value

C) existence

11) In the flow of inventory and costs, when work-in-progress is credited, ________ is (are) debited. A) raw materials B) cost of goods sold C) finished goods D) direct labor

C) finished goods

11) When a physical count of inventory is performed at an interim date, the auditor observes it at that time and tests the perpetual records for transactions A) throughout the year. B) which are a representative sample of the period under audit. C) from the date of the count to year-end. D) from the date of the count to the end of the audit field work.

C) from the date of the count to year-end.

9) 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 reports. D) material requisitions.

D) material requisitions.

1) 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) acquisition and payments cycle. B) payroll and personnel cycle. C) inventory and warehousing cycle. D) sales and collection cycle.

C) inventory and warehousing cycle.

10) When auditing manufacturing overhead costs assigned to inventory, auditors should keep in mind that A) GAAP has strict procedures that must be followed when assigning overhead to work-in- process inventory. B) overhead costs must be allocated to raw materials, work-in-process, and finished goods inventory. C) management typically allocates overhead using total direct labor dollars as the basis for the allocation. D) determining the reasonableness of the allocation method is relatively simple for work-in- process inventory.

C) management typically allocates overhead using total direct labor dollars as the basis for the allocation.

11) A major difficulty in the verification of inventory cost records for the purpose of inventory valuation is in determining the reasonableness of the A) direct labor costs. B) raw material costs. C) manufacturing overhead costs. D) period costs.

C) manufacturing overhead costs.

8) 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) understated $400. B) understated $300. C) overstated $400. D) overstated $700.

C) overstated $400.

5) A major source of cutoff information for sales and purchases of inventory is A) confirmations from outside parties. B) the test of details of balances. C) physical observation. D) the performance of analytical procedures.

C) physical observation.

13) If the perpetual inventory master files show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded A) sales. B) sales discounts. C) purchases. D) purchase discounts.

C) purchases.

14) Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which A) materials are ordered for purchase until the finished product is sold. B) the customer's order is received until the finished product is shipped. C) raw materials are requisitioned until the finished product is sent to storage. D) raw materials are requisitioned until the finished product is completely manufactured.

C) raw materials are requisitioned until the finished product is sent to storage.

17) A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is A) classification. B) cutoff. C) realizable value. D) rights.

C) realizable value.

3) There must be a periodic physical count by the client of the inventory items on hand A) only if the client uses the LIFO method. B) only if the client uses a lower-of-cost-or-market method. C) regardless of the client's inventory valuation method. D) only if the client uses either the LIFO or FIFO method.

C) regardless of the client's inventory valuation method.

28) An auditor must inquire about consigned or customer inventory included on the client's premises to satisfy the balance-related audit objective of A) cutoff. B) classification. C) rights. D) completeness.

C) rights.

16) 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 over the preparation and maintenance of perpetual inventory records. B) competent personnel assigned to count the inventory. C) third-party inventory counting specialists. D) an adequately designed plan to count the inventory.

C) third-party inventory counting specialists.

10) Which of the following is a continuously updated computerized record of inventory items purchased, used, sold, and on hand for merchandise, raw materials, and finished goods? A) job cost system B) standard cost records C) cost accounting records D) perpetual inventory master file

D) perpetual inventory master file

5) Auditors usually test cost accounting records as part of the A) acquisition tests. B) payroll tests. C) sales tests. D) All of the above are correct.

D) All of the above are correct.

10) Which of the following is an accurate statement regarding the audit of pricing and compilation of inventory? A) Inventory compilation tests include all of the tests of the client's unit prices to determine whether they are correct. B) The review for obsolete inventory should be performed by the accounting department. C) The most important internal control for accurate unit costs is external verification by an outside consultant. D) Inventory compilation internal controls are needed to ensure that the physical counts are correctly summarized and priced.

D) Inventory compilation internal controls are needed to ensure that the physical counts are correctly summarized and priced.

3) Inventory is a complex area to audit for all except which of the following reasons? A) Inventory is often in different locations. B) There are several acceptable valuation methods and some entities use different methods for different types of inventory. C) Inventory is often the largest account on the balance sheet. D) Inventory valuation includes few estimates.

D) Inventory valuation includes few estimates.

11) In valuing inventory, the auditor must consider all but which of the following factors? A) The valuation method must be in accordance with GAAP. B) The valuation method must be applied on a consistent basis. C) The inventory must be valued at the lower of cost or market. D) LIFO must be used for work-in-process inventory.

D) LIFO must be used for work-in-process inventory.

6) To ensure proper segregation of duties, who should maintain the perpetual inventory master files? A) production personnel B) inventory storeroom personnel C) inventory receiving personnel D) accounting department personnel

D) accounting department personnel

8) Comparing the physical counts with the perpetual inventory master files satisfies the balance- related audit objective of A) classification. B) observation. C) completeness. D) accuracy.

D) accuracy.

4) In most manufacturing companies, the inventory and warehousing cycle begins with the A) receipt of a customer's order. B) completion of production of a customer's order. C) initiation of production of a customer's order. D) acquisition of raw materials for production.

D) acquisition of raw materials for production.

16) The auditor is concerned with four aspects of cost accounting, including A) documents and records for transferring inventory. B) perpetual inventory master files. C) unit cost records. D) all of the above.

D) all of the above.

17) One of the auditor's primary concerns in verifying the transfer of inventory from one location to another is that A) recorded transfers exist. B) all actual transfers are recorded. C) the quantity, date, and description of all recorded transfers are accurate. D) all of the above.

D) all of the above.

18) 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 tie-in. D) completeness.

D) completeness.

3) The reliability of perpetual inventory master files affects the timing and ________ of the auditor's physical examination of inventory. A) cutoff B) accuracy C) nature D) extent

D) extent

14) A useful starting point for becoming familiar with the client's inventory is for the auditor to A) read the AICPA's Industry Audit Guide. B) review accounting theory covering special inventory problems. C) read the client's accounting manual. D) tour the client's facility.

D) tour the client's facility.