ACCT 402 CH 12 HW

12-29 c) The document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement is the: 1) Bill of lading 2) Job time shipping 3) Production order 4) Production schedule

1) Bill of lading

12-29 k) McPherson Corp. does not take 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: 1) Can issue an unqualified opinion without disclosing that she did not observe year-end inventories 2) Should comment in the scope paragraph as to her inability to observe year-end inventories, but can nevertheless issue an unqualified opinion 3) Is required, if the inventories are material, to disclaim an opinion on the financial statements taken as a whole 4) Should, if the inventories are material, qualify her opinion

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

12-29 e) The organization established by Congress to narrow the options in cost accounting that are available under generally accepted accounting principles is the: 1) Cost Accounting Standards Board 2) Financial Accounting Standards Board 3) Public Company Accounting Oversight Board 4) Securities and Exchange Commission

1) Cost Accounting Standards Board

12-29 d) Which of the following should be included as part of inventory costs of a manufacturing company? 1) Direct Labor: Yes; Raw Materials: Yes; Factory Overhead: Yes 2) Direct Labor: Yes; Raw Materials: No; Factory Overhead: No 3) Direct Labor: No; Raw Materials: Yes; Factory Overhead: No 4) Direct Labor: No; Raw Materials: No; Factory Overhead: No

1) Direct Labor: Yes; Raw Materials: Yes; Factory Overhead: Yes

12-29 f) When a primary risk related to an audit is possible overstated inventory, the assertion most directly related is: 1) Existence 2) Completeness 3) Clarity 4) Presentation

1) Existence

12-29 h) The auditor's analytical procedures will be facilitated if the client: 1) Uses a standard cost system that produces variance reports 2) Segregates obsolete inventory before the physical inventory count 3) Corrects material weaknesses in internal control before the beginning of the audit 4) Reduces inventory balances to the lower of cost or market

1) Uses a standard cost system that produces variance reports

12-29 i) When perpetual inventory records are maintained in quantities and in dollars, and internal control over inventory is weak, the auditor would probably: 1) Want the client to schedule the physical inventory count at the end of the year 2) Insist that the client perform physical counts of inventory items several times during the year 3) Increase the extent of tests for unrecorded liabilities at the end of the year 4) Have to disclaim an opinion on the income statement for that year

1) Want the client to schedule the physical inventory count at the end of the year

12-29 g) 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: 1) Well-kept records of perpetual inventory are maintained 2) Inventory is slow-moving 3) Computer error reports are generated for missing prenumbered inventory tickets 4) Obsolete inventory items are segregated and excluded

1) Well-kept records of perpetual inventory are maintained

12-29 j) Which of the following is the best audit procedure for the discovery of damaged merchandise in a client's ending inventory? 1) Compare the physical quantities of slow-moving items with corresponding quantities in the prior year 2) Observe merchandise and raw materials during the client's physical inventory taking 3) Review the management's inventory representations letter for accuracy 4) Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average

2) Observe merchandise and raw materials during the client's physical inventory taking

12-4) Do you believe that the normal review of purchase transactions by the auditors should include examination of receiving reports? Explain.

Adequate internal control of purchase transactions requires the preparation of serially numbered receiving reports by an independent receiving department and the comparison of these reports with vendors' invoices and purchase orders by the accounts payable department prior to approval of the invoice for payment. To ascertain that these procedures are actually being followed, the auditors will make various tests including the examination of receiving reports to see that they are complete, current, legible, and controlled by serial numbers.

12-3) What segregation of duties would you recommend to attain maximum internal control over purchasing activities in a manufacturing concern?

Internal control over purchasing activities is strengthened by placing exclusive authority for purchases of all kinds in a separate purchasing department, and creating another independent department to handle the receiving function. In addition, the recording of purchase transactions should be assigned to an accounts payable section within the accounting department. In a small concern, departmentalization of operations may not be feasible to this extent, but if internal control is to be achieved, it is necessary as a minimum requirement that the functions of purchasing, receiving, and recording be assigned to different employees not subordinate to one another.

12-19) The controller of a new client company informs you that most of the inventories are stored in bonded public warehouses. He presents warehouse receipts to account for the inventories. Will careful examination of these warehouse receipts constitute adequate verification of these inventories? Explain.

No. Inspection of the warehouse receipts does not constitute sufficient verification. The inventories should be confirmed in writing directly to the auditors by the custodians of the stored goods. If the inventories stored in public warehouses are substantial in relation to other assets, the auditors should also review client records regarding selection and performance of the warehouses, and any available reports on the warehouses' internal control. The auditors also should consider observing substantial inventories stored in public warehouses.

12-1) Many auditors consider the substantiation of the figure for inventory to be a more difficult and challenging task than the verification of most other items on the balance sheet. List several specific factors that support this view.

Substantiation of the figure for inventories is an especially challenging task because of the variety of acceptable methods of valuation. In addition, the variety of materials found in inventories calls for considerable experience and skill to do an efficient job of identifying and test-counting goods on hand. The possibilities of obsolescence and of excessive stocks also create problems. Finally, the relatively large size of inventories and their significance in the determination of net income make purposeful misstatement by the client a possibility that the auditors must guard against.

12-8) For what purposes do the auditors make and record test counts of inventory quantities during their observation of the taking of the physical inventory? Discuss.

The auditors make test counts of inventory quantities during their observation of the taking of the physical inventory to ascertain that the individuals taking the inventory are making an accurate count. The extent of test counting will be determined by the inventory-taking procedures; for example, the number of the auditors' test counts would be reduced if there were two teams, one verifying, the other taking the inventory. On the other hand, the auditors' test counts would be expanded if they found errors in the inventory counts. Some test counts are recorded by the auditors for the purpose of subsequent comparison with the client's compilation of the inventory. The auditors must determine that the compilation of the inventory from the tags, sheets, or computer readable forms is accurate. In addition, the auditors seek assurance that the description and condition of the inventory items is accurate for pricing purposes and that the quantity information, such as dozen, gross, cartons, etc., is proper. A secondary reason for recording test counts in the audit working papers is to provide evidence of the extent of the auditors' tests in the event that audit procedures are questioned at some future date.

12-7) What are the purposes of the auditors' observation of the taking of the physical inventory? (Do not discuss the procedures or techniques involved in making the observation.)

The auditors observe the taking of the physical inventory to obtain evidence supporting its existence. In addition, information relevant to valuation of and rights to inventory is obtained. Observation of the physical inventory is a major step in meeting the standard of field work that requires the auditors to gather sufficient, competent, evidential matter to provide a reasonable basis for an opinion on the financial statements. By observing the taking of the physical inventory, the auditors are seeking sufficient competent evidence as to the effectiveness of the methods of inventory taking and as to the measure of reliance which may be placed upon the client's inventory records and its representations as to inventory quantities. The auditors must ascertain that the physical inventory actually exists, that the inventory quantities are being determined by reasonably accurate methods, and the inventory is in a saleable or usable condition.

12-6) What part, if any, do the independent auditors play in the planning for a client's physical inventory?

The independent auditors are key participants in the planning for a client's physical inventory. Although the auditors do not actually do the planning for the client, they offer advice on such matters as the assignment of a key client employee to assume responsibility for the inventory; selection of the most advantageous dates for the inventory taking; scheduling operations to minimize goods-in-process; etc. Most important is the auditors' determination that the client's inventory instructions are adequate.

12-9) 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.

The test counts and tag numbers should be listed by the auditors in their working papers and later traced to the client's inventory summary sheets. By this procedure, the auditors obtain evidence that the quantities on the tags have been accurately transcribed to the summary sheets by the client employees in developing the total valuation for inventory. If a significant number of differences are found, the auditors may need to reexamine the original tags or request that the client recompile the inventory.

12-16) Darnell Equipment Company uses the LIFO method of valuation for part of its inventories and weighted-average cost for another portion. Would you be willing to issue an unqualified opinion under these circumstances? Explain.

The use of different methods of inventory valuation for different components of the company's inventory is acceptable practice and would not prevent the issuance of an unqualified audit report. Generally accepted accounting principles allow the use of different valuation methods for different components of a company's inventory.

12-29 a) Which of the following is least likely to be among the auditors' objectives in the audit of inventories and cost of goods sold? 1) Determine that the valuation of inventories and cost of goods sold is arrived at by appropriate methods 2) Determine the existence of inventories and occurrence of transactions affecting cost of goods sold 3) Establish that the client includes only inventory on hand at year-end in inventory totals 4) Establish the completeness of inventories

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

12-29 b) The receiving department is least likely to be responsible for the: 1) Determination of quantities of goods received 2) Detection of damaged or defective merchandise 3) Preparation of a shipping document 4) Transmittal of goods received to the store's department.

3) Preparation of a shipping document

12-18) How do the independent auditors use the client's backlog of unfilled sales orders in the examination of inventories?

The independent auditors utilize the client's backlog of unfilled sales orders in the determination of net realizable value of finished goods and goods-in-process, and in the determination of losses, if any, on firm sales commitments for which no production has yet been undertaken.

12-29 l) The primary objective of a CPA's observation of a client's physical inventory count is to: 1) Discover whether a client has counted a particular inventory item or group of items 2) Obtain direct knowledge that the inventory exists and has been properly counted 3) Provide an appraisal of the quality of the merchandise on hand on the day of the physical count 4) Allow the auditor to supervise the conduct of the count in order to obtain assurance that the inventory quantities are reasonably accurate

2) Obtain direct knowledge that the inventory exists and has been properly counted

12-11) What is meant by a "bill and hold" scheme?

A bill and hold scheme involves transactions in which sales of merchandise are improperly billed to customers prior to delivery, with the goods being held by the seller. These transactions overstate revenues and net income. Bill and hold transactions have to meet rigorous requirements to be recognized as legitimate sales.

12-10) When perpetual inventory records are maintained, is it necessary for a physical inventory to be taken at the balance sheet date? Explain.

A physical inventory at least once a year is generally essential regardless of whether perpetual inventories are maintained. However, when perpetual inventories and good internal control are maintained, the annual physical count may be taken at a date other than the year-end. Some companies with good perpetual inventory records prefer to take a physical inventory in one department at a time with the counting work thereby spread throughout the year. Furthermore, if statistical sampling techniques are applied in the periodic counting process and the sampling is appropriately planned and executed, the entire inventory need not be counted.

12-20) Enumerate specific steps to be taken by the auditors to ascertain that a client's inventories have not been pledged or subjected to a lien of any kind.

In the confirmation of bank accounts and bank loans, the reply from the bank may disclose a lien on inventory. Also in examining insurance policies on inventory, the auditors may find a "loss payable clause" to a third party indicating inventories have been pledged. Finally, the client officials should be asked to disclose any lien on inventory as part of the written representations furnished to the auditors.