Chapter 12

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.

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 from the file of all: A. Cash disbursements. B. Approved vouchers. C. Receiving reports. D. Vendors' invoices.

A. Cash disbursements.

During the year 1 audit of Cellenting Company the auditor performed various procedures relating to inventory. Match each of the descriptions provided below with the appropriate audit procedure. A. 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. B. During a site visit to a construction site, the auditor determined that all employees were wearing proper safety equipment. C. The auditor asked the warehouse manager about whether certain inventory items were becoming obsolete. D. 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. E. The auditor calculated the accounts receivable turnover for the year. F. The auditor obtained a copy of the company's accounting manual and read the section on inventory to prepare for the physical inventory observation. G. 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.

A. Inspection of tangible assets B. Observation C. Inquiry D. Reperformance E. Analytical procedure F. Inspection of records or documents G. Recalculation

The most reliable procedure for an auditor to use to test the existence of a client's inventory at an outside location would be to: A. Observe physical counts of the inventory items. B. Trace the total on the inventory listing to the general ledger inventory account. C. Obtain a confirmation from the client indicating inventory ownership. D. Analytically compare the current-year inventory balance to the prior-year balance.

A. Observe physical counts of the inventory items.

In testing management's rights and obligations assertion in relation to inventories, which of the following procedures would the auditor most likely consider most reliable? A. Review consignment agreements. B. Vouch inventory counts to accounting records. C. Trace inventory in accounting records to inventory counts. D. Make inquiries and analyze inventory turnover to identify slow-moving or obsolete items.

A. Review consignment agreements.

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.

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.

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. sales.

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. Rights. B. Completeness. C. Existence. D. Valuation.

B. Completeness.

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.

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.

In testing controls over purchases, an auditor most likely would determine that the person who receives inventory A. Already has advance copies of purchase orders with the quantity of goods to expect. B. Prepares receiving reports for all good received. C. Conducts periodic comparisons of receiving reports to general ledger postings. D. Posts to the general ledger to reflect the receipt of goods.

B. Prepares receiving reports for all good received.

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 supervise the taking of the inventory. 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 supervise the taking of the inventory.

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. Rights. B. Completeness. C. Existence. D.Valuation.

C. Existence.

A client's physical count of inventories was higher than the inventory quantities per the perpetual records. This situation could be the result of the failure to record: A. Sales. B. Sales discounts. C. Purchases. D. Purchase returns.

C. Purchases.

Which of the following is true about the auditors' observation of the client's 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.

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

D. Valuation.

Auditors should not review the client's planning of the physical inventory. T/F

FALSE

Observation of inventories is a required audit procedure under all circumstances. T/F

FALSE

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. T/F

False

When auditing inventory and cost of goods sold, auditors select the most appropriate procedures for the audit but typically follow the same general pattern. Step 1 Step 2 Step 3 Step 4 Step 5

Step 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. Step 2- Obtain an understanding of internal control over inventories and cost of goods sold. Step 3- Assess the risks of material misstatement and design further audit procedures Step 4- Perform tests of controls Step 5- Perform substantive audit procedures

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

TRUE

The auditors should record the details of their test counts in the audit working papers, which are used to test the client's completed physical inventory listing. T/F

TRUE

Warren Manufacturing Company retains you on April 1 to perform an audit for the fiscal year ending June 30. During the month of May, you make extensive studies of internal control over inventories. All goods purchased pass through a receiving department under the direction of the chief purchasing agent. The duties of the receiving department are to unpack, count, and inspect the goods. The quantity received is compared with the quantity shown on the receiving department's copy of the purchase order. If there is no discrepancy, the purchase order is stamped "OK—Receiving Department" and forwarded to the accounts payable section of the accounting department. Any discrepancies in quantity or variations from specifications are called to the attention of the buyer by returning the purchase order to him with an explanation of the circumstances. No records are maintained in the receiving department, and no reports originate there. As soon as goods have been inspected and counted in the receiving department, they are sent to the factory production area and stored alongside the machines in which they are to be processed. Finished goods are moved from the assembly line to a storeroom in the custody of a stock clerk, who maintains a perpetual inventory record in terms of physical units but not in dollars. What weaknesses, if any, do you see in the internal control over inventories?

Weaknesses in internal control of Warren Manufacturing Company include the following: (1) Organization structure is poor. The receiving department should not be under the authority of the purchasing agent. (2) Copies of purchase orders sent to receiving department should not show quantities. This encourages careless counting. (3) The receiving department should prepare a receiving report for each shipment received. These documents will permit evaluation of the department's work, indicate proportion of returns, and establish accountability for goods. (4) Errors by buyers are covered up by the existing system since any deficiency in goods received is not reported by the receiving department to anyone but the buyer. (5) Goods should be kept in storerooms until required for production, not sent directly to the factory production area. (6) There is apparently no control over the movement of raw materials into goods-in-process and no record of the quantities of goods-in-process. (7) The perpetual inventory records (physical units only) for finished goods are apparently not integrated with the accounting records. (8) The custody of finished goods and the recordkeeping for these goods are assigned to the same employee.

Observation of a client's inventory is a presumptively mandatory audit procedure. a. What part should the auditors play in planning the physical inventory? b. Describe the procedures performed by the auditors during their observation of a client's physical inventory. c. Why do the auditors document their inventory test counts in their working papers?

a. The auditors should review the client's planning of the physical inventory and make suggestions for improvement. b. During the inventory observation, the auditors: 1. Evaluate whether the inventory procedures are followed which assure that all items are counted, and nothing is counted twice. 2. Be alert for goods that appear to be damaged or obsolete. 3.Obtain information to test the client's cutoff of purchases and sales. 4. Make test counts and record them in their working papers. 5. Make inquiries regarding goods on consignment. 6. Obtain tag control information and record the information in the working papers. c. The auditors document their test counts in the working papers to later test the accuracy of the final inventory listing.