Audit Theory for Inventory

CHAPTER 14 MULTIPLE CHOICE

 b

1. To strengthen control procedures over the custody of heavy mobile equipment, the client would most likely institute a policy requiring a periodic a. Increase Increase in insura insurance nce coverage coverage..  b. Inspection of equipment and reconciliation with accounting records. c. Verification of liens, liens, pledges, and collateralizations. collateralizations. d. Accounting for work orders. (AICPA ADAPTED)

c

2. To improve improve accounta accountability bility for fixed fixed asset asset retireme retirements, nts, manag manageme ement nt most most likely likely would would imple implemen mentt an internal control structure that includes a. Continuou Continuouss analysis analysis of the repairs repairs and maintena maintenance nce account. account.  b. Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired. c. Continuous utilization of serially numbered retirement work orders. orders. d. Peri Period odic ic insp inspec ecti tion on of insu insura ranc ncee poli polici cies es by inte intern rnal al audi audito tors rs.. (AIC (AICPA PA ADAP ADAPTE TED) D)

 b

3. From the auditor's point of view, inventory counts are more acceptable prior to the year-end, when a. Internal Internal control control is deficient deficient..  b. Accurate perpetual inventory records r ecords are maintained. c. Inventor Inventory y is slow moving. moving. d. Sign Signif ific ican antt amou amount ntss of inve invent ntor ory y are are held held on cons consig ignm nmen ent. t. (AI (AICPA CPA ADAP ADAPTE TED) D)

c

4. Apex Manufactu Manufacturing ring Corporatio Corporation n mass mass produces produces eight eight differen differentt products products.. The controller controller who is interested in strengthening control procedures over the accounting for materials used in  production would be most likely to implement implement a. An econom economic ic order order quantity quantity (EOQ) system. system.  b. A job j ob order cost accounting system. c. A perpe perpetual tual inventory inventory system. system. d. A separation of duties among production personnel. (AICPA ADAPTED)

a

5. For severa severall years, years, a client client's 's physic physical al invento inventory ry count count has been lower than what what was was shown shown on the  books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory inventory problem could be deficiencies deficiencies in internal control that led to the failure to record some a. Purchases Purchases returned returned to vendors. vendors.  b. Sales returns received. c. Sales Sales discounts discounts allowed. allowed. d. Cash purchases. (AICPA ADAPTED)

a

6. When perpetual perpetual inven inventory tory records records are mainta maintained ined in in quantitie quantitiess and in in dollars, dollars, and and internal internal contro controll  procedures over inventory are deficient, the auditor would probably a. Want the client client to schedule schedule the the physical physical inventory inventory count count at the end of the year. year.  b. Insist that the client perform physical counts of inventory items several times during the year. c. Increase Increase the extent extent of tests tests for unrecorded unrecorded liabiliti liabilities es at the end of the year. year. d. Have Have to disc discla laim im an opin opinio ion n on the the inco income me stat statem emen entt that that year year.. (AIC (AICPA PA ADAP ADAPTE TED) D)

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a

7. a.  b. c. d.

Purchase cutoff procedures should be designed to test whether or not all inventory Purchased and received before the year-end was recorded. Was carried at the lower of cost or market on the year-end balance sheet. Was paid for by the company on the year-end balance sheet. Owned by the company is in the possession of the company. (AICPA ADAPTED)

c

8. In tests of property, plant, and equipment, the auditor tries to determine all of the following except the a. Adequacy of the internal control.  b. Extent of property abandoned during the year. c. Adequacy of replacement funds. d. Reasonableness of depreciation. (AICPA ADAPTED)

 b

9. 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. (AICPA ADAPTED)

 b

10. The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the following could explain the difference? a. Inventory items had been counted, but the tags placed on the items had not been taken off the items and added to the inventory accumulation sheets.  b. Credit memos for several items returned by customers had not been recorded. c. No journal entry had been made on the retailer's books for several items returned to its suppliers. d. An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not been reflected in the perpetual records. (AICPA ADAPTED)

c

11. 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. (AICPA ADAPTED)

d

12. The controller of Excello Manufacturing, Inc., wants to use ratio analysis to identify the possible existence of idle equipment or the possibility that equipment has been disposed of without having  been written off. Which of the following ratios would best accomplish this objective? a. Depreciation expense divided by book value of manufacturing equipment.  b. Accumulated depreciation divided by book value of manufacturing equipment. c. Repairs and maintenance cost divided by direct labor costs. d. Gross manufacturing equipment cost divided by units produced. (AICPA ADAPTED)

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 b

13. The accuracy of perpetual inventory records may be established, in part, by comparing inventory records with a. Purchase requisitions.  b. Receiving reports. c. Purchase orders. d. Vendor payments. (AICPA ADAPTED)

d

14. The audit procedure of analyzing the repairs and maintenance accounts is primarily designed to  provide evidence in support of the audit proposition that all a. Expenditures for plant assets have been recorded in the proper period.  b. Capital expenditures have been properly authorized. c. Noncapitalizable expenditures have been properly expensed. d. Expenditures for plant assets have been capitalized. (AICPA ADAPTED)

a

15. Which of the following explanations might satisfy an auditor who discovers significant debits to an accumulated depreciation account? a. Extraordinary repairs have lengthened the life of an asset.  b. Prior years' depreciation charges were erroneously understated. c. A reserve for possible loss on retirement has been recorded. d. An asset has been recorded at its fair value. (AICPA ADAPTED)

c

16. a.  b. c. d.

d

17. When an outside specialist has assumed full responsibility for taking the client's physical inventory, reliance on the specialist's report is acceptable if  a. The auditor is satisfied about the specialist's reputation and competence.  b. Circumstances make it impracticable or impossible for the auditor either to do the work   personally or to observe the specialist's work. c. The auditor performs the same tests and procedures as would have been applicable if the client's employees took the physical inventory. d. The auditor's report assumes full responsibility. (AICPA ADAPTED)

d

18. An auditor's tests of a client's cost accounting system are designed primarily to determine that a. Quantities on hand have been computed based on acceptable methods that reasonably approximate actual quantities on hand.  b. Physical inventories substantially agree with book inventories. c. The system complies with generally accepted accounting principles and functions as planned. d. Costs have been assigned properly to finished goods, work in process, and cost of goods sold. (AICPA ADAPTED)

Which of the following activities is not common to the conversion cycle? Maintaining perpetual inventory records. Accounting for fixed asset disposals and retirements. Implementing a just-in-time order entry system. Recording depreciation allocations.

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d

19. Sanbor Corporation's parts inventory consists of thousands of different items that are small in value individually, but quite significant in total. Sanbor could establish effective control over the  parts by requiring a. An officer's approval of requisitions for inventory parts.  b. Maintaining inventory records for all parts included in the inventory. c. Physical counts on a cycle basis rather than at year-end. d. Separation of the storekeeping function from the production and inventory record-keeping functions. (AICPA ADAPTED)

c

20. When verifying debits to a manufacturing company's perpetual inventory records, an auditor  would be most interested in testing a sample of purchase a. Approvals.  b. Requisitions. c. Invoices. d. Orders. (AICPA ADAPTED)

c

21. a.  b. c. d.

a

22. Which of the following is not likely a motive for management to manipulate the timing and amount of impaired asset writedowns? a. Steady increases in earnings per share over the past 5 years.  b. Income smoothing. c. A "big bath." d. An abnormally unprofitable year.

c

23. 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 subsequent period.  b. Purchase in the current period. c. Sale in the current period. d. Purchase return in the subsequent period. (AICPA ADAPTED)

d

24. a.  b. c. d.

 b

25. Which of the following internal control efficiencies relates to factory equipment? a. Checks issued in payment of purchases of equipment are not signed by the controller.  b. All purchases of factory equipment are required to be made by the department that needs the equipment. c. Factory equipment replacements are generally made when estimated useful lives have expired. d. Proceeds from sales of fully depreciated equipment are credited to other income. (AICPA ADAPTED)

Assets may suffer an impairment in value for a variety of reasons, but not likely as a result of: A corporate restructuring. Slumping demand for uncompetitive products. Significant increases in market share. Obsolescence.

An auditor would be most likely to learn of slow-moving inventory through Inquiry of sales personnel. Inquiry of stores personnel. Physical observation of inventory. Review of perpetual inventory records. (AICPA ADAPTED)

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c

26. a.  b. c. d.

When auditing fixed assets, an auditor attempts to determine all of the following except Control risk. Property abandoned during the year. Adequacy of replacement funds. Reasonableness of depreciation. (AICPA ADAPTED)

c

27. Which of the following is the best evidence that an entity owns real estate at the balance sheet date? a. Title insurance policy.  b. Original deed. c. Paid real estate tax bills. d. Closing statement. (AICPA ADAPTED)

 b

28. Which of the following procedures would least likely lead the auditor to detect unrecorded fixed asset disposals? a. Examine insurance policies.  b. Review repairs and maintenance expense. c. Review property tax files. d. Scan invoices for fixed asset additions. (AICPA ADAPTED)

c

29. a.  b. c. d.

d

30. In violation of company policy, Lowell Company erroneously capitalized the cost of painting its warehouse. An auditor would most likely detect this when a. Discussing capitalization policies with Lowell's controller.  b. Examining maintenance expense accounts. c. Observing that the warehouse had been painted. d. Examining construction work orders that support items capitalized during the year. (AICPA ADAPTED)

The auditor may conclude that depreciation charges are insufficient by noting Insured values greatly in excess of book values. Large amounts of fully depreciated assets. Continuous trade-ins of relatively new assets. Excessive recurring losses on assets retired. (AICPA ADAPTED)

SHORT ANSWER 

1. Explain the conversion cycle. Answer: The conversion cycle encompasses the production of finished products for sale, and relates directly to two other cycles. It uses resources and information provided by the expenditure/disbursement cycles and provides resources and information to the revenue/receipt cycle.

2. To control inventory recording what controls should management have in place? Answer: To avoid misstated or misplaced inventory used or transferred inventory should be recorded in the correct amounts, be recognized in the proper period, and be classified properly. To control

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inventory recording, management could establish processing and recording procedures,  prenumber and control material release forms and production orders, and maintain logs of  inventory movement into and out of storerooms and production. 3. How should management safeguard inventory from fraud or misappropriation? Answer: Access to inventory should be restricted to personnel authorized by management. Management could establish physical control over inventory, maintain insurance, both for inventory and for  inventory personnel in the form of fidelity bonds and segregate responsibility for handling inventory from inventory recording, cost accounting, and general accounting. Management should also restrict access to production, cost accounting, and perpetual inventory records,  preventing misuse, destruction, or loss of inventory or inventory records.

4. Explain the internal controls management can use to assure control over the transaction authorization of fixed assets. Address the separate controls for transaction authorization, execution, and recording. Answer: To control unauthorized transactions, management could develop written procedures for all additions, disposals, and retirements, and periodically compare scrap sale prices with published  price lists. Transaction Authorization  – Prepare written procedures for all additions, disposals, and retirements. Periodically compare prices received for scrap with published prices. Transaction Execution –  Establish procedures for operating, using, moving, and otherwise controlling fixed assets. Restrict access to movable fixed assets. Recording –  Establish procedures for processing and recording fixed asset transaction. Establish  procedures for identifying fixed assets eligible for disposal. Maintain detailed fixed assets records. Periodically reconcile fixed asset records with existing assets and investigate differences. Establish policies for determining depreciation methods and for calculating depreciation on all categories of fixed assets.

5. Describe the preliminary review process as it pertains to obtaining an understanding of a client’s inventory controls relating to inventory. Answer: An auditor performs the preliminary review for inventory by reading the client’s procedures manuals and by interviewing client personnel who are responsible for perpetual inventory records, cost records, and inventory accounting. Assuming the existing controls appear   potentially reliable in assessing control risk below the maximum, an auditor proceeds by documenting the system.

PROBLEMS

1. Complete the table below as it concerns to the related assertions and audit procedures of  inventory and fixed assets accounts.

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Assertions Existence or Occurrence

Inventory

Fixed Assets

Inventory Observe physical inventory Confirm off-premises inventory Test cutoff  Observe physical inventory Confirm off-premises inventory Test cutoff Perform analytical procedures Confirm off-premises inventory Test cutoff Review consignment and  purchase commitments Test final priced inventory

Fixed Assets Observe asset additions Test cutoff 

Completeness

Rights and Obligations

Valuation or allocation Presentation and Disclosure Answer: Assertions Existence or Occurrence

Completeness

Rights and Obligations

Valuation or allocation

Presentation and Disclosure

Review physical inventory for  obsolete, slow moving, otherwise unsalable goods Compare statement presentation and disclosures with those required by GAAP

Observe asset additions Test cutoff  Perform analytical procedures Test additions Test cutoff   Examine contracts and other  documentation Verify accuracy of recorded fixed assets and depreciation expense Test additions and disposals

Compare statement  presentation and disclosures with those required by GAAP

2. Complete the questionnaire with applicable questions that an auditor may use to address fixed assets control procedures. Give at least two questions for each of the following categories:  Fixed Asset Records  Additions  Disposals and Retirements  Depreciation

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Answer, Yes, No, or N/A

Question

Remarks

Answer: Students’ answers may include the following possibilities. Answer, Yes, No, or N/A

Question Fixed Asset Records 1. Are detailed records maintained for each class of fixed assets? 2. Is responsibility for maintaining fixed asset records segregated from responsibility for   physically controlling fixed assets and from general accounting? 3. Are detailed records reconciled periodically with general ledger control accounts? 4. Are procedures followed to determine whether  recorded fixed assets actually exist? 5. Is access to and the use of fixed assets restricted to authorized personnel? 6. Is insurance coverage maintained and reviewed for all fixed assets? 7. Are fixed assets physically safeguarded from deterioration and theft? Additions 1. Do procedures require authorization by the board of directors or senior management for fixed asset additions? 2. Are actual expenditures for fixed assets compared with amounts authorized? 3. Are procedures established to assure that fixed assets purchased are delivered in accordance with orders placed? 4. Are fixed asset additions promptly recorded in fixed asset records? 5. Are fixed asset additions promptly reported to general accounting? 6. Are insurance companies notified of fixed asset additions in order to increase insurance coverage? 7. Is construction in progress – whether internally or externally contracted – authorized and  periodically inspected?

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Remarks

Answer, Yes, No, or N/A

Question Disposals and Retirements 1. Do procedures require authorization by the board of directors or senior management for fixed asset disposals and retirements? 2. Are procedures established to assure that the  proceeds from fixed asset disposals are recorded  properly and deposited? 3. Are fixed asset disposals and retirements promptly record in fixed asset records? 4. Are fixed asset additions promptly reported to general accounting for recording gains or losses? 5. Are insurance companies notified of fixed asset disposals and retirements to assure that insurance coverage is altered accordingly? Depreciation 1. Are procedures established to assure that additions are added to depreciation records and that disposals/retirements are deleted? 2. Are procedures established to assure that depreciation is recorded only for those fixed assets actually in service during the period? 3. Are procedures established for determining depreciation methods, estimated useful lives, and salvage values?

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Remarks

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