auditing and assurance services chapter 13 tb

Chapter 13 - Auditing the Inventory Management Process

Chapter 13Auditing the Inventory Management Process

True / False Questions

1. The "cradle-to-grave" cycle for inventory begins when goods are purchased and stored and ends when the finished goods are shipped to customers. True False

2. A receiving report records the shipment of goods to customers. True False

3. Sale of finished goods is a part of the inventory management process. True False

4. Once the controls in the inventory system have been tested, the auditor sets the level of control risk. True False

5. The major control procedure for preventing fictitious inventory transactions from being recorded is proper segregation of duties. True False

6. Inventory should be valued using the lower-of-cost-or-market rule. True False

7. A high inventory turnover ratio normally indicates inefficient inventory policies. True False

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8. The three components that make up the cost of producing a product include materials, direct labor, and indirect labor. True False

9. The auditor's observation of inventory is a generally accepted auditing procedure. True False

10. Obsolete inventory should be written down to its current market value. True False

11. In the audit of inventory, the client is responsible for actually making and recording the count of physical inventory; the auditor's responsibility is to evaluate and observe the client's procedures and draw conclusions about the adequacy of the physical inventory. True False

12. An approved purchase requisition form authorizes shipment of goods to customers. True False

13. A comparison of the current year's inventory turnover ratio with previous years' may indicate the presence of obsolete inventory. True False

14. When the client's perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date. True False

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15. The audit test of control "Review and test procedures for issuing materials to manufacturing departments" provides assurance mainly for the occurrence assertion for inventory management. True False

16. Production personnel should ordinarily be responsible for maintaining perpetual inventory records. True False

17. Inherent risk is typically assessed at a low to moderate level for inventory due to the nature of the asset. True False

Multiple Choice Questions

18. Shipping orders are forwarded from the revenue process to A. The materials requisitions departmentB. Finished goods storesC. Raw materials storesD. Inventory management

19. Which of the following departments typically approves purchase requisitions? A. Raw materials storesB. Cost accountingC. Inventory managementD. IT

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20. Which of the following best describes the occurrence assertion for inventory? A. Purchase requisitions initiated by authorized personnelB. Recorded inventory actually existsC. Inventory properly accumulated from journals and ledgersD. All inventory is recorded

21. Auditors are most likely to ensure that no production activity is scheduled prior to A. Determining standard costsB. Observing physical inventoryC. Completing the book to physical adjustmentD. Determining the amount of consigned inventory

22. The safeguarding of inventory most likely includes A. Comparison of the information contained on the purchase requisitions, purchase orders, receiving reports, and vendors' invoicesB. Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical countC. Analytical procedures for raw materials, goods in process, and finished goods that identify unusual transactions, theft and obsolescenceD. Application of established overhead rates on the basis of direct labor hours or direct labor costs

23. Which of the following is not a misstatement related to the occurrence assertion for inventory? A. Consigned goods are included as part of inventoryB. Unauthorized production activityC. Fictitious inventoryD. Recorded inventory is not on hand because of theft

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24. Failure to record inventory in the proper period can affect all of the following accounts except A. SalesB. ReceivablesC. Cost of Goods SoldD. Prepaid Expenses

25. Which of the following audit procedures would provide the least reliable evidence that the client has legal title to inventories? A. Confirmation of inventories at locations outside the client's facilitiesB. Analytical review of inventory balances compared to purchasing and sales activitiesC. Observation of physical inventory countsD. Examination of paid vendors' invoices

26. 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 periodB. Purchase in the current periodC. Sale in the current periodD. Purchase return in the subsequent period

27. For the purpose of determining proper cutoff for inventory, the auditor will select a sample from which of the following for a few days before and after year-end? A. Materials requisitionsB. Production schedulesC. Receiving documentsD. Purchase orders

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28. Which of the following auditing procedures most likely would provide assurance about a manufacturing entity's inventory valuation? A. Vouching the raw materials costs to vendors' invoicesB. Obtaining confirmation of inventories pledged under loan agreementsC. Reviewing shipping and receiving cutoff activities for inventoriesD. Tracing test counts to the entity's inventory listing

29. An auditor will usually trace the details of the test counts made during the observation of the physical inventory count to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are A. Owned by the clientB. Not obsoleteC. Physically present at the time of the preparation of the final inventory scheduleD. Included in the final inventory schedule

30. 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. SalesB. Sales returnsC. PurchasesD. Purchase discounts

31. 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 costB. All inventory represented by an inventory tag is listed on the inventory sheetsC. All inventory represented by an inventory tag is bona fideD. Inventory sheets do not include untagged inventory items

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32. 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. SalesB. Sales discountsC. PurchasesD. Purchase returns

33. If the perpetual inventory records show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded A. SalesB. Sales discountsC. PurchasesD. Purchase discounts

34. An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. This procedure most likely obtained evidence concerning management's assertion of A. Rights and obligationsB. CompletenessC. ExistenceD. Valuation

35. While observing a client's annual physical inventory, an auditor recorded test counts for several items and noticed that certain test counts were higher than the recorded quantities in the client's perpetual records. This situation could be the result of the client's failure to record A. Purchase discountsB. Purchase returnsC. SalesD. Sales returns

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36. In a manufacturing company, which one of the following audit procedures would give the least assurance about the valuation of inventory at the audit date? A. Testing the computation of standard overhead ratesB. Examining paid vendors' invoicesC. Reviewing direct labor ratesD. Obtaining confirmation of inventories pledged under loan agreements

37. Which of the following is least likely to be a possible cause of book-to-physical differences in inventory quantities? A. Inventory cutoff errorsB. Misapplication of LIFOC. Unreported scrap or spoilageD. Theft

38. An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support management's financial statement assertion of A. ValuationB. Rights and obligationsC. ExistenceD. Completeness

39. Which of the following is a plausible explanation for a large increase in the number of days outstanding in inventory? A. Obsolete inventoryB. New product line where sales exceed productionC. Manufacturing overhead was not allocated to the production processD. Manufacturing salaries were recorded as administrative expenses

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40. Key segregations of duties in the inventory management process include all of the following except separating A. Cost accounting from review of variance reportsB. Inventory management from cost accountingC. Cost accounting from the general ledger functionD. Supervision of physical inventory from inventory management

41. An auditor generally tests physical security controls over inventory by A. Test counts and cutoff proceduresB. Examination and reconciliationC. Inspection and recomputationD. Inquiry and observation

42. 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 yearB. Insist that the client perform physical counts of inventory items several times during the yearC. Increase the extent of tests for unrecorded liabilities at the end of the yearD. Have to disclaim an opinion on the income statement for that year

43. A client maintains perpetual inventory records in both quantities and dollars. If the assessed level of control risk is high, an auditor would probably A. Increase the extent of tests of controls for the inventory cycleB. Request that the client schedule the physical inventory count at the end of the yearC. Insist that the client perform physical counts of inventory items several times during the yearD. Apply gross profit tests to ascertain the reasonableness of the physical counts

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44. In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would A. Review the entity's description of inventory policies and proceduresB. Perform test counts of inventory during the entity's physical countC. Analyze inventory turnover statistics to identify slow-moving and obsolete itemsD. Analyze monthly production reports to identify variances and unusual transactions

45. For several years, a client's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal controls that led to the failure to record some A. Purchases returned to vendorsB. Sales returns receivedC. Sales discounts allowedD. Cash purchases

46. Which of the following control activities would most likely be used to maintain accurate perpetual inventory records? A. Independent storeroom count of goods receivedB. Periodic independent reconciliation of control and subsidiary recordsC. Periodic independent comparison of records with goods on handsD. Independent matching of purchase orders, receiving reports and vendors' invoices

47. An inventory turnover analysis is useful to the auditor because it may detect A. Inadequacies in inventory pricingB. Methods of avoiding cyclical holding costsC. The optimum automatic reorder pointsD. The existence of obsolete merchandise

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48. Tracing costs used to price inventory to vendors' invoices tests which of the following assertions? A. OccurrenceB. CutoffC. AccuracyD. Classification

49. The auditor tests the quantity of materials charged to work-in-process by tracing these quantities to A. Cost ledgersB. Perpetual inventory recordsC. Receiving reportsD. Material requisitions

50. Purchase cutoff activities should be designed to test that merchandise is included in the inventory of the client company if the company A. Has paid for the merchandiseB. Has physical possession of the merchandiseC. Holds legal title to the merchandiseD. Holds the shipping documents for the merchandise issued in the company's name

51. Which one of the following procedures would not be appropriate for an auditor in discharging his or her responsibilities concerning the client's physical inventories? A. Confirmation of goods in the hands of public warehousesB. Supervising the annual physical inventory countC. Carrying out physical inventory procedures at an interim dateD. Obtaining written representation from the client as to the existence, quality and dollar amount of the inventory

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52. When outside firms of non-accountants specializing in physical inventory counts are used to count, list, price and subsequently compute the total dollar amount of inventory on hand at the date of the physical count, the auditor will ordinarily A. Consider the report of the outside inventory firm to be an acceptable alternative procedure to the observation of physical inventoriesB. Make or observe some physical counts of the inventory, recompute certain inventory calculations, and test certain inventory transactionsC. Increase the extent of work on the physical count of inventoryD. Consider the reduced audit effort with respect to the physical count of inventory as a scope limitation

53. 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 of the prior yearB. Observe the condition of merchandise and raw materials during the client's physical inventory countC. Review the management's inventory representation letter for accuracyD. Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average

54. 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 tags placed on the items had not been taken off the items and added to the inventory accumulation sheetsB. Credit memos for several items returned by customers had not been preparedC. No journal entry had been made on the retailer's books for several items returned to its suppliersD. 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

55. In an audit of inventories, an auditor would least likely verify that A. All inventory owned by the client is on hand at the time of the countB. The client has used proper inventory pricingC. The financial statement presentation of inventories is appropriateD. Damaged goods and obsolete items have been properly accounted for

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56. The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the A. Evidence to be gathered to provide a sufficient basis for the auditor's opinionB. Procedures to be undertaken to discover litigation, claims and assessmentsC. Pending legal matters to be included in the inquiry of the client's attorneyD. Timing of inventory observation procedures to be performed

57. To gain assurance that all inventory items in a client's inventory listing schedule are valid, an auditor most likely would trace A. Inventory tags noted during the auditor's observation to items listed in the inventory listing scheduleB. Inventory tags noted during the auditor's observation to items listed in receiving reports and vendors' invoicesC. Items listed in the inventory listing schedule to inventory tags and the count sheetsD. Items listed in receiving reports and vendors' invoices to the inventory listing schedule

58. Observing a client's inventory held on consignment by others tests the assertion of A. ExistenceB. CompletenessC. ValuationD. Rights and obligations

59. When an auditor tests a client's cost accounting system, the auditor's 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 handB. Physical inventories are in substantial agreement with book inventoriesC. The system is in accordance with generally accepted accounting principles and is functioning as plannedD. Costs have been properly assigned to finished goods, work-in-process, and cost of goods sold

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60. Which of the following is not one of the independent auditor's objectives regarding the examination of inventories? A. Verifying that inventory counted is owned by the clientB. Verifying that the client has used proper inventory pricingC. Ascertaining the physical quantities of inventory on handD. Verifying that all inventory owned by the client is on hand at the time of the count

61. An auditor concluded that no excessive costs for idle plant were charged to inventory. This conclusion most likely related to the auditor's objective to obtain evidence about the financial statement assertions regarding inventory, including presentation and disclosure and A. Valuation and allocationB. CompletenessC. ExistenceD. Rights and obligations

62. Which assertion for ending inventory is most likely violated if the gross profit percentage is much greater than last year? A. ExistenceB. CompletenessC. Rights and obligationsD. Valuation and allocation

63. Which of the following is a question that the auditor would expect to find on the production process section of an internal control questionnaire? A. Are vendors' invoices for raw materials approved for payment by an employee who is independent of the cash disbursements function?B. Are signed checks for the purchase of raw materials mailed directly after signing without being returned to the person who authorized the invoice processing?C. Are all releases by storekeepers of raw materials from storage based on approved requisition documents?D. Are details of individual disbursements for raw materials balanced with the total to be posted to the appropriate general ledger account?

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64. In order to efficiently establish the correctness of the accounts payable cutoff, an auditor will be most likely to A. Coordinate cutoff tests with physical inventory observationB. Compare cutoff reports with purchase ordersC. Compare vendors' invoices with vendors' statementsD. Coordinate mailing of confirmations with cutoff tests

65. The accuracy of perpetual inventory records may be established, in part, by comparing perpetual inventory records with A. Purchase requisitionsB. Receiving reportsC. Purchase ordersD. Vendor payments

Short Answer Questions

66. The audit of the inventory management process is affected by the audit results from multiple other processes. Identify the processes, other than the inventory management process, that affect the audit of inventory and explain how each affect the audit of inventory.

67. State the six functions that make up the inventory management process. For each function, identify the related documents and/or records that would be used by a manufacturing company.

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68. The audit of inventory is often the most involved aspect of an audit. Describe at least three inherent risk factors that affect the audit of inventory.

69. For each of the following tests of details, state whether it is a test of details of account balances or whether it is a test of details of disclosures. Then note for which assertion it provides evidence.1. Inspect loan agreements under which an entity's inventories are pledged.2. Review inventory compilation for proper classification among raw materials, work in process and finished goods.3. Observe the count of physical inventory.4. Trace test counts and tag control information to the inventory compilation.5. Inquire of management about issues related to LIFO liquidations.6. Review book-to-physical adjustments for possible misstatements.

70. You are auditing SBT, which has a December 31st year-end. On December 24th, the person responsible for processing receiving reports and recording the receipt of inventory became very ill and was out of the office for a week. Due to the company's small staff and the holiday season, a number of the receiving reports were not processed on a timely basis. As an auditor, on which assertion would you place a high importance for this client and how would you test for it?

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71. Below is information relating to the inventory management of your audit client, Quick Sell. Using analytical procedures identify any concerns you have about misstatements in the financial statements.

72. We know from cost accounting that there are three components that make up the standard costs for inventory. Explain how an auditor could test each of these components for a company that manufactures pillows.

73. Explain the importance of observing physical inventory during an audit.

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74. List five things an auditor should do during the observation of the physical count of inventory.

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Chapter 13 Auditing the Inventory Management Process Answer Key

True / False Questions

1. The "cradle-to-grave" cycle for inventory begins when goods are purchased and stored and ends when the finished goods are shipped to customers. TRUE

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: KnowledgeDifficulty: EasyLearning Objective: 1

2. A receiving report records the shipment of goods to customers. FALSE


3. Sale of finished goods is a part of the inventory management process. FALSE


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4. Once the controls in the inventory system have been tested, the auditor sets the level of control risk. TRUE

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: KnowledgeDifficulty: EasyLearning Objective: 6

5. The major control procedure for preventing fictitious inventory transactions from being recorded is proper segregation of duties. TRUE

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ApplicationDifficulty: EasyLearning Objective: 7

6. Inventory should be valued using the lower-of-cost-or-market rule. TRUE


7. A high inventory turnover ratio normally indicates inefficient inventory policies. FALSE

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: AnalysisDifficulty: ModerateLearning Objective: 9

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8. The three components that make up the cost of producing a product include materials, direct labor, and indirect labor. FALSE


9. The auditor's observation of inventory is a generally accepted auditing procedure. TRUE


10. Obsolete inventory should be written down to its current market value. TRUE


11. In the audit of inventory, the client is responsible for actually making and recording the count of physical inventory; the auditor's responsibility is to evaluate and observe the client's procedures and draw conclusions about the adequacy of the physical inventory. TRUE

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 11

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12. An approved purchase requisition form authorizes shipment of goods to customers. FALSE

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: KnowledgeDifficulty: ModerateLearning Objective: 2

13. A comparison of the current year's inventory turnover ratio with previous years' may indicate the presence of obsolete inventory. TRUE

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: AnalysisDifficulty: ModerateLearning Objective: 9

14. When the client's perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date. FALSE


15. The audit test of control "Review and test procedures for issuing materials to manufacturing departments" provides assurance mainly for the occurrence assertion for inventory management. TRUE


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16. Production personnel should ordinarily be responsible for maintaining perpetual inventory records. FALSE


17. Inherent risk is typically assessed at a low to moderate level for inventory due to the nature of the asset. FALSE

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: KnowledgeDifficulty: ModerateLearning Objective: 5

Multiple Choice Questions

18. Shipping orders are forwarded from the revenue process to A. The materials requisitions departmentB. Finished goods storesC. Raw materials storesD. Inventory management

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: KnowledgeDifficulty: EasyLearning Objective: 1Learning Objective: 2

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19. Which of the following departments typically approves purchase requisitions? A. Raw materials storesB. Cost accountingC. Inventory managementD. IT

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: KnowledgeDifficulty: EasyLearning Objective: 1Learning Objective: 3

20. Which of the following best describes the occurrence assertion for inventory? A. Purchase requisitions initiated by authorized personnelB. Recorded inventory actually existsC. Inventory properly accumulated from journals and ledgersD. All inventory is recorded

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ComprehensionDifficulty: EasyLearning Objective: 1Learning Objective: 7

21. Auditors are most likely to ensure that no production activity is scheduled prior to A. Determining standard costsB. Observing physical inventoryC. Completing the book to physical adjustmentD. Determining the amount of consigned inventory

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: EasyLearning Objective: 1Learning Objective: 12

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22. The safeguarding of inventory most likely includes A. Comparison of the information contained on the purchase requisitions, purchase orders, receiving reports, and vendors' invoicesB. Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical countC. Analytical procedures for raw materials, goods in process, and finished goods that identify unusual transactions, theft and obsolescenceD. Application of established overhead rates on the basis of direct labor hours or direct labor costs

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: EasyLearning Objective: 7

23. Which of the following is not a misstatement related to the occurrence assertion for inventory? A. Consigned goods are included as part of inventoryB. Unauthorized production activityC. Fictitious inventoryD. Recorded inventory is not on hand because of theft

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: AnalysisDifficulty: EasyLearning Objective: 7

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24. Failure to record inventory in the proper period can affect all of the following accounts except A. SalesB. ReceivablesC. Cost of Goods SoldD. Prepaid Expenses

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: AnalysisDifficulty: EasyLearning Objective: 7

25. Which of the following audit procedures would provide the least reliable evidence that the client has legal title to inventories? A. Confirmation of inventories at locations outside the client's facilitiesB. Analytical review of inventory balances compared to purchasing and sales activitiesC. Observation of physical inventory countsD. Examination of paid vendors' invoices

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: EasyLearning Objective: 12Learning Objective: 13Learning Objective: 9

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26. 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 periodB. Purchase in the current periodC. Sale in the current periodD. Purchase return in the subsequent period

AACSB: AnalyticAICPA BB: IndustryAICPA FN: MeasurementBloom's: AnalysisDifficulty: EasyLearning Objective: 10Learning Objective: 12Learning Objective: 13

27. For the purpose of determining proper cutoff for inventory, the auditor will select a sample from which of the following for a few days before and after year-end? A. Materials requisitionsB. Production schedulesC. Receiving documentsD. Purchase orders

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ApplicationDifficulty: EasyLearning Objective: 10Learning Objective: 13

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28. Which of the following auditing procedures most likely would provide assurance about a manufacturing entity's inventory valuation? A. Vouching the raw materials costs to vendors' invoicesB. Obtaining confirmation of inventories pledged under loan agreementsC. Reviewing shipping and receiving cutoff activities for inventoriesD. Tracing test counts to the entity's inventory listing

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: EasyLearning Objective: 11Learning Objective: 13

29. An auditor will usually trace the details of the test counts made during the observation of the physical inventory count to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are A. Owned by the clientB. Not obsoleteC. Physically present at the time of the preparation of the final inventory scheduleD. Included in the final inventory schedule


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30. 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. SalesB. Sales returnsC. PurchasesD. Purchase discounts

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: AnalysisDifficulty: EasyLearning Objective: 12Learning Objective: 13

31. 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 costB. All inventory represented by an inventory tag is listed on the inventory sheetsC. All inventory represented by an inventory tag is bona fideD. Inventory sheets do not include untagged inventory items


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32. 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. SalesB. Sales discountsC. PurchasesD. Purchase returns


33. If the perpetual inventory records show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded A. SalesB. Sales discountsC. PurchasesD. Purchase discounts


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34. An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. This procedure most likely obtained evidence concerning management's assertion of A. Rights and obligationsB. CompletenessC. ExistenceD. Valuation


35. While observing a client's annual physical inventory, an auditor recorded test counts for several items and noticed that certain test counts were higher than the recorded quantities in the client's perpetual records. This situation could be the result of the client's failure to record A. Purchase discountsB. Purchase returnsC. SalesD. Sales returns


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36. In a manufacturing company, which one of the following audit procedures would give the least assurance about the valuation of inventory at the audit date? A. Testing the computation of standard overhead ratesB. Examining paid vendors' invoicesC. Reviewing direct labor ratesD. Obtaining confirmation of inventories pledged under loan agreements

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: EasyLearning Objective: 13

37. Which of the following is least likely to be a possible cause of book-to-physical differences in inventory quantities? A. Inventory cutoff errorsB. Misapplication of LIFOC. Unreported scrap or spoilageD. Theft

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: AnalysisDifficulty: EasyLearning Objective: 13

38. An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support management's financial statement assertion of A. ValuationB. Rights and obligationsC. ExistenceD. Completeness

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: EasyLearning Objective: 13Learning Objective: 14

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39. Which of the following is a plausible explanation for a large increase in the number of days outstanding in inventory? A. Obsolete inventoryB. New product line where sales exceed productionC. Manufacturing overhead was not allocated to the production processD. Manufacturing salaries were recorded as administrative expenses

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: AnalysisDifficulty: ModerateLearning Objective: 1Learning Objective: 9

40. Key segregations of duties in the inventory management process include all of the following except separating A. Cost accounting from review of variance reportsB. Inventory management from cost accountingC. Cost accounting from the general ledger functionD. Supervision of physical inventory from inventory management

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: KnowledgeDifficulty: ModerateLearning Objective: 4

41. An auditor generally tests physical security controls over inventory by A. Test counts and cutoff proceduresB. Examination and reconciliationC. Inspection and recomputationD. Inquiry and observation

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: ModerateLearning Objective: 7

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42. 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 yearB. Insist that the client perform physical counts of inventory items several times during the yearC. Increase the extent of tests for unrecorded liabilities at the end of the yearD. Have to disclaim an opinion on the income statement for that year

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13Learning Objective: 7Learning Objective: 8

43. A client maintains perpetual inventory records in both quantities and dollars. If the assessed level of control risk is high, an auditor would probably A. Increase the extent of tests of controls for the inventory cycleB. Request that the client schedule the physical inventory count at the end of the yearC. Insist that the client perform physical counts of inventory items several times during the yearD. Apply gross profit tests to ascertain the reasonableness of the physical counts

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13Learning Objective: 7Learning Objective: 8

13-34


44. In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would A. Review the entity's description of inventory policies and proceduresB. Perform test counts of inventory during the entity's physical countC. Analyze inventory turnover statistics to identify slow-moving and obsolete itemsD. Analyze monthly production reports to identify variances and unusual transactions

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: ModerateLearning Objective: 7Learning Objective: 9

45. For several years, a client's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal controls that led to the failure to record some A. Purchases returned to vendorsB. Sales returns receivedC. Sales discounts allowedD. Cash purchases

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: AnalysisDifficulty: ModerateLearning Objective: 12Learning Objective: 13Learning Objective: 7

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46. Which of the following control activities would most likely be used to maintain accurate perpetual inventory records? A. Independent storeroom count of goods receivedB. Periodic independent reconciliation of control and subsidiary recordsC. Periodic independent comparison of records with goods on handsD. Independent matching of purchase orders, receiving reports and vendors' invoices

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: ModerateLearning Objective: 7

47. An inventory turnover analysis is useful to the auditor because it may detect A. Inadequacies in inventory pricingB. Methods of avoiding cyclical holding costsC. The optimum automatic reorder pointsD. The existence of obsolete merchandise

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: AnalysisDifficulty: ModerateLearning Objective: 13Learning Objective: 9

48. Tracing costs used to price inventory to vendors' invoices tests which of the following assertions? A. OccurrenceB. CutoffC. AccuracyD. Classification

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: ModerateLearning Objective: 10

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49. The auditor tests the quantity of materials charged to work-in-process by tracing these quantities to A. Cost ledgersB. Perpetual inventory recordsC. Receiving reportsD. Material requisitions

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 10Learning Objective: 13

50. Purchase cutoff activities should be designed to test that merchandise is included in the inventory of the client company if the company A. Has paid for the merchandiseB. Has physical possession of the merchandiseC. Holds legal title to the merchandiseD. Holds the shipping documents for the merchandise issued in the company's name

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: ModerateLearning Objective: 10Learning Objective: 13

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51. Which one of the following procedures would not be appropriate for an auditor in discharging his or her responsibilities concerning the client's physical inventories? A. Confirmation of goods in the hands of public warehousesB. Supervising the annual physical inventory countC. Carrying out physical inventory procedures at an interim dateD. Obtaining written representation from the client as to the existence, quality and dollar amount of the inventory

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

52. When outside firms of non-accountants specializing in physical inventory counts are used to count, list, price and subsequently compute the total dollar amount of inventory on hand at the date of the physical count, the auditor will ordinarily A. Consider the report of the outside inventory firm to be an acceptable alternative procedure to the observation of physical inventoriesB. Make or observe some physical counts of the inventory, recompute certain inventory calculations, and test certain inventory transactionsC. Increase the extent of work on the physical count of inventoryD. Consider the reduced audit effort with respect to the physical count of inventory as a scope limitation

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

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53. 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 of the prior yearB. Observe the condition of merchandise and raw materials during the client's physical inventory countC. Review the management's inventory representation letter for accuracyD. Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

54. 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 tags placed on the items had not been taken off the items and added to the inventory accumulation sheetsB. Credit memos for several items returned by customers had not been preparedC. No journal entry had been made on the retailer's books for several items returned to its suppliersD. 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

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: AnalysisDifficulty: ModerateLearning Objective: 12Learning Objective: 13

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55. In an audit of inventories, an auditor would least likely verify that A. All inventory owned by the client is on hand at the time of the countB. The client has used proper inventory pricingC. The financial statement presentation of inventories is appropriateD. Damaged goods and obsolete items have been properly accounted for

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

56. The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the A. Evidence to be gathered to provide a sufficient basis for the auditor's opinionB. Procedures to be undertaken to discover litigation, claims and assessmentsC. Pending legal matters to be included in the inquiry of the client's attorneyD. Timing of inventory observation procedures to be performed

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

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57. To gain assurance that all inventory items in a client's inventory listing schedule are valid, an auditor most likely would trace A. Inventory tags noted during the auditor's observation to items listed in the inventory listing scheduleB. Inventory tags noted during the auditor's observation to items listed in receiving reports and vendors' invoicesC. Items listed in the inventory listing schedule to inventory tags and the count sheetsD. Items listed in receiving reports and vendors' invoices to the inventory listing schedule

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: ModerateLearning Objective: 12Learning Objective: 13

58. Observing a client's inventory held on consignment by others tests the assertion of A. ExistenceB. CompletenessC. ValuationD. Rights and obligations

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: AnalysisDifficulty: ModerateLearning Objective: 12Learning Objective: 13

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59. When an auditor tests a client's cost accounting system, the auditor's 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 handB. Physical inventories are in substantial agreement with book inventoriesC. The system is in accordance with generally accepted accounting principles and is functioning as plannedD. Costs have been properly assigned to finished goods, work-in-process, and cost of goods sold

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: ModerateLearning Objective: 13

60. Which of the following is not one of the independent auditor's objectives regarding the examination of inventories? A. Verifying that inventory counted is owned by the clientB. Verifying that the client has used proper inventory pricingC. Ascertaining the physical quantities of inventory on handD. Verifying that all inventory owned by the client is on hand at the time of the count

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: ApplicationDifficulty: ModerateLearning Objective: 13

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61. An auditor concluded that no excessive costs for idle plant were charged to inventory. This conclusion most likely related to the auditor's objective to obtain evidence about the financial statement assertions regarding inventory, including presentation and disclosure and A. Valuation and allocationB. CompletenessC. ExistenceD. Rights and obligations

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingBloom's: AnalysisDifficulty: ModerateLearning Objective: 13Learning Objective: 14

62. Which assertion for ending inventory is most likely violated if the gross profit percentage is much greater than last year? A. ExistenceB. CompletenessC. Rights and obligationsD. Valuation and allocation

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: AnalysisDifficulty: HardLearning Objective: 1Learning Objective: 5Learning Objective: 9

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63. Which of the following is a question that the auditor would expect to find on the production process section of an internal control questionnaire? A. Are vendors' invoices for raw materials approved for payment by an employee who is independent of the cash disbursements function?B. Are signed checks for the purchase of raw materials mailed directly after signing without being returned to the person who authorized the invoice processing?C. Are all releases by storekeepers of raw materials from storage based on approved requisition documents?D. Are details of individual disbursements for raw materials balanced with the total to be posted to the appropriate general ledger account?

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: HardLearning Objective: 3Learning Objective: 4Learning Objective: 7

64. In order to efficiently establish the correctness of the accounts payable cutoff, an auditor will be most likely to A. Coordinate cutoff tests with physical inventory observationB. Compare cutoff reports with purchase ordersC. Compare vendors' invoices with vendors' statementsD. Coordinate mailing of confirmations with cutoff tests

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: HardLearning Objective: 10Learning Objective: 13

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65. The accuracy of perpetual inventory records may be established, in part, by comparing perpetual inventory records with A. Purchase requisitionsB. Receiving reportsC. Purchase ordersD. Vendor payments

AACSB: AnalyticAICPA BB: IndustryAICPA FN: MeasurementBloom's: ApplicationDifficulty: HardLearning Objective: 10Learning Objective: 13

Short Answer Questions

66. The audit of the inventory management process is affected by the audit results from multiple other processes. Identify the processes, other than the inventory management process, that affect the audit of inventory and explain how each affect the audit of inventory.

The inventory management process is affected by the control activities in the revenue, purchasing, and payroll processes. The revenue process accounts for the sale of finished goods. The purchasing process controls the acquisition and payment for inventory. The payroll process affects the costs of direct and indirect labor that is assigned to inventory. (See Figure 13-1 on page 468 of the textbook for a diagram of the relationship between the processes.)

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: MeasurementBloom's: KnowledgeDifficulty: ModerateLearning Objective: 1

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67. State the six functions that make up the inventory management process. For each function, identify the related documents and/or records that would be used by a manufacturing company.

Inventory management function - The inventory management function maintains inventory at appropriate levels. It is responsible for producing the production schedule and issuing purchases requisitions.Raw materials stores function - This function would typically control the issuance of raw materials and therefore handle the materials requisitions forms.Manufacturing function - The manufacturing function produces the product and therefore creates the production data information. This information is then used to update the perpetual inventory records (which is used by the general ledger function) and as input for the cost accumulation and variance reports (used by the cost accounting function).Finished goods stores function - The finished goods function uses the shipping order forwarded from the revenue process to ship goods to the customers.Cost accounting function - The cost accounting function ensures that costs are properly attached to inventory. It reviews the cost accumulation and variance reports to accomplish this.General ledger function - The general ledger function maintains the records for the inventory management process. Information from the inventory master file and inventory status report is used to reconcile the perpetual inventory records to the general ledger inventory accounts.

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: MeasurementBloom's: KnowledgeDifficulty: ModerateLearning Objective: 2Learning Objective: 3

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68. The audit of inventory is often the most involved aspect of an audit. Describe at least three inherent risk factors that affect the audit of inventory.

One inherent risk concerns the valuation of inventory. A company in a competitive or highly technological industry has the risk of having inventory that should be properly valued at lower-of-market or that is obsolete. These valuation issues can easily lead to material misstatements in the financial statements.There is also the risk of defalcation of inventory, especially in an industry where the inventory is small and high-valued. Proper controls should be in place to prevent misappropriation of assets.A third inherent risk is the number of estimations involved in valuing inventory. These estimates can lead to disagreements with clients.

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ComprehensionDifficulty: EasyLearning Objective: 5

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69. For each of the following tests of details, state whether it is a test of details of account balances or whether it is a test of details of disclosures. Then note for which assertion it provides evidence.1. Inspect loan agreements under which an entity's inventories are pledged.2. Review inventory compilation for proper classification among raw materials, work in process and finished goods.3. Observe the count of physical inventory.4. Trace test counts and tag control information to the inventory compilation.5. Inquire of management about issues related to LIFO liquidations.6. Review book-to-physical adjustments for possible misstatements.

1. Disclosures - Occurrence, Rights and obligations2. Disclosures - Classification and understandability3. Account balances - Existence4. Account balances - Completeness, Valuation and allocation5. Disclosures - Accuracy, Valuation6. Account balances - Valuation and allocation

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Decision MakingBloom's: ApplicationDifficulty: HardLearning Objective: 13

70. You are auditing SBT, which has a December 31st year-end. On December 24th, the person responsible for processing receiving reports and recording the receipt of inventory became very ill and was out of the office for a week. Due to the company's small staff and the holiday season, a number of the receiving reports were not processed on a timely basis. As an auditor, on which assertion would you place a high importance for this client and how would you test for it?

The cutoff assertion would be very important in this situation. The risk of inventory transactions being recorded in the wrong period is very high. To test for misstatements, the auditor should trace a sample of receiving reports before and after year-end to ensure that the inventory was recorded in the proper period.

AACSB: AnalyticAICPA BB: IndustryAICPA FN: Risk AnalysisBloom's: ApplicationDifficulty: ModerateLearning Objective: 7

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71. Below is information relating to the inventory management of your audit client, Quick Sell. Using analytical procedures identify any concerns you have about misstatements in the financial statements.

Inventory has significantly increased, especially when compared to the industry average. At the same time, inventory turnover is decreasing and is significantly below the industry average in 2009. The auditor should be concerned about obsolescent or excess inventory and should do additional testing to ensure the inventory is being valued properly by the client.

AACSB: AnalyticAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: AnalysisDifficulty: ModerateLearning Objective: 9

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72. We know from cost accounting that there are three components that make up the standard costs for inventory. Explain how an auditor could test each of these components for a company that manufactures pillows.

Materials - The auditor could obtain a list of materials needed to manufacturer a certain type of pillow and compare that list with the standard cost card. The prices can then be traced to the vendor's invoices to verify that the proper cost is being applied for materials.Labor - Historical data regarding the amount of labor necessary to make a pillow can be obtained. It can then be compared to the amount of authorized wages.Overhead - The allocation of overhead should be reviewed by the auditor for reasonableness. The auditor should also verify that the amounts included in overhead are appropriate.

AACSB: CommunicationsAICPA BB: IndustryAICPA FN: Decision MakingBloom's: ComprehensionDifficulty: ModerateLearning Objective: 11

73. Explain the importance of observing physical inventory during an audit.

Inventory is typically a large account on the financial statements, especially for manufacturing and retail companies. Examining physical inventory primarily provides evidence that the inventory does exist, but it can also provide evidence for the rights and obligations and valuation assertions. It is also a generally accepted auditing procedure.

AACSB: CommunicationsAICPA BB: Critical ThinkingAICPA FN: Risk AnalysisBloom's: ComprehensionDifficulty: EasyLearning Objective: 12

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74. List five things an auditor should do during the observation of the physical count of inventory.

Ensure that no production is scheduled during the count. Ensure that there is no movement of goods during the inventory count. Make sure the count teams are following the inventory count instructions. Ensure that inventory tags are issued sequentially to individual departments. Perform test counts and record a sample of counts in the work papers. Obtain tag control information for testing the client's inventory compilation. Obtain cutoff information. Observe the condition of obsolete, slow moving, or carried in excess inventories. Inquire about goods held on consignment.

AACSB: AnalyticAICPA BB: IndustryAICPA FN: MeasurementBloom's: ApplicationDifficulty: ModerateLearning Objective: 12

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auditing and assurance services chapter 13 tb

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