Download Audit Program for Inventories and more Lecture notes Mathematics in PDF only on Docsity!
CHAPTER 3
Audit of Inventories
Audit Program for Inventories
Audit Objectives: To determine that:
- Inventories included in the statement of financial position physically exist.
- Inventories represent items held for sale in the ordinary course of business, in the process of production for such sale, or n the form of materials or supplies to be used in the production process or in the rendering of services.
- Inventory quantities include products, materials, and supplies owned by the company (on hand, in transit, or stored at outside locations).
- The entity has legal title or similar rights of ownership to the inventories.
- Inventories are properly stated at the lower of cost and net realizable value.
- Inventories are properly described and classified in the financial statements and disclosures are adequate. Audit Procedures:
- Observe physical inventory counts Test shipping and receiving cutoff procedures. Account for al inventory tags and count sheets used in recording the physical inventory counts. Test the clerical accuracy of inventory listings. Trace test counts recorded during the physical inventory observation to the inventory listing. Reconcile physical counts to perpetual records and general ledger balances and investigate significant variations. Test inventory transactions between a preliminary physical inventory date and the end of the reporting period.
- Obtain confirmation of inventories at locations outside the entity.
- Review perpetual inventory records, production records and purchasing records for indications of current activities.
- Analytically review the relationship of inventory balances to recent purchasing, production, and sales activities, and to anticipated sales volume.
- Examine paid vendors’ invoices, consignment agreements, and contracts.
- Review direct labor rates.
- Test the computation of standard overhead rates.
- Examine analysis of purchasing and manufacturing standard cost variances.
- Examine inventory turnover analysis.
- Review industry experience and trends.
- Tour the plant, inquire of production and sales personnel concerning possible excess or obsolete inventory items.
- Examine sales after year-end and open purchase order commitments.
- Obtain confirmation of inventories pledged under loan agreements.
- Review drafts of the financial statements.
- Compare the disclosures made in the financial statement to the requirements of PFRS.
PROBLEM 3-
Scope of PAS 2: Inventories Your client, ALBATROSS APARTMENTS COMPANY, has recently diversified its operations to include the purchase and resale of housing units. Albatross has made some acquisitions of properties in line with its expansion program. These properties are being prepared for resale in the succeeding month. The company’s management is unsure of how these assets are to be properly classified. The properties should be classified as A. Property, Pant and equipment under PAS 16. B. Inventory under PAS 2. C. Investment property under PAS 40. D. Intangible under PAS 38. Solution 3- As defined in PAS 2, inventories are assets: a. Held for sale in the ordinary course of business; b. In the process of production for such sale; or c. In the form of materials or supplies to be consumed in the production process or in the rendering of services. Because the properties are held for the purpose of resale in the ordinary course of business, they must be classified as inventory under PAS 2. Answer: B
PROBLEM 3-
Inventories of a Service Provider FIERCE HUNTER CONSULTANCY is a business consulting firm. The firm’s inexperienced accountant seeks your advice on how to classify some of the firm’s costs – whether as inventory or expenses. Which of the following are to be classified as inventory – either as direct expenditure or overhead allocation? A. Rent of office space, new laptop computers for consultants, travel allowance for consultants, and management time. B. Travel allowance for consultants, sales staff’s salaries and rent of office space. C. Management time, administrative staff’s salaries, and travel allowance for consultants. D. Rent of office space, sales and administrative staff’s salaries, new laptop computers for consultants, management time, and travel allowance for consultants.
Solution 3 -
Sales Inventories Unadjusted balances P 7,500,000 P 330, Invoice No. 6672 7,500 -- 6674 (12,600) 9, 6675 -- 24, 6676 (19,500) -- 6678 11,700 -- 6679 (25,800) -- Adjusted Balances: P 7,461,300 P 363,
- Sales P 7,461, Answer: B
- Inventories P 363, Answer: B
Problem 3-
Cut-off test for purchases You are conducting a financial statement audit of the BEVERLY HILS CORP. for the year ended December 31, 2010. You have observed the taking of physical inventory and have noted that all merchandise actually received up to the close of business on December 2, 2010, has been recorded on the inventory sheets. The total invoice cost of the items included in the physical count is P 300,000. The following purchase invoices have been recorded in the purchases Journal as follows: December 2010 Invoice Number Amount Invoice Date FOB Term Date Received 251 P10,248 Dec. 23 Destination Dec. 24 252 8,136 Dec. 23 Destination Dec. 29 253 3,123 Dec. 26 Shipping Point Dec. 30 254 12, 600 Dec. 26 Shipping point Jan. 5 255 13, 833 Jan. 2 Destination Dec. 31 256 6, 309 Dec. 31 Destination Jan. 4 257 3, 486 Dec. 27 Shipping point Dec. 21 258 21, 162 Jan. 8 Shipping point Jan. 2 259 34, 866 Dec. 22 Destination Dec. 28
260 11, 331 Dec. 28 Destination Dec. 27 January 2011 261 P 3,672 Dec. 28 Destination Jan. 4 262 11, 391 Dec. 30 Destination Dec. 28 263 17,712 Dec. 29 Shipping point Dec. 31 264 14, 700 Jan. 2 Shipping point Jan. 5 265 41, 400 Dec. 28 Shipping point Jan. 4 266 17, 877 Dec. 30 Destination Jan. 6 Required:
- Auditor’s adjusting entries, if any, required by the above information.
- Show the detailed composition of the value of the inventory to be used on the financial statements. Transportation-in charges on purchases averaged 6% during the year and are to be included in the inventory valuation.
Solution 3-
- Adjusting Entries December 31, 2010 a. Accounts payable 27, Purchases 27, Invoice No. 256 P 6, 309 258 21, 162 TOTAL: P 27, 471 b. Purchases 70, 503 Accounts payable 70, 503 Invoice No. 262 P 11, 391 263 17, 712 265 41, 400 TOTAL: P 70, c. Freight in 3,
holds legal title. The company’s experience suggests that full payment on installment sales is reasonably assured.
- An item costing P65,000 was sold and delivered to the customer on December 29, 2010. The goods were included in the inventory because the sale was with a repurchase agreement that requires Goat to buy back the inventory on January 15, 2011. Indicate which of the above items are to be included in the inventory balance at December 31, 2010. State your reasons for the treatment you suggest. Solution 3-
- Included - Merchandise, except “special orders”, should be included in the inventory until shipped.
- Excluded – Goat Company does not possess legal title because the merchandise was received on a consignment basis.
- Included – Because the purchase was made under FOB shipping point term, the merchandise should e included in the inventory at the shipping date.
- Excluded – A product that is manufactured for a particular customer (special order) is considered sold upon its completion.
- Excluded – The merchandise was purchased under FOB Destination term and was not received until January 5, 2011.
- Excluded – The sale is recognized even though legal title has not passed.
- Included – This is actually a loan transaction with the inventory as collateral. Problem 3- Determining Inventory Quantity The management of PIG , INC. has engaged you to assist in the preparation of year-end (December 31) financial statements. You are told that on November 30, the correct inventory level was 145,730 units. During the month of December, sales totaled 138, 630 units including 40,000 units shipped on consignment to AA Corp. A letter received from AA indicates that as of December 31, it has sold 15, 200 units and was still trying to sell the remainder. A review of the December purchase orders to various suppliers shows the following: Purchase Order Date Invoice Date Quantity in Units Date shipped Date Received Terms 12/31/ 0
FOB Destination 12/05/ 0
FOB Destination 12/06/ 0
FOB Shipping point 12/18/ 0
FOB Shipping point 12/22/1 01/05/1 4,600 01/04/1 01/06/1 FOB
0 1 1 1 Destination 12/27/ 0
FOB Destination Pig, Inc. uses the “passing of legal title” for inventory recognition.
- Good purchases during December totaled A. 11, 600 units C. 19, 500 units B. 15, 800 units D. 8, 000 units
- How many units were sold during December? A. 138, 630 units C. 98, 630 units B. 113, 830 units D. 153, 830 units
- How many units should be included in Pig, Inc.’s Inventory at December 31, 2010? A. 18, 700 units C. 43, 500 units B. 39, 900 units D. 47, 700 units
- Purchase cut-off procedures should be designed to test whether all inventory A. Purchased and received before year-end was paid for. B. Ordered before year-end was received. C. Purchased and received before year end was recorded. D. Owned by the company is in the possession of the company at year-end.
- 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 b designed to detect whether merchandise included in the physical count at year-end was mot 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.
Solution 3-
Inventory Quantity 145, 730 Add: December purchases: PO Date: 12.05.10 Purchase under FOB Destination received 12.22.10 3, 12.18.10 Purchased under FOB Shipping pt. ;shipped 12.29.10 8,000 11, Units available for sale 157, Less: Units sold in December: Consignment Sales 15, 0 Other Sales 98, 0 113, Inventory Quantity, Dec. 31 43,
Alternative computation: Cost of goods sold P1,859, Less: Decrease in inventory (P815,386 – P488,874) 326,512 1 Purchases 1,532, Less: Increase in accounts payable (P737,824 – P286,924) 450,900 2 Amount paid to suppliers in 2010 P1,081, 1 The decrease in inventory indicates that more goods were sold than purchased during the year. Hence, such decrease in inventory level is deducted from cost of goods sold to arrive at the cost of purchases. 2 The increase in accounts payable balance shows that purchases on account are greater than payments made to suppliers during the period. This explains why the increase in accounts payable is deducted from purchases to arrive at the amount paid to suppliers during the period. Answer: B
Problem 3-
FIFO Costing Method
The following information was provided by the bookkeeper of COW, INC.:
1. Sales for the month of June totaled 286,000 units.
2. The following purchases were made in June:
Date Quantity Unit Cost
June 4 50,000 P13.
3. There were 108,500 units on hand on June 1 with a total cost of P1,450,000.
Cow, Inc. uses a periodic FIFO costing system. The company’s gross profit for June was
P2,058,750.
1. How many units were on hand on June 30?
A. 80,000 C. 28,
B. 177,500 D.149,
2. What is the FIFO cost of the company’s inventory on June 30?
A. P1,025,000 C. P988,
B. P1,016,230 D. P1,069,
3. What is the total cost of goods sold in June?
A. P3,632,200 C. P3,580,
B. P3,617,900 D. P3,661,
4. The 286,000 units sold in June had a unit selling price of
A. P20 C. P12.
B. P13 D. P7.
5. An essential procedural control to ensure the accuracy of the recorded inventory
quantities is
A. Performing a gross profit test.
B. Testing inventory extensions.
C. Calculating unit costs and valuing obsolete or damaged inventory items in
accordance with inventory policy.
D. Establishing a cutoff for goods received and shipped.
Solution 3 – 8
1. Inventory quantity, June 1 108,
Add: Units purchased during June 257,
Units available for sale 366,
Less: Units sold during June 286,
Inventory quantity, June 30 80,
Answer: A
2. FIFO cost of June 30 inventory:
From Quantity Unit Cost Amount
June 24 purchase 70,000 P12.40 P868,
June 11 purchase 10,000 12.00 120,
80,000 P988,
Answer: C
3. Composition of June of Cost of Goods Sold:
From Quantity Unit Cost Amount
Beginning invty. 108,500^ P1,450,
June 4 purchase 50,000^ P13.00 650,
June 8 purchase 62,500^ 12.50 781,
Prior to any adjustments, Chicken, Inc.’s ending inventory is valued at P445,000 and the
reported net income for the year P1,648,000.
1. Chicken’s December 31, 2010, inventory should be increased by
A. P8,000 C. P66,
B. P40,000 D. P61,
2. Which of the errors described in “a to g” will not affect the company’s net income for
A. Item a C. Item e
B. Item g D. Item b
3. What is Chicken’s adjusted net income for the year 2010?
A. P1,565,800 C. P1,615,
B. P1,607,160 D. P1,666,
4. Purchase cutoff procedures test the cutoff and completeness assertions. A company
should include goods in its inventory if it
A. Has sold the goods.
B. Holds legal title to the goods.
C. Has physical possession of the goods.
D. Has paid for the goods.
5. When title to merchandise in transit has passed to the audit client, the auditor
engaged in the performance of a purchase cutoff will encounter the greatest
difficulty in gaining assurance with respect to the
A. Quantity C. Price
B. Quality D. Terms
Solution 3- Inventory December 31, 2010 Net Income Per client P445,000 P 1,648, a) Goods on consignment with a customer 50,000 50, b) Goods purchased FOB shipping point 16,500 - c) Goods sold FOB Shipping point (21,640) (21,640) d) Goods sold FOB Destination 8,640 8, e) Goods purchased FOB Destination - 8, f) Goods received on consignment (51,000) (51,000) g) Goods sold FOB Destination 37,500 (26,800) Per audit P485,000 P 1,615,
1. Inventory per audit P485,
Inventory per client 445,
Adjustment increase P40,
Answer: B
2. In item b, the goods were purchased under FOB shipping point term and they were shipped
on December 29, 2010. The company’s failure to record the purchase in 2010 will overstate its
income by P16,500. However, since the goods were not included in the year-end physical count,
the clients ending inventory is understated and the company’s net income will be understated
by P166,500. Hence, the combined effect on 2010 net income is nil.
Answer: D
3. Adjusted Net Income for 2010 P1,615,
Answer: C
4. Holds legal title to the goods.
Answer: B
5. Quality
Answer: B
Problem 3-
Inventory Valuation: Lower of Cost or Net realizable value ZEBRA MUSIKAHAN CO. sells musical instruments. In your audit of the company’s financial statements for the year ended December 31, 2010, you have gathered the following data concerning inventory. At December 31, 2009, the balance in Zebra’s Inventory account was 502,000, and the Allowance for Inventory Write down had a balance of 32,000. The relevant inventory cost and market data at December 31, 2010 are summarized in the schedule below. Cost Replace ment Sales Net Realizabl e Normal cost Price Value Profit Guitars
Xylopho nes (^) 94,00 92,000 93,000 85,000 7,
(P502, 000 - P477, 000) P25, 000
Inventories are usually written down to net realizable value on an item by item basis. The practice of valuing inventories at the lower of cost or net realizable value is consistent with the view that assets should not be carried in excess of amounts expected to be realized from their sale or use. Answer: D
- Allowance for Inventory Write down 7, Gain on inventory recovery 7, Required allowance (see no. 1) P25, 000 Allowance balance 32, 000 Decrease in allowance (P7, 000) Answer: A
Problem 3-
FIFO cost method
Gavial, Inc. sells electric stoves. It uses the perpetual system and allocates
cost to inventory on a first-in, first-out basis. The company’s reporting date is
December 31. At December 1, 2010, Inventory on hand consisted of 350
stoves at P820 each and 43 stoves at P850 each. During the month ended
December 31, 2010, the following inventory transactions occurred (all
purchase and sales transactions are on credit):
De c 1 Sold 300 stoves for P1200 each 3 Five stoves were returned by customers. They had originally Cost P820 each and were sold for P each. 9 Purchased 55 stoves at P910 each. 1 0 Purchased 76 stoves at P960 each. 1 5 Sold 86 stoves for P1350 each. 1 7 Returned one damaged stove to the supplier. This stove had been purchased on December 9. 2 2 Sold 60 stoves for P1250 each. Purchased 72 stoves at P980 each.
2 6
- What is the FIFO cost of Gavial’s inventory on December 31, 2010? A. P148, 930 B. P148, C. P133, 607 D. P126, 280
- What is the cost of goods sold in December 2010? A. P367, 230 B. P371, C. P366, D. P389,
- What is Gavial’s gross profit in December 2010? A. P173, 770 B. P155, C. P177, D. P183,
- PAS 2 requires inventories to be measured at the lower of cost and net realizable value. Which of the following are possible reasons why the net realizable value of the stoves on hand at December 31, 2010 may be below their cost? I. Inventories are damaged. II. Inventories are wholly or partially obsolete. III. Selling prices have declined below cost. A. I and II only B. II and III only C. I and III only D. I, II, and III
- If the net realizable value of Gavial’s inventory on December 31, 2010 falls to P920, the inventory value should be reduced by A. P7, 300 B. P7, C. P8, D. P Solution: Dat e Details PURCHASES COST OF GOODS SOLD BALANCE No. of unit Total No. of unit Total No. of unit Total units cost Cost Unit s cost Cost Unit s cost Cost 1 Beginning bal 350 P 0 P287, 43 850 36, 1 Sales 300 P P246, 0 50 820 41, 43 850 36, 3 Sales return (5) 820 (4,100) 55 820 45, 43 850 36,
FIFO Costing Method The following information was obtained from the statement of financial position of LION, INC.: December 31, 2010 December 31, 2009 Cash P706, 600 P200, Notes receivable 0 50, Inventory? 399, Accounts payable? 150, 000 All operating expenses are paid by Lion, Inc. with cash and all purchases of inventory are made on account. Lion, Inc. sells only one product. All sales are cash sales which are made for P100 per unit. Lion, Inc. purchases 1,500 units of inventory per month and values its inventory using periodic FIFO. The unit cost of inventory during January 2010 was P65.20 and increased P0.20 per month during the year. During 2010, payments to suppliers totaled P943, 400 and operating expenses totaled P440, 000. The ending inventory for 2009 was valued at P65 per unit. Based on the preceding information, determine the following:
- Number of units sold A. 18, B. 18, C. 16, D. 21,
- Total cost of purchases during 2010 A.P1, 173,600 C.P1,213, B.P1, 191, 600 D.P1, 193,
- Accounts payable balance at December 31, 2010 A. P793, 400 B. P393, C. P400,000 D. P419,
- Inventory quantity at December 31, 2010 A. 5,750 B. 6, C. 5,250 D. 8,
- FIFO cost of inventory on December 31, 2010 A. P352,500 B. P439, C. P385,900 D. P425,
Solution:
- Cash balance, Jan 1, 2010 P200, Add: Sales (squeeze) P1, 840, Collection of Notes receivable 50,000 1,890, Total 2,090, Less: Cash paid for operating expenseP440, 000 Cash paid on accounts payable 943,400 1,383, Cash balance, December 31, 2010 P706, 600 Sales during 2010 P1, 840, Divide by Sales price per unit ÷ P Number of units sold 18,400 units
Answer: B
- Computation of total purchases during 2010 Month Unit Cost Quantity Total cost January P65.20 1,500 P 97, February 65.40 1,500 98, March 65.60 1,500 98, April 65.80 1,500 98, May 66.00 1,500 99, June 66.20 1,500 99, July 66.40 1,500 99, August 66.60 1,500 99, September 66.80 1,500 100, October 67.00 1,500 100, November 67.20 1,500 100, December 67.40 1,500 101, Total 18,000 P1,193,
* Alternative method
P65.20+67.40 x (1,500 units x12) 2 P66.30 x18, 000 units= P1, 193, Answer: D
- Accounts payable, Jan. 1, 2010 P150, 000 Add: Purchases (see no. 2) 1, 193, 400 Total 1, 343, 400 Less: Cash paid on Accounts payable 943, 400 Accounts payable, Dec 31, 2010 P400, 000 Answer: C
- Inventory quantity, Jan.1,2010( 399,750/65) 6, 150 Add: Purchases (see no. 2) 18, 000 Units available for sale 24, 150 Less: units sold (see no. 1) 18, 400 Inventory quantity, Dec. 31, 2010 5, Answer: A
- Computation of inventory FIFO cost at December 31, 2010 From Qty. Unit cost Total cost December purchase 1,500 P67.40 P101, November purchase 1,500 67.20 100, October purchase 1,500 67.00 100, September purchases(SQUEEZE)
5,750 P385,
