Chapter 12 Inventories And Cost Of Goods Sold

Chapter 12 - Inventories and Cost of Goods Sold

Chapter 12 Inventories and Cost of Goods Sold

True / False Questions

1. Observation of inventories is a generally accepted auditing standard. True False

2. The receiving department should accept only goods for which there is an approved purchase order on hand. True False

3. For good internal control over purchase transactions, purchases should be made from approved vendors by the department needing the goods. True False

4. Auditors should not review the client's planning of the physical inventory. True False

5. The proper cutoff of inventories is best achieved when the client uses prenumbered purchase orders. True False

6. The lower of cost or market test by the auditors is generally designed to assure that inventories are not valued above their net realizable values. True False

7. When the auditors cannot satisfy themselves as to the accuracy of ending inventory and a material misstatement may exist, they normally may still give an unqualified opinion on the client's income statement. True False

12-1 Chapter 12 - Inventories and Cost of Goods Sold

8. To test the client's cutoff of inventories, the auditors will make a record of the serial number of the final receiving and shipping documents used prior to the taking of the physical inventory. True False

9. The use of a tagging system for inventory taking is designed to prevent double counting of goods. True False

10. The examination of warehouse receipts is not sufficient verification of a material amount of goods stored in public warehouses. True False

Multiple Choice Questions

11. An auditor suspects that certain client employees are ordering merchandise for themselves over the Internet without recording the purchase or receipt of the merchandise. When vendors' invoices arrive, one of the employees approves the invoices for payment. After the invoices are paid, the employee destroys the invoices and the related vouchers. In gathering evidence regarding the fraud, the auditor most likely would select items for testing from the file of all A. Cash disbursements. B. Approved vouchers. C. Receiving reports. D. Vendors' invoices.

12. Which of the following is not true relating to the auditors' observation of the client's physical inventory? A. The auditors should evaluate the client's planning of the physical inventory. B. The auditors should make certain that consigned items from suppliers are included in physical inventory totals. C. The auditors should evaluate the adequacy of the client's counting procedures. D. The auditors should take test counts of the client's inventory.

13. A receiving department compares inventory items received with copies of purchase orders. The purchase orders list the name of the vendor and do not list the quantities of the material ordered. Using the purchase orders, the receiving department is most likely to detect: A. Deliveries for which no purchase order was issued. B. Unapproved sales orders. C. Partial deliveries. D. Deliveries of a greater quantity of items than those ordered.

14. To measure how effectively a client employs its assets, an auditor calculates inventory turnover by dividing the average inventory into: A. Net sales. B. Cost of good sold. C. Operating income. D. Gross sales.

15. Which of the following audit procedures most likely would provide assurance that a manufacturing entity's inventory valuation is proper? A. Testing the entity's computation of standard overhead rates. B. Obtaining confirmation of inventories pledged under loan agreements. C. Reviewing a cutoff procedure for inventories. D. Tracing test counts to the entity's inventory listing.

16. A client uses a periodic inventory system. Would one expect a credit to which of the following accounts at the point of sale?

A. Option A B. Option B C. Option C D. Option D

17. A client uses a perpetual inventory system. Would one expect a credit to which of the following accounts at the point of sale?

18. Which of the following would an auditor most likely question included in calculation of the overhead rate for a company that manufactures a product? A. Factory supervisor salary. B. Indirect materials. C. Miscellaneous expense. D. Sales expense.

19. A "bill and hold" scheme is most likely to include: A. Shipment of items to a customer beyond what the customer has ordered. B. Recording as sales items that the company retains as of year-end. C. Billing of items that are held by customers for future revenue production purposes. D. Selling items at substantial discounts near year-end.

20. Which of the following is an auditor least likely to consider a departure from generally accepted accounting principles? A. Valuing inventory at cost. B. Including in inventory items that are consigned out to vendors, but not yet sold. C. Using standard cost as the measure of inventory cost. D. Including in inventory items shipped subsequent to year-end, but for which valid orders did exist at year-end.

21. Which of the following is least likely to be accurate statement concerning characteristics of an audit? A. An analysis of inventory turnover addresses whether the proper method of determining inventory costs--as contrasted to market values--is being applied. B. Characteristics of the double entry bookkeeping system make it possible to test for overstated sales when tests of accounts receivable are being performed. C. The direction of tests for overstatement errors is generally directed from the recorded entry to source documents. D. Use of a perpetual rather than a periodic inventory system is likely to affect the nature of cutoff errors made at year-end.

22. Which of the following is not a reason for the special significance attached by the auditors to the verification of inventories? A. The determination of inventory valuation directly affects net income. B. The existence of inventories is inherently difficult to substantiate. C. Special valuation problems often exist for inventories. D. Inventories are often the largest current asset of an enterprise.

23. Which of the following is true about the auditors' observation of the client's physical inventory? A. The count must be made at year-end. B. The auditors should supervise the client's personnel. C. The auditors' observation addresses the existence assertion. D. The auditors should justify any omission of the observation in the audit report.

24. In verifying debits to perpetual inventory records of a non-manufacturing firm, the auditor would be most interested in examining the: A. Purchases journal. B. Purchase requisitions. C. Purchase orders. D. Vendors' invoices.

25. In verifying credits to perpetual inventory records of a non-manufacturing firm, the auditor would be most interested in examining the: A. Shipping documents. B. Receiving reports. C. Purchase orders. D. Vendors' invoices.

26. The client's physical count of inventories is lower than the inventory quantities in the perpetual records. This could be the result of a failure to record: A. Purchases. B. Purchase discounts. C. Sales. D. Sales discounts.

27. 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 inventory summary sheets. Which assertion does this procedure relate to most directly? A. Completeness. B. Existence. C. Legality. D. Valuation.

28. The use of a "blind" purchase order is designed to prevent errors by the: A. Purchase department. B. Receiving department. C. Stores department. D. Accounting department.

29. An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all: A. Merchandise received. B. Vendor's invoices. C. Canceled checks. D. Receiving reports.

30. To assure that all purchases are authorized before payment is made, accounting department personnel should match the vendor's invoice to: A. The purchase requisition. B. The receiving report. C. The purchase order. D. The voucher.

31. Which of the following is true about the auditors' observation of the client's physical inventory? A. The auditors should plan the physical inventory. B. The auditors should segregate damaged and obsolete goods. C. The auditors should evaluate the adequacy of the client's counting procedures. D. The auditors should supervise the client's personnel.

32. Which of the following is not a procedure that typically is used by the auditors in their examination of a client's goods held in the custody of a public warehouse? A. Confirmation. B. Obtaining reports on internal control at the warehouse. C. Observation. D. Corresponding with the state agency regarding the authenticity of the public warehouse.

33. Which of the following best describes the reason that the auditors record their inventory test counts in the working papers? A. To document every test count. B. For subsequent comparison with the completed inventory listing. C. To document compliance with generally accepted accounting principles. D. For use in subsequent audits.

34. Which of the following best describes the auditors' response to a client's use of statistical sampling techniques to estimate the inventory? A. The auditors should satisfy themselves as to the statistical validity of the technique, and the reasonableness of the allowance for sampling risk and sampling error used. B. The auditors should qualify their opinion, because the client must perform a complete count of the inventory. C. The auditors should increase the extent of their test counts to compensate for the use of a statistical technique. D. The auditors should withdraw from the engagement.

35. Which of the following best describes the reason for the auditors' review of the client's cost accounting system? A. To obtain evidence regarding the quantities of good described as work-in-process. B. To obtain evidence about the valuation of work-in-process, finished goods, and cost of goods sold. C. To obtain evidence about the profit margin on specific jobs. D. To obtain evidence about compliance with Cost Accounting Standards.

36. Effective internal control for purchases generally can be achieved in a well-planned organizational structure with a separate purchasing department that has: A. The ability to prepare payment vouchers based on the information on a vendor's invoice. B. The responsibility of reviewing purchase orders issued by user departments. C. The authority to make purchases of requisitioned materials and services. D. A direct reporting responsibility to controller of the organization.

37. Purchase cutoff procedures should be designed to test that merchandise is included in the inventory of the client company, if the company: A. Has paid for the merchandise. B. Has physical possession of the merchandise. C. Holds legal title to the merchandise. D. Holds the shipping documents for the merchandise issued in the company's name.

38. Which of the following is an internal control weakness for a company whose inventory of supplies consists of a large number of individual items? A. Supplies of relatively little value are expensed when purchased. B. The cycle basis is used for physical counts. C. The storekeeper is responsible for maintenance of perpetual inventory records. D. Perpetual inventory records are maintained only for items of significant value.

39. The auditors will usually trace the details of the test counts made during the observation of the physical inventory taking to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditors at the time of the physical inventory count are: A. Owned by the client. B. Not obsolete. C. Physically present at the time of the preparation of the final inventory schedule. D. Included in the final inventory schedule.

40. An internal control questionnaire indicates that an approved receiving report is required to accompany every check request for payment of merchandise. Which of the following procedures provides the greatest assurance that this control is operating effectively? A. Select and examine receiving reports and ascertain that the related canceled checks are dated no earlier than the receiving reports. B. Select and examine receiving reports and ascertain that the related canceled checks are dated no later than the receiving reports. C. Select and examine canceled checks and ascertain that the related receiving reports are dated no earlier than the checks. D. Select and examine canceled checks and ascertain that the related receiving reports are dated no later than the checks.

41. 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.

42. Which one of the following procedures would not be appropriate for the auditors in discharging their responsibilities concerning the client's physical inventories? A. Confirmation of goods in the hands of public warehouses. B. Supervising the taking of the annual physical inventory. C. Carrying out physical inventory procedures at an interim date. D. Obtaining written representation from the client as to the existence, quality, and dollar amount of the inventory.

43. To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditors should review and test the: A. Terms of the open purchase orders. B. Purchase cutoff procedures. C. Contractual commitments made by the purchasing department. D. Purchase invoices received on or around year end.

44. 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 client. B. Verifying that the client has used proper inventory pricing. C. Ascertaining the physical quantities of inventory on hand. D. Verifying that all inventory owned by the client is on hand at the time of the count.

45. Purchase cutoff procedures should be designed to test whether all inventory: A. Owned by the company was recorded. B. On the year end balance sheet was carried at lower of cost or market. C. On the year end balance sheet was paid for by the company. D. Owned by the company is in the possession of the company.

46. Which of the following is an effective control that encourages receiving department personnel to count and inspect all merchandise received? A. Quantities ordered are excluded from the receiving department copy of the purchase order. B. Vouchers are prepared by accounts payable department personnel only after they match item counts on the receiving report with the purchase order. C. Receiving department personnel are expected to match and reconcile the receiving report with the purchase order. D. Internal auditors periodically examine, on a surprise basis, the receiving department copies of receiving reports.

47. The accuracy of perpetual inventory records may be established, in part, by comparing perpetual inventory records with: A. Purchase requisitions. B. Receiving reports. C. Purchase orders. D. Vendor payments.

48. An inventory turnover analysis is useful to the auditor because it may detect: A. Inadequacies in inventory pricing. B. Methods of avoiding cyclical holding cost. C. The optimum automatic reorder points. D. The existence of obsolete merchandise.

49. After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items: A. Included in the listing have been counted. B. Represented by inventory tags are included in the listing. C. Included in the listing are represented by inventory tags. D. Represented by inventory tags are bona fide.

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

51. Tracing copies of computer-prepared sales invoices to copies of the corresponding computer-prepared shipping documents provides evidence that A. Shipments to customers were properly billed. B. Entries in the accounts receivable subsidiary ledger were for sales actually shipped. C. Sales billed to customers were actually shipped. D. No duplicate shipments to customers were made.

52. In auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified? A. Test the computation of standard overhead rates. B. Tour the manufacturing plant or production facility. C. Compare inventory balances to anticipated sales volume. D. Review inventory experience and trends.

Essay Questions

53. In auditing a client's inventory, the auditors must be concerned with the detection of goods that are both damaged and obsolete. a. Why are the auditors concerned with detecting damaged and obsolete goods? b. How do the auditors test for damaged goods in the client's inventory? c. How do the auditors test for obsolete goods in the client's inventory?

54. Observation of a client's inventory is a generally accepted auditing procedure that should be performed whenever it is possible. a. What part should the auditors play in planning the physical inventory? b. Describe the procedures performed by the auditors during their observation of a client's physical inventory. c. Why do the auditors document their inventory test counts in their working papers?

Chapter 12 Inventories and Cost of Goods Sold Answer Key

True / False Questions

1. Observation of inventories is a generally accepted auditing standard. FALSE

Difficulty: Easy

2. The receiving department should accept only goods for which there is an approved purchase order on hand. TRUE

Difficulty: Medium

3. For good internal control over purchase transactions, purchases should be made from approved vendors by the department needing the goods. FALSE

Difficulty: Medium

4. Auditors should not review the client's planning of the physical inventory. FALSE

Difficulty: Medium

5. The proper cutoff of inventories is best achieved when the client uses prenumbered purchase orders. FALSE

Difficulty: Medium

6. The lower of cost or market test by the auditors is generally designed to assure that inventories are not valued above their net realizable values. TRUE

Difficulty: Easy

7. When the auditors cannot satisfy themselves as to the accuracy of ending inventory and a material misstatement may exist, they normally may still give an unqualified opinion on the client's income statement. FALSE

Difficulty: Medium

8. To test the client's cutoff of inventories, the auditors will make a record of the serial number of the final receiving and shipping documents used prior to the taking of the physical inventory. TRUE

Difficulty: Medium

9. The use of a tagging system for inventory taking is designed to prevent double counting of goods. TRUE

Difficulty: Easy

10. The examination of warehouse receipts is not sufficient verification of a material amount of goods stored in public warehouses. TRUE

Difficulty: Medium

Multiple Choice Questions

11. An auditor suspects that certain client employees are ordering merchandise for themselves over the Internet without recording the purchase or receipt of the merchandise. When vendors' invoices arrive, one of the employees approves the invoices for payment. After the invoices are paid, the employee destroys the invoices and the related vouchers. In gathering evidence regarding the fraud, the auditor most likely would select items for testing from the file of all A. Cash disbursements. B. Approved vouchers. C. Receiving reports. D. Vendors' invoices.

Difficulty: Medium Source: AICPA

12. Which of the following is not true relating to the auditors' observation of the client's physical inventory? A. The auditors should evaluate the client's planning of the physical inventory. B. The auditors should make certain that consigned items from suppliers are included in physical inventory totals. C. The auditors should evaluate the adequacy of the client's counting procedures. D. The auditors should take test counts of the client's inventory.

Difficulty: Easy

13. A receiving department compares inventory items received with copies of purchase orders. The purchase orders list the name of the vendor and do not list the quantities of the material ordered. Using the purchase orders, the receiving department is most likely to detect: A. Deliveries for which no purchase order was issued. B. Unapproved sales orders. C. Partial deliveries. D. Deliveries of a greater quantity of items than those ordered.

Difficulty: Hard

14. To measure how effectively a client employs its assets, an auditor calculates inventory turnover by dividing the average inventory into: A. Net sales. B. Cost of good sold. C. Operating income. D. Gross sales.

Difficulty: Medium

15. Which of the following audit procedures most likely would provide assurance that a manufacturing entity's inventory valuation is proper? A. Testing the entity's computation of standard overhead rates. B. Obtaining confirmation of inventories pledged under loan agreements. C. Reviewing a cutoff procedure for inventories. D. Tracing test counts to the entity's inventory listing.

Difficulty: Hard

16. A client uses a periodic inventory system. Would one expect a credit to which of the following accounts at the point of sale?

Difficulty: Easy

17. A client uses a perpetual inventory system. Would one expect a credit to which of the following accounts at the point of sale?

Difficulty: Easy

18. Which of the following would an auditor most likely question included in calculation of the overhead rate for a company that manufactures a product? A. Factory supervisor salary. B. Indirect materials. C. Miscellaneous expense. D. Sales expense.

Difficulty: Easy

19. A "bill and hold" scheme is most likely to include: A. Shipment of items to a customer beyond what the customer has ordered. B. Recording as sales items that the company retains as of year-end. C. Billing of items that are held by customers for future revenue production purposes. D. Selling items at substantial discounts near year-end.

Difficulty: Hard

20. Which of the following is an auditor least likely to consider a departure from generally accepted accounting principles? A. Valuing inventory at cost. B. Including in inventory items that are consigned out to vendors, but not yet sold. C. Using standard cost as the measure of inventory cost. D. Including in inventory items shipped subsequent to year-end, but for which valid orders did exist at year-end.

Difficulty: Medium

21. Which of the following is least likely to be accurate statement concerning characteristics of an audit? A. An analysis of inventory turnover addresses whether the proper method of determining inventory costs--as contrasted to market values--is being applied. B. Characteristics of the double entry bookkeeping system make it possible to test for overstated sales when tests of accounts receivable are being performed. C. The direction of tests for overstatement errors is generally directed from the recorded entry to source documents. D. Use of a perpetual rather than a periodic inventory system is likely to affect the nature of cutoff errors made at year-end.

Difficulty: Hard

22. Which of the following is not a reason for the special significance attached by the auditors to the verification of inventories? A. The determination of inventory valuation directly affects net income. B. The existence of inventories is inherently difficult to substantiate. C. Special valuation problems often exist for inventories. D. Inventories are often the largest current asset of an enterprise.

Difficulty: Hard

23. Which of the following is true about the auditors' observation of the client's physical inventory? A. The count must be made at year-end. B. The auditors should supervise the client's personnel. C. The auditors' observation addresses the existence assertion. D. The auditors should justify any omission of the observation in the audit report.

Difficulty: Medium

24. In verifying debits to perpetual inventory records of a non-manufacturing firm, the auditor would be most interested in examining the: A. Purchases journal. B. Purchase requisitions. C. Purchase orders. D. Vendors' invoices.

Difficulty: Hard

25. In verifying credits to perpetual inventory records of a non-manufacturing firm, the auditor would be most interested in examining the: A. Shipping documents. B. Receiving reports. C. Purchase orders. D. Vendors' invoices.

Difficulty: Hard

26. The client's physical count of inventories is lower than the inventory quantities in the perpetual records. This could be the result of a failure to record: A. Purchases. B. Purchase discounts. C. Sales. D. Sales discounts.

Difficulty: Medium

27. 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 inventory summary sheets. Which assertion does this procedure relate to most directly? A. Completeness. B. Existence. C. Legality. D. Valuation.

Difficulty: Medium

28. The use of a "blind" purchase order is designed to prevent errors by the: A. Purchase department. B. Receiving department. C. Stores department. D. Accounting department.

Difficulty: Medium

29. An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all: A. Merchandise received. B. Vendor's invoices. C. Canceled checks. D. Receiving reports.

30. To assure that all purchases are authorized before payment is made, accounting department personnel should match the vendor's invoice to: A. The purchase requisition. B. The receiving report. C. The purchase order. D. The voucher.

Difficulty: Medium

31. Which of the following is true about the auditors' observation of the client's physical inventory? A. The auditors should plan the physical inventory. B. The auditors should segregate damaged and obsolete goods. C. The auditors should evaluate the adequacy of the client's counting procedures. D. The auditors should supervise the client's personnel.

Difficulty: Medium

32. Which of the following is not a procedure that typically is used by the auditors in their examination of a client's goods held in the custody of a public warehouse? A. Confirmation. B. Obtaining reports on internal control at the warehouse. C. Observation. D. Corresponding with the state agency regarding the authenticity of the public warehouse.

Difficulty: Medium

33. Which of the following best describes the reason that the auditors record their inventory test counts in the working papers? A. To document every test count. B. For subsequent comparison with the completed inventory listing. C. To document compliance with generally accepted accounting principles. D. For use in subsequent audits.

Difficulty: Medium

34. Which of the following best describes the auditors' response to a client's use of statistical sampling techniques to estimate the inventory? A. The auditors should satisfy themselves as to the statistical validity of the technique, and the reasonableness of the allowance for sampling risk and sampling error used. B. The auditors should qualify their opinion, because the client must perform a complete count of the inventory. C. The auditors should increase the extent of their test counts to compensate for the use of a statistical technique. D. The auditors should withdraw from the engagement.

Difficulty: Medium

35. Which of the following best describes the reason for the auditors' review of the client's cost accounting system? A. To obtain evidence regarding the quantities of good described as work-in-process. B. To obtain evidence about the valuation of work-in-process, finished goods, and cost of goods sold. C. To obtain evidence about the profit margin on specific jobs. D. To obtain evidence about compliance with Cost Accounting Standards.

Difficulty: Medium

36. Effective internal control for purchases generally can be achieved in a well-planned organizational structure with a separate purchasing department that has: A. The ability to prepare payment vouchers based on the information on a vendor's invoice. B. The responsibility of reviewing purchase orders issued by user departments. C. The authority to make purchases of requisitioned materials and services. D. A direct reporting responsibility to controller of the organization.

Difficulty: Hard Source: AICPA