Chapter 21 Audit of the Inventory and Warehousing Cycle

Learning Objective 21-1

B 1) Receipt of ordered materials by the receiving department will generate the completion of a form called
the:
A) bill of lading.
B) receiving report.
C) materials requisition.
D) inventory acquisition summary.
C 2) ________ is normally characterized as a difficult and complex account to audit.
A) Property, plant and equipment
B) Cash
C) Inventory
D) Prepaid insurance
D 3) Inventory is a complex area to audit for all but which of the following reasons?
A) Inventory is often in different locations.
B) There are several acceptable valuation methods and some entities use different methods for different
types of inventory.
C) Inventory is often the largest account on the balance sheet.
D) Inventory valuation includes few estimates.
D 4) In most manufacturing companies, the inventory and warehousing cycle begins with the:
A) receipt of a customer's order.
B) completion of production of a customer's order.
C) initiation of production of a customer's order.
D) acquisition of raw materials for production of an order.
B 5) ________ accumulate costs by individual jobs as material is issued into production and labor costs are
incurred.
A) Just-in-time production systems
B) Job order cost systems
C) Process cost systems
D) Manufacturing systems
C 6) Master files, spreadsheets, and reports that accumulate material, labor, and overhead as the costs are
incurred are:
A) accounting systems.
B) storeroom documents.
C) cost accounting records.
D) finished goods inventory records.
B 7) The main difference between job order and process costing systems is that:
A) one accumulates costs by materials issued and the other by labor incurred.
B) one accumulates costs by individual jobs and the other by particular processes.
C) one emphasizes costs accumulated in completed products and the other emphasizes costs associated
with work-in-process.
D) one emphasizes costs adding value to the product and the other emphasizes costs incurred because
of waste, scrap, and obsolescence.
A 8) The inventory and warehousing cycle can be thought of as having two separate but closely related
systems, one involving the actual physical flow of goods, and the other the:
A) related costs.
B) storage of the goods.
C) internal control over those goods.
D) prevention of waste, obsolescence, and theft.
D 9) Auditors test the quantity of materials charged to work-in-process by tracing these quantities to:
A) cost ledgers.
B) perpetual inventory records.
C) receiving reports.
D) material requisitions.
10) What are two factors affecting the complexity of the audit of inventory?
Answer:
• Inventory is often the largest account on the balance sheet.
• Inventory is often in different locations.
• Diverse items in inventory are often difficult to value.
• Inventory valuation is difficult due to the estimates involved.
• There are several acceptable methods of valuing inventory and some entities use different methods
for different parts of the inventory, which is acceptable under accounting standards.
11) State the six functions that make up the inventory and warehousing cycle and, for each function,
identify the related documents and/or records that would be used by a manufacturing company.
Answer: The six functions are:
• Process purchase orders. Related documents are the purchase requisition and the purchase order.
• Receive raw materials. Related documents are the receiving report and the vendor's invoice.
• Store raw materials. Related record is the raw materials perpetual inventory master file.
• Process the goods. Related documents and records are the raw materials requisition and the cost
accounting records.
• Store finished goods. Related records are the finished goods perpetual inventory master file and the
cost accounting records.
• Ship finished goods. Related documents and records are the shipping document, the finished goods
perpetual inventory master file, and the cost accounting records.
B 12) In process cost systems, costs are accumulated by individual jobs.
B) False
A 13) In job cost systems, costs are accumulated by individual jobs.
A) True
A 14) While separate perpetual inventory records are normally kept for raw materials and finished goods,
most companies do not use perpetual records for work-in-process.
A) True

Learning Objective 21-2

C 1) The audit tests to verify that the client is using an inventory method which is generally accepted and to
verify that physical counts were correctly summarized are performed during the audit of the:
A) acquisition and payments cycle.
B) payroll and personnel cycle.
C) inventory and warehousing cycle.
D) sales and collection cycle.
B 2) Handling the receipt of ordered goods is a part of the ________ cycle.
A) purchasing
B) acquisition and payment
C) inventory
D) inventory and warehousing
D 3) Which of the following is not a function within the inventory and warehousing cycle?
A) Process the goods
B) Store raw materials
C) Ship finished goods
D) Process invoices for shipped goods
4) The audit of the inventory and warehousing cycle will be affected by the results from other business
processes. Identify the "other" business cycles and how they impact the audit of inventory.
Answer: Acquisition and Payment: Acquire and record raw materials, labor, overhead
Sale and collection: Ship goods and record revenue and the appropriate costs
5) The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for
each part, identify the cycle in which that part is tested by the auditor.
Answer: The five parts are:
• Acquire and record raw materials, labor, and overhead. This is tested during the audits of the
acquisition and payment cycle, and the payroll and personnel cycle.
• Internally transfer assets and costs. This is tested in the inventory and warehousing cycle.
• Ship goods, and record revenue and costs. This is tested during the audit of the sales and collection
cycle.
• Physically observe inventory. This is tested in the inventory and warehousing cycle.
• Price and compile inventory. This is tested in the inventory and warehousing cycle.
B 6) Inventory compilation tests are used to verify that the inventory is recorded at the lower of cost or
market.
B) False
B 7) An approved purchase requisition form authorizes shipment of goods to customers.
B) False
A 8) The receipt of raw materials is a part of the acquisition and payment cycle.
A) True
B 9) The physical observation of the inventory and the acquisition of raw materials are part of the inventory
and warehousing cycle.
B) False

Learning Objective 21-3

B 1) Auditor tests of the physical controls over raw materials, work in process, and finished goods are
generally limited to:
A) observation and confirmation.
B) observation and inquiry.
C) inquiry and reconciliation.
D) observation and reconciliation.
A 2) Almost all companies need physical controls over their assets to prevent loss. Which of the following is
not an example of such a control?
A) Perpetual inventory master files
B) Segregated, limited-access storage areas
C) Custody of assets assigned to specific responsible individuals
D) Approved prenumbered documents for authorizing movement of inventory
D 3) The reliability of perpetual inventory master files affects the timing and ________ of the auditor's
physical examination of inventory.
A) cutoff
B) accuracy
C) nature
D) extent
A 4) When auditing inventory cost accounting, the auditor is concerned with all of the following except for:
A) net realizable value.
B) unit cost records.
C) physical controls over inventory.
D) documents and records for transferring inventory.
C 5) Which of the following controls would be appropriate regarding the release of materials from a
stockroom?
A) Production employees request materials be delivered to their work areas as they need them.
B) Stockroom employees deliver materials to work areas throughout the day to maintain acceptable
levels of safety stock — no written records are maintained.
C) Production employees submit approved requisition forms to the stockroom for materials needed.
D) Production employer in need of materials should personally pick up needed materials from the
stockroom.
D 6) To assure proper segregation of duties, who should maintain the perpetual inventory master files?
A) Production personnel
B) Inventory storeroom personnel
C) Inventory receiving personnel
D) Accounting department personnel
C 7) Which of the following statements is correct regarding the audit of inventory cost accounting?
A) Cost accounting systems and controls are the same for all manufacturing companies.
B) All companies that have work-in-process must use a perpetual inventory system.
C) Auditors test perpetual inventory master files by examining documentation that supports additions
and reductions of inventory amounts in the master files.
D) Manufacturing companies keep their cost accounting records separate from the production and other
accounting records.
D 8) A well-designed computerized system of perpetual inventory master files includes information about
the:
A) units of inventory purchased, sold, and on hand.
B) unit costs of inventory purchased, sold, and on hand.
C) units of raw materials, work-in-process, and finished goods.
D) units and unit costs of inventory purchased, sold, and on hand.
A 9) Which of the following is a significant audit concern related to the transfer of inventory from one
location to another?
A) Recorded transfers occurred.
B) Transfers were properly transported.
C) Transfers were properly planned.
D) Transfers represent efficient movement of assets.
C 10) When auditing manufacturing overhead costs assigned to inventory, auditors should keep in mind
that:
A) GAAP has strict procedures that must be followed when assigning overhead to work-in-process
inventory.
B) overhead costs must be allocated to raw materials, work-in-process, and finished goods inventory.
C) management typically allocates overhead using total direct labor dollars as the basis for the
allocation.
D) determining the reasonableness of the allocation method is relatively simple for work-in-process
inventory.
C 11) A major difficulty in the verification of inventory cost records for the purpose of inventory valuation is
in determining the reasonableness of the:
A) direct labor hourly rate.
B) raw material per unit cost.
C) manufacturing overhead costs.
D) number of direct labor hours applied.
D 12) Auditor tests of physical controls over raw materials, work-in-process, and finished goods are
performed by:
D)

Examination Observation Inquiry

No Yes Yes

C 13) If the perpetual inventory master files show lower quantities of inventory than the physical count, an
explanation of the difference might be unrecorded:
A) sales.
B) sales discounts.
C) purchases.
D) purchase discounts.
C 14) Cost accounting controls are those related to the physical inventory and the consequent costs from
the point at which:
A) materials are ordered for purchase until the finished product is sold.
B) the customer's order is received until the finished product is shipped.
C) raw materials are requisitioned until the finished product is sent to storage.
D) raw materials are requisitioned until the finished product is completely manufactured.
A 15) In order to strengthen controls over cost accounting information, a company should consider
implementing:
A) perpetual inventory master files.
B) a job order cost accounting system.
C) an accounting system that keeps separate the records of the accounting department from the records
of the production department.
D) an economic quantity order system.
D 16) 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) The cycle basis is used for physical counts.
B) Supplies of relatively little value are expensed when purchased.
C) Perpetual inventory records are maintained only for items of significant value.
D) The storekeeper is responsible for maintenance of perpetual inventory records.
D 17) One of the auditor's primary concerns in verifying the transfer of inventory from one location to
another is that:
A) recorded transfers exist.
B) all actual transfers are recorded.
C) the quantity, date, and description of all recorded transfers are accurate.
D) all of the above.
B 18) The audit of cost accounting begins with the internal transfer of assets from raw materials to work-
inprocess to:
A) manufacturing overhead.
B) finished goods inventory.
C) the perpetual inventory master files.
D) retail sales.
19) Discuss the four aspects of the audit of cost accounting with which the auditor is most concerned.
Answer: The auditor is most concerned with:
• Physical controls over inventory. Generally limited to observation and inquiry to determine if
inventory is protected from theft and misuse.
• Documents and records for transferring inventory. The auditor's primary concerns in verifying the
transfer of inventory from one location to another are that the recorded transfers exist, the transfers
that have actually taken place are recorded, and the quantity, description, and date of all recorded
transfers are accurate.
• Perpetual inventory master files. The adequacy of perpetual inventory master files has a major
effect on the timing and extent of the auditor's physical examination of inventory.
• Unit cost records. To maintain accurate cost data, clients must integrate their cost accounting
records with production and other accounting records. The auditor is concerned that there is
accurate cost data for raw materials, direct labor, and manufacturing overhead to ensure that raw
materials, work-in-process, and finished goods inventories are fairly stated.
20) What are the auditor's primary concerns in verifying the transfer of inventory from one location to
another?
Answer:
1. recorded transfers exist
2. all transfers are recorded
3. the quantity, description, and date of all recorded transfer are accurate
B 21) Management typically allocates overhead using total raw materials as the basis for the allocation.
B) False
A 22) When verifying the transfer of inventory from one location to another, the audit objectives with
which the auditor is primarily concerned are occurrence of recorded transfers, completeness of recorded
transfers, and accuracy of recorded transfers.
A) True
B 23) Production personnel should ordinarily be responsible for maintaining perpetual inventory records.
B) False
A 24) The extent and timing of an auditor's physical examination of inventory is significantly influenced by
the adequacy of the client's perpetual inventory records.
A) True

Learning Objective 21-4

C 1) Which one of the following analytical procedures would be most useful in alerting the auditor to the
possibility of obsolete inventory?
A) Compare gross margin percentage with previous years'.
B) Compare unit costs of inventory with previous years'.
C) Compare inventory turnover ratio with previous years'.
D) Compare current year manufacturing costs with previous years'.
2) In addition to performing analytical procedures that examine the relationship of inventory account
balances with related financial statement accounts, auditor's will often use non-financial measures in
determining the reasonableness of inventory balances. List below at least two non-financial measures
that may be useful to auditors.
Answer: Size and weight of inventory products, Methods of storage, Storage capacity
3) Given the following information about your audit client, perform analytical procedures and comment
on your findings.

2010 2011 Industry Average

Inventory $20,000 $32,000 $25,000

Cost of Sales $240,000 $320,000 $400,000

Answer: Inventory turnover for 2010 is 12, and for 2011 is 10, industry average is 16. (Basic
accounting information that should be known applied to the inventory chapter)
Inventory is increasing with lower inventory turns, and much below industry average. Principal
audit concern would be that inventory is over-valued on the balance sheet. A concern will be the
realizable value of the inventory.
A 4) A comparison of the current year's inventory turnover ratio with previous years' may indicate the
presence of obsolete inventory.
A) True

Learning Objective 21-5

A 1) You are auditing the inventory account and are concerned about the possibility of an inventory
overstatement. What is the best audit procedure to detect damaged inventory?
A) Observe the condition of inventory during the client's physical count.
B) Compare the condition of inventory from the previous year's count to the current year.
C) Compare inventory turnover from the previous year's inventory to the current year's inventory.
D) Reconcile the inventory counts to the cost accounting records.
B 2) When determining the sample size for the number of items the auditor should count during the
physical inventory:
A) it is easy to quantify the number of items based on a formula developed by the AICPA.
B) one of the key determinants that must be considered is internal control over the physical count.
C) one of the key determinants that must be considered is the time involved.
D) generally accepted auditing standards require that at least 80% of the dollar value of the inventory
should be included in the sample.
C 3) There must be a periodic physical count by the client of the inventory items on hand:
A) only if the client uses the LIFO method.
B) only if the client uses a lower-of-cost-or-market method.
C) regardless of the client's inventory valuation method.
D) only if the client uses either the LIFO or FIFO method.
C 4) If the auditor concludes that physical controls over inventory are so inadequate that the inventory will
be difficult to count, the auditor should ordinarily:
A) withdraw from the engagement.
B) issue a qualified audit report.
C) conduct expanded observation tests of physical inventory.
D) hire a specialist to assist the auditor.
A 5) From which of the following evidence-gathering audit procedures would an auditor obtain most
assurance concerning the existence of inventories?
A) Observation of physical inventory counts
B) Written inventory representations from management
C) Confirmation of inventories in a public warehouse
D) Auditor's recomputation of inventory extensions
B 6) When auditors observe the client counting inventory, they should be careful to do all of the following
except:
A) inquire about items that are likely to be obsolete or damaged.
B) calculate the unit cost of the inventory items.
C) discuss with management the reasons for excluding any material items.
D) observe the counting of the most significant items.
A 7) It is frequently possible to test the physical inventory prior to the balance sheet date when:
A) there are accurate perpetual inventory master files.
B) year-end sales are small.
C) the internal control system is no better at year-end than at an earlier point in time.
D) the client counts inventory at interim dates.
D 8) Comparing the physical counts with the perpetual inventory master files satisfies the balance-related
audit objective of:
A) classification.
B) observation.
C) completeness.
D) accuracy.
B 9) Which of the following statements is correct regarding the auditor's responsibility with respect to the
year-end inventory procedures of an audit client?
B)

The auditor is responsible for

The auditor is responsible The auditor is responsible
setting up the procedures for
for taking and compiling for observing the physical
taking an accurate physical
the inventory. counting of inventory.
inventory.

No No Yes

No Yes No

A 10) McKesson & Robbins Company is a well-known audit case involving auditor responsibility. What
occurred at the McKesson & Robbins Company to change the way in which auditors audit inventory?
A) The company recorded nonexistent inventory.
B) The auditor did not perform any audit tests of the inventory.
C) The auditor and company colluded to overstate inventory balances.
D) The company counted inventory three months prior to year-end.
C 11) When a physical count of inventory is performed at an interim date, the auditor observes it at that
time and tests the perpetual records for transactions:
A) throughout the year.
B) which are a representative sample of the period under audit.
C) from the date of the count to year-end.
D) from the date of the count to the end of the audit field work.
B 12) When there are no perpetual inventory files and inventory is material:
A) an audit cannot be performed, so the auditor must issue a disclaimer.
B) a physical inventory should be taken by the client near year-end.
C) the auditor will have to perform the inventory count and determine valuation.
D) the auditor need not observe inventory counts but must do test counts.
D 13) The most important part of the observation of inventory is to determine whether:
A) all counts are accurate.
B) the inventory-takers are qualified.
C) obsolete inventory has been identified.
D) the physical count is being taken in accordance with the client's instructions.
D 14) A useful starting point for becoming familiar with the client's inventory is for the auditor to:
A) read the AICPA's Industry Audit Guide.
B) review accounting theory covering special inventory problems.
C) read the client's accounting manual.
D) tour the client's facility.
A 15) A common inventory observation procedure is to select a random sample of tag numbers and identify
the tag with that number attached to the actual inventory item. The audit objective being achieved by
this procedure is:
A) inventory as recorded on tags actually exists (existence).
B) existing inventory is counted and tagged (completeness).
C) inventory is counted accurately (accuracy).
D) inventory is classified correctly (classification).
C 16) If a client intends to count inventory at an interim date, the auditor should expect there to be all of
the following except:
A) controls over the preparation and maintenance of perpetual inventory records.
B) competent personnel assigned to count the inventory.
C) third-party inventory counting specialists.
D) an adequately designed plan to count the inventory.
C 17) A common inventory observation procedure is to be alert for items that are damaged, rust- or
dustcovered, or located in inappropriate places. The balance-related audit objective being achieved by this
procedure is:
A) classification.
B) cutoff.
C) realizable value.
D) rights.
D 18) The test of details of balance procedure which requires the auditor to account for unused inventory
tag numbers to make sure none have been deleted is associated with the audit objective of:
A) accuracy.
B) existence.
C) detail tie-in.
D) completeness.
A 19) Which of the following is an accurate statement regarding inventory and risk?
A) Inventory with a high business risk includes products with potential obsolescence.
B) Auditors often have a greater concern for misstatements when inventory is stored in one warehouse.
C) Inherent risk is generally set at low for manufacturing companies.
D) Performance materiality for inventory is determined before assessing client business risk.
C 20) The auditor's tour of the client's inventory facilities should be led by:
A) a member of the audit committee.
B) the CFO.
C) a plant supervisor.
D) the company president.
A 21) The physical counting of inventory may be performed at which of the following times?
A)

Interim dates On a cycle basis during the year

Yes Yes

A 22) When an auditor observes that personnel who are responsible for physically counting inventory are
not following the inventory instructions, the auditor should:
A) contact a client's supervisor to correct the problem.
B) modify the client's physical inventory instructions.
C) not discuss the problem with client's supervisor in order to maintain independence.
D) assign audit staff to the inventory count.
B 23) Auditors need to understand the client's physical inventory count controls before the count of the
inventory begins so that:
A) the auditors can accurately count and tag the inventory for the client.
B) the auditors can make constructive suggestions as to the adequacy of the procedures.
C) the client will be informed on exactly what items the auditor intends to test count.
D) the auditor can communicate any weaknesses directly to the audit committee.
A 24) 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 current period.
B) sale in the subsequent period.
C) purchase in the current period.
D) purchase return in the subsequent period.
B 25) Which one of the following procedures would not be appropriate for an auditor in discharging his
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
B 26) The auditor generally decides whether the inventory count can be taken before year-end primarily on
the basis of:
A) audit efficiency.
B) accuracy of the perpetual inventory master files.
C) client convenience.
D) audit staff availability.
B 27) An auditor selects a random sampling of tag numbers and identifies the tag with that number
attached to the actual inventory. The purpose of the procedure is to:
A) obtain proper cutoff information.
B) uncover the inclusion of nonexistent items as inventory.
C) to determine if the client has adequately priced the inventory item.
D) to verify that the client has not changed the recorded counts after the auditor left the premises.
C 28) An auditor must inquire about consigned or customer inventory included on the client's premises to
satisfy the balance-related audit objective of:
A) cutoff.
B) classification.
C) rights.
D) completeness.
B 29) To best ascertain that a company has properly included merchandise that it owns in its ending
inventory, the auditor 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.
C 30) Boxes or other containers holding inventory should also be opened during test counts to determine
the________ of the inventory.
A) classification
B) detail tie-in
C) existence
D) realizable value
A 31) When may auditors observe the physical inventory count?
A)

At an interim date At year-end

Yes Yes

32) Discuss the auditor's responsibilities for inventory maintained in public warehouses or with other
outside custodians.
Answer: An auditor's physical examination of inventory is not required if inventory is housed in a
public warehouse or overseen by outside custodians. In these situations, auditors verify inventory by
confirmation with the custodian. However, the auditor may perform additional procedures if the
amounts involved are significant. These additional procedures may include: an investigation of the
custodian's inventory procedures, obtaining an independent accountant's report on the custodian's
control procedures over the custody of goods, or observing the physical count of goods held by the
custodian, if practical.
33) Discuss the key control procedures relating to the client's physical count of inventory.
Answer: The key control procedures relating to the client's physical count of inventory include:
1. proper instructions for the physical count
2. supervision by responsible personnel
3. independent internal verification of the counts
4. independent reconciliations of the physical counts with perpetual inventory master files
5. adequate control over count sheets or tags.
34) Auditing standards require that auditors satisfy themselves about the effectiveness of the client's
methods of counting inventory and the reliance they can place on the client's representations about the
quantities and physical condition of the inventories. To meet this requirement auditors must perform
four activities. List below.
Answer:
• Be present at the time the client counts the inventory
• Observe the client's counting procedures
• Make inquiries of client personnel about their counting procedures
• Make their own independent tests of the physical count
B 35) Auditing standards recommend that auditors observe physical inventory counts by the client.
B) False
B 36) In the audit of inventory, the auditor and client are jointly responsible for making and recording the
count of physical inventory; while the auditor is responsible for drawing conclusions about the
adequacy of the physical inventory.
B) False
A 37) A common source of business risk for inventory is the reliance on a few key suppliers.
A) True
A 38) To test for proper sales cutoff, an auditor would obtain the number of the last bill of lading issued
during the period under audit and verify that the item shipped had been excluded from the inventory
listing.
A) True
B 39) 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.
B) False
A 40) When part of the client's inventory is in a public warehouse or in the possession of other outside
custodians, the auditor does not need to observe a physical count of the inventory if a written
confirmation is obtained directly from the inventory custodians.
A) True
A 41) The adequacy of internal controls over the physical count of inventory is one of the key determinants
of the amount of time needed to test inventory.
A) True
B 42) Inherent risk is typically assessed at a low level for inventory due to the nature of the asset.
B) False

Learning Objective 21-6

B 1) If an auditor were concerned with obtaining evidence about the appropriateness of the value of
inventory, which of the following tests would be most appropriate?
A) Compilation tests
B) Price tests
C) Confirmation of inventory held by outside parties
D) Physical examination of the inventory
B 2) The first step in verifying the valuation of purchased inventory is in determining the valuation method
used by the client. The next step is:
A) determining that all inventory that is purchased is expensed through cost of goods sold.
B) determining which costs should be included in the valuation of an item of inventory.
C) determining that all inventory on hand reconciles to the perpetual inventory records.
D) determining that cut-off procedures have been adhered to prior to counting inventory.
A 3) You are gathering evidence for the audit objective that existing inventory items are included in the
inventory listing schedule. The audit procedure that would provide you with the best evidence to
confirm this objective is:
A) trace from inventory tags to the inventory listing schedule and make sure the inventory tag is
included.
B) trace the inventory totals to the general ledger.
C) perform tests of lower-of-cost-or-market.
D) account for unused tags shown in the auditor's documentation to make sure no tags have been added.
D 4) The test of details of balance procedure which requires the auditor to perform tests of lower of cost or
market, selling price, and obsolescence is an attempt to satisfy the objective of:
A) existence.
B) completeness.
C) accuracy.
D) realizable value.
C 5) A major source of cutoff information for sales and purchases of inventory is:
A) confirmations from outside parties.
B) the test of details of balances.
C) physical observation.
D) the performance of analytical procedures.
C 6) Pricing manufactured inventory is difficult. Auditors must evaluate the method of allocating
manufacturing overhead for all but which of the following?
A) Reasonableness
B) Computational correctness
C) Compliance with generally accepted auditing standards
D) Consistency
C 7) Controls which provide a means of ensuring that the physical counts are properly summarized, priced
at the same amount as the unit records, correctly extended and totaled, and included in the general ledger
at the proper amount are known as:
A) standard cost controls.
B) pricing internal controls.
C) compilation internal controls.
D) count quantity internal controls.
C 8) Assume that the client's valuation of an inventory item is $10 per unit for 1,000 units, using first-in,
first-out (FIFO). If the most recent acquisition of inventory was for 600 units at $10 per unit and the
immediately preceding acquisition was for 700 units at $9 per unit, the inventory item is in error and it
is:
A) understated $400.
B) understated $300.
C) overstated $400.
D) overstated $700.
B 9) The auditor traces inventory tags identified as non-owned during the physical observation to the
inventory listing schedule to make sure these have not been included. This test satisfies the balancerelated
audit objective of:
A) cutoff.
B) rights.
C) accuracy.
D) existence.
D 10) Which of the following is an accurate statement regarding the audit of pricing and compilation of
inventory?
A) Inventory compilation tests include all of the tests of the client's unit prices to determine whether
they are correct.
B) The review for obsolete inventory should be performed by the accounting department.
C) The most important internal control for accurate unit costs is external verification by an outside
consultant.
D) Inventory compilation internal controls are needed to ensure that the physical counts are correctly
summarized and priced.
D 11) In valuing inventory, the auditor must consider all but which of the following factors?
A) The valuation method must be in accordance with GAAP.
B) The valuation method must be applied on a consistent basis.
C) The inventory must be valued at the lower of cost or market.
D) LIFO must be used for work-in-process inventory.
12) Explain why the audit of work in process and finished goods inventory is generally more complex than
the audit of purchased inventory.
Answer: The need to verify the cost of raw materials, direct labor, and manufacturing overhead in
pricing work in process and finished goods has the effect of making the audit of work in process and
finished goods inventory more complex than the audit of purchased inventory.
A 13) In pricing raw materials in manufactured products, auditors must consider both the unit cost of the
raw
materials and the number of units required to manufacture a unit of output.
A) True
A 14) The audit procedure "Perform tests of lower-of-cost-or-market, selling price, and obsolescence"
provides assurance mainly for the realizable value objective for inventory pricing and compilation.
A) True
B 15) When performing price tests for purchased inventory, the auditor would not be concerned with the
most recent vendors' invoices if the client uses the FIFO valuation method.
B) False
A 16) When a client has standard cost records, an efficient and useful method of determining valuation is to
review and analyze variances.
A) True
A 17) The major concerns in performing inventory valuation tests are compliance with GAAP and
consistency with prior years.
A) True
B 18) The audit procedure "Foot the inventory listing schedules for raw materials, work-in-process, and
finished goods" provides assurance mainly for the accuracy objective for inventory pricing and
compilation.
B) False
A 19) The audit procedure "Account for unused tag numbers shown in the auditor's working papers to
make sure no tags have been added" provides assurance mainly for the existence objective for inventory
pricing and compilation.
A) True
B 1) When labor is a significant part of inventory, verifying the proper accounting of these costs should be
tested in the:
A) inventory and warehousing cycle.
B) payroll and personnel cycle.
C) acquisitions and payments cycle.
D) cash cycle.
2) The design of tests of details of balances for inventory is affected by audit results from multiple cycles.
Identify the cycles, other than the inventory and warehousing cycle that affect the audit of inventory.
Answer: Tests of details of balances for inventory are affected by the results of tests of controls and
substantive tests of transactions in the sales and collection cycle, acquisition and payment cycle, and
payroll and personnel cycle, as well as the inventory and warehousing cycle.
B 3) Internal controls over the ship finished goods function in the inventory and warehousing cycle are not
normally tested by the auditor as a part of performing tests of controls and substantive tests of
transactions in the sales and collection cycle.
A) True
B) False
B 4) Cost of goods sold is generally a residual of beginning inventory less acquisitions plus ending
inventory.
A) True
B) False