Deck 21: Audit of the Inventory and Warehousing Cycle

Question 1

Which of the following would you normally characterize as a difficult and complex account to audit?

A) property, plant and equipment
B) cash
C) inventory
D) prepaid insurance

Answer 1

C

Question 2

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 2

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.

Question 3

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.

Answer 3

D

Question 4

Handling the receipt of ordered goods is a part of the ________ cycle.

A) purchasing
B) acquisition and payment
C) inventory
D) inventory and warehousing

Question 5

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 documentation.
B) storage of the goods.
C) internal control over those goods.
D) prevention of waste, obsolescence, and theft.

Question 6

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.

Question 7

Master files, worksheets, 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.

Question 8

In process cost systems, costs are accumulated by individual jobs.

Question 9

In job cost systems, costs are accumulated by individual jobs.

Question 10

What are two factors affecting the complexity of the audit of inventory?

Question 11

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.

Question 12

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 in working capital.
D) Inventory valuation includes few estimates.

Question 13

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.

Question 14

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

Question 15

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.

Question 16

The auditor's main concerns in verifying transfers of inventory do not include whether:

A) recorded transfers exist.
B) transfers represent appropriate uses of company resources.
C) all actual transfers are recorded.
D) the details of the transfer are accurately recorded.

Question 17

While separate perpetual inventory records are normally kept for raw materials and finished goods, most companies do not use perpetual for work-in-process.

Question 18

________ 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

Question 19

In performing audit tests of the client's cost accounting system, the auditor is primarily concerned with which of the following?

A) System is functioning properly in providing costing and pricing information for management.
B) Costs have been properly assigned to finished goods, work-in-process, and cost of goods sold.
C) Inventory counts agree with the client's accounting records.
D) The client's cost accounting system is designed on the basis on acceptable cost accounting systems.

Question 20

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.

Question 21

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

Question 22

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.

Question 23

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.

Question 24

In any company involved in manufacturing, an adequate cost accounting internal control system is necessary to indicate the relative profitability of the various products for management planning and control and to:

A) determine variances from standards.
B) determine variances from budgets.
C) value inventories for financial statement purposes.
D) value inventories for audit verification.

Question 25

Johnson Co.'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) sales.
B) sales returns.
C) purchases.
D) purchase discounts.

Question 26

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.

Question 27

Internal controls over the processing of purchase orders function, the receipt of raw materials function, and the storage of raw materials function in the inventory and warehousing cycle are normally tested by the auditor as a part of performing tests of controls and substantive tests of transactions in the acquisition and payment cycle and the payroll and personnel cycle.

Question 28

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

Question 29

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.

Question 30

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

Question 31

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.

Question 32

The auditor's tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods are usually restricted to:

A) observation and inquiry.
B) documentation and observation.
C) documentation and confirmation.
D) documentation and inquiry.

Question 33

Auditor tests of physical controls over raw materials, work-in-process, and finished goods are performed by:

A)
B)
C)
D)

Question 34

Perpetual inventory records should be maintained by persons having access to inventory.

Question 35

Which department within a manufacturing company is often responsible for the review of production and scrap reports?

A) Purchasing
B) Accounts Payable
C) Accounting
D) Production

Question 36

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

Question 37

The receipt of raw materials is a part of the acquisition and payment cycle.

Question 38

A major difficulty in the verification of inventory cost records for the purpose of inventory valuation is in determining the reasonableness of:

A) direct labor's hourly rate.
B) raw materials per unit cost.
C) cost allocations.
D) number of direct labor hours applied.

Question 39

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.

Question 40

What are the auditor's primary concerns in verifying the transfer of inventory from one location to another?

Question 41

The audit procedure "observe the client taking a physical inventory count and test the count" is sufficient to determine all of the following except:

A) whether recorded inventory actually exists.
B) whether recorded inventory was properly valued by the client.
C) whether recorded inventory was properly counted by the client.
D) whether client inventory instruction had properly been followed.

Question 42

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.

Question 43

Given the following information about your audit client, perform analytical procedures and comment on your findings.

Question 44

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.

Question 45

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.

Question 46

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.

Question 47

Which of the following statements is correct regarding the auditor's responsibility with respect to the year-end inventory procedures of an audit client?

A)
B)
C)
D)

Question 48

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.

Question 49

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

Question 50

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

Question 51

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

Question 52

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.

Question 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 year.
B) Observe merchandise and raw materials during the client's physical inventory count.
C) Review the management's inventory representation letter for accuracy.
D) Test overall fairness of inventory values by comparing the company's turnover ratio with the industry average.

Question 54

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'.

Question 55

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

Question 56

Discuss the four aspects of the audit of cost accounting with which the auditor is most concerned.

Question 57

Hardy Company mass-produces eight different products. The controller who is interested in strengthening internal controls over the accounting for materials used in production would be most likely to implement a(n):

A) perpetual inventory system.
B) job order cost accounting system.
C) economic order quantity system.
D) separation of duties among production personnel.

Question 58

If the perpetual inventory master files show lower quantities of inventory than the physical count, one explanation of the difference might be unrecorded sales.

Question 59

Tests of the perpetual inventory master files for the purpose of reducing the tests of physical inventory or changing their timing are done through the use of:

A) inquiry.
B) observation.
C) confirmation.
D) documentation.

Question 60

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.

Question 61

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.

Question 62

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.

Question 63

The physical counting of inventory may be performed at which of the following times?

A)
B)
C)
D)

Question 64

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.

Question 65

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 in an attempt 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.

Question 66

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

Question 67

The auditor's objective during an observation of a client's physical inventory count is to:

A) discover whether a client has counted a particular inventory item or group of items.
B) obtain direct knowledge that the inventory exists and has been properly counted.
C) provide an appraisal of the quality of the merchandise on hand on the day of the physical count.
D) allow the auditor to supervise the conduct of the count so as to obtain assurance that inventory quantities are reasonably accurate.

Question 68

Which of the following control procedures would most likely be used to maintain accurate perpetual inventory records?

A) independent storeroom count of goods received
B) periodic independent comparison of records with goods on hand
C) periodic independent reconciliation of control and subsidiary records
D) independent matching of purchase orders, receiving reports, and vendors' invoices

Question 69

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.

Question 70

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).

Question 71

Most of the audit testing of the storage of finished goods as well as the shipment of merchandise takes place during the testing of the:

A) sales and collection cycle.
B) payroll and personnel cycle.
C) acquisitions and payments cycle.
D) inventory and warehousing cycle.

Question 72

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.

Question 73

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 problems, such as gas and oil accounting, or lease-purchase agreements.
C) read the client's Accounting Manual.
D) tour the client's facility.

Question 74

A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, 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.

Question 75

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) All inventory must be valued using the same valuation method under GAAP.

Question 76

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.

Question 77

Which of the following situations would most likely require special audit planning?

A) Inventory consists of precious stones.
B) Some items of factory and office equipment do not bear identification numbers.
C) Depreciation methods used on the client's tax return differ from those used on the books.
D) Assets costing less than $500 are expensed even though their expected life exceeds one year.

Question 78

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 control that led to the failure to adjust the accounting records for some:

A) purchases returned to vendors.
B) sales returns received.
C) sales discounts allowed.
D) cash purchases.

Question 79

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.

Question 80

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.