Auditing and Assurance Services, 16e (Arens/Elder/Beasley)
Chapter 21 Audit of the Inventory and Warehousing Cycle
21.1 Learning Objective 21-1
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.
2) ________ is normally characterized as a difficult and complex account to audit.
A) Property, plant and equipment
B) Cash
C) Inventory
D) Prepaid insurance
3) Inventory is a complex area to audit for all except 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.
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.
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 cost systems
C) Process cost systems
D) Manufacturing systems
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.
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.
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.
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) Which of the following is a continuously updated computerized record of inventory items
purchased, used, sold, and on hand for merchandise, raw materials, and finished goods?
A) job cost system
B) standard cost records
C) cost accounting records
D) perpetual inventory master file
11) In the flow of inventory and costs, when work-in-progress is credited, ________ is (are)
debited.
A) raw materials
B) cost of goods sold
C) finished goods
D) direct labor
12) What are two factors affecting the complexity of the audit of inventory?
13) Separate perpetual records are likely to be kept only for raw materials inventory.
14) In process cost systems, costs are accumulated by individual jobs.
15) In job cost systems, costs are accumulated by individual jobs.
16) In some inventory systems, raw materials can be requisitioned by automated computer
software when raw materials reach a predetermined level.
21.2 Learning Objective 21-2
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.
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
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) Inventory is often a significant part of a company’s current assets. Because of its importance,
A) auditors are required by auditing standards to observe the client taking a physical inventory
count.
B) price tests must be performed to verify whether the physical counts were correctly
summarized.
C) companies are required to use perpetual inventory systems.
D) auditors are required by auditing standards to take the physical inventory for the client.
5) 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.
6) 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.
7) State the six functions that make up the inventory and warehousing cycle and, for each
function, identify the related documents that would be used by a manufacturing company.
8) Inventory compilation tests are used to verify that the inventory is recorded at the lower of
cost or market.
9) An approved purchase requisition form authorizes shipment of goods to customers.
10) The receipt of raw materials is a part of the acquisition and payment cycle.
11) The physical observation of the inventory and the acquisition of raw materials are part of the
inventory and warehousing cycle.
12) Physical examination is an essential type of evidence used to verify the existence and count
of inventory.
21.3 Learning Objective 21-3
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.
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
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
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.
5) Auditors usually test cost accounting records as part of the
A) acquisition tests.
B) payroll tests.
C) sales tests.
D) All of the above are correct.
6) To ensure 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
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.
8) Which of the following is an accurate statement regarding perpetual inventory master files?
A) When perpetual inventory master files are accurate, auditors can test the physical inventory
after the balance sheet date.
B) It is a difficult procedure for the auditor to test the accuracy of the perpetual inventory master
files.
C) Auditors test the perpetual records for reductions in finished goods for sale as part of the sales
and collection cycle.
D) All of the above are accurate statements.
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.
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.
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 costs.
B) raw material costs.
C) manufacturing overhead costs.
D) period costs.
12) Auditor tests of physical controls over raw materials, work-in-process, and finished goods
are performed by
A)
Examination
Observation
Inquiry
Yes
No
Yes
B)
Examination
Observation
Inquiry
No
Yes
No
C)
Examination
Observation
Inquiry
Yes
Yes
No
D)
Examination
Observation
Inquiry
No
Yes
Yes
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.
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.
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.
16) The auditor is concerned with four aspects of cost accounting, including
A) documents and records for transferring inventory.
B) perpetual inventory master files.
C) unit cost records.
D) all of the above.
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
18) The audit of cost accounting begins with the internal transfer of assets from raw materials to
work-in-process 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.
20) What are the auditor’s primary concerns in verifying the transfer of inventory from one
location to another?
21) Management typically allocates overhead using total raw materials as the basis for the
allocation.
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.
23) Cost accounting systems and controls are the same for all manufacturing companies.
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.
21.4 Learning Objective 21-4
1) Which one of the following substantive analytical procedures would be most useful in alerting
the auditor to the possibility of obsolete inventory?
A) Compare gross margin percentage with that of 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) Which one of the following substantive analytical procedures would be most useful in alerting
the auditor to the possibility inventory and cost of goods sold being overstated or understated?
A) Compare extended inventory value with that of 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.
3) In addition to performing analytical procedures that examine the relationship of inventory
account balances with related financial statement accounts, auditor’s will often use nonfinancial
measures in determining the reasonableness of inventory balances. List below at least two
nonfinancial measures that may be useful to auditors.
4) Given the following information about your audit client, perform analytical procedures and
comment on your findings.
2015
2016
Industry Average
Inventory
$20,000
$32,000
$25,000
Cost of Sales
$240,000
$320,000
$400,000
5) A comparison of the current year’s inventory turnover ratio with previous years’ may indicate
the presence of obsolete inventory.
21.5 Learning Objective 21-5
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.
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 cost involved.
D) generally accepted auditing standards require that at least 80% of the dollar value of the
inventory should be included in the sample.
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.
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.
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
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.