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Chapter 13 - Auditing the Inventory Management Process

Chapter 13 Auditing the Inventory Management Process


True / False Questions

1. The "cradle-to-grave" cycle for inventory egins !hen goods are purchased and stored and ends !hen the finished goods are shipped to customers. True "alse

#. A receiving report records the shipment of goods to customers. True "alse

3. $ale of finished goods is a part of the inventory management process. True "alse

%. &nce the controls in the inventory system have een tested' the auditor sets the level of control ris(. True "alse

). The ma*or control procedure for preventing fictitious inventory transactions from eing recorded is proper segregation of duties. True "alse

+. Inventory should e valued using the lo!er-of-cost-or-mar(et rule. True "alse

,. A high inventory turnover ratio normally indicates inefficient inventory policies. True "alse

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Chapter 13 - Auditing the Inventory Management Process

-. The three components that ma(e up the cost of producing a product include materials' direct la or' and indirect la or. True "alse

.. The auditor/s o servation of inventory is a generally accepted auditing procedure. True "alse

10. & solete inventory should e !ritten do!n to its current mar(et value. True "alse

11. In the audit of inventory' the client is responsi le for actually ma(ing and recording the count of physical inventory1 the auditor/s responsi ility is to evaluate and o serve the client/s procedures and dra! conclusions a out the ade2uacy of the physical inventory. True "alse

1#. An approved purchase re2uisition form authori3es shipment of goods to customers. True "alse

13. A comparison of the current year/s inventory turnover ratio !ith previous years/ may indicate the presence of o solete inventory. True "alse

1%. 4hen the client/s perpetual inventory master files are inade2uate' the auditor !ill pro a ly choose to test the physical inventory prior to the alance sheet date. True "alse

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Chapter 13 - Auditing the Inventory Management Process

1). The audit test of control "5evie! and test procedures for issuing materials to manufacturing departments" provides assurance mainly for the occurrence assertion for inventory management. True "alse

1+. Production personnel should ordinarily e responsi le for maintaining perpetual inventory records. True "alse

1,. Inherent ris( is typically assessed at a lo! to moderate level for inventory due to the nature of the asset. True "alse

Multiple Choice Questions

1-. $hipping orders are for!arded from the revenue process to A. The materials re2uisitions department. 6. "inished goods stores. C. 5a! materials stores. 7. Inventory management.

1.. 4hich of the follo!ing departments typically approves purchase re2uisitions8 A. 5a! materials stores. 6. Cost accounting. C. Inventory management. 7. IT.

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Chapter 13 - Auditing the Inventory Management Process

#0. 4hich of the follo!ing est descri es the occurrence assertion for inventory8 A. Purchase re2uisitions initiated y authori3ed personnel. 6. 5ecorded inventory actually e9ists. C. Inventory properly accumulated from *ournals and ledgers. 7. All inventory is recorded.

#1. Auditors are most li(ely to ensure that no production activity is scheduled prior to A. 7etermining standard costs. 6. & serving physical inventory. C. Completing the oo( to physical ad*ustment. 7. 7etermining the amount of consigned inventory.

##. The safeguarding of inventory most li(ely includes A. Comparison of the information contained on the purchase re2uisitions' purchase orders' receiving reports' and vendors/ invoices. 6. Periodic reconciliation of detailed inventory records !ith the actual inventory on hand y ta(ing a physical count. C. Analytical procedures for ra! materials' goods in process' and finished goods that identify unusual transactions' theft and o solescence. 7. Application of esta lished overhead rates on the asis of direct la or hours or direct la or costs.

#3. 4hich of the follo!ing is not a misstatement related to the occurrence assertion for inventory8 A. Consigned goods are included as part of inventory. 6. :nauthori3ed production activity. C. "ictitious inventory. 7. 5ecorded inventory is not on hand ecause of theft.

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Chapter 13 - Auditing the Inventory Management Process

#%. "ailure to record inventory in the proper period can affect all of the follo!ing accounts e9cept; A. $ales. 6. 5eceiva les. C. Cost of <oods $old. 7. Prepaid =9penses.

#). 4hich of the follo!ing audit procedures !ould provide the least relia le evidence that the client has legal title to inventories8 A. Confirmation of inventories at locations outside the client/s facilities. 6. Analytical revie! of inventory alances compared to purchasing and sales activities. C. & servation of physical inventory counts. 7. =9amination of paid vendors/ invoices.

#+. The audit of year-end physical inventories should include steps to verify that the client/s purchases and sales cutoffs !ere ade2uate. The audit steps should e designed to detect !hether merchandise included in the physical count at year-end !as not recorded as a A. $ale in the su se2uent period. 6. Purchase in the current period. C. $ale in the current period. 7. Purchase return in the su se2uent period.

#,. "or the purpose of determining proper cutoff for inventory' the auditor !ill select a sample from !hich of the follo!ing for a fe! days efore and after year-end8 A. Materials re2uisitions. 6. Production schedules. C. 5eceiving documents. 7. Purchase orders.

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Chapter 13 - Auditing the Inventory Management Process

#-. 4hich of the follo!ing auditing procedures most li(ely !ould provide assurance a out a manufacturing entity/s inventory valuation8 A. >ouching the ra! materials/ costs to vendors/ invoices. 6. & taining confirmation of inventories pledged under loan agreements. C. 5evie!ing shipping and receiving cutoff activities for inventories. 7. Tracing test counts to the entity/s inventory listing.

#.. An auditor !ill usually trace the details of the test counts made during the o servation of the physical inventory count to a final inventory schedule. This audit procedure is underta(en to provide evidence that items physically present and o served y the auditor at the time of the physical inventory count are A. &!ned y the client. 6. ?ot o solete. C. Physically present at the time of the preparation of the final inventory schedule. 7. Included in the final inventory schedule.

30. A client/s physical count of inventories !as lo!er than the inventory 2uantities sho!n in its perpetual records. This situation could e the result of the failure to record A. $ales. 6. $ales returns. C. Purchases. 7. Purchase discounts.

31. An auditor has accounted for a se2uence of inventory tags and is no! going to trace information on a representative num er of tags to the physical inventory sheets. The purpose of this procedure is to o tain assurance that A. The final inventory is valued at cost. 6. All inventory represented y an inventory tag is listed on the inventory sheets. C. All inventory represented y an inventory tag is ona fide. 7. Inventory sheets do not include untagged inventory items.

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Chapter 13 - Auditing the Inventory Management Process

3#. A client/s physical count of inventories !as higher than the inventory 2uantities per the perpetual records. This situation could e the result of the failure to record A. $ales. 6. $ales discounts. C. Purchases. 7. Purchase returns.

33. If the perpetual inventory records sho! lo!er 2uantities of inventory than the physical count' an e9planation of the difference might e unrecorded A. $ales. 6. $ales discounts. C. Purchases. 7. Purchase discounts.

3%. An auditor selected items for test counts !hile o serving a client/s physical inventory. The auditor then traced the test counts to the client/s inventory listing. This procedure most li(ely provided evidence concerning management/s assertion of A. 5ights and o ligations. 6. Completeness. C. =9istence. 7. >aluation.

3). 4hile o serving a client/s annual physical inventory' an auditor recorded test counts for several items and noticed that certain test counts !ere higher than the recorded 2uantities in the client/s perpetual records. This situation could e the result of the client/s failure to record A. Purchase discounts. 6. Purchase returns. C. $ales. 7. $ales returns.

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Chapter 13 - Auditing the Inventory Management Process

3+. In a manufacturing company' !hich one of the follo!ing audit procedures !ould give the least assurance a out the valuation of inventory at the audit date8 A. Testing the computation of standard overhead rates. 6. =9amining paid vendors/ invoices. C. 5evie!ing direct la or rates. 7. & taining confirmation of inventories pledged under loan agreements.

3,. 4hich of the follo!ing is least li(ely to e a possi le cause of oo(-to-physical differences in inventory 2uantities8 A. Inventory cutoff errors. 6. Misapplication of @I"&. C. :nreported scrap or spoilage. 7. Theft.

3-. An auditor most li(ely !ould ma(e in2uiries of production and sales personnel concerning possi le o solete or slo!-moving inventory to support management/s financial statement assertion of A. >aluation. 6. 5ights and o ligations. C. =9istence. 7. Completeness.

3.. 4hich of the follo!ing is a plausi le e9planation for a large increase in the num er of days outstanding in inventory8 A. & solete inventory. 6. ?e! product line !here sales e9ceed production. C. Manufacturing overhead !as not allocated to the production process. 7. Manufacturing salaries !ere recorded as administrative e9penses.

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Chapter 13 - Auditing the Inventory Management Process

%0. Aey segregations of duties in the inventory management process include all of the follo!ing e9cept separating; A. Cost accounting from revie! of variance reports. 6. Inventory management from cost accounting. C. Cost accounting from the general ledger function. 7. $upervision of physical inventory from inventory management.

%1. An auditor generally tests physical security controls over inventory y A. Test counts and cutoff procedures. 6. =9amination and reconciliation. C. Inspection and recomputation. 7. In2uiry and o servation.

%#. 4hen perpetual inventory records are maintained in 2uantities and in dollars and internal control over inventory is !ea(' the auditor !ould pro a ly A. 4ant the client to schedule the physical inventory count at the end of the year. 6. Insist that the client perform physical counts of inventory items several times during the year. C. Increase the e9tent of tests for unrecorded lia ilities at the end of the year. 7. Bave to disclaim an opinion on the income statement for that year.

%3. A client maintains perpetual inventory records in oth 2uantities and dollars. If the assessed level of control ris( is high' an auditor !ould pro a ly A. Increase the e9tent of tests of controls for the inventory cycle. 6. 5e2uest that the client schedule the physical inventory count at the end of the year. C. Insist that the client perform physical counts of inventory items several times during the year. 7. Apply gross profit tests to ascertain the reasona leness of the physical counts.

%%. In o taining an understanding of a manufacturing entity/s internal control concerning inventory alances' an auditor most li(ely !ould A. 5evie! the entity/s description of inventory policies and procedures. 6. Perform test counts of inventory during the entity/s physical count. C. Analy3e inventory turnover statistics to identify slo!-moving and o solete items. 7. Analy3e monthly production reports to identify variances and unusual transactions.

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Chapter 13 - Auditing the Inventory Management Process

%). "or several years' a client/s physical inventory count has een lo!er than !hat !as sho!n on the oo(s at the time of the count so that do!n!ard ad*ustments to the inventory account !ere re2uired. Contri uting to the inventory pro lem could e !ea(nesses in internal controls that led to the failure to record some A. Purchases returned to vendors. 6. $ales returns received. C. $ales discounts allo!ed. 7. Cash purchases.

%+. 4hich of the follo!ing control activities !ould most li(ely e used to maintain accurate perpetual inventory records8 A. Independent storeroom count of goods received. 6. Periodic independent reconciliation of control and su sidiary records. C. Periodic independent comparison of records !ith goods on hands. 7. Independent matching of purchase orders' receiving reports and vendors/ invoices.

%,. An inventory turnover analysis is useful to the auditor ecause it may detect A. Inade2uacies in inventory pricing. 6. Methods of avoiding cyclical holding costs. C. The optimum automatic reorder points. 7. The e9istence of o solete merchandise.

%-. Tracing costs used to price inventory to vendors/ invoices test !hich of the follo!ing assertions8 A. &ccurrence. 6. Cutoff. C. Accuracy. 7. Classification.

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Chapter 13 - Auditing the Inventory Management Process

%.. The auditor tests the 2uantity of materials charged to !or( in process y tracing these 2uantities to A. Cost ledgers. 6. Perpetual inventory records. C. 5eceiving reports. 7. Material re2uisitions.

)0. Purchase cutoff activities should e designed to test that merchandise is included in the inventory of the client company if the company A. Bas paid for the merchandise. 6. Bas physical possession of the merchandise. C. Bolds legal title to the merchandise. 7. Bolds the shipping documents for the merchandise issued in the company/s name.

)1. 4hich one of the follo!ing procedures !ould not e appropriate for an auditor in discharging his or her responsi ilities concerning the client/s physical inventories8 A. Confirmation of goods in the hands of pu lic !arehouses. 6. $upervising the annual physical inventory count. C. Carrying out physical inventory procedures at an interim date. 7. & taining !ritten representation from the client as to the e9istence' 2uality and dollar amount of the inventory.

)#. 4hen outside firms of non-accountants speciali3ing in physical inventory counts are used to count' list' price' and su se2uently compute the total dollar amount of inventory on hand at the date of the physical count' the auditor !ill ordinarily A. Consider the report of the outside inventory firm to e an accepta le alternative procedure to the o servation of physical inventories. 6. Ma(e or o serve some physical counts of the inventory' recompute certain inventory calculations' and test certain inventory transactions. C. Increase the e9tent of !or( on the physical count of inventory. 7. Consider the reduced audit effort !ith respect to the physical count of inventory as a scope limitation.

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Chapter 13 - Auditing the Inventory Management Process

)3. 4hich of the follo!ing is the est audit procedure for the discovery of damaged merchandise in a client/s ending inventory8 A. Compare the physical 2uantities of slo!-moving items !ith corresponding 2uantities of the prior year. 6. & serve the condition of merchandise and ra! materials during the client/s physical inventory count. C. 5evie! the management/s inventory representation letter for accuracy. 7. Test overall fairness of inventory values y comparing the company/s turnover ratio !ith the industry average.

)%. The physical count of inventory of a retailer !as higher than sho!n in its perpetual records. 4hich of the follo!ing could e9plain the difference8 A. Inventory items had een counted ut tags placed on the items had not een ta(en off the items and added to the inventory accumulation sheets. 6. Credit memos for several items returned y customers had not een prepared. C. ?o *ournal entry had een made on the retailer/s oo(s for several items returned to its suppliers. 7. An item purchased ""&6 shipping point" had not arrived at the date of the inventory count and had not een reflected in the perpetual records.

)). In an audit of inventories' an auditor !ould least li(ely verify that A. All inventory o!ned y the client is on hand at the time of the count. 6. The client has used proper inventory pricing. C. The financial statement presentation of inventories is appropriate. 7. 7amaged goods and o solete items have een properly accounted for.

)+. The element of the audit planning process most li(ely to e agreed upon !ith the client efore implementation of the audit strategy is the determination of the A. =vidence to e gathered to provide a sufficient asis for the auditor/s opinion. 6. Procedures to e underta(en to discover litigation' claims and assessments. C. Pending legal matters to e included in the in2uiry of the client/s attorney. 7. Timing of inventory o servation procedures to e performed.

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Chapter 13 - Auditing the Inventory Management Process

),. To gain assurance that all inventory items in a client/s inventory listing schedule are valid' an auditor most li(ely !ould trace A. Inventory tags noted during the auditor/s o servation to items listed in the inventory listing schedule. 6. Inventory tags noted during the auditor/s o servation to items listed in receiving reports and vendors/ invoices. C. Items listed in the inventory listing schedule to inventory tags and the count sheets. 7. Items listed in receiving reports and vendors/ invoices to the inventory listing schedule.

)-. & serving a client/s inventory held on consignment y others tests the assertion of A. =9istence. 6. Completeness. C. >aluation. 7. 5ights and o ligations.

).. 4hen an auditor tests a client/s cost accounting system' the auditor/s tests are primarily designed to determine that A. Cuantities on hand have een computed ased on accepta le cost accounting techni2ues that reasona ly appro9imate actual 2uantities on hand. 6. Physical inventories are in su stantial agreement !ith oo( inventories. C. The system is in accordance !ith generally accepted accounting principles and is functioning as planned. 7. Costs have een properly assigned to !or( in process' finished goods' and cost of goods sold.

+0. 4hich of the follo!ing is not one of the independent auditor/s o *ectives regarding the e9amination of inventories8 A. >erifying that inventory counted is o!ned y the client. 6. >erifying that the client has used proper inventory pricing. C. Ascertaining the physical 2uantities of inventory on hand. 7. >erifying that all inventory o!ned y the client is on hand at the time of the count.

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Chapter 13 - Auditing the Inventory Management Process

+1. An auditor concluded that no e9cessive costs for idle plant !ere charged to inventory. This conclusion most li(ely related to the auditor/s o *ective to o tain evidence a out the financial statement assertions regarding inventory' including presentation and disclosure and A. >aluation and allocation. 6. Completeness. C. =9istence. 7. 5ights and o ligations.

+#. 4hich assertion for ending inventory is most li(ely violated if the gross profit percentage is much greater than last year8 A. =9istence. 6. Completeness. C. 5ights and o ligations. 7. >aluation and allocation.

+3. 4hich of the follo!ing is a 2uestion that the auditor !ould e9pect to find on the production process section of an internal control 2uestionnaire8 A. Are vendors/ invoices for ra! materials approved for payment y an employee !ho is independent of the cash dis ursements function8 6. Are signed chec(s for the purchase of ra! materials mailed directly after signing !ithout eing returned to the person !ho authori3ed the invoice processing8 C. Are all releases y store(eepers of ra! materials from storage ased on approved re2uisition documents8 7. Are details of individual dis ursements for ra! materials alanced !ith the total to e posted to the appropriate general ledger account8

+%. In order to efficiently esta lish the correctness of the accounts paya le cutoff' an auditor !ill e most li(ely to A. Coordinate cutoff tests !ith physical inventory o servation. 6. Compare cutoff reports !ith purchase orders. C. Compare vendors/ invoices !ith vendors/ statements. 7. Coordinate mailing of confirmations !ith cutoff tests.

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Chapter 13 - Auditing the Inventory Management Process

+). The accuracy of perpetual inventory records may e esta lished' in part' y comparing perpetual inventory records !ith A. Purchase re2uisitions. 6. 5eceiving reports. C. Purchase orders. 7. >endor payments.

Short Ans er Questions

++. The audit of the inventory management process is affected y the audit results from multiple other processes. Identify the processes' other than the inventory management process' that affect the audit of inventory and e9plain ho! each affect the audit of inventory.

+,. $tate the si9 functions that ma(e up the inventory management process. "or each function' identify the related documents andDor records that !ould e used y a manufacturing company.

+-. The audit of inventory is often the most involved aspect of an audit. 7escri e at least three inherent ris( factors that affect the audit of inventory.

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Chapter 13 - Auditing the Inventory Management Process

+.. "or each of the follo!ing' state !hether it is a test of details of account alances or a test of details of disclosures. Then note for !hich assertion the test provides evidence. 1. Inspect loan agreements under !hich an entity/s inventories are pledged. #. 5evie! inventory compilation for proper classification among ra! materials' !or( in process and finished goods. 3. & serve the count of physical inventory. %. Trace test counts and tag control information to the inventory compilation. ). In2uire of management a out issues related to @I"& li2uidations. +. 5evie! oo(-to-physical ad*ustments for possi le misstatements.

,0. Eou are auditing $6T' !hich has a 7ecem er 31st year-end. &n 7ecem er #%th' the person responsi le for processing receiving reports and recording the receipt of inventory ecame very ill and !as out of the office for a !ee(. 7ue to the company/s small staff and the holiday season' a num er of the receiving reports !ere not processed on a timely asis. As an auditor' on !hich assertion !ould you place a high importance for this client and ho! !ould you test for it8

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Chapter 13 - Auditing the Inventory Management Process

,1. 6elo! is information relating to the inventory management of your audit client' Cuic( $ell. :sing analytical procedures' identify any concerns you have a out misstatements in the financial statements.

,#. 4e (no! from cost accounting that there are three components that ma(e up the standard costs for inventory. =9plain ho! an auditor could test each of these components for a company that manufactures pillo!s.

,3. =9plain the importance of o serving physical inventory during an audit.

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Chapter 13 - Auditing the Inventory Management Process

,%. @ist five things an auditor should do during the o servation of the physical count of inventory.

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Chapter 13 - Auditing the Inventory Management Process

Chapter 13 Auditing the Inventory Management Process Ans!er Aey

True / False Questions

1. The "cradle-to-grave" cycle for inventory egins !hen goods are purchased and stored and ends !hen the finished goods are shipped to customers. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ ,opic: $&er&ie- o In&entory Management Process

#. A receiving report records the shipment of goods to customers. FA$S#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'(). Be able to identi y and describe t*e types o documents and records used in t*e in&entory management process+ ,opic: ,ypes o Documents and Records

3. $ale of finished goods is a part of the inventory management process. FA$S#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()' /nderstand t*e unctions in t*e in&entory management process+ ,opic: ,*e Ma%or Functions

13-1.

Chapter 13 - Auditing the Inventory Management Process

%. &nce the controls in the inventory system have een tested' the auditor sets the level of control ris(. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()0 1no- *o- to assess control risk or t*e in&entory system+ ,opic: Control Risk Assessment

). The ma*or control procedure for preventing fictitious inventory transactions from eing recorded is proper segregation of duties. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

+. Inventory should e valued using the lo!er-of-cost-or-mar(et rule. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-#0

Chapter 13 - Auditing the Inventory Management Process

,. A high inventory turnover ratio normally indicates inefficient inventory policies. FA$S#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures

-. The three components that ma(e up the cost of producing a product include materials' direct la or' and indirect la or. FA$S#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'(!) 1no- *o- to audit standard costs+ ,opic: $bser&ing P*ysical In&entory

.. The auditor/s o servation of inventory is a generally accepted auditing procedure. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

10. & solete inventory should e !ritten do!n to its current mar(et value. T!"#

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-#1

Chapter 13 - Auditing the Inventory Management Process

11. In the audit of inventory' the client is responsi le for actually ma(ing and recording the count of physical inventory1 the auditor/s responsi ility is to evaluate and o serve the client/s procedures and dra! conclusions a out the ade2uacy of the physical inventory. T!"#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: $bser&ing P*ysical In&entory

1#. An approved purchase re2uisition form authori3es shipment of goods to customers. FA$S#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Remember Di iculty: . Medium #earning $b%ecti&e: !'(). Be able to identi y and describe t*e types o documents and records used in t*e in&entory management process+ ,opic: ,ypes o Documents and Records

13. A comparison of the current year/s inventory turnover ratio !ith previous years/ may indicate the presence of o solete inventory. T!"#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures

13-##

Chapter 13 - Auditing the Inventory Management Process

1%. 4hen the client/s perpetual inventory master files are inade2uate' the auditor !ill pro a ly choose to test the physical inventory prior to the alance sheet date. FA$S#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures

1). The audit test of control "5evie! and test procedures for issuing materials to manufacturing departments" provides assurance mainly for the occurrence assertion for inventory management. T!"#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()0 1no- *o- to assess control risk or t*e in&entory system+ #earning $b%ecti&e: !'()2: 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Risk Assessment

1+. Production personnel should ordinarily e responsi le for maintaining perpetual inventory records. FA$S#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()6 1no- t*e appropriate segregation o duties or t*e in&entory management process+ ,opic: ,*e 1ey Segregation o Duties

13-#3

Chapter 13 - Auditing the Inventory Management Process

1,. Inherent ris( is typically assessed at a lo! to moderate level for inventory due to the nature of the asset. FA$S#

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Remember Di iculty: . Medium #earning $b%ecti&e: !'()7 Be able to identi y and e&aluate in*erent risks rele&ant to t*e in&entory management process+ ,opic: In*erent Risk Assessment

Multiple Choice Questions

1-. $hipping orders are for!arded from the revenue process to A. The materials re2uisitions department. %& "inished goods stores. C. 5a! materials stores. 7. Inventory management.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'(). Be able to identi y and describe t*e types o documents and records used in t*e in&entory management process+ ,opic: $&er&ie- o In&entory Management Process ,opic: ,ypes o Documents and Records

13-#%

Chapter 13 - Auditing the Inventory Management Process

1.. 4hich of the follo!ing departments typically approves purchase re2uisitions8 A. 5a! materials stores. 6. Cost accounting. C& Inventory management. 7. IT.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Di iculty: ! "asy #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'()' /nderstand t*e unctions in t*e in&entory management process+ ,opic: $&er&ie- o In&entory Management Process ,opic: ,*e Ma%or Functions

#0. 4hich of the follo!ing est descri es the occurrence assertion for inventory8 A. Purchase re2uisitions initiated y authori3ed personnel. %& 5ecorded inventory actually e9ists. C. Inventory properly accumulated from *ournals and ledgers. 7. All inventory is recorded.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: /nderstand Di iculty: ! "asy #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls ,opic: $&er&ie- o In&entory Management Process

13-#)

Chapter 13 - Auditing the Inventory Management Process

#1. Auditors are most li(ely to ensure that no production activity is scheduled prior to A. 7etermining standard costs. %& & serving physical inventory. C. Completing the oo( to physical ad*ustment. 7. 7etermining the amount of consigned inventory.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: $&er&ie- o In&entory Management Process ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

##. The safeguarding of inventory most li(ely includes A. Comparison of the information contained on the purchase re2uisitions' purchase orders' receiving reports' and vendors/ invoices. %& Periodic reconciliation of detailed inventory records !ith the actual inventory on hand y ta(ing a physical count. C. Analytical procedures for ra! materials' goods in process' and finished goods that identify unusual transactions' theft and o solescence. 7. Application of esta lished overhead rates on the asis of direct la or hours or direct la or costs.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

13-#+

Chapter 13 - Auditing the Inventory Management Process

#3. 4hich of the follo!ing is not a misstatement related to the occurrence assertion for inventory8 A. Consigned goods are included as part of inventory. %& :nauthori3ed production activity. C. "ictitious inventory. 7. 5ecorded inventory is not on hand ecause of theft.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

#%. "ailure to record inventory in the proper period can affect all of the follo!ing accounts e9cept; A. $ales. 6. 5eceiva les. C. Cost of <oods $old. '& Prepaid =9penses.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

13-#,

Chapter 13 - Auditing the Inventory Management Process

#). 4hich of the follo!ing audit procedures !ould provide the least relia le evidence that the client has legal title to inventories8 A. Confirmation of inventories at locations outside the client/s facilities. %& Analytical revie! of inventory alances compared to purchasing and sales activities. C. & servation of physical inventory counts. 7. =9amination of paid vendors/ invoices.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

#+. The audit of year-end physical inventories should include steps to verify that the client/s purchases and sales cutoffs !ere ade2uate. The audit steps should e designed to detect !hether merchandise included in the physical count at year-end !as not recorded as a A. $ale in the su se2uent period. 6. Purchase in the current period. C& $ale in the current period. 7. Purchase return in the su se2uent period.

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

#,. "or the purpose of determining proper cutoff for inventory' the auditor !ill select a sample from !hich of the follo!ing for a fe! days efore and after year-end8 A. Materials re2uisitions. 6. Production schedules. C& 5eceiving documents. 7. Purchase orders.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

#-. 4hich of the follo!ing auditing procedures most li(ely !ould provide assurance a out a manufacturing entity/s inventory valuation8 A& >ouching the ra! materials/ costs to vendors/ invoices. 6. & taining confirmation of inventories pledged under loan agreements. C. 5evie!ing shipping and receiving cutoff activities for inventories. 7. Tracing test counts to the entity/s inventory listing.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!) 1no- *o- to audit standard costs+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: $bser&ing P*ysical In&entory ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

#.. An auditor !ill usually trace the details of the test counts made during the o servation of the physical inventory count to a final inventory schedule. This audit procedure is underta(en to provide evidence that items physically present and o served y the auditor at the time of the physical inventory count are A. &!ned y the client. 6. ?ot o solete. C. Physically present at the time of the preparation of the final inventory schedule. '& Included in the final inventory schedule.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

30. A client/s physical count of inventories !as lo!er than the inventory 2uantities sho!n in its perpetual records. This situation could e the result of the failure to record A& $ales. 6. $ales returns. C. Purchases. 7. Purchase discounts.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

31. An auditor has accounted for a se2uence of inventory tags and is no! going to trace information on a representative num er of tags to the physical inventory sheets. The purpose of this procedure is to o tain assurance that A. The final inventory is valued at cost. %& All inventory represented y an inventory tag is listed on the inventory sheets. C. All inventory represented y an inventory tag is ona fide. 7. Inventory sheets do not include untagged inventory items.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

3#. A client/s physical count of inventories !as higher than the inventory 2uantities per the perpetual records. This situation could e the result of the failure to record A. $ales. 6. $ales discounts. C& Purchases. 7. Purchase returns.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-31

Chapter 13 - Auditing the Inventory Management Process

33. If the perpetual inventory records sho! lo!er 2uantities of inventory than the physical count' an e9planation of the difference might e unrecorded A. $ales. 6. $ales discounts. C& Purchases. 7. Purchase discounts.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

3%. An auditor selected items for test counts !hile o serving a client/s physical inventory. The auditor then traced the test counts to the client/s inventory listing. This procedure most li(ely provided evidence concerning management/s assertion of A. 5ights and o ligations. %& Completeness. C. =9istence. 7. >aluation.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-3#

Chapter 13 - Auditing the Inventory Management Process

3). 4hile o serving a client/s annual physical inventory' an auditor recorded test counts for several items and noticed that certain test counts !ere higher than the recorded 2uantities in the client/s perpetual records. This situation could e the result of the client/s failure to record A. Purchase discounts. 6. Purchase returns. C. $ales. '& $ales returns.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

3+. In a manufacturing company' !hich one of the follo!ing audit procedures !ould give the least assurance a out the valuation of inventory at the audit date8 A. Testing the computation of standard overhead rates. 6. =9amining paid vendors/ invoices. C. 5evie!ing direct la or rates. '& & taining confirmation of inventories pledged under loan agreements.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

3,. 4hich of the follo!ing is least li(ely to e a possi le cause of oo(-to-physical differences in inventory 2uantities8 A. Inventory cutoff errors. %& Misapplication of @I"&. C. :nreported scrap or spoilage. 7. Theft.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Analy5e Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

3-. An auditor most li(ely !ould ma(e in2uiries of production and sales personnel concerning possi le o solete or slo!-moving inventory to support management/s financial statement assertion of A& >aluation. 6. 5ights and o ligations. C. =9istence. 7. Completeness.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Apply Di iculty: ! "asy #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ #earning $b%ecti&e: !'(!' /nderstand *o- to e&aluate t*e audit indings and reac* a inal conclusion on in&entory and related accounts+ ,opic: "&aluating t*e Audit Findings ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-3%

Chapter 13 - Auditing the Inventory Management Process

3.. 4hich of the follo!ing is a plausi le e9planation for a large increase in the num er of days outstanding in inventory8 A& & solete inventory. 6. ?e! product line !here sales e9ceed production. C. Manufacturing overhead !as not allocated to the production process. 7. Manufacturing salaries !ere recorded as administrative e9penses.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: $&er&ie- o In&entory Management Process ,opic: Substanti&e Analytical Procedures

%0. Aey segregations of duties in the inventory management process include all of the follo!ing e9cept separating; A& Cost accounting from revie! of variance reports. 6. Inventory management from cost accounting. C. Cost accounting from the general ledger function. 7. $upervision of physical inventory from inventory management.

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Remember Di iculty: . Medium #earning $b%ecti&e: !'()6 1no- t*e appropriate segregation o duties or t*e in&entory management process+ ,opic: ,*e 1ey Segregation o Duties

%1. An auditor generally tests physical security controls over inventory y A. Test counts and cutoff procedures. 6. =9amination and reconciliation. C. Inspection and recomputation. '& In2uiry and o servation.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

13-3)

Chapter 13 - Auditing the Inventory Management Process

%#. 4hen perpetual inventory records are maintained in 2uantities and in dollars and internal control over inventory is !ea(' the auditor !ould pro a ly A& 4ant the client to schedule the physical inventory count at the end of the year. 6. Insist that the client perform physical counts of inventory items several times during the year. C. Increase the e9tent of tests for unrecorded lia ilities at the end of the year. 7. Bave to disclaim an opinion on the income statement for that year.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ #earning $b%ecti&e: !'()8 /nderstand *o- to relate t*e assessment o control risk to substanti&e procedures+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Control Acti&ities and ,ests o Controls ,opic: Relating t*e Assessed #e&el o Control Risk to Substanti&e Procedures ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

%3. A client maintains perpetual inventory records in oth 2uantities and dollars. If the assessed level of control ris( is high' an auditor !ould pro a ly A. Increase the e9tent of tests of controls for the inventory cycle. %& 5e2uest that the client schedule the physical inventory count at the end of the year. C. Insist that the client perform physical counts of inventory items several times during the year. 7. Apply gross profit tests to ascertain the reasona leness of the physical counts.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ #earning $b%ecti&e: !'()8 /nderstand *o- to relate t*e assessment o control risk to substanti&e procedures+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Control Acti&ities and ,ests o Controls ,opic: Relating t*e Assessed #e&el o Control Risk to Substanti&e Procedures ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-3+

Chapter 13 - Auditing the Inventory Management Process

%%. In o taining an understanding of a manufacturing entity/s internal control concerning inventory alances' an auditor most li(ely !ould A& 5evie! the entity/s description of inventory policies and procedures. 6. Perform test counts of inventory during the entity/s physical count. C. Analy3e inventory turnover statistics to identify slo!-moving and o solete items. 7. Analy3e monthly production reports to identify variances and unusual transactions.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: Control Acti&ities and ,ests o Controls ,opic: Substanti&e Analytical Procedures

%). "or several years' a client/s physical inventory count has een lo!er than !hat !as sho!n on the oo(s at the time of the count so that do!n!ard ad*ustments to the inventory account !ere re2uired. Contri uting to the inventory pro lem could e !ea(nesses in internal controls that led to the failure to record some A& Purchases returned to vendors. 6. $ales returns received. C. $ales discounts allo!ed. 7. Cash purchases.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Control Acti&ities and ,ests o Controls ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-3,

Chapter 13 - Auditing the Inventory Management Process

%+. 4hich of the follo!ing control activities !ould most li(ely e used to maintain accurate perpetual inventory records8 A. Independent storeroom count of goods received. 6. Periodic independent reconciliation of control and su sidiary records. C& Periodic independent comparison of records !ith goods on hands. 7. Independent matching of purchase orders' receiving reports and vendors/ invoices.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

%,. An inventory turnover analysis is useful to the auditor ecause it may detect A. Inade2uacies in inventory pricing. 6. Methods of avoiding cyclical holding costs. C. The optimum automatic reorder points. '& The e9istence of o solete merchandise.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

%-. Tracing costs used to price inventory to vendors/ invoices test !hich of the follo!ing assertions8 A. &ccurrence. 6. Cutoff. C& Accuracy. 7. Classification.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs

13-3-

Chapter 13 - Auditing the Inventory Management Process

%.. The auditor tests the 2uantity of materials charged to !or( in process y tracing these 2uantities to A. Cost ledgers. 6. Perpetual inventory records. C. 5eceiving reports. '& Material re2uisitions.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!) 1no- *o- to audit standard costs+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

)0. Purchase cutoff activities should e designed to test that merchandise is included in the inventory of the client company if the company A. Bas paid for the merchandise. 6. Bas physical possession of the merchandise. C& Bolds legal title to the merchandise. 7. Bolds the shipping documents for the merchandise issued in the company/s name.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-3.

Chapter 13 - Auditing the Inventory Management Process

)1. 4hich one of the follo!ing procedures !ould not e appropriate for an auditor in discharging his or her responsi ilities concerning the client/s physical inventories8 A. Confirmation of goods in the hands of pu lic !arehouses. %& $upervising the annual physical inventory count. C. Carrying out physical inventory procedures at an interim date. 7. & taining !ritten representation from the client as to the e9istence' 2uality and dollar amount of the inventory.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

)#. 4hen outside firms of non-accountants speciali3ing in physical inventory counts are used to count' list' price' and su se2uently compute the total dollar amount of inventory on hand at the date of the physical count' the auditor !ill ordinarily A. Consider the report of the outside inventory firm to e an accepta le alternative procedure to the o servation of physical inventories. %& Ma(e or o serve some physical counts of the inventory' recompute certain inventory calculations' and test certain inventory transactions. C. Increase the e9tent of !or( on the physical count of inventory. 7. Consider the reduced audit effort !ith respect to the physical count of inventory as a scope limitation.

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-%0

Chapter 13 - Auditing the Inventory Management Process

)3. 4hich of the follo!ing is the est audit procedure for the discovery of damaged merchandise in a client/s ending inventory8 A. Compare the physical 2uantities of slo!-moving items !ith corresponding 2uantities of the prior year. %& & serve the condition of merchandise and ra! materials during the client/s physical inventory count. C. 5evie! the management/s inventory representation letter for accuracy. 7. Test overall fairness of inventory values y comparing the company/s turnover ratio !ith the industry average.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

)%. The physical count of inventory of a retailer !as higher than sho!n in its perpetual records. 4hich of the follo!ing could e9plain the difference8 A. Inventory items had een counted ut tags placed on the items had not een ta(en off the items and added to the inventory accumulation sheets. %& Credit memos for several items returned y customers had not een prepared. C. ?o *ournal entry had een made on the retailer/s oo(s for several items returned to its suppliers. 7. An item purchased ""&6 shipping point" had not arrived at the date of the inventory count and had not een reflected in the perpetual records.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-%1

Chapter 13 - Auditing the Inventory Management Process

)). In an audit of inventories' an auditor !ould least li(ely verify that A& All inventory o!ned y the client is on hand at the time of the count. 6. The client has used proper inventory pricing. C. The financial statement presentation of inventories is appropriate. 7. 7amaged goods and o solete items have een properly accounted for.

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

)+. The element of the audit planning process most li(ely to e agreed upon !ith the client efore implementation of the audit strategy is the determination of the A. =vidence to e gathered to provide a sufficient asis for the auditor/s opinion. 6. Procedures to e underta(en to discover litigation' claims and assessments. C. Pending legal matters to e included in the in2uiry of the client/s attorney. '& Timing of inventory o servation procedures to e performed.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-%#

Chapter 13 - Auditing the Inventory Management Process

),. To gain assurance that all inventory items in a client/s inventory listing schedule are valid' an auditor most li(ely !ould trace A. Inventory tags noted during the auditor/s o servation to items listed in the inventory listing schedule. 6. Inventory tags noted during the auditor/s o servation to items listed in receiving reports and vendors/ invoices. C& Items listed in the inventory listing schedule to inventory tags and the count sheets. 7. Items listed in receiving reports and vendors/ invoices to the inventory listing schedule.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

)-. & serving a client/s inventory held on consignment y others tests the assertion of A& =9istence. 6. Completeness. C. >aluation. 7. 5ights and o ligations.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

).. 4hen an auditor tests a client/s cost accounting system' the auditor/s tests are primarily designed to determine that A. Cuantities on hand have een computed ased on accepta le cost accounting techni2ues that reasona ly appro9imate actual 2uantities on hand. 6. Physical inventories are in su stantial agreement !ith oo( inventories. C. The system is in accordance !ith generally accepted accounting principles and is functioning as planned. '& Costs have een properly assigned to !or( in process' finished goods' and cost of goods sold.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!) 1no- *o- to audit standard costs+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

+0. 4hich of the follo!ing is not one of the independent auditor/s o *ectives regarding the e9amination of inventories8 A. >erifying that inventory counted is o!ned y the client. 6. >erifying that the client has used proper inventory pricing. C. Ascertaining the physical 2uantities of inventory on hand. '& >erifying that all inventory o!ned y the client is on hand at the time of the count.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

+1. An auditor concluded that no e9cessive costs for idle plant !ere charged to inventory. This conclusion most li(ely related to the auditor/s o *ective to o tain evidence a out the financial statement assertions regarding inventory' including presentation and disclosure and A& >aluation and allocation. 6. Completeness. C. =9istence. 7. 5ights and o ligations.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ #earning $b%ecti&e: !'(!' /nderstand *o- to e&aluate t*e audit indings and reac* a inal conclusion on in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

+#. 4hich assertion for ending inventory is most li(ely violated if the gross profit percentage is much greater than last year8 A. =9istence. %& Completeness. C. 5ights and o ligations. 7. >aluation and allocation.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Analy5e Di iculty: ' 9ard #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ #earning $b%ecti&e: !'()7 Be able to identi y and e&aluate in*erent risks rele&ant to t*e in&entory management process+ #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: In*erent Risk Assessment ,opic: $&er&ie- o In&entory Management Process ,opic: Substanti&e Analytical Procedures

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Chapter 13 - Auditing the Inventory Management Process

+3. 4hich of the follo!ing is a 2uestion that the auditor !ould e9pect to find on the production process section of an internal control 2uestionnaire8 A. Are vendors/ invoices for ra! materials approved for payment y an employee !ho is independent of the cash dis ursements function8 6. Are signed chec(s for the purchase of ra! materials mailed directly after signing !ithout eing returned to the person !ho authori3ed the invoice processing8 C& Are all releases y store(eepers of ra! materials from storage ased on approved re2uisition documents8 7. Are details of individual dis ursements for ra! materials alanced !ith the total to e posted to the appropriate general ledger account8

AACSB: Communication AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Apply Di iculty: ' 9ard #earning $b%ecti&e: !'()' /nderstand t*e unctions in t*e in&entory management process+ #earning $b%ecti&e: !'()6 1no- t*e appropriate segregation o duties or t*e in&entory management process+ #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls ,opic: ,*e 1ey Segregation o Duties ,opic: ,*e Ma%or Functions

+%. In order to efficiently esta lish the correctness of the accounts paya le cutoff' an auditor !ill e most li(ely to A& Coordinate cutoff tests !ith physical inventory o servation. 6. Compare cutoff reports !ith purchase orders. C. Compare vendors/ invoices !ith vendors/ statements. 7. Coordinate mailing of confirmations !ith cutoff tests.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: ' 9ard #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

+). The accuracy of perpetual inventory records may e esta lished' in part' y comparing perpetual inventory records !ith A. Purchase re2uisitions. %& 5eceiving reports. C. Purchase orders. 7. >endor payments.

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Blooms: Apply Di iculty: ' 9ard #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: Auditing Standard Costs ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

Short Ans er Questions

++. The audit of the inventory management process is affected y the audit results from multiple other processes. Identify the processes' other than the inventory management process' that affect the audit of inventory and e9plain ho! each affect the audit of inventory. The inventory management process is affected y the control activities in the revenue' purchasing' and payroll processes. The revenue process accounts for the sale of finished goods. The purchasing process controls the ac2uisition and payment for inventory. The payroll process affects the costs of direct and indirect la or that is assigned to inventory. F$ee "igure 13-1 of the te9t oo( for a diagram of the relationship et!een the processes.G

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: Remember Di iculty: . Medium #earning $b%ecti&e: !'()! De&elop an understanding o t*e in&entory management process+ ,opic: $&er&ie- o In&entory Management Process

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Chapter 13 - Auditing the Inventory Management Process

+,. $tate the si9 functions that ma(e up the inventory management process. "or each function' identify the related documents andDor records that !ould e used y a manufacturing company. Inventory management function - The inventory management function maintains inventory at appropriate levels. It is responsi le for producing the production schedule and issuing purchases re2uisitions. 5a! materials stores function - This function !ould typically control the issuance of ra! materials and therefore handle the materials re2uisition forms. Manufacturing function - The manufacturing function produces the product and therefore creates the production data information. This information is then used to update the perpetual inventory records F!hich is used y the general ledger functionG and as input for the cost accumulation and variance reports Fused y the cost accounting functionG. "inished goods stores function - The finished goods function uses the shipping order for!arded from the revenue process to ship goods to the customers. Cost accounting function - The cost accounting function ensures that costs are properly attached to inventory. It revie!s the cost accumulation and variance reports to accomplish this. <eneral ledger function - The general ledger function maintains the records for the inventory management process. Information from the inventory master file and inventory status report is used to reconcile the perpetual inventory records to the general ledger inventory accounts.

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Measurement Blooms: Remember Di iculty: . Medium #earning $b%ecti&e: !'(). Be able to identi y and describe t*e types o documents and records used in t*e in&entory management process+ #earning $b%ecti&e: !'()' /nderstand t*e unctions in t*e in&entory management process+ ,opic: ,*e Ma%or Functions ,opic: ,ypes o Documents and Records

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Chapter 13 - Auditing the Inventory Management Process

+-. The audit of inventory is often the most involved aspect of an audit. 7escri e at least three inherent ris( factors that affect the audit of inventory. &ne inherent ris( concerns the valuation of inventory. A company in a competitive or highly technological industry has the ris( of having inventory that should e properly valued at lo!er-of-mar(et or that is o solete. These valuation issues can easily lead to material misstatements in the financial statements. There is also the ris( of defalcation of inventory' especially in an industry !here the inventory is small and high-valued. Proper controls should e in place to prevent misappropriation of assets. A third inherent ris( is the num er of estimations involved in valuing inventory. These estimates can lead to disagreements !ith clients.

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: /nderstand Di iculty: ! "asy #earning $b%ecti&e: !'()7 Be able to identi y and e&aluate in*erent risks rele&ant to t*e in&entory management process+ ,opic: In*erent Risk Assessment

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Chapter 13 - Auditing the Inventory Management Process

+.. "or each of the follo!ing' state !hether it is a test of details of account alances or a test of details of disclosures. Then note for !hich assertion the test provides evidence. 1. Inspect loan agreements under !hich an entity/s inventories are pledged. #. 5evie! inventory compilation for proper classification among ra! materials' !or( in process and finished goods. 3. & serve the count of physical inventory. %. Trace test counts and tag control information to the inventory compilation. ). In2uire of management a out issues related to @I"& li2uidations. +. 5evie! oo(-to-physical ad*ustments for possi le misstatements. 1. 7isclosures-&ccurrence' 5ights and o ligations #. 7isclosures-Classification and understanda ility 3. Account alances-=9istence %. Account alances-Completeness' >aluation and allocation ). 7isclosures-Accuracy' >aluation +. Account alances->aluation and allocation

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Decision Making Blooms: Apply Di iculty: ' 9ard #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ #earning $b%ecti&e: !'(!. Be amiliar -it* tests o transactions and tests o details used to audit in&entory and related accounts+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

13-)0

Chapter 13 - Auditing the Inventory Management Process

,0. Eou are auditing $6T' !hich has a 7ecem er 31st year-end. &n 7ecem er #%th' the person responsi le for processing receiving reports and recording the receipt of inventory ecame very ill and !as out of the office for a !ee(. 7ue to the company/s small staff and the holiday season' a num er of the receiving reports !ere not processed on a timely asis. As an auditor' on !hich assertion !ould you place a high importance for this client and ho! !ould you test for it8 The cutoff assertion !ould e very important in this situation. The ris( of inventory transactions eing recorded in the !rong period is very high. To test for misstatements' the auditor should trace a sample of receiving reports efore and after year-end to ensure that the inventory !as recorded in the proper period.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'()2 1no- key internal controls and de&elop rele&ant tests o controls or in&entory transactions+ ,opic: Control Acti&ities and ,ests o Controls

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Chapter 13 - Auditing the Inventory Management Process

,1. 6elo! is information relating to the inventory management of your audit client' Cuic( $ell. :sing analytical procedures' identify any concerns you have a out misstatements in the financial statements.

Inventory has significantly increased' especially !hen compared to the industry average. At the same time' inventory turnover is decreasing and is significantly elo! the industry average in #00.. The auditor should e concerned a out o solescent or e9cess inventory and should do additional testing to ensure the inventory is eing valued properly y the client.

AACSB: Analytic AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: Analy5e Di iculty: . Medium #earning $b%ecti&e: !'()3 Be amiliar -it* substanti&e analytical procedures used to audit in&entory and related accounts+ ,opic: Substanti&e Analytical Procedures

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Chapter 13 - Auditing the Inventory Management Process

,#. 4e (no! from cost accounting that there are three components that ma(e up the standard costs for inventory. =9plain ho! an auditor could test each of these components for a company that manufactures pillo!s. Materials-The auditor could o tain a list of materials needed to manufacturer a certain type of pillo! and compare that list !ith the standard cost card. The prices can then e traced to the vendors/ invoices to verify that the proper cost is eing applied for materials. @a or-Bistorical data regarding the amount of la or necessary to ma(e a pillo! can e o tained. It can then e compared to the amount of authori3ed !ages. &verhead-The allocation of overhead should e revie!ed y the auditor for reasona leness. The auditor should also verify that the amounts included in overhead are appropriate.

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: /nderstand Di iculty: . Medium #earning $b%ecti&e: !'(!) 1no- *o- to audit standard costs+ ,opic: $bser&ing P*ysical In&entory

,3. =9plain the importance of o serving physical inventory during an audit. Inventory is typically a large account on the financial statements' especially for manufacturing and retail companies. =9amining physical inventory primarily provides evidence that the inventory does e9ist' ut it can also provide evidence for the rights and o ligations and valuation assertions. It is also a generally accepted auditing procedure.

AACSB: Communication AICPA BB: Critical ,*inking AICPA FN: Risk Analysis Blooms: /nderstand Di iculty: ! "asy #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: ,ests o Details o Classes o ,ransactions4 Account Balances4 and Disclosures

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Chapter 13 - Auditing the Inventory Management Process

,%. @ist five things an auditor should do during the o servation of the physical count of inventory. H =nsure that no production is scheduled during the count. H =nsure that there is no movement of goods during the inventory count. H Ma(e sure the count teams are follo!ing the inventory count instructions. H =nsure that inventory tags are issued se2uentially to individual departments. H Perform test counts and record a sample of counts in the !or(ing papers. H & tain tag control information for testing the client/s inventory compilation. H & tain cutoff information. H & serve the condition of o solete' slo!-moving' or carried in e9cess inventories. H In2uire a out goods held on consignment.

AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement Blooms: Apply Di iculty: . Medium #earning $b%ecti&e: !'(!! 1no- *o- to obser&e p*ysical in&entory+ ,opic: $bser&ing P*ysical In&entory

13-)%