Audit of Inventories

Vadimir Añora
BSA – 3

Theoretical Questions:

1. To ascertain whether inventories included in the statement of financial position physically exist, a CPA
will ordinarily:

a. Obtain confirmation of pledged inventories

b. Observe physical inventory counts
c. Test client’s shipping cutoff procedures
d. Perform analytic review of the relationship of the inventory balance to recent sales

2. Which of the following items should not be included in a physical inventory?

a. Materials in transit from vendors

b. Goods in a private warehouse
c. Goods receive for repairs under warranty
d. Consignment to an agent

3. An auditor selected items for test counts while observing a client’s physical inventory. The auditor then
traced the test counts to the client’s inventory listing. This procedure most likely obtained evidence
concerning management’s assertion of

a. Completeness
b. Valuation
c. Rights and obligations
d. Existence or occurrence

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Audit of Inventories
Vadimir Añora
BSA – 3

Computational Questions:

Problem 1

Desolator Company is engaged in raising dairy livestock. Information regarding its activities relating to the dairy
livestock is as follows:

Carrying amount on January 1, 2019 5,000,000

Increase due to purchases 2,000,000
Gain arising from change in fair value less cost of disposal attributable to price change 400,000
Gain arising from change in fair value less cost of disposal attributable to physical change 600,000
Decrease due to sales 850,000
Decrease due to harvest 200,000

What is the carrying amount of the biological asset on December 31, 2019?

Solution:

Carrying amount – January 1, 2019 5,000,000

Increase due to purchases 2,000,000
Gain from change in fair value due to price change 400,000
Gain from change in fair value due to physical change 600,000
Decrease due to sales (850,000)
Decrease due to harvest (200,000)
Carrying amount – December 31, 2019 6,950,000

Problem 2

At December 31, 2019, Tiny Company reported current assets of P2,400,000 and current liabilities of P1,200,000.
The following items may have been recorded incorrectly.

a. Goods purchased costing P132,000 were shipped FOB shipping point by a supplier on December 28. Tiny
received and recorded the invoice on December 29, but the goods were not included in the physical count
of inventory because there were not received until January 4, 2020.

b. Goods purchased costing P90,000 were shipped FOB destination by a supplier on December 26. Tiny
received and recorded the invoice on December 31, but the goods were not included in the physical count
of inventory because they were not received until January 2, 2020.

c. Goods held on consignment from White Corporation were included in the physical count of inventory at
P78,000.

What is the current ratio after corrections are made? By what amount will income be adjusted up or down as a
result of the corrections?

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Audit of Inventories
Vadimir Añora
BSA – 3

Solution:
Current Current
Assets Liabilities
Balances per books 2,400,000 1,200,000
Goods in transit, purchased FOB shipping point, not counted in the inventory 132,000
Goods in transit, purchased FOB destination, recorded as purchase (90,000)
Goods held on consignment, included in the physical count (78,000)
Adjusted balances 2,454,000 1,110,000

Current ratio = Current assets / Current liabilities → 2,454,000 / 1,110,000 → 2.21

Net income
adjustment
Understatement of ending inventory (goods purchased FOB shipping point) 132,000
Overstatement of purchases (goods purchased FOB destination) 90,000
Overstatement of ending inventory (goods held on consignment) (78,000)
Net increase in income before taxes 144,000

Problem 3

You were assigned to audit the factory accounts of Nemo Manufacturing Corporation for the year ended
December 31, 2019. The following data were gathered: Manufacturing cost totaled P900,000. Cost of goods
manufactured was P800,000 of which factory overhead was 75% of direct labor. Overhead was 25% of total
manufacturing cost. Beginning work-in-process inventory was 60% of ending work-in-process inventory.
Manufacturing costs for the year ended December 31, 2019 submitted to you by the factory accountant were as
follows: Raw materials used, P400,000; Direct labor, P275,000; Factory overhead, P225,000. Assume cost
percentage relationships as stated are correct. Determine the adjustment on manufacturing cost and the work-in-
process beginning and ending.

Solution:
Per Per (Over)
client audit Under
Raw materials (900,000 -225,000 - 300,000) 400,000 375,000 (25,000)
Direct labor (225,000 / 75%) 275,000 300,000 25,000
Factory overhead (900,000 x 25%) 225,000 225,000
Manufacturing cost 900,000 900,000 0
Work-in-process computation: Work-in-process, beginning:
*900,000 + 0.6a - a = 800,000 → 150,000 (250,000 x 60%) Adjusting entry: Debit to direct
*-0.4a = -100,000 Work-in-process, ending: labor and credit to raw materials
*a = 250,000 → 250,000 (a = 250,000) amounting to 25,000.

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