Review Questions:

4. What is the role of the following documents in the audit of productions costs?
a. Production order – provides documentation of production personnel's authorization to
manufacture products
b. Bill of materials – specifies the components that will be used in the manufacture of a
product
c. Materials requisitions – indicates recorded approval for material release to production
d. Cost accumulation report – prepared by operating personnel wherein the costs incurred as
goods are transferred through production.
e. Materials requisition summary – contains a record of materials used during a specific time
period, such as, but not limited to, a day
f. Labor ticket – reflects the amount of time a production worker spends on a job
g. Labor ticket summary - provides a record of production labor used over a set period of time,
such as a day
h. Completed production report - serve as a foundation for inventory valuation
5. Identify controls an entity should have to ensure that all production transactions that occur are
recorded.
Answer: Auditors go through three steps to ensure that all production transactions are
recorded. First, auditors examine whether pre-numbered production orders are properly
accounted for in order to ensure that all material issued is recorded. An auditor may also
account for a series of production orders. Second, auditors observe that the client records pre-
numbered material requisitions in order to reduce inventory and allocate costs to production.
An auditor may also account for a series of material requisitions. Finally, auditors may notice a
clerk reconciling completed and charged time tickets with the total number of hours paid to
production workers.
Exercise 1: The following questions related to payroll are included on the internal control questionnaire
for Mama Company:

1. Does payroll require written authorization to add an employee to be payroll?

2. Do employee use a time clock for recording time worked?
3. Does a supervisor approve time cards before they are sent to payroll?
4. Are a payroll checks distributed by someone other than the people involved in supervising
employees, personnel, payroll preparation and check signing?
5. Are pre-numbered checks used and accounted for?
6. Is the payroll bank account reconciled by a person independent of the payroll function?

Requirements:

For each of the six preceding questions, provide the following information about Mama Company’s
internal control:

a. Identify the financial statement assertion related to the control addressed in each questions
b. Identify a potential misstatement that could arise from the absence of the control you identified
in part A.
c. Identify the tests of controls an auditor might perform for the controls you identified in part A.
d. Indicate the substantive tests of transactions an auditor might perform after the test of control
is ineffective.

Answer:

1. A. Existence or Occurrence
B. Payroll may include fictitious or former employees
C. Examine approval signatures
D. For selected entries, examine signed authorizations for hiring and compare signature on paid
check to signature on job application
2. A. Rights and Obligations

B. Employees may be paid for more hours than they work

C. Examine signature on cards

D. Reconcile time charged to jobs to total hours worked

 3. A. Rights and Obligations
B. Employees may be paid for more hours than they work
C. Examine signature on cards
D. Reconcile time charged on cards to total charged to jobs

4. A. Existence or Occurrence
B. Payroll may include fictitious or former employees
C. Observe separation of duties
D. For selected entries, examine signed authorization for hiring, pay rates and deductions and
compare signature on paid check to signature on application or distribute paychecks in a
surprise payoff

5. A. Completeness
B. Paychecks may be issued but nor recorded
C. Observe whether paychecks are pre-numbered and determine whether a bank reconciliation
is prepared by a person independent of the payroll function
D. Test or prepare a bank reconciliation

6. A. Completeness
B. Paychecks may be issued but not recorded
C. Observe whether a bank reconciliation is prepared by a person independent of the payroll
function
D. Test or prepare a bank reconciliation

Exercise 2: Match the audit objectives listed on the left with the best audit procedure from the list on
the right. Use the audit procedures only once.

Audit Objective:

1. The entity has legal rights to items included in inventory

2. Recorded inventory represents assets that actually exist at the balance sheet date
3. Inventory is properly valued at the balance sheet date

Audit Procedure:

A. Foot the client’s inventory listing

B. Determine that the perpetual inventory records is segregated from the responsibility for
receiving inventory
C. Reconcile inventory tags gathered during inventory listing
D. Perform cut-off tests to verify that inventory purchases are recorded in the proper period
E. Determine that the inventory is adequately insured
F. Compare receiving reports to packing slips and invoices
G. Compare the inventory turnover rate for the current period to that of the industry
Answer:

1. D. Perform cut-off tests to verify that inventory purchases are recorded in the proper period
2. C. Reconcile inventory tags gathered during inventory listing
3. A. Foot the client’s inventory listing

Exercise 3: An auditor discovered the following matters while performing tests of controls:

1. The production supervisor believes he has good judgment about what customers will buy. He
surprised the sales manager with a new product that was produced on December 24
2. Raw materials were transferred to production but not transferred in the accounting records
3. Salaries of the sales department were charged to manufacturing overhead
4. The material-usage variance is unusually large because materials issued to product development
were charged to production
5. The work-in process account is overstated because goods were not transferred out when they
were completed
6. The labor cost on one job is high because an employee completed a duplicate labor ticket

Requirement:

A. What control would have prevented or detected each of the errors or irregularities?
B. What tests should the auditor perform to test each control?
C. To which financial statement assertion does each error or irregularity relate?

Answers:

1. A. Production planning should sign a production order authorizing personnel to undertake work
B. Examine signature on production orders
C. Rights and Obligations

2. A. Materials requisitions should be pre-numbered and accounted for by a clerk in accounting

B. Observe procedure and account for a sequence of materials requisitions
C. Completeness

3. A. Chart of accounts should adequately describe accounts to be used and account coding should
be assigned by one person and checked by another
B. Examine chart of accounts and signature of employee performing check on the account
coding
C. Presentation and Disclosure

4. A. Chart of accounts should adequately describe accounts to be used and account coding should
be assigned by one person and checked by another
B. Examine chart of accounts and signature of employee performing check on the account
coding
C. Presentation and Disclosure
 5. A. Production orders should be pre-numbered and accounted for to determine that all
production is recorded
B. Observe procedure and account for a numerical sequence of production orders
C. Completeness

6. A. Time charged on job tickets should be reconciled to time-clock cards from which employees
are paid
B. Observe procedure
C. Completeness

Exercise 4: An auditor discovered the following errors and irregularities while performing test of
controls:

1. Goods received on June 3 were never placed in the storeroom but instead were taken to the
receiving clerk’s home
2. Raw materials issued on July 15 were never recorded as issued from the storeroom
3. Inventory damaged by rain remains in inventory at full cost
4. While storeroom personnel are at lunch, production employees come into the storeroom to get
the materials they need. They always complete and sign the requisition forms
5. Sometimes the storeroom issues raw materials to production without obtaining a signature on a
material requisition

Requirement:

a. What control would have prevented or detected each of the errors or irregularities?
b. What tests should the auditor perform to test each control?
c. To which financial statement assertion does each error or irregularity relate?

Answer:

1. A. An inventory storage clerk should sign a copy of the pre-numbered receiving report after
counting goods transferred to the storage are
B. Observe procedure and examine signature on receiving reports
C. Rights and Obligations

2. A. Receiving reports and requisitions should be pre-numbered and accounted for by a clerk in
accounting
B. Observe procedure and account for a numerical sequence of receiving reports to determine
that the all have been recorded
C. Completeness

3. A. Provision for inventory obsolescence should be review by officials and adjusted as necessary
B. Inquire about review for obsolescence
C. Valuation
4. A. Access to inventory storage should be limited to personnel responsible for its custody
B. Observe procedures
C. Completeness of inventory or completeness of issuances

5. A. A production employee should sign a copy of the purchase requisition after counting goods
transferred to production
B. Observe procedure and examine signature on requisitions
C. Rights and Obligations.