APPLIED AUDITING

CHAPTER 3
AUDIT OF INVENTORIES

Objective
1. Solving Audit of Inventories Problems
2. Theory of Audit of Inventories

PROBLEM NO. 1

Presented below is a list of items that may or may not reported as inventory in
a company’s December 31 balance sheet.

1. Goods out on consignment at another company’s P800,000

store
2. Goods sold on installment basis 100,000
3. Goods purchased f.o.b. shipping point that are in
transit at December 31 120,000
4. Goods purchased f.o.b. destination that are in
transit at December 31 200,000
5. Goods sold to another company, for which our
company has signed an agreement to repurchase
at a set price that covers all costs related to the 300,000
inventory
6. Goods sold where large returns are predictable 280,000
7. Goods sold f.o.b. shipping point that are in transit
December 31 120,000
8. Freight charges on goods purchased 80,000
9. Factory labor costs incurred on goods still unsold 50,000
10. Interest cost incurred for inventories that are
routinely manufactured 40,000
11. Costs incurred to advertise goods held for resale 20,000
12. Materials on hand not yet placed into production 350,000
13. Office supplies 10,000
14. Raw materials on which a the company has started
APPLIED AUDITING

production, but which are not completely processed 280,000

15. Factory supplies 20,000
16. Goods held on consignment from another company 450,000
17. Costs identified with units completed but not yet 260,000
sold
18. Goods sold f.o.b. destination that are in transit at
December 31 40,000
19. Temporary investment in stocks and bonds that will
be resold in the near future 500,000

Question:

How much of these items would typically be reported as inventory in the

financial statements?
a. P2,300,000 c. P2,260,000
b. P2,000,000 d. P2,220,000

Suggested Solution:

PAS 2 par. 6 defines “Inventories” as assets

a. held for sale in the ordinary course of business;
b. in the process of production for such sale; or
c. in the form of materials or supplies to be consumed in the production
process or in the rendering of services.

Par. 10 further states that the cost of inventories shall comprise all costs of
purchase, costs of conversion and other costs incurred in bringing the
inventories to their present location and condition.

Therefore, items 1, 3, 5, 8, 9, 12, 14, 15, 17 and 18 would be reported as

inventory in the financial statements.

The other items will be reported as follows:

Item 2 - Cost of goods sold in the income statement

Item 4 - Not reported in the financial statements
Item 6 - Cost of goods sold in the income statement
Item 7 - Cost of goods sold in the income statement
Item 10 - Interest expense in the income statement
Item 11 - Advertising expense in the income statement
Item 13 - Office supplies in the current asset section of the
balance sheet
Item 16 - Not reported in the financial statements
Item 19 - Trading securities in the current asset section of the
balance sheet

Answer: A
APPLIED AUDITING

PROBLEM NO. 2

In connection with your audit of the Alcala Manufacturing Company, you

reviewed its inventory as of December 31, 2006 and found the following items:

(a) A packing case containing a product costing P100,000 was standing in the
shipping room when the physical inventory was taken. It was not included
in the inventory because it was marked “Hold for shipping instructions.”
The customer’s order was dated December 18, but the case was shipped
and the costumer billed on January 10, 2007.

(b) Merchandise costing P600,000 was received on December 28, 2006, and
the invoice was recorded. The invoice was in the hands of the purchasing
agent; it was marked “On consignment”.

(c) Merchandise received on January 6, 2007, costing P700,000 was entered

in purchase register on January 7. The invoice showed shipment was
made FOB shipping point on December 31, 2006. Because it was not on
hand during the inventory count, it was not included.

(d) A special machine costing P200,000, fabricated to order for a particular

customer, was finished in the shipping room on December 30. The
customer was billed for P300,000 on that date and the machine was
excluded from inventory although it was shipped January 4, 2007.

(e) Merchandise costing P200,000 was received on January 6, 2007, and the
related purchase invoice was recorded January 5. The invoice showed the
shipment was made on December 29, 2006, FOB destination.

(f) Merchandise costing P150,000 was sold on an installment basis on

December 15. The customer took possession of the goods on that date.
The merchandise was included in inventory because Alcala still holds legal
title. Historical experience suggests that full payment on installment sale is
received approximately 99% of the time.

(g) Goods costing P500,000 were sold and delivered on December 20. The
goods were included in the inventory because the sale was accompanied
by a purchase agreement requiring Alcala to buy back the inventory in
February 2007.

Question:

Based on the above and the result of your audit, how much of these items
should be included in the inventory balance at December 31, 2006?
a. P1,300,000 c. P1,650,000
b. P 800,000 d. P1,050,000
APPLIED AUDITING

Suggested Solution:

Unshipped goods P 100,000

Purchased merchandise shipped
FOB shipping point 700,000
Goods used as collateral for a loan 500,000
Total P1,300,000

Reasons for including and excluding the items:

a) Included - Merchandise should be included in the inventory until shipped.

An exception would be special orders.
b) Excluded - Alcala Manufacturing has the merchandise on a consignment
basis and therefore does not possess legal title.
c) Included - The merchandise was shipped FOB shipping point and therefore
would be included in the inventory on the shipping date.
d) Excluded - Title may pass on special orders when segregated for shipment.
e) Excluded - The merchandise was shipped FOB destination and was not
received until January 3, 2006.
f) Excluded - Historical experience suggests that Alcala will collect the full
purchase price, so the sale is recognized even though legal title has not
passed.
g) Included - This is not a sale of inventory but instead is a loan with the
inventory as collateral.

Answer: A

PROBLEM NO. 3

The Anda Company is on a calendar year basis. The following data were
found during your audit:

a. Goods in transit shipped FOB destination by a supplier, in the amount of

P100,000, had been excluded from the inventory, and further testing
revealed that the purchase had been recorded.

b. Goods costing P50,000 had been received, included in inventory, and

recorded as a purchase. However, upon your inspection the goods were
found to be defective and would be immediately returned.

c. Materials costing P250,000 and billed on December 30 at a selling price of

P320,000, had been segregated in the warehouse for shipment to a
customer. The materials had been excluded from inventory as a signed
purchase order had been received from the customer. Terms, FOB
destination.

d. Goods costing P70,000 was out on consignment with Hermie Company.

Since the monthly statement from Hermie Company listed those materials
APPLIED AUDITING

as on hand, the items had been excluded from the final inventory and
invoiced on December 31 at P80,000.

e. The sale of P150,000 worth of materials and costing P120,000 had been
shipped FOB point of shipment on December 31. However, this inventory
was found to be included in the final inventory. The sale was properly
recorded in 2005.

f. Goods costing P100,000 and selling for P140,000 had been segregated,
but not shipped at December 31, and were not included in the inventory. A
review of the customer’s purchase order set forth terms as FOB destination.
The sale had not been recorded.

g. Your client has an invoice from a supplier, terms FOB shipping point but the
goods had not arrived as yet. However, these materials costing P170,000
had been included in the inventory count, but no entry had been made for
their purchase.

h. Merchandise costing P200,000 had been recorded as a purchase but not

included as inventory. Terms of sale are FOB shipping point according to
the supplier’s invoice which had arrived at December 31.

Further inspection of the client’s records revealed the following December 31,
2006 balances: Inventory, P1,100,000; Accounts receivable, P580,000;
Accounts payable, P690,000; Net sales, P5,050,000; Net purchases,
P2,300,000; Net income, P510,000.

QUESTIONS:

Based on the above and the result of your audit, determine the adjusted
balances of following as of December 31, 2006:

1. Inventory
a. P1,230,000 c. P1,550,000
b. P1,650,000 d. P1,480,000

2. Accounts payable
a. P710,000 c. P810,000
b. P540,000 d. P760,000

3. Net sales
a. P4,550,000 c. P4,730,000
b. P4,650,000 d. P4,970,000

4. Net purchases
a. P2,370,000 c. P2,150,000
b. P2,420,000 d. P2,320,000

5. Net income
APPLIED AUDITING

a. P220,000 c. P540,000
b. P290,000 d. P550,000

Suggested Solution:

Questions No. 1 to 5

Accounts Net Net

Inventory Payable
Net Sales Purchases Income
Unadjusted
balances P1,100,000 P690,000 P5,050,000 P2,300,000 P510,000
(a) - (100,000) - (100,000) 100,000
(b) (50,000) (50,000) - (50,000) -
(c) 250,000 - (320,000) - (70,000)
(d) 70,000 - (80,000) - (10,000)
(e) (120,000) - - - (120,000)
(f) 100,000 - - - 100,000
(g) - 170,000 - 170,000 (170,000)
(h) 200,000 - - - 200,000
Adjusted
balances P1,550,000 P710,000 P4,650,000 P2,320,000 P540,000

Answers: 1) C; 2) A; 3) B; 4) D, 5) C

PROBLEM NO. 4

You were engaged by Asingan Corporation for the audit of the company’s
financial statements for the year ended December 31, 2006. The company is
engaged in the wholesale business and makes all sales at 25% over cost.

The following were gathered from the client’s accounting records:

SALES PURCHASES
Date Reference Amount Date Reference Amount
Balance forwarded P7,800,000 Balance forwarded P4,200,000
12/27 SI No. 965 60,000 12/28 RR #1059 36,000
12/28 SI No. 966 225,000 12/30 RR #1061 105,000
12/28 SI No. 967 15,000 12/31 RR #1062 63,000
12/31 SI No. 969 69,000 12/31 RR #1063 96,000
12/31 SI No. 970 102,000 12/31 Closing
entry (4,500,000)
12/31 SI No. 971 24,000 P -
12/31 Closing
entry (8,295,000)
P -
Note: SI = Sales Invoice RR = Receiving Report

Accounts receivable P750,000

Inventory 900,000
Accounts payable 600,000
APPLIED AUDITING

You observed the physical inventory of goods in the warehouse on December

31 and were satisfied that it was properly taken.

When performing sales and purchases cut-off tests, you found that at
December 31, the last Receiving Report which had been used was No. 1063
and that no shipments had been made on any Sales Invoices whose number is
larger than No. 968. You also obtained the following additional information:

a) Included in the warehouse physical inventory at December 31 were goods

which had been purchased and received on Receiving Report No. 1060 but
for which the invoice was not received until the following year. Cost was
P27,000.

b) On the evening of December 31, there were two trucks in the company
siding:
 Truck No. XXX 888 was unloaded on January 2 of the following year
and received on Receiving Report No. 1063. The freight was paid by
the vendor.
 Truck No. MGM 357 was loaded and sealed on December 31 but leave
the company premises on January 2. This order was sold for P150,000
per Sales Invoice No. 968.

c) Temporarily stranded at December 31 at the railroad siding were two

delivery trucks enroute to ABC Trading Corporation. ABC received the
goods, which were sold on Sales Invoice No. 966 terms FOB Destination,
the next day.

d) Enroute to the client on December 31 was a truckload of goods, which was

received on Receiving Report No. 1064. The goods were shipped FOB
Destination, and freight of P2,000 was paid by the client. However, the
freight was deducted from the purchase price of P800,000.

QUESTIONS:

Based on the above and the result of your audit, determine the following:

1. Sales for the year ended December 31, 2006

a. P8,100,000 c. P7,875,000
b. P7,725,000 d. P8,025,000

2. Purchases for the year ended December 31, 2006

a. P4,500,000 c. P5,631,000
b. P5,727,000 d. P4,527,000

3. Accounts receivable as of December 31, 2006

a. P330,000 c. P525,000
b. P555,000 d. P180,000
APPLIED AUDITING

4. Inventory as of December 31, 2006

a. P1,452,000 c. P1,200,000
b. P1,221,000 d. P1,296,000

5. Accounts payable as of December 31, 2006

a. P600,000 c. P 531,000
b. P627,000 d. P1,827,000

Suggested Solution:

Questions No. 1 to 5

Sales Purchases AR Inventory AP

Unadjusted
balances P8,295,000 P4,500,000 P750,000 P900,000 P600,000
AJE No. 1 (195,000) - (195,000) - -
AJE No. 2 - 27,000 - - 27,000
AJE No. 3 - - - 96,000 -
AJE No. 4 - - - 120,000 -
AJE No. 5 (225,000) - (225,000) - -
AJE No. 6 - - - 180,000 -
Adjusted
balances P7,875,000 P4,527,000 P330,000 P1,296,000 P627,000

Adjusting entries:

1) Sales (P69,000+P102,000+P24,000) P195,000

Accounts receivable P195,000
To adjust unshipped goods recorded as sales (SI No. 969, 970 and
971)

2) Purchases P27,000
Accounts payable P27,000
To take up unrecorded purchases (RR No. 1060)

3) Inventory P96,000
Cost of sales P96,000
To take up goods under RR No. 1063

4) Inventory (P150,000/1.25) P120,000

Cost of sales P120,000
To take up unshipped goods under SI No. 968

5) Sales P225,000
Accounts receivable P225,000
To reverse entry made to record SI No. 966

6) Inventory (P225,000/1.25) P180,000

Cost of sales P180,000
APPLIED AUDITING

To take up goods under SI No. 966

Answers: 1) C; 2) D; 3) A; 4) D, 5) B

PROBLEM NO. 5

The following accounts were included in the unadjusted trial balance of Bani
Company as of December 31, 2006:

Cash P 481,600
Accounts receivable 1,127,000
Inventory 3,025,000
Accounts payable 2,100,500
Accrued expenses 215,500

During your audit, you noted that Bani held its cash books open after year-end.
In addition, your audit revealed the following:

1. Receipts for January 2007 of P327,300 were recorded in the December

2006 cash receipts book. The receipts of P180,050 represent cash sales
and P147,250 represent collections from customers, net of 5% cash
discounts.

2. Accounts payable of P186,200 was paid in January 2007. The payments,

on which discounts of P6,200 were taken, were included in the December
2006 check register.

3. Merchandise inventory is valued at P3,025,000 prior to any adjustments.

The following information has been found relating to certain inventory
transactions.

a. Goods valued at P137,500 are on consignment with a customer. These

goods are not included in the inventory figure.

b. Goods costing P108,750 were received from a vendor on January 4,

2007. The related invoice was received and recorded on January 6,
2007. The goods were shipped on December 31, 2006, terms FOB
shipping point.

c. Goods costing P318,750 were shipped on December 31, 2006, and

were delivered to the customer on January 3, 2007. The terms of the
invoice were FOB shipping point. The goods were included in the 2006
ending inventory even though the sale was recorded in 2006.

d. A P91,000 shipment of goods to a customer on December 30, terms

FOB destination are not included in the year-end inventory. The goods
cost P65,000 and were delivered to the customer on January 3, 2007.
The sale was properly recorded in 2007.
APPLIED AUDITING

e. The invoice for goods costing P87,500 was received and recorded as a
purchase on December 31, 2006. The related goods, shipped FOB
destination were received on January 4, 2007, and thus were not
included in the physical inventory.

f. Goods valued at P306,400 are on consignment from a vendor. These

goods are not included in the physical inventory.

QUESTIONS:

Based on the above and the result of your audit, determine the adjusted
balances of the following as of December 31, 2006:

1. Cash
a. P481,600 c. P334,300
b. P340,500 d. P346,700

2. Accounts receivable
a. P1,454,300 c. P1,127,000
b. P1,282,000 d. P1,274,250

3. Inventory
a. P3,017,500 c. P2,930,000
b. P3,040,000 d. P2,505,000

4. Accounts payable
a. P2,395,450 c. P2,286,500
b. P2,307,950 d. P2,301,750

5. Current ratio
a. P2.00 c. P1.84
b. P1.83 d. P2.01

Suggested Solution:

Questions No. 1 to 4

Accounts Accounts
Cash Receivable Inventory Payable
Unadjusted P481,600 P1,127,000 P3,025,000 P2,100,500
balances
Add
(deduct):
AJE No. 1 (327,300) 155,000 - -
AJE No. 2 180,000 - - 186,200
AJE No. - - 137,500 -
3.a
AJE No. - - 108,750 108,750
APPLIED AUDITING

3.b
AJE No. - - (318,750) -
3.c
AJE No. - - 65,000 -
3.d
AJE No. - - - (87,500)
3.e
Adjusted P334,300 P1,282,000 P3,017,500 P2,307,950
balances

Adjusting entries:

1) Accounts receivable (P147,250/.95) P155,000

Sales 180,050
Cash P327,300
Sales discount (P147,250/.95 x .05) 7,750

2) Cash P180,000
Purchase discount 6,200
Accounts payable P186,200

3.a) Inventory P137,500

Cost of sales P137,500

3.b) Inventory P108,750

Accounts payable P108,750

3.c) Cost of sales P318,750

Inventory P318,750

3.d) Inventory P 65,000

Cost of sales P 65,000

3.e) Accounts payable P 87,500

Cost of sales P 87,500

3.f) No adjusting entry

Question No. 5

Current assets
Cash P 334,300
Accounts receivable 1,282,000
Inventory 3,017,500 P4,633,800
Divide by current liabilities
Accounts payable 2,307,950
Accrued expenses 215,500 2,523,450
Current ratio 1.84
APPLIED AUDITING

Answers: 1) C; 2) B; 3) A; 4) B, 5) C

PROBLEM NO. 6

The Bolinao Company values its inventory at the lower of FIFO cost or net
realizable value (NRV). The inventory accounts at December 31, 2005, had
the following balances.

Raw materials P 650,000

Work in process 1,200,000
Finished goods 1,640,000

The following are some of the transactions that affected the inventory of the
Bolinao Company during 2006.

Jan. 8 Bolinao purchased raw materials with a list price of

P200,000 and was given a trade discount of 20% and

10%; terms 2/15, n/30. Bolinao values inventory at the

net invoice price

Feb. Bolinao repossessed an inventory item from a

14
customer who was overdue in making payment. The

unpaid balance on the sale is P15,200. The

repossessed merchandise is to be refinished and

placed on sale. It is expected that the item can be sold

for P24,000 after estimated refinishing costs of P6,800.

The normal profit for this item is considered to be

P3,200.

Mar. 1 Refinishing costs of P6,400 were incurred on the

repossessed item.

Apr. 3 The repossessed item was resold for P24,000 on

APPLIED AUDITING

account, 20% down.

Aug. 30 A sale on account was made of finished goods that

have a list price of P59,200 and a cost P38,400. A

reduction of P8,000 off the list price was granted as a

trade-in allowance. The trade-in item is to be priced to

sell at P6,400 as is. The normal profit on this type of

inventory is 25% of the sales price.

QUESTIONS:

Based on the above and the result of your audit, answer the following:
(Assume the client is using perpetual inventory system)

1. The entry on Jan. 8 will include a debit to Raw Materials Inventory of

a. P200,000 c. P141,120
b. P144,000 d. P196,000

2. The repossessed inventory on Feb. 14 is most likely to be valued at

a. P14,000 c. P17,200
b. P24,000 d. P14,400

3. The journal entries on April 3 will include a

a. Debit to Cash of P24,000.
b. Debit to Cost of Repossessed Goods Sold of P14,000.
c. Credit to Profit on Sale of Repossessed Inventory of P3,600.
d. Credit to Repossessed Inventory of P20,400.

4. The trade-in inventory on Aug. 30 is most likely to be valued at

a. P8,000 c. P6,000
b. P4,800 d. P6,400

5. How much will be recorded as Sales on Aug. 30?

a. P51,200 c. P57,200
b. P56,000 d. P57,600

Suggested Solution:

Question No. 1

Amount to be debited to Raw Materials

Inventory P141,120
(P200,000 x .8 x .9 x .98)
APPLIED AUDITING

Question No. 2

Estimated selling price P24,000

Less refinishing costs 6,800
Net realizable value 17,200
Less normal profit 3,200
Valuation of repossessed inventory P14,000

Repossessed inventory is valued at fair value or best possible

approximation of fair value. Since fair value of the item is not given, the
item was valued at net realizable value less the normal profit. Incidentally,
this is the valuation of trade-in inventory.

Question No. 3

Journal entries on April 3, 2006:

Cash (P24,000 x 20%) P 4,800

Accounts receivable (P24,000 – P4,800) 19,200
Sales – Repossessed inventory P24,000

Cost of Repossessed Goods Sold (P14,000+P6,400) P20,400

Repossessed Inventory P20,400

Question No. 4

Estimated selling price (net realizable P6,400

value)
Less normal profit (P6,400 x 25%) 1,600
Valuation of trade-in inventory P4,800

Question No. 5

Accounts receivable (P59,200 - P51,200

P8,000)
Trade-in inventory (see no. 4) 4,800
Amount to be recorded as sales P56,000

Answers: 1) C; 2) A; 3) D; 4) B, 5) B

PROBLEM NO. 7

Calasiao Construction Corporation engaged you to advise it regarding the

proper accounting for a series of long-term contracts. Calasiao commenced
APPLIED AUDITING

doing business on January 2, 2006. Construction activities for the first year of
operations are shown below. All contract costs are with different customers,
and any work remaining at December 31, 2006, is expected to be completed in
2007.

Contra
ct Estimated
Total Billings Collectio Costs Additional
Contract Throug ns Incurre Costs to
Project Price h Through d Complete
12/31/ 12/31/06 Throug
06 h
12/31/0
6
A P1,200,000 P P P P 268,000
800,000 720,000 992,000
B 1,400,000 440,000 420,000 271,200 1,084,800
C 1,120,000 1,120,0 1,020,000 744,000 -
00
D 800,000 140,000 100,000 492,000 348,000
E 960,000 60,000
820,000 800,000 740,000
P5,420,000 P3,320, P3,060,0 P3,239, P1,760,800
000 00 200

QUESTIONS:

Based on the above and the result of your engagement, determine the
following using the percentage-of-completion method:

1. Net realized gross profit for the year 2006

a. P462,133 c. P1,149,419
b. P432,800 d. P 276,000

2. Balance of Construction in Progress account as of December 31, 2006

a. P2,552,000 c. P3,268,619
b. P2,581,333 d. P2,395,200

3. Amount to be reported in the current assets section of the balance sheet as

Inventories as of December 31, 2006
a. P541,333 c. P352,000
b. P512,000 d. P444,000

4. Amount to be reported in the current liabilities section of the balance sheet

as of December 31, 2006
a. P 56,960 c. P160,000
b. P248,800 d. P 0
APPLIED AUDITING

5. Net realized gross profit for the year 2006 assuming the company used the
completed-contract method
a. P432,800 c. P376,000
b. P436,000 d. P276,000

Suggested Solution:

Question No. 1

Estimated
gross Percentage Realized
Project profit (loss)* of gross profit
completion** (loss)
A (P60,000) not (P60,000)
applicable
B 44,000 20.00% 8,800
C 376,000 100.00% 376,000
D (40,000) not (40,000)
applicable
E 160,000 92.50% 148,000
Total P432,800

* (Total contract price - Total estimated costs)

** (Costs incurred through Dec. 31, 2006 / Total estimated costs)

Question No. 2

Costs
incurred Realized Construction
Project through gross profit in Progress
12/31/06 (loss)
A P992,000 (P60,000) P 932,000
B 271,200 8,800 280,000
D 492,000 (40,000) 452,000
E 740,000 148,000 888,000
Total P2,552,000

Question No. 3

Construction Progress
Project in Progress Billings Net
A P 932,000 P 800,000 P132,000
D 452,000 140,000 312,000
E 888,000 820,000 68,000
Total P2,272,000 P1,760,000 P512,000
APPLIED AUDITING

Question No. 4

Progress billings in excess of costs and

recognized profit – Project B (P440,000 - P280,000) P160,000

Question No. 5

Realized
Project gross profit
(loss)
A (P60,000)
B – not yet completed -
C 376,000
D – not yet completed -
E (40,000)
P276,000

Answers: 1) B; 2) A; 3) B; 4) C, 5) D

PROBLEM NO. 8
During your audit of the records of the Manaoag Corporation for the year
ended December 31, 2006, the following facts were disclosed:

Raw materials inventory, 1/1/2006 P 720,200

Raw materials purchases 5,232,800
Direct labor 4,900,000
Manufacturing overhead applied (150% of direct 7,350,000
labor)
Finished goods inventory, 1/1/2006 1,240,000
Selling expenses 8,112,800
Administrative expenses 7,377,200

Your examination disclosed the following additional information:

a) Purchases of raw materials

Month Units Unit Price Amount

January – February 55,000 P17.76 P 976,800
March – April 45,000 20.00 900,000
May – June 25,000 19.60 490,000
July – August 35,000 20.00 700,000
September – October 45,000 20.40 918,000
November – 60,000 20.80 1,248,000
December
APPLIED AUDITING

265,000 P5,232,800

b) Data with respect to quantities are as follows:

Units
Explanation 1/1/06 12/31/06
Raw materials 35,000 ?
Work in process (80% - 25,000
completed)
Finished goods 15,000 40,000
Sales, 200,000 units

c) Raw materials are issued at the beginning of the manufacturing process.

During the year, no returns, spoilage, or wastage occurred. Each unit of
finished goods contains one unit of raw materials.

d) Inventories are stated at cost as follows:

 Raw materials – according to the FIFO method
 Direct labor – at an average rate determined by correlating total direct
labor cost with effective production during the period
 Manufacturing overhead – at an applied rate of 150% of direct labor
cost

QUESTIONS:

Based on the above and the result of your audit, answer the following:

1. The raw materials inventory as of December 31, 2006 is

a. P992,000 c. P 936,000
b. P888,000 d. P1,040,000

2. The work in process inventory as of December 31, 2006 is

a. P1,496,000 c. P1,746,000
b. P1,514,000 d. P1,776,000

3. The finished goods inventory as of December 31, 2006 is

a. P2,793,600 c. P3,553,130
b. P3,334,000 d. P2,812,000

4. The cost of goods sold for the year ended December 31, 2006 is
a. P16,897,000 c. P14,077,000
b. P14,161,400 d. P13,911,400

Suggested Solution:

Question No. 1

Units
Raw materials, 1/1/06 35,000
APPLIED AUDITING

Add Purchases 265,000

Raw materials available for use 300,000
Less raw materials, 12/31/06 (squeeze) 50,000
Goods placed in process 250,000
Less work-in-process, 12/31/06 25,000
Goods manufactured 225,000
Finished goods, 1/1/06 15,000
Total goods available for sale 240,000
Less finished goods, 12/31/06 40,000
Goods sold 200,000

Raw materials, 12/31/06 (50,000 units x P1,040,000

P20.80)

Question No. 2

Raw materials [(10,000 units x P20.80) +

(15,000 units x P20.40)] P 514,000
Direct labor (25,000 units x 80% x P20a) 400,000
Factory overhead (25,000 units x 80% x 600,000
P30b)
Work in process, 12/31/06 P1,514,000

Labor unit cost (P4,900,000/245,000* units) P20a

Overhead unit cost (P7,350,000/245,000* P30b

units)

*Equivalent production for labor and overhead

Started, finished and sold [(200,000 units -
15,000 units) x 100%] 185,000
Started, finished and on hand (40,000 units x 40,000
100%)
Started, and in process (25,000 units x 80%) 20,000
Total 245,000

Question No. 3

Raw materials [(30,000 units x P20.40)

+(10,000 units x P20)] P 812,000
Direct labor (40,000 units x P20a) 800,000
Factory overhead (40,000 units x P30b) 1,200,000
Finished goods inventory, 12/31/06 P2,812,000

Question No. 4

Raw materials, 1/1/06 P 720,200

APPLIED AUDITING

Add purchases 5,232,800

Raw materials available for use 5,953,000
Less raw materials, 12/31/06 (see no. 1) 1,040,000
Direct materials used 4,913,000
Direct labor 4,900,000
Factory overhead 7,350,000
Total manufacturing cost 17,163,000
Add work-in-process, 1/1/06 -
Total cost placed in process 17,163,000
Less work-in-process, 12/31/06 (see no. 1,514,000
2)
Cost of goods manufactured 15,649,000
Add finished goods, 1/1/06 1,240,000
Total goods available for sale 16,889,000
Less finished goods, 12/31/06 (see no. 3) 2,812,000
Cost of goods sold P14,077,000

Answers: 1) D; 2) B; 3) D; 4) C

PROBLEM NO. 9

The Mangaldan Merchandising Company is a leading distributor of kitchen

wares. The company uses the first-in, first-out method of calculating the cost
of goods sold. The following information concerning two of the company’s
products is taken from the month of May:

PANS KETTLES
No. of Unit No. of Unit
units cost units cost
May 1, beginning inventory 10,000 P 60 6,000 P 40

Purchases:
May 15 14,000 65 9,000 P 42
May 25 6,000 75

Sales for the month 20,000 10,000

(@ (@
P80) P44)

On May 31, Mangaldan’s suppliers reduced their price from the last purchase
price by the following percentages:

Pans…………………..25% Kettles…………………20%

Accordingly, the company agreed to reduce selling prices by 15% on all items
beginning June 1.

Mangaldan Merchandising Company’s selling costs are calculated at 10% of

selling price. Both products have a normal profit of 30% on sales prices (after
selling costs).
APPLIED AUDITING

QUESTIONS:

Based on the above and the result of your audit, answer the following:

1. Total cost of Pans as of May 31 is

a. P710,000 c. P600,000
b. P653,300 d. P612,000

2. Total cost of Kettles as of May 31 is

a. P210,000 c. P200,000
b. P206,000 d. P168,300

3. The inventory at May 31 should be valued at

a. P768,300 c. P920,000
b. P780,300 d. P890,000

4. The loss on inventory write down for the month of May is

a. P139,700 c. P29,300
b. P137,300 d. P27,600

5. The cost of sales, before loss on inventory write down, for the month of
May is
a. P1,778,000 c. P1,797,700
b. P1,685,600 d. P1,658,000

Suggested Solution:

Question No. 1

4,000 units @ P65 P260,000

6,000 units @ P75 450,000
Total cost of Pans P710,000

Question No. 2

Total cost of Kettles (5,000 units @ P210,000

P42)

Question No. 3

Inventory
Item Units Unit Cost NRV* Amount**
Pans 4,000 P65 P61.20 P244,800
6,000 75 61.20 367,200
Kettles 5,000 42 33.66 168,300
P780,300

* Estimated selling price – Estimated cost to sell

APPLIED AUDITING

** Lower of cost or NRV

Question No. 4

Total cost of inventory (P710,000 + P920,000

P210,000)
Less inventory value (see no. 3) 780,300
Required allowance for inventory writedown 139,700
Less allowance, May 1 (6,000 x P0.40) 2,400
Loss on inventory writedown for May P137,300

Question No. 5

Pans:
10,000 units @ P60 P600,000
10,000 units @ P65 650,000 P1,250,000

Kettles:
6,000 units @ P40 240,000
4,000 units @ P42 168,000 408,000
Total cost of sales P1,658,000

Alternative computation:
Inventory, 5/1:
Pans (10,000 units x P60) P600,000
Kettles (6,000 units x P40) 240,000 P 840,000
Add purchases:
Pans [(14,000 units x P65)
+ (6,000 x P75)] 1,360,000
Kettles (9,000 units x P42) 378,000 1,738,000
Total goods available for sale 2,578,000
Less inventory, 5/31 (at cost) 920,000
Cost of sales, before
inventory writedown P1,658,000

Answers: 1) A; 2) A; 3) B; 4) B, 5) D

PROBLEM NO. 10

In conducting your audit of Mangatarem Corporation, a company engaged in

import and wholesale business, for the fiscal year ended June 30, 2006, you
determined that its internal control system was good. Accordingly, you
observed the physical inventory at an interim date, May 31, 2006 instead of at
June 30, 2006.

You obtained the following information from the company’s general ledger.
APPLIED AUDITING

Sales for eleven months ended May 31, 2006 P1,344,000

Sales for the fiscal year ended June 30, 2006 1,536,000
Purchases for eleven months ended May 31,
2006 (before audit adjustments) 1,080,000
Purchases for the fiscal year ended June 30, 1,280,000
2006
Inventory, July 1, 2005 140,000
Physical inventory, May 31, 2006 220,000

Your audit disclosed the following additional information.

(1) Shipments costing P12,000 were received in May and included in the
physical inventory but recorded as June purchases.

(2) Deposit of P4,000 made with vendor and charged to purchases in April
2006. Product was shipped in July 2006.

(3) A shipment in June was damaged through the carelessness of the

receiving department. This shipment was later sold in June at its cost of
P16,000.

QUESTIONS:

In audit engagements in which interim physical inventories are observed, a

frequently used auditing procedure is to test the reasonableness of the
year-end inventory by the application of gross profit ratio. Based on the above
and the result of your audit, you are to provide the answers to the following:

1. The gross profit ratio for eleven months ended May 31, 2006 is
a. 20% c. 30%
b. 35% d. 25%

2. The cost of goods sold during the month of June, 2006 using the gross
profit ratio method is
a. P132,000 c. P148,000
b. P144,000 d. P160,000

3. The June 30, 2006 inventory using the gross profit method is
a. P264,000 c. P268,000
b. P340,000 d. P260,000

Suggested Solution:

Question No. 1

Sales for 11 months

ended 5/31/06 P1,344,000
Less cost of sales for 11
months ended
5/31/06:
APPLIED AUDITING

Inventory, July 1, P 140,000

2005
Add adjusted
purchases:
Unadjusted P1,080,000
Item no. 1 12,000
Item no. 2 (4,000) 1,088,000
Goods available for 1,228,000
sale
Less inventory, 220,000 1,008,000
5/31/06
Gross profit 336,000
Divide by sales for 11
months ended 1,344,000
5/31/06
Gross profit rate for 11
months ended 25%
5/31/06

Question No. 2

Sales for the fiscal year ended June 30, P1,536,000

2006
Less sales for 11 months ended May 31, 1,344,000
2006
Sales for June, 2006 192,000
Less sales without profit 16,000
Sales with profit 176,000
Multiply by cost ratio (100% - 25%) 75%
Cost of sales with profit 132,0000
Add cost of sales without profit 16,000
Total cost of sales for June, 2006 P 148,000

Question No. 3

Inventory, 7/1/05 P 140,000

Add adjusted purchases:
Unadjusted P1,280,000
Item no. 2 (4,000) 1,276,000
Total goods available for sale 1,416,000
Less cost of sales:
Sales without profit 16,000
Sales with profit
[(P1,536,000 - P16,000) x 1,140,000 1,156,000
75%]
Inventory, 6/30/06 P 260,000

Answers: 1) D; 2) C; 3) D
APPLIED AUDITING

PROBLEM NO. 11

Select the best answer for each of the following:

1. In auditing inventories, a major objective relates to the existence assertion.

Of the following audit procedures relating to inventories, which does not
support the existence assertion?
a. The auditor reviews the client's inventory-taking instructions for such
matters as proper arrangement of goods, separation of consigned
goods, and limits on movements of goods during inventory.
b. The auditor observes the client's inventory and performs test counts as
appropriate.
c. The auditor confirms inventories not on the premises.
d. The auditor performs a lower of cost or market test for major categories
of inventory.

2. In a manufacturing company, which one of the following audit procedures

would give the least assurance of the valuation of inventory at the audit
date?
a. Obtaining confirmation of inventories pledged under loan agreements.
b. Testing the computation of standard overhead rates.
c. Examining paid vendors' invoices.
d. Reviewing direct labor rates.

3. When auditing merchandise inventory at year end, the auditor performs a

purchase cutoff test to obtain evidence that
a. No goods held on consignment for customers are included in the
inventory balance.
b. No goods observed during the physical count are pledged or sold.
c. All goods owned at year end are included in the inventory balance
d. All goods purchased before year end are received before the physical
inventory count.

4. 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 received for repairs under warranty.
d. Consignment to an agent.

5. You were engaged to conduct an annual examination for the fiscal year
ended October 31, 2006. Because of the expected holiday, you were able to
convince your client to take a complete physical inventory, in which you were
present on October 15. Perpetual inventory records are kept and the client
considers a sale to be made in the period in which goods are shipped. You
had a sales cut-off test worksheet prepared. Which item among those listed
below will not require an adjusting entry to reconcile the client's detailed
inventory record with the physical inventory?
APPLIED AUDITING

a. b. c. d.
Date Goods Shipped Oct Nov 2 Oct 14 Oct 10
31
Transaction Recorded as Nov 2 Oct Oct 16 Oct 19
Sale 31
Date Inventory Control Oct Oct Oct 16 Oct 12
Credited 31 31

Answers: 1) D; 2) A; 3) C; 4) C, 5) D;

 To have Information about Introduction to Audit of Inventories

https://youtu.be/t2i2ubLIGww

 This video is all about Theory of Audit of Inventories

https://youtu.be/WDNJR1RsRo4

 This video is all about solving Audit of Inventories

https://youtu.be/DZKDAHgJlOg

Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc