ASCA301

Auditing and Assurance Concepts and Applications 1 – Module 1

Learning Module on ASCA301

STUDENT
Name:
Student Number:
Program:
Section:
Home Address:
Email Address:
Contact Number:

PROFESSOR
Name: Winston Alcalde, CPA, MM / Ronnelson Pascual, CPA, MBA
Academic Department: Department of Business and Accountancy
Consultation Schedule: Saturday 8:00am - 6:00pm / Monday 10:00am to 4:00pm
Email Address: wbalcalde@ccc.edu.ph / ronnelson.pascual@yahoo.com.ph
Contact Number: 09354067813 / 09955493123

Learning Module on ASCA301

Overview of the Module
Financial statements are the representation of the reporting entity’s management. To lend credibility to the
entity’s prepared financial statements, they must be examined by an independent certified public accountant, who
expresses an opinion as to the fairness by which such financial statements are presented.

This course covers detailed approaches to problems and situations normally encountered in the independent
examination of financial statement line items, applying the transaction cycle audit. Audit objectives are identified,
and internal control is evaluated so that the auditor could formulate and apply audit procedures to each of the
major asset accounts in the financial statements.

Learners must be able to identify and perform the appropriate audit procedures, prepare audit adjustments and
complete working papers relating to audit of current and non-current assets, to serve as bases for the preparation
of audit reports.

ASCA301 Summary
Module Lesson Topics: Audit of Module Preparer
1 Cash and cash equivalents
1 2 Receivables
3 Inventories Alcalde
1 Investments (Debt, Equity)
2 2 Derivatives and other investments
3 Property, Plant and Equipment
1 Investment properties
Pascual
3 2 Intangible assets
3 Biological assets

General Instructions
1. Read your textbook, if you have, for a thorough understanding of the topics.
2. Answer the questions in each of the Application parts of the lesson to assess your understanding of the topic.
After doing this, check the suggested answers that will be provided to you separately by your professors. You
are highly encouraged to review and go back to each topic before proceeding to the graded enrichment and
assessment parts of the module.
3. Answer each enrichment and assessment exercise depending on the instruction of your professor (e.g. via
LMS or separate answer sheets submitted).
4. Students' learning is primarily the students’ responsibility.
5. Most importantly, CCC BSA students shall always maintain honesty and integrity.

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LEARNING MODULE INFORMATION

I. Course Code ASCA 301
II. Course Title Auditing and Assurance Concepts and Applications 1
III. Module Number 1
IV. Module Title Audit of Cash and cash equivalents, Receivables, and Inventories
V. Overview of the Module • This module covers the audit of Cash and cash equivalents,
Receivables and Inventories.
• Included in the discussion are the management assertions,
audit objectives and audit procedures.
• Internal control procedures for each account or transaction
cycle are likewise provided in this module.

VI. Module Outcomes As for the outcome of the module, you should be able to:
• Explain the objectives and relevant assertions in auditing Cash
and cash equivalents, Receivables and Inventories;
• Apply substantive audit procedures for Cash and cash
equivalents, Receivables and Inventories; and
• Prepare audit working paper and audit adjustments for Cash
and cash equivalents, Receivables and Inventories.

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Lesson 1: AUDIT OF CASH AND CASH EQUIVALENTS

Lesson Objectives: At the end of this lesson, you should be able to:
• Apply audit procedures to establish management assertions on cash and cash equivalents;
• Reconcile bank balances;
• Formulate audit adjustments to bring cash to correct balances; and
• Evaluate appropriateness of the presentation of cash balance in the statement of financial position.

Discussion

The audit of cash and cash equivalents takes more time as compared to other accounts due to its inherent risk. The
following table discusses substantive testing of cash which summarized the management assertions, audit objectives and
procedures:

Assertions Audit Objectives Audit Procedures

To obtain an understanding of
internal control procedures See the details of internal control procedures
By the auditors
adopted by the entity to safeguard for cash receipts and disbursements below.
cash
To determine whether cash exists
Obtain analysis of cash balance and
at year-end and cash related
reconcile to the general ledger;
transactions occur within the year;
Confirm bank balances as of year-end;
and
Existence or occurrence Perform cash count procedures for cash on hand;
To determine that all cash balances
of the client are reflected on the Obtain/prepare bank reconciliations as of year-end; and
statement of financial position at Trace all transfers occurring between banks near year-
year-end. end.
Obtain a cut-off bank statement containing transactions
after the reporting period;
Examine items returned with the cut-off bank statement;
To determine whether all cash
Prepare proof of cash and reconcile cash transactions
Completeness transactions are recorded in the
occurring during a specified period as they are recorded
proper accounting period.
by the bank and the client; and
Verify the client’s cut-off of cash receipts and cash
disbursements.
To determine that cash balances
are available for use without
Review bank statements and the bank replies to
Rights and obligations restrictions or if with restrictions,
confirmation letters.
properly indicated in the statement
of financial position
Verify existence of cash in banks under receivership,
To determine if cash is recorded cash subject to court’s restraining order, in foreign
Valuation or allocation
and presented at the proper amount banks and in foreign currency. This is in addition to the
foregoing procedures which will enable the auditor to

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verify proper valuation of cash.

Investigate any checks representing large or unusual

To determine whether cash is
Presentation and payments to related parties; and
presented in accordance with PAS
disclosure Evaluate proper financial statement presentation and
and PFRS
disclosure of cash.

Internal Control Procedures for Cash Receipts:

1. No person should be assigned the function of cash handling and record keeping.
2. Official receipts must be pre-numbered and sequentially used.
3. Each day’s cash receipts must be deposited intact.
4. Deposits should be matched with official receipts. The person reconciling the official receipts with the deposits made
should be one other than the person making the deposit.
5. Cash sales should be recorded at the point of sale.
6. Cash register totals and credit card machines should be balanced daily. Any resulting cash shortage or overage should
be monitored.

Internal Control Procedures for Cash Disbursements:

1. All disbursements must be properly authorized and adequately documented. The adoption of the voucher system,
which requires review of supporting documents as support for disbursements, is most ideal.
2. Payments must be made by checks, electronic fund transfer or from petty cash or similar funds.
3. Issued checks must be sequentially numbered.
4. Checks should be signed by at least two persons to prevent fictitious disbursements.
5. Check signatories shall be persons in appropriate high levels in the organization.
6. Checks issued must be payable to specific entities and must not be made payable to “Cash.”
7. Periodic bank reconciliations must be made by a person independent of the authorization, check signing function and
cash receipts function. The reconciliation must be made at least once a month, upon receipt of bank statement, to
ensure that all deposits and disbursements are properly made and recorded both by the entity and the bank.

Application
A. An examination on the morning of January 2, 2021 by the auditor for the CCC Company discloses the following items
in the petty cash drawer:

Postage stamps P220.00

Currency and coins 1,156.60
IOUS from members of the office staff 1,210.00
Envelope containing collections for a gift for a departing employee, with office
names attached 350.00
Petty cash vouchers for miscellaneous expenses (including PCV stamps
purchased for P450.00) 985.00
Employee's check postdated January 15, 2021 1,500.00
Employee's check marked "DAIF" 1,890.00
Check drawn by the Company to Petty Cash 3,450.00

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P10,761.60
The ledger account discloses a P10,500 balance for Petty Cash.

1. How much is the cash shortage or overage as of December 31, 2020? Indicate whether shortage or overage.
2. How much petty cash fund shall be shown as part of "Cash” balance as of December 31, 2020?

B. During your audit of BRN Corporation, you established the following data concerning the cash position as of
December 31, 2020:

Bank credit memo P150,000

Bank debit memo 4,500
Balance per bank statement 850,000
Cash on hand and in bank, per books 750,500
Outstanding checks 120,400
Cash on hand per count 88,000
Check of OMG Inc. erroneously charged by the bank 21,000
Check #1423 for P19,500 in payment to a supplier was erroneously recorded
as P15,900

3. How much is the cash shortage or overage as of December 31, 2020? Indicate whether shortage of overage.
4. What is the adjusted cash balance as of December 31, 2020?

C. The accountant of BLCK Company prepared the following bank reconciliation at December 31, 2020:

Balance per bank statement P350,000

Add: Deposit in transit 175,250
Noted collected by bank 15,000
Total P540,250
Less: Outstanding checks 246,750
Balance per ledger P293,500

In the course of your examination, you noted the following information:

a. At December 31, 2020, the bank statement and the general ledger showed balances of P350,000 and P293,500,
respectively.
b. The cut-off bank statement showed a bank charge on January 2, 2021 for P25,000 representing a correction of an
erroneous bank credit.
c. Included in the list of outstanding checks were the following:
- a check payable to a supplier dated December 29, 2020, in the amount of P15,000 released on January 5, 2021.
- a check representing advance payment to a supplier in the amount of P37,200, the date of which is January 4,
2021 and released in December 2020.
d. On December 31, 2020, the company received and recorded a customer's check dated January 2021 amounting to
P50,000.

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As at December 31, 2020:

6. What is the correct amount of deposit in transit?
7. What is the correct amount of outstanding checks?
8. What is the correct cash balance?
9. How much was the cash shortage?

D. In connection with your audit of TZY Corporation for the year ended December 31, 2021, you gathered the following:

Current account at Metrobank P2,000,000

Current account at BPI (100,000)
Payroll account 500,000
Foreign bank account - restricted (in equivalent pesos) 1,000,000
Postage stamps 1,000
Employee's post-dated check 4,000
IOU from controller's sister 10,000
Credit memo from a vendor for a purchase return 20,000
Traveler's check 50,000
Not-sufficient-funds check 15,000
Money order 30,000
Petty cash fund (P4,000 in currency and expense receipts for 10,000
P6,000)
Treasury bills, due 3/30/22 (purchased 12/29/21) 200,000
Treasury bills, due 1/31/22 (purchased 2/1/21) 300,000

10. Based on the above information and the result of your audit, compute for the cash and cash equivalents that will be
reported on the December 31, 2021 statement of financial position.

a. P2,704,000 c. P2,790,000
b. P2,784,000 d. P3,084,000

E. The accountant for the WBA Company assembled the following data:

June 30 July 30
Cash account balance 15,822 39,745
Bank statement balance 107,082 137,817
Deposits in transit 8,201 12,880
Outstanding checks 27,718 30,112
Bank service charge 72 60
Customer's check deposited July 10, returned by bank on July 16 8,250
marked NSF, and redeposited immediately; no entry made on
books for return or redeposit

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Collection by bank of company's notes receivable 71,815 80,900

The bank statements and the company's cash records show these totals:
Disbursements in July per bank statement P218,373
Cash receipts in July per WBA's books 236,452

Based on the application of the necessary audit procedures and appreciation of the given information, you are to provide
the answers to the following:

11. How much is the adjusted cash balance as of June 30?

a. P3,695 c. P87,565
b. P15,822 d. P107,082

12. How much is the adjusted bank receipts for July?

a. P214,802 c. P253,787
b. P232,881 d. P245,537

13. How much is the adjusted book disbursements for July?

a. P212,517 c. P181,782
b. P206,673 d. P220,767

14. How much is the adjusted cash balance as of July 31?

a. P22,513 c. P120,585
b. P112,335 d. P137,817

15. How much is the cash shortage as of July 31?

a. P0 c. P71,815
b. P8,250 d. P196,144

Summary of the Lesson

• More audit time is devoted to the examination of cash and cash equivalents due to its inherent risk as it is prone to
misappropriation and frauds.
• Evaluation of the entity’s internal control for cash and cash equivalents is part of the risk assessment conducted
by the auditors.
• Audit objectives and audit procedures are in line with the management assertions of existence, completeness,
rights and obligations, valuation, and presentation and disclosure.
• Documentations in the form of cash count sheet, bank reconciliation, proof of cash and bank confirmations are
part of test of controls and substantive tests for cash and cash equivalents.

Reference
Empleo P. Practical Auditing (Textbook and IFRS-based exercises) 2017

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Lesson 2: AUDIT OF RECEIVABLES

Lesson Objectives: At the end of this lesson, you should be able to:
• Recall the financial accounting for receivables and its related accounts;
• Explain the objectives in auditing receivables and its related accounts;
• Apply audit procedures to establish management assertions on receivables and its related accounts; and
• Prepare working papers and audit adjusting entries for receivables and its related accounts.

Discussion

The audit of receivables is alongside with the other related accounts such as sales, sales discounts, returns and allowances,
uncollectible and allowance for uncollectible accounts. Below is the summary of assertions, audit objectives and audit
procedures along with management assertions of receivables and related accounts:

Assertions Audit Objectives Audit Procedures

Existence or To determine that receivables
occurrence exists and represent bona fide
obligations owed to the company
on the statement of financial
Rights and obligations position as of year-end
To determine that all transactions
relative to receivables have been
Completeness
recorded in the proper accounting
period
To determine that receivables are
Valuation or allocation recorded and presented at proper
amounts in accordance with
PAS/PFRS
To determine that the receivables
Presentation and are properly presented and
disclosure classified in the statement of
financial position.
Obtain schedule of aged trade accounts receivable
and notes receivable schedule and reconcile to the
ledgers.
Confirm receivables with debtors.
Inspect notes on hand.
Perform analytical procedures to determine whether
recorded sales and receivables balances appear
reasonable.
Test cut-off of sales and sales returns to determine
whether receivable is recorded in the proper accounting
period.
Review collectability of receivables and determine the
adequacy of allowance for doubtful accounts.
Recalculate the interest income from the notes
receivable.
Evaluate financial statement presentation and
disclosure of receivables.
Obtain written client representations regarding
pledge, discount or assignment of receivables from
officers, directors, affiliates or other related parties.

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Internal Control Over Revenue Cycle:

Internal control over sales transactions is best achieved by having separate departments (or individuals) responsible for the
set of activities in the revenue cycle. An entity must segregate the functions of transaction authorization, record keeping
and custody of asset. In companies where it is not practical to separate such duties, increased supervision is an alternative.

The revenue cycle starts with the preparation of the sales order which specifies the terms of the customer's order for
guidance by stores department and the shipping department. Such sales order is subject to the approval of the credit
department (for sales on account). The approved sales order is forwarded to the stores department for the issuance of the
goods to the shipping department. The shipping department prepares a shipping document and forwards the goods to the
common carrier, which in turn, issues a bill of lading. A copy of the shipping document is transmitted to the billing
department for the preparation of the sales invoice. Prices, quantity, and payment terms are reviewed before the sales
invoice is sent to the customer.

The daily totals of sales invoices processed should be transmitted to the accounting department for the proper journal
entries in the sales journal and postings to the general ledger and subsidiary ledger of accounts receivable. Any
adjustments to sales, such as sales discounts and sales returns and allowances, must be properly approved before they are
recorded in the books. Daily totals of cash receipts from customers must be transmitted to the accounting department for
proper posting to the subsidiary ledger accounts. At least once a month, the total of the subsidiary ledger balances should
be reconciled with the controlling account in the general ledger by an employee from the internal audit group or
operations control group.

Statements of accounts should be sent to customers, at least once a month. Dormant accounts should be reviewed and
tested for impairment. Approval shall be made for writing off receivables assessed to be uncollectible. Accounts written
off should be transferred to a separate ledger and control account, for proper control. Otherwise, subsequent collections
may be abstracted without the necessity of manipulating the accounting records.

Application

A. You were engaged to perform an audit of the accounts of the TY Corporation for the year ended December 31, 2020
and have observed the taking of the physical inventory of the company on December 30, 2020. Only merchandise shipped
by the TY Corporation to customers up to and including December 30, 2020 have been eliminated from inventory. The
inventory as determined by physical inventory count has been recorded in the books by the company's controller. No
perpetual inventory records are maintained. All sales are made on an FOB shipping point basis. You are to assume that all
purchase invoices have been correctly recorded.

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The following lists of sales invoices are entered in the sales books for the months of December, 2020 and January, 2021,
respectively.

December, 2020 Sales Invoice Sales Invoice Cost of Goods

Date Shipped
Amount Date Sold
a. P30,000 Dec. 21 P20,000 Dec 31, 2020
b. 22,000 Dec. 31 18,000 Dec.31, 2020
c. 10,000 Dec. 29 6,000 Dec.30, 2020
d. 40,000 Dec. 31 24,000 Jan.3, 2021
Dec. 29, 2020
e. 100,000 Dec. 30 56,000
(shipped to consignee)*
f. 120,000 Dec. 30 80,000 Jan. 2, 2021
January, 2021 g. 60.000 Dec. 31 40,000 Dec. 30, 2020
h. 40,000 Jan. 2 23000 Jan. 2, 2021
i. 80,000 Jan. 3 55,000 Dec. 31, 2020
j. 90,000 Jan. 4 64,000 Dec. 29, 2020
*Verification from the consignee indicates that 60% of the merchandise is still unsold at December 31, 2020.

Required:
Prepare the necessary adjusting journal entries at December 31, 2020 in connection with the foregoing data.

B. You are assigned to assess the collectability of the receivables carried in the books of DGG Company, your company's
audit client. The working trial balance prepared at December 31, 2020 showed the following balances:

Notes Receivable P6,000,000

Accounts Receivable 4,000,000

In the course of your examination, you discovered the following:

Notes Receivable from Company A P2,000,000

Notes Receivable from Company B 3,000,000
Notes Receivable from Company C 1,000,000

No interest has yet been recorded by DGG during 2020 on any of the notes above.

Company A is undergoing bankruptcy proceedings and has negotiated for a restructuring of its notes receivable. The note
was for a four-year period and interest of 10% is collectible annually. All interest accrued before 2020 has been collected.
The note matured on December 31, 2020. Collection of interest was last made on December 31, 2019. The restructuring
agreement with Company A calls for annual payment of P550,000 starting December 31, 2021. No further interest will be
collected during the four-year term.

The Notes Receivable from Company B is a three-year non-interest-bearing note, with face value of P3,000,000. The note
was received in exchange for a piece of land sold by DGG on May 1, 2020. The land was carried in the books at the date

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of sale at P2,600,000. The difference between the face amount of the note and the carrying value of the land was credited
to gain on sale of land. The market interest rate for a note of this type is 10%.

The Notes Receivable from Company C bears interest at 10%. The note was received from sale of goods in the normal
course of business. The note is dated October 1, 2020 and matures on March 31, 2021.

Required:
1. Prepare any audit adjustments as a result of the foregoing.
2. Determine the carrying value of the notes that would appear under the current assets section and non-current assets
section of the statement of financial position at December 31, 2020.
3. Determine the amount of impairment loss on receivables and interest revenue that would appear in profit or loss for the
year 2020.

C. The financial statements of ECH Corporation included the following:

Dec 31, 2019 Dec 31, 2020

AR 735,000
Allow. for uncollectible accounts 16,200
Sales on account 4,500,000
Cash collected from customers 4,200,000

Among the cash collections was the full recovery of a P16,000 receivable from RRQ, a customer whose account had been
written off as worthless late in 2019. During 2020, it was necessary to write off uncollectible customers' accounts totaling
P20,200.

On December 1, 2020, a customer settled his account by issuing to ECH Corporation a 9%, six-month note for P250,000.

At December 31, 2020, the accounts receivable included P100,800 past due accounts. After careful study of all past-due
accounts, the management estimated that the probable loss contained therein was 10%. In addition, 2% of the current
accounts receivable might prove uncollectible.

1. What is the balance of Accounts Receivable as of Dec. 31, 2020?

a. P821,200 b. P801,000
c. P780,800 d. P1,051,000

2. What is the amount of the current accounts receivable that might prove to be uncollectible?
a. P13,600 b. P14,004
c. P14,408 d. P19,004

3. What is the balance of the allowance for uncollectible accounts before adjustments on December 31, 2020?
a. P4,000 b. P12,000
c. P12,200 d. P32,200

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4. What is the balance of the allowance for uncollectible accounts after all the necessary adjusting entries on December
31, 2020?
a. P10,080 b. P12,084
c. P14,004 d. P23,680

D. In your audit of HB Products Co., you noted that the company’s statement of financial position shows the accounts
receivable balance at December 31, 2020 as follows:

Accounts receivable P3,600,000

Allowance for doubtful accounts 72,000
P3,528,000

During 2021, transactions relating to the accounts were as follows:

• Sales on account, P38,400,000.
• Cash received from collection of current receivable totaled P31,360,000, after discount of P640,000 were allowed for
prompt payment.
• Customers’ accounts of P160,000 were ascertained to be worthless and were written off.
• Bad accounts previously written off prior to 2021 amounting to P40,000 were recovered.
• The company decided to provide P184,000 for doubtful accounts by journal entry at the end of the year.
• Accounts receivable of P5,600,000 have been pledged to a local bank on a loan of P3,200,000. Collections of
P1,200,000 were made on these receivables (not included in the collections previously given) and applied as partial
payment to the loan.

Based on the above and the result of your audit, answer the following:
1. The accounts receivable as of December 31, 2021 is
a. P4,240,000 b. P9,840,000
c. P8,680,000 d. P8,640,000

2. The allowance for doubtful accounts as of December 31,2021 is

a. 8,000 b. P136,000
c. P176,000 d. P184,000

3. The net realizable value of accounts receivable as of December 31, 2021 is

a. P8,504,000 b. P8,456,000
c. P4,104,000 d. P8,544,000

E. The following information pertains to LNX Corp.'s loan portfolio at December 31, 2021:
• LNX Corp. considers all loans over 90 days past due to be credit-impaired based on historical experience, with
recovering the associated debt.

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• The aging of LNX's loans on December 31, 2021 follows:

Current P1,400,000
More than 30 days past due 75,000
More than 60 days past due 100,000
More than 90 days past due 125,000
Total P1,700,000

• LNX monitors certain loans more closely on an individual basis given their significance and unique
characteristics. These loans are not included in the P1,700,000 loan portfolio. The following information is
available without undue cost or effort on an individual loan basis:

Past Due PV of Expected Future

Loan Amount
Status Cash Flows
1 P200,000 90 days P180,000
2 150,000 Current Not calculated
3 50,000 60 days 37,000

Other information:
Loan 1 - The borrower has filed for bankruptcy.
Loan 2 - None
Loan 3 - The borrower recently lost his job due to an economic recession and was granted a concession to skip
payments.

• Additional information taking into account historical information, current conditions and forward-looking
information, including actual loss experience and recoveries from the sale of collateral, is as follows:
Probability of default in the next 12 months 2%
Lifetime probability of default
Credit-impaired loans 100%
Not credit impaired loans 5%
Loss given default on all loans 25%

Based on the given information, answer the following:

1. The total loans classified under Stage 1 is
a. P1,400,000 b. P1,550,000
c. P1,625,000 d. P1,670,000

2. The total loans classified under Stage 2 is

a. P 75,000 b. P100,000
c. P175,000 d. P235,000

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3. The total loans classified under Stage 3 is

a. P325,000 b. P375,000
c. P495,000 d. P595,000

4. The total loss allowance to be recognized at December 31, 2021 is

a. P73,438 b. P74,188
c. P74,938 d. P75,688

Summary of the Lesson

• Evaluation of the entity’s internal control for accounts receivable and related accounts is part of the risk
assessment conducted by the auditors.
• Audit objectives and audit procedures of receivables and related accounts are in line with the management
assertions of existence, completeness, rights and obligations, valuation, and presentation and disclosure.
• Documentations in the form of schedule of aged accounts receivable, request for confirmation of accounts
receivable directly from the customers and its summary, audit working papers for accounts receivable, notes
receivable and client’s written representations regarding related parties are part of test of controls and substantive
tests for receivables and related account.

Reference
Empleo P. Practical Auditing (Textbook and IFRS-based exercises) 2017

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Lesson 3: AUDIT OF INVENTORIES

Lesson Objectives: At the end of this lesson, you should be able to:
• Recall the financial accounting for inventories and its related accounts.
• Explain the objectives in auditing inventories and its related accounts.
• Apply audit procedures to establish management assertions on inventories and its related accounts.
• Prepare working papers and audit adjusting entries for inventories and its related accounts.
• Formulate audit adjustments to bring inventories and related expenses to correct balances; and
• Evaluate the appropriateness of the presentation of inventories and related expenses in the financial statements.

Discussion

Review of Accounting for Inventories, Cost of Goods Sold and other Related Accounts
PAS 2 describes inventories as assets held for sale in the ordinary course of business (finished goods); in the process of
production for such sale (work in process), or in the form of materials and supplies to be consumed in the production
process or in the rendering of services (raw materials and manufacturing supplies) and the entity has a legal title to it. For
inventories to be included in the current assets one should be familiar with the following terminologies:
✓ FOB shipping point - ownership of goods is transferred upon shipment
✓ FOB destination - ownership of goods is transferred upon receipt
✓ Consigned goods - belongs to the consignor until sold by the consignee
✓ Goods sold under a product financing agreement - the seller is obliged to repurchase the goods sold at a future
date, therefore it belongs to the seller
✓ Goods sold under installment sales - belongs to the buyer even though the seller retains the title

The two accounting systems for inventories are (1) periodic and (2) perpetual, and are measured at the lower of cost and
net realizable value (NRV), which is net of estimated selling price less estimated costs of completion and disposal.

Measurement of inventories includes purchase cost, conversion costs and other incidental costs incurred in bringing the
inventories to its present condition and location (freight, insurance, non- refundable taxes, etc.) and excludes selling and
administrative costs. Cash discounts are recorded while trade discounts are not. Under PAS 2, only the following cost
formulas are allowed: (a) specific identification, (b) first in first out; and (c) weighted average.

Audit of Inventories and Related Accounts

The interrelationship of inventories and cost of goods sold are considered in the determination of its value for it also
affects the net income for the year. The asset will eventually become an expense when sale is recognized. Also, the
decline in the net realizable value is recognized as expense relating to inventories and its recovery on the other hand is
shown as an income but not exceeding on the loss recognized previously. The following are the assertions, audit
objectives and procedures in the conduct of audit of inventories and its related accounts:

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Assertions Audit Objectives Audit Procedures

To obtain an understanding of
See the details of internal control procedures for
internal control procedures adopted
By the auditor inventories below.
by the entity to safeguard inventories
Obtain listing of inventory and reconcile to ledgers;
To determine whether inventories
Observe the taking of physical inventory and conduct
exist at year-end and represent items
test counts; and
Existence or occurrence held for sale in the ordinary course of
Confirm inventories in public warehouse and with
business
consignees.

Obtain a final inventory listing from the client;

To determine whether all Trace test counts made during the inventory observation
transactions related to inventory are into inventory listing;
recorded in the proper accounting Test the clerical accuracy of the final inventory listing;
period. Review and conduct year-end cutoff test of purchases
Completeness and sales transactions;
To determine that inventory listings Test numerical sequence of inventory purchase
are accurately compiled, and requisition;
inventory quantities include all items Review entries to cost of goods sold; and
on hand and in transit. Perform analytical review related to inventories and cost
of goods sold.
To determine whether the company
has legal title or ownership rights to Make inquiries of management regarding inventory
Rights and obligations inventory items and exclude ownership and examine consignment agreements and
inventories on those items billed to goods stored in public warehouses.
customers or owned by others.
To determine whether the inventories
are properly stated with respect to
cost determined by an acceptable
To evaluate the bases and methods of inventory costing;
method consistently applied; and that
Valuation or allocation Vouch and test inventory costing; and
Slow-moving, excess, defective and
Check inventory for quality and/or obsolescence.
obsolete items are identified and
reduced to replacement cost or net
realizable value if lower than cost.

Internal control procedures adopted by the entity must be reviewed by the auditor to ensure that the objectives of
safeguarding the inventories are in place and that reliable information are in place. Internal control procedures are usually
focused on:
1. Physical inspection and counting of all items received by the company from suppliers to remedy any discrepancy.
2. Keeping inventories in warehouse which restricts access to unauthorized persons.
3. Monitoring inventory movements from the receiving department until its shipment.

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4. Control in the storage by proper classification and identification for efficient handling.
5. Monitoring quantities to minimize losses.
6. Conducting periodic review of obsolete inventories.
7. Regular reconciliation of records vis-à-vis physical inventory.
8. Auditing of bill of materials.
9. Creating a procedure to track scrap transactions.

In observing the physical count, the auditor must be keen as to how the employees are conducting the inventory plan, alert
for empty containers that may exist, damaged, obsolete and slow-moving merchandise, appraise its general condition of
inventory as well as its storage.

The tests of the cost accounting systems are designed to determine that appropriate costs have been applied to work in
process, finished goods and cost of goods sold which must be in conformity with the cost formula applicable to the entity
in accordance with PAS 2. The auditor has to review the bill of materials for a sample of finished goods; trace the labor
charged to production based on time cards and labor routings to ensure proper charges; and validate overhead costs
whether the entity uses appropriate and consistent method of allocating overhead to the manufactured products.

In case of audit of a new client, the auditor must obtain evidence that the beginning balance of the client are fairly stated
by review of the audit working papers of previous auditor, test of inventory records and documents used in the physical
inventory, tests of overall reasonableness of figures, transactions and other analytical procedures.

Application
A. A physical count of inventory at December 31, 2020 revealed that RSG Enterprises had inventory on hand at that date
with a cost of P441,800. The annual audit identified that the following items were excluded from this amount:
• Merchandise of P61,000 is held by RSG on consignment. The consignor is BRN Company.
• Merchandise costing P38,000 was shipped by RSG Enterprises FOB destination to a customer on December 31,
2020.
• Merchandise costing P46,000 was shipped by RSG, FOB shipping point to a customer on December 29, 2020.
The customer was scheduled to receive the goods on January 6, 2021.
• Merchandise costing P83,000 shipped by a vendor FOB destination on December 31, 2020 was received by RSG
on January 4,2021.
• Merchandise costing P51,000 purchased FOB shipping point was shipped by the supplier on December 31, 2020
and received by RSG on January 5, 2021.

Required:
(a) Calculate the amount that should appear for inventory on RSG Enterprise's statement of financial position at December
31, 2020.
(b) Prepare any journal entries necessary to adjust the inventory general ledger account to the amount calculated in part
(a).

B. The management of ECH Company has engaged you to audit its 2020 financial statements. The company's accounting
period ends on December 31. You verified that on November 30, the correct inventory level was 60,000 units. A review

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of the December purchase orders to various suppliers showed the following. Only merchandise received up to December
31, 2020 were recorded as purchases by ECH.

Date of
Invoice Quantity Date Date
Purchase Terms
Date in Units Shipped Received
Order
12/2/2020 1/4/2021 10,000 1/3/2021 1/4/2021 Shipping point
12/11/2020 1/4/2021 12,000 12/22/2020 12/23/2020 Destination
12/16/2020 1/3/2021 14,000 12/28/2020 1/3/2021 Shipping point
12/23/2020 12/26/2020 10,000 1/3/2021 1/4/2021 Shipping point
12/28/2020 1/10/2021 8,000 12/31/2020 1/10/2021 Destination
12/31/2020 1/10/2021 15,000 1/4/2021 1/11/2021 Destination

During the month of December, the company recorded the sale of 50,000 units at P125 selling price per unit. This
includes the sale of 14,000 units shipped to BLCK Company, a consignee. A letter received from BLCK Company
indicates that as of December 31, 2020, it had sold 10,000 units and was still trying to sell the remaining units. Inventories
presented on the client prepared statement of financial position pertain to inventories actually on hand at yearend.

Required:
(a) Compute the number of units that should be included in the December 31, 2020 inventory.
(b) Assuming a uniform unit cost of P90 for the inventory, prepare the necessary audit adjusting entries as at December
31, 2020.
C. A portion of the OMG Company's statement of financial position appears as follows:

Dec.31, 2020 Dec.31,2019

Assets
Cash P353,300 P100,000
Notes Receivable - 25,000
Inventory ? 199,875
Liabilities
Accounts Payable 75,000

OMG Company pays for its operating expenses with cash and purchases all inventories on credit. During 2020, cash
totaling P474,700 was paid on accounts payable. Operating expenses for 2020 totaled P220,000. All sales are cash sales.
The inventory was restocked by purchasing 1,500 units per month and valued by using periodic FIFO. The unit cost of
purchases was P32.60 during January 2020 and increased P0.10 per month during the year. OMG sells only one product.
All sales are made for P50 per unit. The ending inventory for 2019 was valued at P32.50 per unit.

1. How many units were sold during 2020?

a. 20,960 units b. 18,960 units
c. 18,460 units d. 8,828 units

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2. What should be the balance of Accounts Payable at December 31, 2020?

a. P197,000 b. P122,000
c. P75,000 d. P596,700

3. The number of units in the January 1, 2020 inventory is

a. 0 b. 6,150
c. 6,100 d. 5,966

4. The number of units and total cost of ending inventory, respectively, are
a. 5,690 and P190,946 b. 5,690 and P189,808
c. 5,190 and P173,208 d. 5,190 and P174,246

D. VH Corporation manufactures three models of gear shift components for bicycles that are sold to bicycle
manufacturers, retailers, and catalog outlets. Since beginning operations in 1944, VH has used normal absorption costing
and has assumed a first- in, first-out cost flow in its perpetual inventory system. Except for overhead, manufacturing costs
are accumulated using actual costs. Overhead is applied to production using predetermined overhead rates.

The balances of the inventory accounts at December 31, 2021 are shown below. The inventories are stated at cost before
any year-end adjustments.
Finished goods P2,588,000
Work-in-process 450,000
Raw materials 960,000
Factory supplies 276,000

The following information relates to VH's inventory and operations.

a. The finished goods inventory consists of the items analyzed below.
Cost NRV
Down tube shifter P1,080,000 P1,056,000
Bar end shifter 728,000 750,400
Head tube shifter 780,000 787,800
Total P2,588,000 P2,594,200

b. One-half of the head tube shifter finished goods inventory is held by catalog outlets on consignment.
c. Three-quarters of the bar end shifter finished goods inventory has been pledged as collateral for a bank loan.
d. One-half of the raw materials balance was acquired at a contracted price of 20 percent above the current market price.
The replacement cost of the rest of the raw materials is P509,600.
e. The net realizable value of the work-in-process inventory is P434,800.
f. Included in the cost of factory supplies are obsolete items with a historical cost of P16,800. The replacement cost of the
remaining factory supplies is P263,600.

Based on the given information and the result of your audit, answer the following:
1.The finished goods inventory on December 31, 2021 should be valued at

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a. P2,174,000 b. P2,594,200
c. P2,588,000 d. P2,564,000

2. The raw materials inventory on December 31, 2021 should be valued at

a. P880,000 b. P909,600
c. P989,600 d. P960,000

3. The factory supplies inventory on December 31, 2021 should be valued at

a. P246,800 b. P259,200
c. P263,600 d. P276,000

4. The total inventories to be recognized in the statement of financial position as of December 31, 2021 is
a. P4,218,000 b. P4,167,600
c. P4,138,000 d. P4,247,600

Summary of the Lesson

• Evaluation of the entity’s internal control for inventories and related accounts is part of the risk assessment
conducted by the auditors.
• Audit objectives and audit procedures of inventories and related accounts are in line with the management
assertions of existence, completeness, rights and obligations, valuation, and presentation and disclosure.
• Documentations in the form of schedule of inventories and related accounts, request for confirmation of
consigned goods, audit working papers for inventories and client’s written representations regarding related
parties are part of test of controls and substantive tests for inventories and related account.

Reference
Empleo P. Practical Auditing (Textbook and IFRS-based exercises) 2017

Learning Module on ASCA301