Task 4 Audit

Lecturer Name : Dr. Hj. Liza Laila Nurwulan, SE, MSi, Ak / Justinia Castellani, SE, MSi, Ak
Student name : Wida Widiawati
NPM : 194020034
Class : 19 AKJ

CHAPTER 21

A. REVIEW QUESTION

1. 21-1 ( Objectives 21-1) give reasons why inventory is most often the most difficult and
time-consuming part of many audits?
Answer:
Inventory is often the most difficult and time consuming part of many audit engagements
because:
• Inventory is generally a major item on the balance sheet and often the largest item
making up the accounts included in working capital.
• The need for organizations to have the inventory in diverse locations makes the
physical control and counting of the inventory difficult.
• Inventory takes many different forms that are difficult for the auditor to fully
understand.
• The consistent application of different valuation methods can be fairly
complicated.
• The valuation of inventory is difficult due to such factors as the large number of
different items involved, the need to allocate the manufacturing costs to
inventory, and obsolescence.

2. 21-2 ( Objectives 21-1, 21-7) Explain the relationship between the acquisition and
payment cycle and the inventory and warehousing cycle in the audit of a manufacturing

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 company. List several audit procedures in the acquisition and payment cycle that support
your explanation.
Answer:
The acquisition and payment cycle includes the system for purchasing all goods
and services, including raw materials and purchased parts for producing finished goods.
Purchase requisitions are used to notify the purchasing department to place orders for
inventory items. When inventory reaches a predetermined level or automatic reorder point,
requisitions may be initiated by stockroom personnel or by computer. In other systems,
orders may be placed for the materials required to produce a customer order, or orders may
be initiated upon periodic evaluation of the situation in light of the prior experience of
inventory activity.
After receiving the materials ordered, as part of the acquisition and payment cycle,
the materials are inspected with a copy of the receiving document used to book perpetual
inventory. In a standard cost inventory system, the acquisition and payment cycle computes
any inventory purchase variances, which then enter the inventory system.
The following audit procedures in the acquisition and payment cycle illustrate the
relationship between that cycle and the inventory and warehousing cycle.
• Compare the inventory cost entered into the inventory system to the
supporting invoice to determine that it was properly recorded and the
purchase variance (standard cost system), if any, was properly reflected.
• Test the purchase cutoff at the physical inventory date and year-end to
determine whether or not the physical inventory and year-end inventory
cutoffs are proper from a purchase standpoint.

3. 21-3 ( Objectives 21-1, 21-3) State what is meant by cost accounting records, and explain
what they mean important in carrying out audits!
Answer:
Cost accounting records are those which are concerned with the processing and
storage of raw materials, work in process, and finished goods, insofar as these activities
constitute internal transfers within the inventory and warehousing cycle. These records

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 include computerized files, ledgers, worksheets and reports which accumulate material,
labor, and overhead costs by job or process as the costs are incurred.
Cost accounting records are important in conducting an audit because they indicate
the relative profitability of the various products for management planning and control, and
determine the valuation of inventories for financial statement purposes.

4. 21-4 ( Objectives 21-3) Many auditors assert that certain audit tests can be significantly
reduced for clients with adequate perpetual records that include both unit and cost data.
What are the most important tests of the perpetual records that the auditor must make before
reducing assessed control risk? Assuming the perpetuals are determined to be accurate,
which tests can be reduced?
Answer:
The most important tests of the perpetual records the auditor must make before assessed
control risk can be reduced, which may permit a reduction in other audit tests are:
• Tests of the purchases of raw materials and pricing thereof.
• Tests of the cost accounting documents and records by verifying the reduction of
the raw material inventory for use in production and the increase in the quantity of
finished goods inventory when goods have been manufactured.
• Tests of the reduction in the finished goods inventory through the sale of goods to
customers.
Assuming the perpetuals are determined to be effective, physical inventory tests may be
reduced, as well as tests of inventory cutoff. In addition, an effective perpetual inventory
will allow the company to test the physical inventory prior to the balance sheet date.

5. 21-5 ( Objectives 21-5) Before the physical examination, the auditor obtains a copy of the
client's inventory instructions and reviews them with the controller. In obtaining an
understanding of inventory procedures for a small manufacturing company, these
deficiencies are identified: Shipping operations will not be completely halted during the
physical examination, and there will be no independent verification of the original
inventory count by a second counting team. Evaluate the importance of each of these
deficiencies and state its effect on the auditor's observation of inventory.

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 Answer:
Physical Observation
It is important for the independent auditor to be present at the time of counting and
observation, testing and appropriate inquiries to determine the effectiveness of the
inventory taking method and the measure (level) of reliability that may be given to client
statements regarding the quantity and physical condition of inventories.
Client is responsible for establishing procedures to perform accurate physical
counts and to perform actual counts and records. The auditor is responsible for evaluating
and observing each client's physical procedures and drawing conclusions about the
adequacy of the physical inventory.
If the inventories in the daily activities of the company are in public warehouses or other
outside party depositors, then a written confirmation of the storage can be accepted on the
condition that if the amount contained shows a significant proportion of current assets or
the total fixed assets, the following information: Additional measures should be made to
reassure the independent auditor of honesty in the situation.

6. 21-6 ( Objectives 21-5) When completing inventory observations, the controller requests
the auditor to provide copies of all recorded test calculations to facilitate correction of any
discrepancies between the client's and the auditor's calculations. Should the auditor comply
with the request, why?
Answer:
The auditor must meet these requirements because the Pricing Audit and Pricing
Compilation include all types of tests of the client's unit prices to determine whether they
are correct. Compilation includes all tests of the summary of the physical count, the result
of multiplying the price by the quantity, the summation of the inventory summary, and
tracing the total inventory amount to the general ledger.

7. 21-7 ( Objectives 21-5) What major audit procedures are involved in testing inventory
holdings during physical count observations and some of the subsequent valuation tests?
Answer:

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 The most important audit procedures to test for the ownership of inventory during the
observation of the physical counts and as a part of subsequent valuation tests are:
• Discuss with the client.
• Obtain an understanding of the client's operations.
• Be alert for inventory set aside or specially marked.
• Review contracts with suppliers and customers to test for the possibility of
consigned inventory or inventory owned by others that is in the client's shop for
repair or some other purpose.
• Examine vendor invoices indicating that merchandise on hand was sold to the
company.
• Test recorded sales just before and just after the physical inventory to determine
that the items were or were not on hand at the physical inventory date and that a
proper cutoff was achieved.

8. 21-8 ( Objectives 21-4, 21-5, 21-6) in verifying the amount of inventory, one of the
auditor's concerns is that slow moving and obsolete items will be identified, specify audit
procedures that can be used to determine whether slow moving or obsolete items have been
included in inventory.
Answer:
Auditing procedures to determine whether slow-moving or obsolete items have been
included in inventory are:
• Obtain a sufficient understanding of the client's business to aid in recognizing
inventory that is no longer useful in the client's business.
• Review the perpetual records for slow-moving items.
• Discuss the quality of the inventory with management.
• Ask questions of production personnel during physical inventory observation about
the extent of the use or nonuse of inventory items.
• Make observations during the physical inventory for rust, damaged inventory,
inventory in unusual locations, and unusual amounts of dust on the inventory.
• Be aware of inventory that is tagged obsolete, spoiled, or damaged, or is set aside
because it is obsolete or damaged.

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 • Examine obsolescence reports, scrap sales, and other records in subsequent periods
that may indicate the existence of inventory that should have been excluded from
the physical inventory or included at a reduced cost.
• Calculate inventory ratios, by type of inventory if possible, and compare them to
previous years or industry standards

9. 21- 9 ( Objectives 21-5) During the physical inventory count, the controller intentionally
withholds some tag inventory of the employee in charge of the physical count. After the
auditor leaves the client premises. Once inventory observation is complete, the controller
records inventory that is not on the tag so that profit overstated significantly. How can the
auditor disclose such misstatements, assuming there are no perpetual records?
Answer:
The auditor could have uncovered the misstatement if there were adequate controls
over the use of inventory tags. More specifically, the auditor should have assured himself
or herself that the client had accounted for all used and unused tag numbers by examining
all tags, if necessary. In addition, the auditor should have selected certain tags (especially
larger items) and had the client show him or her where the goods were stored. The tag
numbers used and unused should have been recorded in the auditor's working papers for
subsequent follow-up. As part of substantive procedures, the auditor could have performed
analytical tests on the inventory and cost of sales. A comparison of ratios such as gross
margin percentage and inventory turnover could have indicated that a problem was present.

10. 21-10 ( Objectives 21-5) explain why the proper cutoff for purchases and sales relies
heavily on physical inventory observations. What information must be obtained during the
physical count to ensure the cutoff is accurate?
Answer:
During the physical inventory count, the auditor must ensure that controls over the entry
and exit procedures of goods or the internal movement of goods during the calculation have
been followed properly. Inventories that are not under the control of the company, the
auditor must ensure that the travel inventory is correct.