Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)

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AUDIT OF INVENTORIES
COLLABORATIVE AUDIT WORKING PAPER ON INVESTMENTS

PRELIMINARIES (GUIDE QUESTIONS)

(1) If an auditor identifies a risk of material misstatement due to fraud, what should be
done by the auditor? (ISA 240, par. A39; A41 and Appendix 2)
(2) Why are inspection and observation done in the audit of inventories? (ISA 500, A16,
A17 and A28)
(3) Discuss the specific considerations for inventories under ISA 501 (pars. 4-8 and A1-
A16)
(4) What are the additional procedures necessary in the audit of inventory opening
balances under ISA 510? (par. A6 and Appendix Illustrations on modified opinion)
(5) When is external confirmation used for inventories? (ISA 330, A48)
(6) How do we define inventories under IAS 2, par. 6 and 8?
(7) What are the two common inventory recording systems used by businesses?
(8) What is the measurement of inventories under IAS 2, par. 9 and IFRS for SMEs par.
13.4?
(9) What comprises the cost of inventories under IAS 2, par. 10-15?
(10) What are examples of costs excluded from the cost of inventories and recognized
as expenses in the period in which they are incurred? (under IAS 2, par. 16)
(11) In what instances can borrowing cost be capitalized for inventories? (IAS 23, par.
4 and 7, and IAS 2, par 17)

CASE A: CUT-OFF TEST AND COUNT (ADAPTED)

You have been engaged for the audit of Z Company for the year ended December 31,
2021. Z Company is engaged in the wholesale chemical business and makes at a
constant gross profit rate of 25% based on sales. Unadjusted balances for accounts
receivable, inventory and accounts payable were: P300,000, P250,000 and P150,000
respectively.

Following are portions of the client’s sales and purchases accounts for the calendar year
2021.

EXHIBIT (*SI = Sales Invoice; **RR = Receiving Report)

Sales
Balance Forward
Date Reference Amount Date Reference Amount
12/31 Closing entry P699,860 P658,320
12/27 SI# 963 5,195
12/28 SI# 964 19,270
12/28 SI# 965 1,303
12/31 SI# 966 5,840
12/31 SI# 967 7,922
12/31 SI# 969 2,010
P699,860 P699,860

Purchases
Balance Forward
Date Reference Amount Date Reference Amount
P360,000 12/31 Closing entry P385,346
12/28 RR# 1059 3,400
12/30 RR# 1061 8,965
12/31 RR# 1062 4,861
12/31 RR# 1063 8,120
P385,346 P385,346

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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.
Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)
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You observed the physical inventory of goods in the warehouse on December 31, 2021,
and were satisfied that it was properly taken.

When performing a sales and purchases cutoff test, you found that at December 31, 2021,
the last receiving report used was no. 1063 and that no shipments have been made on
any sales invoices with numbers larger than no. 968. You also obtained the following
additional information:

1. On the evening of December 31, 2021, two cars were on Z Company siding:
a. Car AR38162 was unloaded on January 2, 2022, and received on receiving
report no. 1063. The freight was paid by the vendor.
b. Car BAE74123 was loaded and sealed on December 31, 2021, and was
switched off the company’s siding on January 2, 2022. The sales price was
P12,700 and the freight was paid by the customer. This order was sold on sales
invoice no. 968.
2. In the warehouse at December 31, 2021, were goods that had been sold and paid for
by the customer but which were not shipped out until the year 2022. They were all
sold on sales invoice no. 965 and were not inventoried. These were not classified as
special order or customized goods by Z Company.
3. Temporarily stranded at December 31, 2021 on a railroad siding were two cars of
chemical en route to the Papyrus Paper Company. They were sold on sales invoice
no. 966, and the terms were FOB destination.
4. Included in the warehouse physical inventory at December 31, 2021, were chemicals
that had been acquired and received on receiving report no. 1060 but for which an
invoice was not received until 2022. Cost was P2,180.
5. Included in the physical inventory were chemicals exposed to rain while in the stored
in the client’s warehouse and deemed unsalable. The invoice cost was P1,250
remained unpaid while the freight charges of P350 were already paid by the entity.

Required:

(1) Prepare an audit working paper for 2021 (using template below) showing the adjusted
balances of (a)accounts receivable account, (b) sales, (c) inventory account, (d)
purchases account and (e) accounts payable.
(2) Prepare a compound journal entry to record the necessary adjustments.

Accounts Sales Merchandise Purchases Accounts

Receivable Inventory Payable
Unadjusted
Adjustments:
1a
1b
2
3
4
5
Others
Adjusted

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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.
Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)
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PRELIMINARIES (GUIDE QUESTIONS)

(1) In performance obligations satisfied at a point in time, what are the common indicators
of transfer of control under IFRS 15, par. 38?
(2) Discuss the concept of shipping terms (FOB shipping point and destination) in relation
to IFRS 15, par. 38.
(3) Discuss the following shipping terms: Free Along Side (FAS); Cost, Insurance and
Freight (CIF); FOB Seller; Ex-ship and FOB Buyer.

CASE B: VALUATION (ADAPTED)

Carl Inc. uses a perpetual inventory system and reports inventory at the lower of FIFO
cost or net realizable value. Carl’s inventory control account balance at June 30, 2021
was 442,040. A physical count conducted on that day found inventory on hand worth
440,400. Net realizable value for each inventory item held for sale exceeded cost. An
investigation of the discrepancy disclosed the following:

(a) Goods worth P13,200 held on consignment for Bugok Co. had been included in the
physical count.
(b) Goods costing P2,400 were purchased on credit from Amor Co. on June 27, 2021 on
FOB shipping point terms. The goods were shipped on June 28, 2021 but, as they
had not arrived by June 30, 2021, were not included in the physical count. The
purchase invoice was received and processed on June 30, 2021.
(c) Goods costing P4,800 were sold on credit to Acero Co. for P7,800 on June 28, 2021
on FOB destination terms. The goods were still in transit on June 30, 2021. The sales
invoice was processed and recorded on June 29. 2021.
(d) Goods costing P5,460 were purchased on credit (FOB Destination) from San Miguel
Co. on June 28, 2021. The goods were received on June 29, 2021 and included in the
physical count. The purchase invoice was received on July 2, 2021.
(e) On June 30, 2021, Carl sold goods costing P12,600 on credit (FOB shipping point)
terms to Piraso Corp. for P19,200. The goods were dispatched from the warehouse
on June 30, 2021 but the sales invoice had not been processed at that date.
(f) Damaged inventory items valued at P5300 were discovered during the physical count.
These items were still recorded on June 30, 2021 but were omitted from the physical
count records pending their write-off.

Required:

Based on the preceding information, determine the proper values of the following on
June 30, 2021.

(1) Prepare an audit working paper for 2021 (using template below) showing the net
adjustment for (a) sales revenue (b) inventory and (c) accounts payable.
(2) Prepare a compound journal entry to record the necessary adjustments.

Accounts Sales Merchandise Merchandise Accounts

Adjustment Receivable Inventory Inventory Payable
(Count) (GL)
Unadjusted P440,400 P442,040
a.
b.
c.
d.
e.
f.
Net adjustments
Adjusted
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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.
Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)
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PRELIMINARIES (GUIDE QUESTIONS)

(1) When do we recognize cost of inventories as expense? (IAS 2, par. 34 and 35)
(2) Discuss the difference between fair value and net realizable value. (IAS 2, par. 6 and
7)
(3) For unsold goods, how do we account for the write-down to NRV and reversal of write-
down? (IAS 2, par. 28 – 34)
(4) How do we account for inventory impairment losses under IFRS for SME (par. 13.19)
and SEs?
(5) What comprises the cost of agricultural produce harvested from biological assets?
(IAS 41, par.3 and 13, and IAS 2, par. 20)
(6) What are the two types of inventories that are exempted from the measurement
requirements (LCNRV) of IAS 2 (par. 3a and 4, and (b and 5)
(7) Discuss the disclosure requirements under IAS 2.

CASE C: SUBSEQUENT MEASUREMENT (ADAPTED)

You were assigned to audit the inventory of an audit client at year-end. Hershey’s Ice
Cream Factory sells a variety of flavors, which includes strawberry, mango, chocolate and
durian to its customers. At December 31, 2021, the balance of the entity’s ending
inventory account was P5,000,000, and the “allowance for inventory writedown” account
before any adjustment was P350,000. Relevant information about the proper valuation
of inventories and the breakdown of inventory cost and market data at December 31,
2021, are as follows:

Cost Replacement Sales Price Net Normal

Cost Realizable Profit
Value
Strawberry 1,000,000 1,100,000 1,450,000 1,100,000 100,000
Mango 1,500,000 1,200,000 1,750,000 1,600,000 200,000
Chocolate 1,700,000 1,300,000 2,000,000 1,450,000 250,000
Durian 800,000 1,000,000 1,300,000 650,000 250,000
Total 5,000,000 4,600,000 6,500,000 4,800,000 800,000

Required:

(1) Prepare a year-end working paper for the year-end audit showing computations
for (a) inventory to be reported in the year-end statement of financial position and
(b) loss on inventory write-down to be included in entity’s 2021 cost of sales.
(2) Prepare the journal entry to record the loss on inventory write-down under Full
IFRS and IFRS for SMEs.

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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.
Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)
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PRELIMINARIES (GUIDE QUESTIONS)

What are the cost formulas available under IAS 2 (par. 23 to 27) When are the usually
used?

CASE D: COST FORMULAS

An audit client requested your team’s expertise in the costing of inventories as they are
considering the to change their inventory cost formula form the existing average method
to first in first out (FIFO). During December 2021, the client company provided the
following information pertaining to its inventory:

Units Unit Total cost Units on

cost hand
Balance on 1/1 10,000 200 2,000,000 10,000
Purchased on 1/11 6,000 300 1,800,000 16,000
Sold on 1/22 9,500 6,500
Sales return on 1/23 500 7,000
Purchased on 1/26 4,600 400 1,840,000 11,600
Purchase return on 600 400 240,000 11,000
1/27

Prepare an audit working paper showing computations for ending inventory and cost of
sales under (a) weighted-average periodic method (simple-average method), (b)
weighted-average perpetual method (moving-average method), and (c) first-in, first out
method.

PRELIMINARIES (GUIDE QUESTIONS)

(1) Discuss the techniques for measurement of cost available under IAS 2 (par. 21-22)
(2) Why do we use analytical procedures for inventories? When are we allowed to use
inventory estimation techniques such as retail and gross profit method?

CASE E: GROSS PROFIT METHOD (INVENTORY ESTIMATION)

Your audit team was assigned to make an interim audit for a client that has recently
experienced loss of inventory due to fire.

The entity reported merchandise inventory of P6,500,000 at the end of December 31,
2021 and has been using a consistent gross profit rate of 25% in selling its merchandise.
It also reported accounts receivable and accounts payable of P3,000,000 and P1,600,000
at the end of December 31, 2021 respectively. All purchases and sales are made on
account with a reasonable credit period for settlement.

On January 25, 2022, a fire damaged the office and warehouse of the entity. The entity
was so concerned about the extent of the damage brought about by the unfortunate event
and as part of the accounting department, you were tasked to do an estimation of the
loss. You were able to gather the following information:

(a) The entity reported outstanding accounts receivable and accounts payable of
P3,700,000 and P2,000,000 as of the date of fire.
(b) The cash records for January showed receipts from customers of P900,000 and
payments to suppliers of P500,000.
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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.
Auditing and Assurance Services: Theory and Practice [for MODAUD1] (Tugas & Bendo)
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(c) Damaged goods costing P150,000 were found after the fire but this could be sold for
just P50,000 because of the defect.
(d) Goods costing P550,000 were sent to a consignee the morning of January 25, prior
to the unfortunate incident.
(e) There were goods purchased in transit worth P120,000 during January which were
expected to be received in the first week of February. These goods were shipped in
January 20 under the terms FOB shipping point and were properly recorded as
purchases in January.

Required:

Prepare an audit working paper for the interim period showing computations for the (a)
cost of sales based on the gross profit method and (b) total value of inventory destroyed
by fire.

CASE F: RETAIL INVENTORY METHOD (INVENTORY ESTIMATION)

Shopemore Supermarket is one of your firm’s new audit client. Based on the risk
assessment made, the audit team decided to perform an interim audit using the retail
inventory method. The following information were presented by Savemore Supermarket:
(round off your cost ratios to the nearest percentage/2 decimal places)

COST RETAIL
Inventory, January 1 250,000 587,000
Purchases 914,500 1,460,000
Purchase returns 60,000 95,000
Purchase discounts 18,000 -
Gross sales, after employee discounts - 1,260,000
Sales returns - 97,500
Markups - 180,000
Markup cancellations - 40,000
Markdowns - 95,000
Markdown cancellations - 20,000
Freight-in 75,000 -
Departmental transfers-in (debit) 50,000 105,000
Departmental transfers-out (credit) 30,000 85,000
Abnormal shrinkages 80,000 140,000
Employee discounts - 8,000
Normal theft losses - 15,000

Required:

Prepare an audit working paper for the interim period showing computations for the
estimated ending inventory under (a) average method, (b) conventional method and (c)
the first-in, first-out method?

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Copyright © 2020 Tugas & Bendo. All rights reserved.
No part of this learner’s material may be reproduced, stored, or transmitted in any form or by any means – electronic,
mechanical, or otherwise – without the written consent of the authors.