Chapter 11: Audit of Acquisition and Payment Cycle and

Inventory

Student: ___________________________________________________________________________

1. Inventory is complex and typically considered a high-risk area in audits of service firms.
True False

2. In order for the auditor to perform an engagement on a manufacturing firm, it is important that the entire
integrated process is understood.
True False

3. An indication of potential inventory fraud is that inventory levels are growing faster than sales.
True False

4. The acquisition process begins with a purchase of goods or services

True False

5. Supply chain management has helped many companies improve the efficiency of operations.
True False

6. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
True False

7. An auditor can utilize a cross-sectional analysis for a client operating in multiple locations to identify areas of
further inventory testing.
True False
8. Inventory turnover is often calculated by the auditor for proper disclosure in client financial statements.
True False

9. The acquisition and payment cycle typically begins with the cash disbursement for requested raw materials.
True False

10. A major control benefit of a centralized purchasing department is the segregation of the authorization
function from the custody and recording functions.
True False

11. A purchase order identifies the quantity and description of products that have been received.
True False

12. For proper control, the receiving department should receive a copy of the purchase order that has the
quantities blanked out.
True False

13. An individual outside of the purchasing department should be the only individual with access to the vendor
tables in the database.
True False

14. The auditor's primary concern with accounts payable is that of existence.
True False

15. Reconciliation of vendor statements to recorded payables provides assurance related to the completeness
assertion.
True False

16. The auditor would most likely use attribute sampling to test transactions in the acquisition cycle for
timeliness of recording transactions.
True False
17. Open invoice files are reviewed subsequent to the year under audit in order to locate expenses that should be
reclassified on the income statement.
True False

18. The primary assertion to be tested on accounts payable is the existence assertion.
True False

19. The use of analytical review procedures applied to related expense accounts would not be used to determine
if accounts payable were understated.
True False

20. Analytical review of related expense accounts when auditing accounts payable would be used when control
risk is assessed as low.
True False

21. Testing cash disbursements subsequent to the year under audit allows the auditor to determine certain
payables that may not have been recorded previously.
True False

22. When auditing accounts payable, the auditor would most likely review a sample of cash disbursements
throughout the year end to determine whether disbursements for goods and services are applicable to the
subsequent year.
True False

23. The auditor tests significant repairs and maintenance expenses to ensure that an item that should be
capitalized has not been expensed.
True False

24. The lower of cost or market assumption is not important to valuation of inventory.
True False
25. Proper internal control over the inventory account would require that inventory items should be reviewed
for obsolescence and proper accounting treatment.
True False

26. Many frauds are committed by overstating inventory accounts.

True False

27. Inventory may become obsolete because of technological advances even though there are no signs of
physical wear and tear.
True False

28. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
True False

29. The auditor is required by GAAP to observe the taking of physical inventory.
True False

30. The inventory observation is performed for the purpose of determining the accuracy of client counting
procedures.
True False

31. Test counts are performed by the auditor to give the impression of control and they are not used for
substantive testing.
True False

32. The auditor is responsible to take a physical inventory at the client location on behalf of the audit client.
True False

33. The auditor may observe the counting of physical inventory throughout the year under audit if perpetual
inventory is used.
True False
34. Legal expenses are reviewed by auditors for possible litigation and related FAS 5 treatment.
True False

35. An auditor would review the direct labor costs charged to inventory when auditing a manufacturing
company.
True False

36. Quality control in the manufacturing process is an operational concern and does not apply to auditor
assessment of internal control.
True False

37. The auditor must test a manufacturing client's cost system to substantiate the valuation of a inventory.
True False

38. Inventory valuation tends to have complexity for manufacturing and merchandising companies because of
cost flow assumptions.
True False

39. Generally accepted auditing standards require the auditor to observe the taking of the physical inventory at
year-end.
True False

40. The acquisition cycle begins with the receipt of goods and services and ends with their payment as reflected
in cash disbursements.
True False

41. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
True False
42. In computerized purchase operations the computer matches three documents, the purchase order, the
receiving report, and the monthly statement, and if the three match within a prespecified tolerable limit, the
invoice is approved for payment.
True False

43. The tracing of a sample of receiving reports through the recording process tests the completeness assertion.
True False

44. In testing the reasonableness of expense accounts in auditing the acquisition cycle, when the auditor has
concluded that internal control risk is high the major substantive tests may be gathering evidence through
analytical procedures.
True False

45. In observing the client’s inventory at year-end the auditor makes test counts that are later traced into the
client’s inventory compilation.
True False

46. Audits of payables and related cash disbursements provide indirect evidence about the correctness of
expense accounts.
True False

47. The acquisition and payment process consists of each of the following phases except
A. receipts of goods and services.
B. approval of items for payment.
C. application of cash receipts.
D. authorized request for goods and services.

48. The acquisition and payment process consists of each of the following phases except
A. shipments of goods and services.
B. approval of items for payment.
C. cash disbursements.
D. authorized purchases of goods and services.
49. Purchasing is a separate function in many organizations due to all of the following rationale except which?
A. It promotes efficiency and effectiveness.
B. It eliminates potential favoritism.
C. It reduces the opportunity for fraud.
D. It decentralizes control.

50. When a purchasing agent benefits personally by accepting payment from a vendor, the purchasing agent is
guilty of
A. performing kiting.
B. committing embezzlement.
C. receiving kickbacks.
D. stealing company assets.

51. Reduction of the risk of understated payables can be accomplished by focusing on which assertion?
A. existence
B. rights
C. presentation and disclosure
D. completeness

52. Variations of the traditional purchase order include all of the following except
A. computer-generated purchase order
B. drop-shipment purchase order
C. supply-chain delivery contract
D. all of the above are variations

53. Which one of the following must the auditor best understand relative to the supply chain when auditing a
manufacturing company?
A. Contract terms, the method of recording and title transfer.
B. Efficiency of operations, purchasing agent compensation and disbursement.
C. Productivity of equipment, cost of capital, and maintenance schedules
D. Quality of scrap, point of sale and carrying costs.

54. Which one of the following control procedures would not apply to the automated receipt of goods?
A. defined procedures for counting the quantity of goods received
B. access, edit, and reasonableness controls built into the computerized accounting application
C. reconciliation of the purchaser's production data with the vendor's billing
D. a contract specifying terms of delivery, penalties, billing and payment terms, and a process for resolving
differences
55. The need for additional control procedures when using computer-generated purchase orders would be met
by
A. establishment of a maximum quantity limits that can be ordered within a given time period.
B. automated acceptance for high dollar levels.
C. purchase order copies sent by purchasing to receiving.
D. accounts payable department entering new vendors into the system.

56. Which of the following signals a potential fraud that may occur for the overstatement of inventory
accounts?
A. Reserves for contingencies are reducing rapidly.
B. Inventory amounts are growing faster than sales.
C. Repairs and maintenance accounts have significant credit entries.
D. The purchase of manufacturing equipment is occurring at a rapid rate.

57. Management may have incentive to fraudulently overstate inventory balances in order to cover up
A. understated cost of goods sold
B. poor financial performance
C. poor internal control
D. taxable income

58. What is the primary reason for management's ability to easily overvalue inventory without rapid detection
by auditors?
A. The limited volume of transactions in the inventory accounts.
B. The auditor's assessment of inventory as a low-risk area.
C. Complexity in the valuation of inventory.
D. Consideration by the auditor of non-financial indicators of inventory fraud.

59. Which of the following is an example of the type of analytics that an auditor would use for inventory?
A. Number of day's sales in receivables compared to industry averages.
B. Inventory turnover for the previous five years.
C. Number of obsolete units this period compared to last.
D. Salaries of marketing personnel as a percent of total inventory.

60. The benefit of a cross sectional analysis of inventory across multiple stores includes
A. Auditor identification of locations for detailed testing of inventory.
B. Auditor detail as to specific units by month.
C. Auditor conclusions regarding the fair presentation of obsolescence.
D. Auditor evidence of physical existence.
61. Receipt of materials for the production process bears a direct relationship to
A. recording of accounts payable.
B. vendor selection.
C. authorization of purchases.
D. obsolescence of inventory.

62. For testing the completeness assertion for accounts payable, the auditor would
A. examine a sample of cash disbursements made after year end to determine whether the disbursements were
for goods applicable to the previous year.
B. reconcile vendor's statements with the accounts receivable trial balance.
C. examine production equipment for useful lives.
D. gather purchase orders immediately previous to and subsequent to year-end.

63. The client's legal expenses should be examined to

A. compare with previously released attorney's letters.
B. determine the types of fraud occurring in the organization.
C. ensure proper recording of vendor payables.
D. determine if there is any litigation pending or threatened.

64. When auditing accounts payable, the greatest emphasis is placed on

A. the existence assertion.
B. the completeness assertion.
C. the presentation assertion.
D. the disclosure assertion.

65. An auditor may best test commissions expense for salespeople when control risk is low by performing:
A. Analytical procedures
B. Tagging and tracing
C. Alternative procedures.
D. Subsequent proof of cash.

66. An internal control benefit of centralized purchasing in an organization includes

A. separation of authorization from accounting.
B. favorite vendors used multiple times.
C. increased compensation of agents through side agreements.
D. mathematically accurate vendor invoices.
67. A primary feature of automated control in the acquisition cycle includes
A. that authorization is no longer required.
B. limits as to the number of items that can be received by the warehouse.
C. calculated order quantities based on set criteria.
D. funds transfer at the request of the controller.

68. Bar code scanning may best be utilized in the receiving process to
A. identify goods arriving automatically in conjunction with a count.
B. notify the shipper that product has arrived.
C. order new items on behalf of the purchasing department.
D. record inventory that has been written off the books.

69. When auditing expense accounts, which of the following would the auditor be least likely to subject to a
detailed test of transactions?
A. legal expense
B. utilities expense
C. repairs and maintenance expense
D. travel expense

70. Please indicate the proper sequence of the acquisition cycle:

1. Approval of items for payment.
2. Authorized requisition for goods or services.
3. Cash disbursements.
4. Receipt of goods and services.
5. Authorized purchase of goods or services.
A. 2, 5, 4, 1, 3
B. 2, 4, 5, 1, 3
C. 2, 1, 4, 5, 3
D. 2, 5, 1, 4, 3

71. Which one of the following accounts would an auditor most likely test by performing analytical
procedures?
A. Sales commissions expense.
B. Legal expenses.
C. Repairs and maintenance expense.
D. Travel expense.
72. Inventory is a complex accounting and auditing area due to all of the following except
A. diversity of items in inventory.
B. low volume of activity.
C. potential difficulty in classifying inventory.
D. difficulty in applying the lower of cost or market principle.

73. Inventory is a complex accounting and auditing area due to all of the following except
A. diversity of items in inventory.
B. high volume of activity.
C. potential difficulty in correctly valuing inventory.
D. ease in identifying obsolete inventory.

74. A risk to the auditor due to the complexity of physical inventory includes possible
A. overstatement of individual items across multiple locations for cutoff testing.
B. utility of the items exceeding their cost for existence testing.
C. movement of goods during existence testing.
D. stocking of only one type of inventory in the warehouse for presentation and disclosure testing.

75. A system of internal financial accounting controls for inventory would include all of the following except
A. authorization for all purchases.
B. proper accounting for receipt of inventory.
C. perpetual inventory system.
D. rapid introduction of new products without market studies.

76. When testing the existence assertion for inventory, the auditor would most likely
A. observe the client's count of the annual physical inventory and test count.
B. review vendor invoices for the amounts recorded.
C. perform year-end tests of invoices received in the final month.
D. trace raw material purchases to invoices and to the general ledger.

77. When testing the valuation assertion, the auditor would most likely
A. confirm inventory on consignment.
B. examine receiving reports for inventory, tracing them recorded amounts.
C. observe the taking of physical inventory.
D. perform price tests to the related cost flow assumption.
78. The auditor may discover that the recorded cost of inventory exceeds the designated market price when
testing which assertion?
A. Existence.
B. Cutoff.
C. Valuation.
D. Rights.

79. Which of the following procedures will usually be performed by the auditor to actively determine obsolete
inventory?
A. Confirmation of inventory with customers.
B. Footing the inventory subsidiary ledger.
C. Tracing inventory ordered by the client to receiving reports.
D. Analysis of inventory turnover and sales reports.

80. A perpetual inventory system is preferable to a periodic system if adequately controlled and maintained
because
A. it requires that a full inventory count be taken at year-end by all warehouse employees.
B. it allows management to calculate cost of goods sold at year end.
C. it provides information to management about inventory that approaches real-time.
D. it better controls the receipt of goods.

81. The auditor should perform all of the following procedures related to the physical inventory count except
A. Document the first and last tag numbers used
B. Take notations of all items that appear to be obsolete or are in questionable condition
C. Make counts of all items and record the counts for subsequent tracing into the client‘s inventory compilation
D. Observe whether there is any physical movement of goods during the counting of the inventory

82. The principle of lower of cost or market and the potential obsolescence of inventory are a concern for the
audit team as
A. they are uncommon and may not exist.
B. they are a burden to the auditor in the undue amount of work caused.
C. they are likely to occur in the last month of the year and cause cutoff problems.
D. they are an inherent component of complexity related to valuation.
83. The inventory of MegaMart Company is distributed between 85 stores throughout the United States, Puerto
Rico and Mexico. MegaMart has a calendar year-end, uses a periodic inventory system and performs a physical
count on January 1st of each year. In the planning of the audit of MegaMart, the engagement team must
consider
A. if the finance departments in Mexico and Puerto Rico are available to perform the audit testing on January
1st.
B. which of the stores to randomly visit and how many items to test.
C. the risk of the company transporting items from Maine to Mexico between audit counts.
D. coordinating with the client which stores will be visited for inventory observation.

84. When a check has been cut for payment to a vendor, the underlying documentation and the check should be
sent to which of the following for signature and cancellation?
A. controller
B. receptionist
C. treasurer
D. accounts payable supervisor

85. Which of the following types of analysis provides useful evidence of multi-location clients?
A. Multi-processing analysis
B. Cross-sectional analysis.
C. Stratification analysis.
D. Common-sized analysis.

86. Auditing the valuation assertion for inventory of a client utilizing the FIFO cost flow assumption will
require the auditor to examine
A. invoices representing the more recent purchases of inventory.
B. invoices representing the purchase of base year inventory in the year of inception.
C. shipping documents for a sample of cost of goods sold transactions during the year.
D. shipping documents for a sample of units on hand in the interim period.

87. The auditor in making inquiries regarding the standard cost systems normally does not make which of the
following inquiries?
A. the method for developing standard costs.
B. the method for identifying components of overhead and of allocating overhead to products.
C. the method for identifying sales cutoff.
D. the method used for identifying variances, following up on their causes, and allocating them to inventory and
cost of goods sold.
88. The acquisition cycle begins with a
A. payment.
B. purchase order.
C. requisition.
D. receiving report.

89. Which of the following is not a potential fraud indicator in the acquisition cycle?
A. expenses that are significantly above or below industry norms.
B. expense accounts that have significant debit entries.
C. payments made to senior officers in the form of loans that are subsequently forgiven.
D. capital assets that seem to be growing faster than the business.

90. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?
A. observe the client taking inventory.
B. make selected test counts and trace into client’s inventory compilation.
C. look for slow-moving, obsolete or damaged inventory.
D. review disclosure of inventory valuation.
E. all of the above are standard audit procedures in the observation of inventory.

91. All of the following are required by the auditor before allowing the client to take inventory before year-end
except which one?
A. absence of “red flags”.
B. internal control is weak.
C. the auditor can effectively test the year-end balance through a combination of analytical procedures and
selective testing of transactions between the physical count and the year-end.
D. the auditor reviews the intervening transactions for evidence of any manipulation or unusual activity.

92. In testing for the completeness of accounts payable at year-end the auditor examines a sample of paid
voucher packets
A. during the cut-off period at year-end.
B. during the last month of the fiscal year.
C. during the month subsequent to the fiscal year.
D. during the fiscal year.
93. Acquisition and payment processes

What are the five major phases of the acquisition and payment process?

94. Centralized purchasing

List the advantages for implementing a centralized purchasing function. What are the disadvantages (if any)?

95. Cost accounting systems

When auditing a manufacturing concern, what major inquiries might be made by the auditor about the cost
accounting system?
96. Preparing for an inventory observation

In the audit of inventory the auditor must perform important procedures prior to the actual observation. Identify
the steps the auditor must take prior to the day the inventory is actually counted.

97. Physical inventory procedures

Discuss the procedures that the audit team will most likely perform during a physical inventory at the client
locations.

98. Auditing accounts payable

What are the procedures available to auditors in auditing accounts payable and what level of assurance is
obtained by each? Describe at least three. Which primary assertion is tested through these approaches?
99. Automation in the acquisition cycle (comprehensive)

As the acquisition of materials, equipment and services continues to be facilitated by automation, certain
benefits and controls result. Discuss the use of computerized processes and specific controls that should be
implemented in the electronic acquisition cycle.

100. Inventory obsolescence procedures

Identify and describe at least four procedures the audit team may perform in order to determine potential
obsolescence of items in the inventory balances.

101. Inventory controls

What are some of the important controls that are expected to be included in a well-conceived inventory control
system?
102. Audit of expenses

Discuss how expenses are audited by the auditor.

Chapter 11: Audit of Acquisition and Payment Cycle and
Inventory Key

1. Inventory is complex and typically considered a high-risk area in audits of service firms.
FALSE

2. In order for the auditor to perform an engagement on a manufacturing firm, it is important that the entire
integrated process is understood.
TRUE

3. An indication of potential inventory fraud is that inventory levels are growing faster than sales.
TRUE

4. The acquisition process begins with a purchase of goods or services

FALSE

5. Supply chain management has helped many companies improve the efficiency of operations.
TRUE

6. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
TRUE

7. An auditor can utilize a cross-sectional analysis for a client operating in multiple locations to identify areas of
further inventory testing.
TRUE

8. Inventory turnover is often calculated by the auditor for proper disclosure in client financial statements.
FALSE
9. The acquisition and payment cycle typically begins with the cash disbursement for requested raw materials.
FALSE

10. A major control benefit of a centralized purchasing department is the segregation of the authorization
function from the custody and recording functions.
TRUE

11. A purchase order identifies the quantity and description of products that have been received.
FALSE

12. For proper control, the receiving department should receive a copy of the purchase order that has the
quantities blanked out.
TRUE

13. An individual outside of the purchasing department should be the only individual with access to the vendor
tables in the database.
TRUE

14. The auditor's primary concern with accounts payable is that of existence.
FALSE

15. Reconciliation of vendor statements to recorded payables provides assurance related to the completeness
assertion.
TRUE

16. The auditor would most likely use attribute sampling to test transactions in the acquisition cycle for
timeliness of recording transactions.
TRUE

17. Open invoice files are reviewed subsequent to the year under audit in order to locate expenses that should be
reclassified on the income statement.
FALSE
18. The primary assertion to be tested on accounts payable is the existence assertion.
FALSE

19. The use of analytical review procedures applied to related expense accounts would not be used to determine
if accounts payable were understated.
FALSE

20. Analytical review of related expense accounts when auditing accounts payable would be used when control
risk is assessed as low.
TRUE

21. Testing cash disbursements subsequent to the year under audit allows the auditor to determine certain
payables that may not have been recorded previously.
TRUE

22. When auditing accounts payable, the auditor would most likely review a sample of cash disbursements
throughout the year end to determine whether disbursements for goods and services are applicable to the
subsequent year.
FALSE

23. The auditor tests significant repairs and maintenance expenses to ensure that an item that should be
capitalized has not been expensed.
TRUE

24. The lower of cost or market assumption is not important to valuation of inventory.
FALSE

25. Proper internal control over the inventory account would require that inventory items should be reviewed
for obsolescence and proper accounting treatment.
TRUE

26. Many frauds are committed by overstating inventory accounts.

TRUE
27. Inventory may become obsolete because of technological advances even though there are no signs of
physical wear and tear.
TRUE

28. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
TRUE

29. The auditor is required by GAAP to observe the taking of physical inventory.
FALSE

30. The inventory observation is performed for the purpose of determining the accuracy of client counting
procedures.
TRUE

31. Test counts are performed by the auditor to give the impression of control and they are not used for
substantive testing.
FALSE

32. The auditor is responsible to take a physical inventory at the client location on behalf of the audit client.
FALSE

33. The auditor may observe the counting of physical inventory throughout the year under audit if perpetual
inventory is used.
TRUE

34. Legal expenses are reviewed by auditors for possible litigation and related FAS 5 treatment.
TRUE

35. An auditor would review the direct labor costs charged to inventory when auditing a manufacturing
company.
TRUE
36. Quality control in the manufacturing process is an operational concern and does not apply to auditor
assessment of internal control.
FALSE

37. The auditor must test a manufacturing client's cost system to substantiate the valuation of a inventory.
TRUE

38. Inventory valuation tends to have complexity for manufacturing and merchandising companies because of
cost flow assumptions.
TRUE

39. Generally accepted auditing standards require the auditor to observe the taking of the physical inventory at
year-end.
TRUE

40. The acquisition cycle begins with the receipt of goods and services and ends with their payment as reflected
in cash disbursements.
FALSE

41. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
TRUE

42. In computerized purchase operations the computer matches three documents, the purchase order, the
receiving report, and the monthly statement, and if the three match within a prespecified tolerable limit, the
invoice is approved for payment.
FALSE

43. The tracing of a sample of receiving reports through the recording process tests the completeness assertion.
TRUE
44. In testing the reasonableness of expense accounts in auditing the acquisition cycle, when the auditor has
concluded that internal control risk is high the major substantive tests may be gathering evidence through
analytical procedures.
FALSE

45. In observing the client’s inventory at year-end the auditor makes test counts that are later traced into the
client’s inventory compilation.
TRUE

46. Audits of payables and related cash disbursements provide indirect evidence about the correctness of
expense accounts.
TRUE

47. The acquisition and payment process consists of each of the following phases except
A. receipts of goods and services.
B. approval of items for payment.
C. application of cash receipts.
D. authorized request for goods and services.

48. The acquisition and payment process consists of each of the following phases except
A. shipments of goods and services.
B. approval of items for payment.
C. cash disbursements.
D. authorized purchases of goods and services.

49. Purchasing is a separate function in many organizations due to all of the following rationale except which?
A. It promotes efficiency and effectiveness.
B. It eliminates potential favoritism.
C. It reduces the opportunity for fraud.
D. It decentralizes control.

50. When a purchasing agent benefits personally by accepting payment from a vendor, the purchasing agent is
guilty of
A. performing kiting.
B. committing embezzlement.
C. receiving kickbacks.
D. stealing company assets.
51. Reduction of the risk of understated payables can be accomplished by focusing on which assertion?
A. existence
B. rights
C. presentation and disclosure
D. completeness

52. Variations of the traditional purchase order include all of the following except
A. computer-generated purchase order
B. drop-shipment purchase order
C. supply-chain delivery contract
D. all of the above are variations

53. Which one of the following must the auditor best understand relative to the supply chain when auditing a
manufacturing company?
A. Contract terms, the method of recording and title transfer.
B. Efficiency of operations, purchasing agent compensation and disbursement.
C. Productivity of equipment, cost of capital, and maintenance schedules
D. Quality of scrap, point of sale and carrying costs.

54. Which one of the following control procedures would not apply to the automated receipt of goods?
A. defined procedures for counting the quantity of goods received
B. access, edit, and reasonableness controls built into the computerized accounting application
C. reconciliation of the purchaser's production data with the vendor's billing
D. a contract specifying terms of delivery, penalties, billing and payment terms, and a process for resolving
differences

55. The need for additional control procedures when using computer-generated purchase orders would be met
by
A. establishment of a maximum quantity limits that can be ordered within a given time period.
B. automated acceptance for high dollar levels.
C. purchase order copies sent by purchasing to receiving.
D. accounts payable department entering new vendors into the system.

56. Which of the following signals a potential fraud that may occur for the overstatement of inventory
accounts?
A. Reserves for contingencies are reducing rapidly.
B. Inventory amounts are growing faster than sales.
C. Repairs and maintenance accounts have significant credit entries.
D. The purchase of manufacturing equipment is occurring at a rapid rate.
57. Management may have incentive to fraudulently overstate inventory balances in order to cover up
A. understated cost of goods sold
B. poor financial performance
C. poor internal control
D. taxable income

58. What is the primary reason for management's ability to easily overvalue inventory without rapid detection
by auditors?
A. The limited volume of transactions in the inventory accounts.
B. The auditor's assessment of inventory as a low-risk area.
C. Complexity in the valuation of inventory.
D. Consideration by the auditor of non-financial indicators of inventory fraud.

59. Which of the following is an example of the type of analytics that an auditor would use for inventory?
A. Number of day's sales in receivables compared to industry averages.
B. Inventory turnover for the previous five years.
C. Number of obsolete units this period compared to last.
D. Salaries of marketing personnel as a percent of total inventory.

60. The benefit of a cross sectional analysis of inventory across multiple stores includes
A. Auditor identification of locations for detailed testing of inventory.
B. Auditor detail as to specific units by month.
C. Auditor conclusions regarding the fair presentation of obsolescence.
D. Auditor evidence of physical existence.

61. Receipt of materials for the production process bears a direct relationship to
A. recording of accounts payable.
B. vendor selection.
C. authorization of purchases.
D. obsolescence of inventory.

62. For testing the completeness assertion for accounts payable, the auditor would
A. examine a sample of cash disbursements made after year end to determine whether the disbursements were
for goods applicable to the previous year.
B. reconcile vendor's statements with the accounts receivable trial balance.
C. examine production equipment for useful lives.
D. gather purchase orders immediately previous to and subsequent to year-end.
63. The client's legal expenses should be examined to
A. compare with previously released attorney's letters.
B. determine the types of fraud occurring in the organization.
C. ensure proper recording of vendor payables.
D. determine if there is any litigation pending or threatened.

64. When auditing accounts payable, the greatest emphasis is placed on

A. the existence assertion.
B. the completeness assertion.
C. the presentation assertion.
D. the disclosure assertion.

65. An auditor may best test commissions expense for salespeople when control risk is low by performing:
A. Analytical procedures
B. Tagging and tracing
C. Alternative procedures.
D. Subsequent proof of cash.

66. An internal control benefit of centralized purchasing in an organization includes

A. separation of authorization from accounting.
B. favorite vendors used multiple times.
C. increased compensation of agents through side agreements.
D. mathematically accurate vendor invoices.

67. A primary feature of automated control in the acquisition cycle includes

A. that authorization is no longer required.
B. limits as to the number of items that can be received by the warehouse.
C. calculated order quantities based on set criteria.
D. funds transfer at the request of the controller.

68. Bar code scanning may best be utilized in the receiving process to
A. identify goods arriving automatically in conjunction with a count.
B. notify the shipper that product has arrived.
C. order new items on behalf of the purchasing department.
D. record inventory that has been written off the books.
69. When auditing expense accounts, which of the following would the auditor be least likely to subject to a
detailed test of transactions?
A. legal expense
B. utilities expense
C. repairs and maintenance expense
D. travel expense

70. Please indicate the proper sequence of the acquisition cycle:

1. Approval of items for payment.
2. Authorized requisition for goods or services.
3. Cash disbursements.
4. Receipt of goods and services.
5. Authorized purchase of goods or services.
A. 2, 5, 4, 1, 3
B. 2, 4, 5, 1, 3
C. 2, 1, 4, 5, 3
D. 2, 5, 1, 4, 3

71. Which one of the following accounts would an auditor most likely test by performing analytical
procedures?
A. Sales commissions expense.
B. Legal expenses.
C. Repairs and maintenance expense.
D. Travel expense.

72. Inventory is a complex accounting and auditing area due to all of the following except
A. diversity of items in inventory.
B. low volume of activity.
C. potential difficulty in classifying inventory.
D. difficulty in applying the lower of cost or market principle.

73. Inventory is a complex accounting and auditing area due to all of the following except
A. diversity of items in inventory.
B. high volume of activity.
C. potential difficulty in correctly valuing inventory.
D. ease in identifying obsolete inventory.
74. A risk to the auditor due to the complexity of physical inventory includes possible
A. overstatement of individual items across multiple locations for cutoff testing.
B. utility of the items exceeding their cost for existence testing.
C. movement of goods during existence testing.
D. stocking of only one type of inventory in the warehouse for presentation and disclosure testing.

75. A system of internal financial accounting controls for inventory would include all of the following except
A. authorization for all purchases.
B. proper accounting for receipt of inventory.
C. perpetual inventory system.
D. rapid introduction of new products without market studies.

76. When testing the existence assertion for inventory, the auditor would most likely
A. observe the client's count of the annual physical inventory and test count.
B. review vendor invoices for the amounts recorded.
C. perform year-end tests of invoices received in the final month.
D. trace raw material purchases to invoices and to the general ledger.

77. When testing the valuation assertion, the auditor would most likely
A. confirm inventory on consignment.
B. examine receiving reports for inventory, tracing them recorded amounts.
C. observe the taking of physical inventory.
D. perform price tests to the related cost flow assumption.

78. The auditor may discover that the recorded cost of inventory exceeds the designated market price when
testing which assertion?
A. Existence.
B. Cutoff.
C. Valuation.
D. Rights.

79. Which of the following procedures will usually be performed by the auditor to actively determine obsolete
inventory?
A. Confirmation of inventory with customers.
B. Footing the inventory subsidiary ledger.
C. Tracing inventory ordered by the client to receiving reports.
D. Analysis of inventory turnover and sales reports.
80. A perpetual inventory system is preferable to a periodic system if adequately controlled and maintained
because
A. it requires that a full inventory count be taken at year-end by all warehouse employees.
B. it allows management to calculate cost of goods sold at year end.
C. it provides information to management about inventory that approaches real-time.
D. it better controls the receipt of goods.

81. The auditor should perform all of the following procedures related to the physical inventory count except
A. Document the first and last tag numbers used
B. Take notations of all items that appear to be obsolete or are in questionable condition
C. Make counts of all items and record the counts for subsequent tracing into the client‘s inventory compilation
D. Observe whether there is any physical movement of goods during the counting of the inventory

82. The principle of lower of cost or market and the potential obsolescence of inventory are a concern for the
audit team as
A. they are uncommon and may not exist.
B. they are a burden to the auditor in the undue amount of work caused.
C. they are likely to occur in the last month of the year and cause cutoff problems.
D. they are an inherent component of complexity related to valuation.

83. The inventory of MegaMart Company is distributed between 85 stores throughout the United States, Puerto
Rico and Mexico. MegaMart has a calendar year-end, uses a periodic inventory system and performs a physical
count on January 1st of each year. In the planning of the audit of MegaMart, the engagement team must
consider
A. if the finance departments in Mexico and Puerto Rico are available to perform the audit testing on January
1st.
B. which of the stores to randomly visit and how many items to test.
C. the risk of the company transporting items from Maine to Mexico between audit counts.
D. coordinating with the client which stores will be visited for inventory observation.

84. When a check has been cut for payment to a vendor, the underlying documentation and the check should be
sent to which of the following for signature and cancellation?
A. controller
B. receptionist
C. treasurer
D. accounts payable supervisor
85. Which of the following types of analysis provides useful evidence of multi-location clients?
A. Multi-processing analysis
B. Cross-sectional analysis.
C. Stratification analysis.
D. Common-sized analysis.

86. Auditing the valuation assertion for inventory of a client utilizing the FIFO cost flow assumption will
require the auditor to examine
A. invoices representing the more recent purchases of inventory.
B. invoices representing the purchase of base year inventory in the year of inception.
C. shipping documents for a sample of cost of goods sold transactions during the year.
D. shipping documents for a sample of units on hand in the interim period.

87. The auditor in making inquiries regarding the standard cost systems normally does not make which of the
following inquiries?
A. the method for developing standard costs.
B. the method for identifying components of overhead and of allocating overhead to products.
C. the method for identifying sales cutoff.
D. the method used for identifying variances, following up on their causes, and allocating them to inventory and
cost of goods sold.

88. The acquisition cycle begins with a

A. payment.
B. purchase order.
C. requisition.
D. receiving report.

89. Which of the following is not a potential fraud indicator in the acquisition cycle?
A. expenses that are significantly above or below industry norms.
B. expense accounts that have significant debit entries.
C. payments made to senior officers in the form of loans that are subsequently forgiven.
D. capital assets that seem to be growing faster than the business.
90. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?
A. observe the client taking inventory.
B. make selected test counts and trace into client’s inventory compilation.
C. look for slow-moving, obsolete or damaged inventory.
D. review disclosure of inventory valuation.
E. all of the above are standard audit procedures in the observation of inventory.

91. All of the following are required by the auditor before allowing the client to take inventory before year-end
except which one?
A. absence of “red flags”.
B. internal control is weak.
C. the auditor can effectively test the year-end balance through a combination of analytical procedures and
selective testing of transactions between the physical count and the year-end.
D. the auditor reviews the intervening transactions for evidence of any manipulation or unusual activity.

92. In testing for the completeness of accounts payable at year-end the auditor examines a sample of paid
voucher packets
A. during the cut-off period at year-end.
B. during the last month of the fiscal year.
C. during the month subsequent to the fiscal year.
D. during the fiscal year.

93. Acquisition and payment processes

What are the five major phases of the acquisition and payment process?

The five phases of the acquisition and payment process are:

1. Requisition for goods or services.

2. Purchase of goods or services according to company policies.

3. Receipt of goods and services.

4. Approval of items for payment.

5. cash disbursements.
94. Centralized purchasing

List the advantages for implementing a centralized purchasing function. What are the disadvantages (if any)?

The advantages for creating a separate purchasing function include the following:

· promotes efficiency and effectiveness.

· eliminates potential favoritism that could take place if individual department heads were allowed to place orders.

· reduces the opportunity for fraud by segregating the authorization to purchase from the custody and recording functions.

· centralizes control in one function.

The possible disadvantages include:

· Potential kickbacks to agents from vendors and suppliers.

· Variations from traditional purchase orders.

95. Cost accounting systems

When auditing a manufacturing concern, what major inquiries might be made by the auditor about the cost
accounting system?

An auditor would be likely to make the following inquiries about a cost accounting system used by a
manufacturing concern:

· the method for developing standards costs

· how recently the standards have been updated

· the method for identifying components of overhead and allocating overhead to products.

· the methods used for identifying variances, following up on their causes, and allocating them to inventory and cost of goods sold.
96. Preparing for an inventory observation

In the audit of inventory the auditor must perform important procedures prior to the actual observation. Identify
the steps the auditor must take prior to the day the inventory is actually counted.

Prior to inventory-taking day the auditor should:

· meet with the client to discuss procedures, timing, location, and personnel involved in the taking of inventory.

· review the client's plans for counting and tagging inventory items; determine that the procedures are sufficient to ensure an accurate
inventory.

· review the inventory taking procedures with all audit personnel; familiarize them with the nature of the inventory, potential problems, and
any other information they may need.

· determine whether specialists are needed to identify, test, or assist in correctly identifying inventory items.

· observe the counting of inventory

· document your conclusion as to the quality of the client’s inventory-taking process

97. Physical inventory procedures

Discuss the procedures that the audit team will most likely perform during a physical inventory at the client
locations.

When performing physical inventory procedures at the client locations, the audit team will most likely:

· observe client counting procedures for accuracy and completeness.

· walk the inventory areas to become familiar with the inventory that is existing at the location.

· check the first and last tag number used in the section.

· account for all tag numbers and determine the disposition of all tag numbers in the sequence.

· sample items from the inventory and perform test counts.

· note items that appear to be obsolete.

· list all large dollar-value inventory items on the working paper.

· note movement of inventory items into or out of the company during the process of inventory taking and that the goods are properly
counted.
98. Auditing accounts payable

What are the procedures available to auditors in auditing accounts payable and what level of assurance is
obtained by each? Describe at least three. Which primary assertion is tested through these approaches?

When auditing accounts payable, the auditor may:

1. Reconcile vendor statements or returned confirmations with recorded payables. This yields a higher level of assurance.
2. Test subsequent disbursements for proper recording as a payable as of either the balance sheet date under audit or in the subsequent
period, as appropriate. This yields a moderate level of assurance.

3. Analytical review of related expense accounts to determine which accounts appear to be understated. This yields a very low level of
assurance and should only be used where control risk and fraud risk are assessed as low for payables.

The primary assertion tested using the three approaches above is that of completeness.
99. Automation in the acquisition cycle (comprehensive)

As the acquisition of materials, equipment and services continues to be facilitated by automation, certain
benefits and controls result. Discuss the use of computerized processes and specific controls that should be
implemented in the electronic acquisition cycle.

Automated Acquisition of Goods and Services

Though purchase orders continue to exist as electronic forms, other means of automatic ordering are becoming
more evident. Where the authorization of purchases historically occurred through manual signature on pre-
configured forms, this authorization becomes replaced with electronic, authenticated authorization. This
authorization may take place in an application by a purchasing supervisor digitally signing a transaction or
automatically with the evidence of a standing contract.

In automated systems, purchase orders are often transmitted electronically to vendors or reorder points signal an
automatic requisition request from suppliers.

Receiving reporting becomes computerized as well through the use of bar code scanners and database
management systems that facilitate data input for goods received at the warehouse. In certain just-in-time
situations, evidence of receipt may occur through a seamless production cycle or a finished product. This is in
place of a formal receiving process.

The recording of payables takes place after an electronic match of authorized requisition (order), and proper
receipt of goods ordered. Payment typically occurs once these two items are then matched with either a manual
or electronic invoice obtained from the vendor and the system determines timing for discounts. Check signing is
automated through the electronic printing of the treasurer's signature on the check as it is prepared or electronic
funds transfers are initiated by the system.

Automated Controls

Restricted Access - All aspects of the system should be controlled by access control lists that are set-up through
careful consideration of roles related to segregated duties. Purchasing agents become the authorization function
and should be separated from accounts payable, which records the transaction, from receiving, which has
custody of inventory and from the treasury, which has custody of cash disbursements. Each of these functions
must be separated from each other in the database and network as well as the modification of the vendor tables.
Such access must also be implemented using proper authentication techniques relating to usernames and
passwords.

Monitoring - Reports should be automatically generated through the interface or in a report to appropriate
parties for resolution. An example of this include resolution of differences between vendor invoicing and
quantities received or agreed upon pricing. Additionally, internal auditing should test for duplicate payments
and fraudulent payments using data extraction techniques.

Other automated controls -

Self-checking digits for approved vendor identification numbers and inventory SKUs.
Edit tests for data input relating to purchasing dollar and quantity limits.
Edit tests for other validity and reasonableness testing.
100. Inventory obsolescence procedures

Identify and describe at least four procedures the audit team may perform in order to determine potential
obsolescence of items in the inventory balances.

Below are seven audit procedures that may be performed by the audit team for determining obsolete inventory
items:

1. Noting potential obsolete inventory when observing the client’s physical inventory

2. Calculating inventory turnover, number of days’ sales in inventory, date of last sale or purchase, and other similar analytic techniques
to identify potential obsolescence

3. Calculating net realizable value for products by referring to current selling prices, cost of disposal, sales commissions, and so on

4. Monitoring trade journals and the Internet for information regarding the introduction of competitive products

5. Inquiring of management about its approach to identifying and classifying obsolete items

6. Calculate turnover and report items with unusually slow turnover.

7. Age inventory and develop a report on inventory that has not been used or sold for an extended period of time.
101. Inventory controls

What are some of the important controls that are expected to be included in a well-conceived inventory control
system?

A well-conceived inventory control system should ensure the following:

All purchases are authorized.

There is a timely, accurate, and complete recording of inventory transactions.

Receipt of inventory is properly accounted for and independently tested.

Costs are properly identified and assigned to products; variances are analyzed,

investigated and properly allocated to inventory and cost of goods sold.

A perpetual inventory system serves as the basis for management’s reports and

assists in managing inventory.

Products are systematically reviewed for obsolescence, and appropriate accounting

action is taken.

Inventory is periodically reviewed by management and appropriate action taken for

excess inventory and technological obsolescence.

Market studies and quality control tests are ran before new products are introduced.

Long-term contracts are closely monitored.

102. Audit of expenses

Discuss how expenses are audited by the auditor.

The audit of payables and related cash disbursements provides indirect evidence about the correctness of
expense accounts. If the tests of controls of the acquisition and disbursement cycle indicates that the controls are
working properly and there is not a problem, then normally the auditor uses analytics in evaluating the
reasonableness of expense balances. Some additional analysis of selected expense accounts is also performed,
e.g., travel and entertainment expense, legal expense, and repairs and maintenance expense because of the
particular risks associated with those particular accounts. Underlying documentation should be examined on a
sampling basis to determine the appropriateness and correctness of transactions in those accounts. Some
expenses are connected to assets, e.g., property, plant and equipment and prepaid insurance, and are analyzed as
part of the work on that account. Other expenses are analyzed as part to the analysis of an important component
of the audit, e.g., income taxes or the pension plan of the client.

When evaluating evidence regarding expense accounts, the auditor should consider that management is more
likely to (1) understate rather than overstate expenses, and (2) classify expense items as assets rather than vice-
versa. Tests should be performed to identify all credits to expense accounts because these credits might indicate
inappropriate transfer of costs to asset accounts.