Chapter 11 - Substantive Test of Inventories and Cost of Sales CHAPTER 11 SUBSTANTIVE TEST OF INVENTORIES AND Cosy OF SALES —o Se TOPIC OVERVIEW: This chapter discusses the audit of inventories and cost sales, its objectives and procedures as well as the management assertions relating t) inventories and cost of sales. LEARNING OBJECTIVES: aes studying this chapter, you should be able to: Identify the audit objectives for inventories, cost of sales and relate accounts. 2. Describe the primary substantive audit procedures for inventories, cos of sales and related accounts. 3, Identify assertions addressed by audit procedures for inventories, cost of sales and related accounts. Introduction Inventories are one of the significant portions of entities current assets, especially for those entities in the manufacturing, servicing and trading industry. For some entities, special audit consideration should be applied for those companies with certain specialized nature of inventories (eg, oil and gas or precious metals). The audit of inventories presents the auditors with significant risk because: 1. they often represent a very substantial portion of current assets; 2. numerous valuation methods are used for inventories; 3. the valuation of inventories directly affects cost of goods sold; and 4. the determination of inventory quality, condition, and value is inherently complex. The nature, timing and extent of the substantive audit procedures for inventories depends, to a great extent, on the sophistication of the entity's inventory and cost of sales application, the effectiveness of controls over the application and the reasonableness of the applicable accounting estimation and non-routine data processes (e.g., the processes for determining any write-downs to net realizable value and for compiling the physical inventory, respectively). Other significant factors affecting the nature, timing and extent of our inventory procedures include: 1, The accounting methods used (e.g,, actual or standard costs; first-iD, first-out (“FIFO”) or average costs); 2. The locations, types and condition of the inventory; 3. The entity's physical inventory procedures; and 342| Chapter 11 - Substantive Test of Inventories and Cost of Sales | 4, Economic conditions, especially those that affect the entity's ability to sell the inventory at a profit. Because of the close relationship between inventory and cost of sales, the two can best be considered jointly. The auditor also should examine the i purchase and accounts payable at the same time with the examination of i inventory and cost of sales. Audit Objectives When auditing inventories and cost of sales, the principal objective for the substantive tests is to determine the following: Assertion Category Account Balances Audit Objectives Existence or All inventories included on the SFP are held by the Occurrence entity or by others for the entity and purchases | | (cost of sales) have really occurred and pertain to the entity. All inventories owned by the entity at the reporting date are included on the SFP and all cost of sales is included in the SCI. | | | Completeness Purchases (cost of sales) have been recorded in the proper accounting period. Valuation and Inventories are carried at the lower of cost and net ‘Allocation realizable value ("NRV’). Rights and The entity owns, or has a legal right to, all the Obligations inventories reported on the SEP. Presentation and Inventories are properly classified, described and pariosare disclosed in the financial statements, including & notes, in accordance with the applicable PFRSs. | Classification Pledged inventories are properly disclosed. | ‘audit Procedures for Inventories and Cost of Sales | ‘The auditor's primary substantive procedures for inventory balances and | pst of sales / cost of goods sold typically include the following: i +o observing inventory count and performing test counts; 3 Reconciling inventory summary sheet with general ledger; 3 Confirming inventories held by others; \ 4, Performing purchases and inventory cut-off; | © Checking appropriate valuation in accordance with accounting | policies: , \ 6, performing lower of cost or net realizable value test; | Fetermining whether any inventories have been pledged and reviewing purchase commitment; and performing test of details on cost of goods sold | Performing analytical procedures. i 343 peChapter 11 - Substantive Test of Inventories and Cost of Sales : Audit procedures presented in this textbook merely illustrate 1 procedures (i.e., primary substantive procedures) for audits of ‘merch ‘al OU and manufacturing entities. It is also primarily designed sop ging corporation; however, some discussions are made for partnership ail’ proprietorship businesses. In actual practice, audit programs must ben eA to each client's risk and internal control. The audit procedures cop "re audit programs may substantially vary from engagement to the next. "ising Assertions mentioned in this textbook relate to primary assertion addy, the audit procedures discussed. However, some other assertions may at addressed. 0 be Observation during inventory count and test counts PrimaryAudit] In the audit of inventories, auditors are Primary Objectives: _| concerned about the existence assertion, that jn" Bistence possibilty of overstatement of year-end balances, He Completeness | the substantive procedures to verify the exten nee inventory is by observation of inventory eguye Valuation required by PSA 501 (Redrafted) Audit Evidence gy Cutoff Considerations for Selected tems. Attendance atte inventory count can provide evidence about the inventories and can al enhance the auditor's understanding of the entity's business by providing opportunity to observe the production process and/or business locations first hand and provide evidence in relation to: 1, Design and operation of the entity's accounting and control systems, 2. Completeness and valuation of inventories; and % 3. Cutoff for recording inventories inwards and outwards and the resultant impact on the measurement of revenues and costs, Management's responsibility - inventory count Whether the company is using perpetual or periodic inventory system inventory count is an essential internal control. Inventory count is normally conducted at year-end but the company may decide to conduct count before year-end. To have an efficient and effective inventory count, managements responsible for careful advance planning, conducting and supervising the inventory count. This is normally documented in the inventory count instruction. Auditor's responsibility - inventory count The auditor should first obtain and understand the inventory count instruction of the client to determine the personnel needed as well a strategy to be implemented during the count. The auditor then will obsene the inventory count, perform test counts and test the reliability of the entity's counting records and procedures. Observation may include ensuring whether: 344Chapter 11 - Substantive Test of Inventories and Cost of Sales 1, Client's employees are complying with the written inventory count instructions; 2. Items belonging to the audit client are accurately counted and recorded; 3, Items to be excluded from inventory (obsolete items, non-inventory items, items owned by others) are either subject to satisfactory control and excluded from the counting process or are accurately counted and recorded, including a clear description of their non- inventory status; 4, Proper cutoff has been established; and 5. Count tags, sheets or cards are properly controlled. During the inventory observation, the auditors should make test counts of selected inventory items and trace it to the inventory count sheet. If there is a discrepancy between the number of items counted and the inventory count sheet, the auditor will normally perform re-count and any errors are resolved with the client. ‘The auditor then will trace the physical inventory to the inventory summary sheet (inventory compilation). The items normally traced is confined to the test counts made, but the auditor may include other items for tracing. Note that for some companies with inventories of a specialized in nature and in-process inventories, the auditor may engage an expert to assist in observing inventory count and performing test counts. Also, because of the impact of COVID-19 in which physical distancing and travel restrictions are in effect, some auditors conduct the observation of the count virtually. Inventory verification when the auditor is engaged after the count In some instances, the auditor may be engaged after the inventory count has been completed and therefore find it impossible to observe the taking of inventory count. Under these circumstances, the auditor performs alternative procedure in lieu of the observation of inventory count such as: 1, Examining internal control on inventories; 2. Examining the availability of instructions and other records showing the client had carried out a well-planned inventory count; 3. Performing test counts on some items considered material and significant and perform roll-backwards for the in-and-out of inventories after the count; and 4. Other procedures that the auditor thinks feasible and necessary. Confirmation of Inventories Held by Others Primary Audit | Some of the inventories owned by the client held by third Objectives: _| parties include: Existence 1. Inventory stored in a warehousing logistic Rights 5 Completeness_| COMPANY: 345Chapter 11 - Substantive Test of Inventories and Cost of Sales 2. Inventories out on consignment; and 3. Inventory held by suppliers (i.e., control to the inventory has passeq to the entity prior to delivery). If the inventory held by third parties is significant and the confirmation can be relied upon, a confirmation letter is sent to the custodian requesting: 1. Details of inventory on hand at the count date (product descriptions, quantities, damaged stock); and 2. Details of the last receipt/shipment as at the count date and for several days prior to and after count date. When confirmation replies are not received, the auditor should generally follow up through email or a telephone call to illicit replies. If confirmation — is still not received or cannot be relied upon, the auditor should perform alternative verification of the existence of such inventory. These procedures include: 1. Inspection of: a. Shipping documents; b. Receipts from logistic companies; c. Reports of and payments for subsequent consignment sales; and d. Correspondence with the third party. 2. Consideration of whether a physical inspection of the inventory is required. ‘The auditor may consider visiting the third party and observing the physical counts of inventories held by others if it is considered material. Year-end Inventory/Purchase Cutoff Primary Audit] The auditor performs cutoff procedures on the cutoff Objectives: _| information obtained at the inventory count to: Existence 1. Check that the inventory transactions are Oceurenee) recorded in the general ledger or perpetual records in the Completeness : correct period; and 2. To determine that inventories are not double-counted or missed due to movements within the plant/warehouse or movement between entity branches or other parties. Common purchase cutoff concern is: 1. Shipments received but purchase invoice received in the next period and 2. Purchase invoice received but merchandise received in the subsequent period, ‘The cutoff procedures may consist of: 1. Examining a sample of receiving reports for inventory receipts immediately before and after the inventory count to check whether it is recorded in the correct accounting period; and 346chapter 11 - Substantive Test of Inventories and Cost of Sales 2, Examining a sample of shipping documents for shipments immediately prior to and subsequent to the count to check whether it is recorded in the correct accounting period. Note that this procedure may be performed in conjunction with the sales cut- off: Exhibit 1: Purchase (Inventory) Cut-off Purchase (Inventory) Cut-off Client; Enbeen Toory Reference: MIO1 Period end: December 31, 2021 Purchase Reg tear ere Soi] Description Goodsin before December31 297444-C 1434410 40,000 Pampers 120e€21 MLL 917897447 1434406 5000 Table napkin 30Decz21 M21 ‘AATIASO 1434408 35000 Tissue 30Dee21 MOB 017887453 14344039850 Tissue2 24De€21 MOB DA-87456 143439914530 Pockettssue 29Dec21 MLIG 17907459 142435016450 Colorlesstissue ——-22Dee21 MLI7 Goodsin alter December 31 a07445-¢ 1434415 6900 Transparenttissue _3Jan22 MLI9 817887469 1434423450 Pockottissue ‘3Jan22 MLA9b 317560 1434431 900 Cotton ‘4Jan22 MLA9e 817087491 44344391450 Cottonballs ‘Janz MLI94 Lege ‘Traced to goods receipt and commercial invoice Reconciliation of Inventory Summary Sheet with General Ledger Primary Audit ] Once physical inventories are counted and valued, the Objectives: entity adjusts their accounting records to reflect actual Accuracy inventories held. Differences between accounting records Completeness _| and the physical amount are closed to Cost of Sales / Cost of Goods Sold account. The review of the reconciliation of the inventory summary sheet (physical inventory compilation) with the general ledger generally consists of: 1. Footing the reconciliation; 2. Reconciling the book and physical inventory figures to the compilation and uncorrected general ledger, respectively; 3. Investigating significant differences between book and physical inventories; Reviewing the nature of reconciling items; . Agreeing reconciling items to the supporting working papers, adjusting journal entries and the general ledger; and se 347Chapter 11 - Substantive Test of Inventories and Cost of Sales 6. Verifying that an accrual for inventory received prior to the count date, but not billed, was included in books. : Valuation in Accordance with Accounting Policies Primary Audit ] The auditor should test the valuation of inventory to tices verify that it is performed in accordance with the client's Accuracy accounting policies and applicable —PFRSs. The Presentation | investigation of inventory valuation often will emphasize and Disclosure _| the following three questions: 1. What method of valuation does the client use? 2. Is the method of valuation the same as that used in prior years? 3. Has the method selected by the client been applied consistently and accurately in practice? For the first question - the method of valuation - PAS 2 Inventories generally prescribes lower of cost or net realizable value (LCNRV), but a company who is commodity broker may use fair value less cost to sell. The cost method general includes many diverse systems, such as first-in first-out (FIFO), weighted average, specific identification and standard cost. The second question concerns a change in method of valuing inventory from one year to the next, for example, a change to or from FIFO to Average. The auditor should ensure that the change is appropriately accounted in accordance with PAS 08 Accounting Policies, Changes in Accounting Estimates and Errors. The third question deals with consistent application in practice of the method of valuation adopted by the client. To answer this question, the auditor will perform test on the valuation by performing the following: 1. Raw Materials - this is usually verified with the purchase invoice. 2. Work in Process & Finished Goods ~ the cost of these two items is traced to the cost accounting records. Items with large total value are normally selected for testing. Lower of Cost or Net Realizable Value Test Primary Audit | As a general rule, inventories should be carried at lower |_Objectives:_| of cost or net realizable value (NRV). Lower of cost or Valuation NRV test generally involves comparing the recorded amount of sample inventory with its NRV. NRV is the estimated selling price less reasonably predictable costs of completion and disposal. To verify the NRV of inventories, the following should be observed: 1. Finished Goods - the NRV of finished goods generally is based on the selling prices evidenced by sales subsequent to the reporting, by the entity's catalogues or price lists or by customers’ contracts less any estimated cost to dispose the item. 348chapter 11 - Substantive Test of Inventories and Cost of Sales 2. Work-in-Process - the NRV of work-in-process generally is based on the selling prices evidenced by sales subsequent to the reporting, by the entity's catalogues or price lists or by customers’ contracts less any estimated cost to complete and dispose the item. 3, Raw Materials - the NRV of raw materials is generally based on the replacement cost (by purchase or reproduction) less any estimated cost to complete and dispose the item. Note that raw materials are no longer subjected to lower of cost or NRV test if the net realizable of the resulting finished goods in which the raw materials will be incorporated exceeds its cost. ‘The auditor should verify whether any write-down to net realizable value and reversal of write-down (if any) is charged to expense (ie, cost of goods sold) in accordance with PAS 02 Inventories. Determine Whether Any Inventories Have Been Pledged and Review Purchase Commitment Primary Audit | The auditor should verify whether any inventories have Objectives: _| been pledged or subjected to a lien of any kind. Pledging Valuation of inventories to secure bank loans may brought to light Presentation ought t vreniisclosure | When bank balances are confirmed (see discussions on Chapter 07 Substantive Test of Cash). ‘The auditor should also check for any existing purchase commitment and check the commitment price as against the market value or NRV of the inventory at year-end as the entity may be required to make a provision regarding the fall of the market value compared with the commitment price. Perform Test of Details on Cost of Goods Sold Primary Audit | In the audit of cost of goods sold, the auditor commonly soulestives performs an examination of recorded cost of sales jecurrence 7 < u ‘ transactions di nm Accuracy s during the period under audit. To perfo Cutoff this test, the auditor requests for the related cost of sales Classification | information (eg, cost of sales subsidiary ledger, cost of “sales. transaction detail) and reconciles it with @ corresponding accounting record depending on the understanding of the inventory transaction cycle of the audit client. Examples of corresponding accounting records would be: 1. Corresponding credits in inventory accounts for the audit period 2. Corresponding sale transaction Note: The above related accounting records should only be used if the results of the procedures to understand the entity and its environment indicate that it is appropriate to relate the cost of goods sold to corresponding reliefs of inventory or corresponding sales transactions. 349Chapter 11 - Substantive Test of Inventories and Cost of Sales After reconciliation of the recorded cost of sales to the corresponding accounting record, the auditor divides the recorded cost of sales into two sets of population based on total debits and total credits. To perform the test, the following audit procedures may be done: 1. The auditor makes audit selections on total debits and total credits to cost of goods sold account that are recorded in the general ledger during the period under audit. 2. To validate the correctness of the items selected on Step 1, the auditor obtains audit evidences such as purchase orders, vendor invoices, shipping documents and/or proof of payments. 3. Vouch the details of selections on Step 1 to the appropriate details as evidenced by documents obtained on Step 2. a. Determine if the appropriate general ledger account was used by inspecting the material description on the purchase order. b. Determine if the accurate amount was recorded based on the vendor invoice obtained. c. Determine if the recorded cost of sales pertains to the entity by checking the shipping support and evaluating when the title to the goods were transferred, d. Determine if the cost was valid by checking the proof of payment. The procedures above mainly relate to an audit of cost of goods sold of a merchandising entity. For manufacturing entities, test of details for the labor component of cost of goods sold may also be performed. To perform the test, the following audit procedures may be done: 1. The auditor makes audit selections on total debits and total credits to cost of goods sold (labor) account that are recorded in the general ledger during the period under audit. 2. Obtain the employee time card and support for labor rate (e.g, labor rate screenshots, employee pay stub, etc.). 3. Compare the selected amount on Step 1 to the corresponding employee time card and verify if the correct number of hours were charged to the correct time period. 4, Recalculate the correct amount of labor charge by using the labor rate obtained on Step 2 and hours charged that were obtained on Step 3. 5. Compare the recalculated amount on Step 4 to the amount recorded as selected on Step 1. 6. Evaluate and conclude on whether material misstatements are present on the account. 350chapter 11 ~ Substantive Test of Inventories and Cost of Sales ical Procedures analytical reasonableness of Existence occurrence Material misstatements of inventory may be disclosed by procedures designed to establish the inventory figures. The auditor after identifying any significant deviations from expectations should investigate any differences. sme following are some examples of analytical procedures using financial mation: info - ‘Analytical Procedure Possible Misstatement Compare gross margin percentage with that of previous years. Compare inventory turnover (cost of goods sold divided by average inventory) with that of previous ears. Overstatement and understatement of inventory and cost of goods sold. Obsolete inventory. Overstatement or understatement of inventory. Compare unit costs of inventory with those of previous years. Overstatement or understatement of unit costs. Compare extended value with that of previous years. Misstatements in compilation, unit costs or extensions. Compare current year manufacturing costs with those of previous years (variable costs should be adjusted for changes in volume). Misstatement of unit costs of inventory, especially direct labor and manufacturing overhead. ‘The auditor may also use non-financial information in performing analytical procedures such as using inventory per square foot, or production statistics such as direct labor hours and machine hours. It may be clarified that the foregoing is only an illustrative list of analytical review procedures which an auditor may employ in carrying out an audit of inventories, cost of sales and other related accounts. The exact nature of analytical review procedures to be applied in a specific situation is a matter of professional judgment of the auditor. 351stantive test of I inventories and Cost of Sales ter 11 - Subs " ' Chapt ait rocedures classified per assertion Summary of aue™ “Applicable to Inventory Existence Primary audit procedures 7 Inventory count observation and test counts v Confirmation of inventories held by others | ¥_ Year-end inventory (purchase) cutoff Y Perform analytical procedures rentory count observation and test counts Vv Completeness Y ecaemation of inventories held by others » Reconciliation of inventory summary sheet with general ledger v Year-end inventory (purchase) cutoff Y Perform analytical procedures 5 7 Inventory count observation and test counts Valuation sae Y Valuation in accordance with accounting policies ¥__Lower of cost or net realizable value test v Review for pledged inventory and for any purchase commitment Rights and v Inventory count observation and test counts Obligations ¥ Confirmation of inventories held by others Presentation and Y Valuation in accordance with accounting Disclosure policies Y Review for pledged inventory and for any purchase commitment Applicable to Cost of Sales / Purchases ‘Assertion Category Primary audit procedures Occurrence v Year-end inventory (purchase) cutoff Y Perform analytical procedures ¥_ Test of details Accuracy Y Reconciliation of inventory summary sheet with general ledger ” Valuation in accordance with accounting policies Cutolf < Test of details ¥ Year-end inventory (purchase) cutoff Classification ¥_ Test of details Test of details 352wr cuastet 11 - Substantive Test of Inventories and Cost of Sales HAPTER. 11: REVIEW QUESTIONS - THEORETICAL what is the most likely course of action that an auditor would take after | determining that performing substantive tests on inventory will take less | time than performing tests of controls? i. Assess control risk at a low level | p. Perform both tests of controls and substantive tests on inventory. ¢__ Perform only substantive tests on inventory. 4, Perform only tests of controls on inventory. | which of the following is not one of the independent auditor's objectives 2 regarding the examination of inventories? | a, Verifying that inventory counted is owned by the client. | b. Verifying that the client has used proper inventory pricing. | ¢,Ascertaining the physical quantities of inventory on hand. \ d._ Verifying that all inventory owned by the client is on hand at the time of | the count, | 3. Which of the following is not a reason for the special significance attached by the auditors to the verification of inventories? a, The determination of inventory valuation directly affects net income. b. The existence of inventories is inherently difficult to substantiate. c. Special valuation problems often exist for inventories. d. Inventories are often the largest current asset of an enterprise. 4, From the auditor's point of view, inventory counts are more acceptable prior to the year-end when a. Internal control is weak. b. Accurate perpetual inventory records are maintained. c. Inventory is slow-moving, d._ Significant amounts of inventory are held on a consignment basis. & Which of the following is not true relating to the auditor's observation of the client's physical inventory? a. The auditors should evaluate the client's planning of the physical inventory. b, The auditors should make certain that consigned items from suppliers are included in physical inventory totals. c. The auditors should evaluate the adequacy of the client's counting procedures. d. The auditors should take test counts of the client's inventory. Which of the following is the best audit procedure for the discovery of damaged merchandise ina client's ending inventory? Compare the physical quantities of slow-moving items with corresponding quantities of the prior year. b. Observe merchandise and raw materials during the client's physical inventory taking. 353Chapter 11 - Substantive Test of Inventories and Cost of Sales | Review the management's inventory representation letter foy <— 4. Test overall fairness of inventory values by comparing the con", turnover ratio with the industry average. Pan, Which of the following is true about the auditor's observation of y, physical inventory? a. The count must be made at year-end. b. The auditor should supervise the client's personnel. c. The auditor's observation addresses the existence assertion, d. The auditor should justify any omission of the observation in the aug lit cient report. Which of the following audit procedures most likely woulq Provig le 8 assurance that a manufacturing entity's inventory valuation is proper a. Testing the entity's computation of standard overhead rates,” b. Obtaining confirmation of inventories pledged under loan agreemenys c. Reviewing a cutoff procedure for inventories. — . d. Tracing test counts to the entity's inventory listing. 4 The client's physical count of inventories is lower than the invent quantities in the perpetual records. This could be the result of a failure to record: a. Purchases. c. Purchase discounts. b. Sales. d. Sales discounts. 10. Your client performed the physical count of inventory as of November 3 one month prior to year-end. Subsequently, your client closed the sales journal on 12/29/2021, two days before year end, and reported those twp days’ credit sales in January of the next year. Assuming the client uses g perpetual inventory system which of the following is most likely to be overstated relating to the year 2021 financial statements? c. Cash, a. Sales. d. Accounts receivable. b. Inventory. Which of the following best describes the reason that the auditors record their inventory test counts in the working papers? a. To document every test count. b. For subsequent comparison with the completed inventory listing, To document compliance with generally accepted accounting principles. 4. Foruse in subsequent audits. The auditors will usually trace the details of the test counts made during the observation of the physical inventory taking to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditors at the time of the physical inventory count are: a. Owned by the client. s b. Notobsolete. 1. © 2 354chapter 11 - Substantive Test of Inventories and Cost of Sales Physically present at the time of the prepa schedule. d. Included in the final inventory schedule. of the final inventory 3, Which of the following is not a procedure that is typically used by the auditors in their examination of a client's goods held in the custody of a public warehouse? a, Confirmation, b, Obtaining reports on internal control at the warehouse. c. Observation. d. Corresponding with the government regulator regarding the authenticity of the warehousing logistic company. 14, After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items: a, Included in the listing have been counted. b. Represented by inventory tags are included in the listing. c. Included in the listing are represented by inventory tags. d. Represented by inventory tags are bona fide. 18, An auditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the inventory summary sheets. Which assertion does this procedure relate to most directly? a, Completeness. c. Existence. b. Legality. d. Valuation. 16 An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all: a. Merchandise received. cc. Vendor's invoices. b. Canceled checks. d, Receiving reports. 11. To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditors should review and test the: a. Terms of the open purchase orders, b. Purchase cutoff procedures, c. Contractual commitments made by the purchasing department. d. Purchase invoices received on or around year end. 3. Purchase cutoff procedures should be designed to test that merchandise is included in the inventory of the client company, if the company: a. Has paid for the merchandise. b. Has physical possession of the merchandise. ¢. Has control to the merchandise. d. Holds the shipping documents for the merchandise issued in the company's name. 355Chapter 11 - Substantive Test of Inventories and Cost of Sales 19, In auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified? a. Test the computation of standard overhead rates. b. Tour the manufacturing plant or production facility. c. Compare inventory balances to anticipated sales volume. d. Review inventory experience and trends. 20, A "bill and hold" scheme is most likely to include: Shipment of items to a customer beyond what the customer has ordered. b. Recording as sales items that the company retains as of year-end. c. Billing of items that are held by customers for future revenue production purposes. d. Selling items at substantial discounts near year-end, a. 21. Inquiries of warehouse personnel concerning possible obsolete or slow- moving inventory items provide assurance about management's assertion of: a. Completeness. c. Existence. b. Rights and obligations. d, Valuation. ‘The accuracy of perpetual inventory records may be established, in part, by 2 comparing perpetual inventory records with a. Purchase requisitions. c. Receiving reports. b. Purchase orders. d. Vendor payments. za, The auditor tests the quantity of materials charged to work in process by tracing these quantities to a. Cost ledgers. c, Perpetual inventory records. b, Receiving reports. d, Material requisitions. 24. To measure how effectively a client employs its assets, an auditor calculates inventory turnover by dividing the average inventory into: a. Netsales. c. Cost of goods sold. b. Operating income. 4. Gross sales. 2%, An inventory turnover analysis is useful to the auditor because it may detect: a, Inadequacies in inventory pricing. b. Methods of avoiding cyclical holding cost. c. The optimum automatic reorder points. d. The existence of obsolete merchandise. 356chapter 12 - Inventories CHAPTER 12 INVENTORIES TOPIC OVERVIEW: This chapter discusses inventory, its characteris components and valuation, initial and subsequent measurement of inventory as well as the periodic and perpetual inventory systems. It also discusses the accounting of inventory under the PFRS's for SMEs. LEARNING OBJECTIVES: ‘After studying this chapter, you should be able to: 1. Describe inventories of manufacturing companies and_ servicing companies. 2. Describe the initial recognition, initial measurement, subsequent measurement, derecognition and financial statement presentation of inventories. 3. Identify the situations in which periodic or perpetual system is appropriate. . Compare and contrast perpetual and periodic inventory system. . Account properly purchase commitments and inventory transactions denominated in foreign currency. . Account properly changes in inventory method and inventory error. Calculate the cost of inventory using inventory estimation. Describe the difference between full PFRS and PFRS for SMEs. Calculate the correct balance of inventory and related accounts, ae waren INVENTORIES As defined in PAS 2 paragraph 6, inventories are assets held for sale in the ordinary course of business, in the process of production for such sale or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Therefore, inventories include the following: a) Assets held for sale in the ordinary course of business (finished goods) Assets in the production process for sale in the ordinary course of business (work in process) c) Materials and supplies that are consumed in production (raw materials). Purchased subcomponents Goods held by a trader for resale i) 357