Unit III – B Audit of the Production and Inventory Warehousing

Cycle

Questions:

III – 1. This caselette is designed to test your proficiency and competence in audit
planning and test of controls.

Deborah, CPA, has just accepted an engagement to audit the financial statements
of Spencer, Inc. for the year ending December 31. 20X7. After obtaining an
understanding of the client’s design of the accounting and internal control systems and
their operations, he then proceeded in performing test of controls related to production
activities.

The following questions relate to test of controls of the production cycle. Choose the
best response.

Questions:

1. To make year-to-year comparison of inventory turnover most meaningful, the

auditor will perform the analysis

a. For the company as a whole.

b. By product.
c. By division.
d. All of the above.

2. Which of the following is an internal control weakness for a company whose

inventory of supplies consists of a large number of individual items?

a. Supplies of relatively little value are expensed when purchased.

b. The cycle basis is used for physical counts.
c. The warehouse manager is responsible for the maintenance of perpetual
inventory records.
d. Perpetual inventory records are maintained only for items of significant value.

3. An auditor reviews job cost sheets to test which transaction assertion?

a. Accuracy
b. Classification
c. Occurrence
d. Completeness
 4. To determine the client’s planned amount and timing of production of a product,
the auditor will review the

a. Sales forecast
b. Purchases journal
c. Inventory reports
d. Production plan

5. Which cycle is not linked to the production cycle?

a. Investing and financing cycle

b. Revenue and receipt cycle
c. Payroll cycle
d. Expenditure and disbursement cycle

III – 2. This caselette is designed to test your proficiency and competence in audit
planning and test of controls.

Zacarias, CPA, has just accepted an engagement to audit the financial statements
of Buffet, Inc. for the year ending December 31. 20X7. After obtaining an understanding
of the client’s design of the accounting and internal control systems and their
operations, he then proceeded in performing test of controls related to production
activities.

The following questions relate to test of controls of the production cycle. Choose the
best response.

Questions:

1. When auditing inventories, an auditor would least likely verify that

a. All inventory owned by the client is on hand at the time of the count.
b. The client has used proper inventory pricing.
c. The financial statement presentation of inventories is appropriate.
d. Damaged goods and obsolete items have been properly accounted for.

2. Which of the following internal control activities most likely addresses the
completeness assertion for inventory?

a. The work-in process account is periodically reconciled with subsidiary inventory

records.
 b. Employees responsible for custody of finished goods do not perform the
receiving function.
c. Receiving reports are prenumbered and the numbering sequence is checked
periodically.
d. There is a separation of duties between the payroll department and inventory
accounting personnel.

3. 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.

4. A retailer’s physical count of inventory was higher than that shown by the perpetual
records. Which of the following could explain the difference?

a. Inventory items had been counted but the tags placed on the items had not been
taken off and added to the inventory accumulation sheets.
b. Credit memos for several items returned by customers had not been recorded.
c. No journal entry had been made on the retailer’s books for several items
returned to its suppliers.
d. An item purchased FOB shipping point had arrived at the date of the inventory
count and had not been reflected in the perpetual records.

5. An auditor will usually trace the details of the test counts made during the
observation of physical inventory counts to a final inventory compilation. This audit
procedure is undertaken to provide evidence that items physically present and
observed by the auditor at the same time of the physical inventory count are

a. Owned by the client.

b. Not obsolete.
c. Physically present at the time of the preparation of the final inventory schedule.
d. Included in the final inventory.

III – 3. This caselette is designed to test your proficiency and competence in audit
planning and test of controls.

Cristobal, CPA, has just accepted an engagement to audit the financial statements
of Avelino, Inc. for the year ending December 31. 20X7. After obtaining an
understanding of the client’s design of the accounting and internal control systems and
their operations, he then proceeded in performing test of controls related to production
activities.
The following questions relate to test of controls of the production cycle. Choose the
best response.

Questions:

1. Which of the following auditing procedure probably would provide the most reliable
evidence concerning the entity’s assertion of rights and obligations related to
inventories?

a. Trace the test counts noted during the entity’s physical count to the entity’s
summarization of quantities.
b. Inspect agreements to determine whether any inventory is pledged as collateral
or subject to any liens.
c. Select the last few shipping documents used before the physical count and
determine whether the shipments were recorded as sales.
d. Inspects the open purchase order file for significant commitments that should be
considered for disclosure.

2. An audit most likely would analyze inventory rates to obtain evidence concerning
management’s balance assertions about

a. Existence
b. Rights and Obligations
c. Completeness
d. Valuation

3. When evaluating inventory controls, an auditor be least likely to

a. Consider policy and procedure manuals.

b. Observe procedures.
c. Make inquiries.
d. Inspect documents.

4. When testing a company’s cost accounting system, the auditor uses procedures that
are primarily designed to determine that

a. The system is in accordance with applicable reporting framework and is

functioning as planned.
b. Physical inventories agree substantially with book inventories.
 c. Costs have been properly assigned to finished goods, work-in-process and cost of
goods sold.
d. Quantities on hand have been computed based on acceptable cost accounting
techniques that reasonably approximate actual quantities on hand.

5. The auditor tests the quantity of materials charged to work-in-process by vouching

these quantities to

a. Cost ledgers
b. Perpetual inventory records
c. Receiving reports
d. Material requisitions

III – 4. Each of the following tests of controls could be performed during the audit
of the controls in the production cycle.

Required:

For each procedure, identify ( a ) the internal control activity ( strength ) being tested
and ( b ) the assertion ( s ) being addressed.

1. Balance and reconcile detailed production cost sheets to the work-in-process

inventory control account.

2. Scan closed production cost sheets for missing numbers in the sequence.

3. Vouch a sample of open and closed production cost sheet entries to (1) labor reports
and (2) issue forms and materials used reports.

4. Locate the material issue forms and determine whether they are (1) prenumbered,
(2) kept in a secure location and (3) available to unauthorized persons.

5. Select several summary journal entries in the work-in-process inventory and (1)
vouch them to weekly labor and material reports and to production cost sheets (2)
trace them to the control account.

6. Select a sample of the material issue forms in the production department file.
Examine them for
a. Issue date and materials used report date.
b. Production order number.
c. Floor supervisor’s signature or initials.
d. Name and number of material.
e. Raw material store clerk’s signature or initials.
 f. Material requisition in raw material stores file, nothing the date of requisition.

7. Determine by inquiry and inspection whether cost clerks review dates on reports of
units completed for accounting in prior period.

III – 4. Support Analysis:

Procedure Proper release of correct
materials.
(1)
(7)

Materials release authorized and

(2) timely.
(a) Strength
Preparation of summary
material and labor entries.
Timely recording.
(3)

Production cost sheets

prenumbered and (b) Assertions(s)
(4)
accounted for. Valid work-in-process inventory
transactions are recorded and
Independent check on none omitted. (completeness)
materials and labor used.
(5)
Valid finished goods inventory
Issue forms secure and transactions are recorded and
(6a) Used by authorized personnel. none omitted. (completeness)
Prenumbered and accounted for.
Recorded labor and material
(6b) transactions are valid.
Use of control account. (occurrence)

(6c) All material issues are

Recording of materials used .
(6d)
Standard control number.
authorized . (occurrence). All
issue forms are recorded.
(completeness)

(6e) Production transactions are

Materials received, custody. recorded properly.
(classification)

(6f) Proper material received.

Material used is recorded in (occurrence) Authorized issue of material
proper and in
period. (accuracy) Job cost accounting accurate. proper period. (occurrence,
(accuracy) completeness)
Job accounting is complete.
(completeness) Material release recorded Inventory recorded in proper
accurately. (accuracy) period. (completeness)
Material used is authorized.
III – 5. This caselette is designed to test your proficiency and competence in audit
planning and test of controls.

Perfectol, CPA, has just accepted an engagement to audit the financial

statements
of Coco Forwarders, Inc. for the year ending December 31. 20X7. After obtaining
an understanding of the client’s design of the accounting and internal control
systems and their operations, he then proceeded in performing test of controls
related to production activities.

The following questions relate to test of controls of the production cycle. Choose
the best response.

Questions:

1. In a manufacturing company, which one of the following audit procedures would

give the least assurance of the valuation of inventory at the audit date?

a. Testing the computation of standard overhead rates.

b. Examining paid vendor’s invoices.
c. Reviewing direct labor rates.
d. Obtaining information of inventories pledged under loan agreements.

2. When auditing merchandise inventory at year end, the auditor performs a purchase
cutoff test to obtain evidence concerning whether

a. All goods purchased before year-end are received before the physical inventory
count.
b. Any goods held on consignment for customers are included in the inventory
balance.
c. Any goods observed during the physical count are pledged or sold.
d. All goods owned at year-end are included in the inventory balance.
3. 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 physical inventory sheets.
The purpose of this procedure is to obtain assurance that

a. The final inventory is valued at cost.

b. All inventory represented by an inventory tag is listed on the inventory sheets.
c. All inventory represented by an inventory tag is bona fide.
d. Inventory sheets do not include untagged inventory items.
4. The physical count of a retailer’s inventory was higher than that shown in the
perpetual records. Which of the following could explain the difference?

a. Inventory items had been counted, but the tags placed on the items had not
been taken off the items and added to the inventory accumulations sheets.
b. Credit memos for several items returned by customers had not been recorded.
c. No journal entry had been made on the retailer’s books for several items
returned to suppliers.
d. An item purchased FOB shipping point had not arrived at the date of the
inventory count and had not been reflected in the perpetual records.

5. An auditor’s test of controls over the issuance of raw materials to production would
probably include

a. Reconciling raw materials and work-in-process perpetual inventory.

b. Inquiring of the inventory custodian about the procedures followed when
defective materials are received materials are received from vendors.
c. Observing that raw materials are stored in secure areas and that storeroom
security is supervised by a responsible person.
d. Examining materials requisitions and reperforming client controls designed to
process and record issuances.
 Answers Key

III – 1. III – 3.

1. B 1. B
2. C 2. D
3. A 3. A
4. D 4. C
5. A 5. D

III – 2. III – 5.

1. A 1. D
2. C 2. D
3. B 3. B
4. B 4. B
5. D 5. D