CHAPTER 20


Multiple-Choice Questions

1.
easy	Which of the following accounts is associated with a transaction cycle other than acquisition and payment?
a	a.	Common stock.
	b.	Property, plant and equipment.
	c.	Accrued property taxes.
	d.	Income tax expense.

2.	Property, plant, and equipment are assets that:
easy	a.	have expected lives of more than one year.
d	b.	are used in the business.
	c.	are not acquired for resale.
	d.	meet all of the requirements stated above.

3.
easy	Which of the following expenses is not typically evaluated as part of the audit of the acquisition and payment cycle?
c	a.	Depreciation expense.
	b.	Insurance expense.
	c.	Bad debts expense.
	d.	Property tax expense.

4.	Debits to manufacturing equipment arise from which cycle?
easy	a.	Sales and collection
c	b.	Payroll
	c.	Acquisition and disbursement
	d.	Inventory and warehousing

5.
easy	It should ordinarily be unnecessary to examine supporting documentation for each addition to property, plant, and equipment, but it is customary to verify:
d	a.	all large transactions.
	b.	all unusual transactions.
	c.	a representative sample of typical additions.
	d.	all three of the above.

6.	The auditor must know the client’s capitalization policies to determine whether acquisitions are:
easy	a.	recorded in accordance with GAAP.
c	b.	treated consistently with those of the preceding year.
	c.	both of the above.
	d.	none of the above.

7.	To be capitalized as part of property, plant and equipment, assets must:
easy	a.	have expected useful lives of more than one year.
d	b.	not be acquired for resale.
	c.	be useful in multiple productive capacities within the organization.
	d.	a and b, but not c.



8.	The primary accounting record for manufacturing equipment and other fixed assets is the:
easy	a.	fixed asset list.
b	b.	fixed asset master file.
	c.	asset inventory.
	d.	equipment roster.

9.	Which of the following statements about the audit of fixed assets is not correct?
easy
b	a.	The primary accounting record for manufacturing equipment and other property, plant and equipment is generally a fixed asset master file.
	b.	Manufacturing equipment and current assets are normally audited in the same fashion regardless of the activity within a particular account.
	c.	The emphasis on auditing fixed assets is on verification of current-period acquisitions.
	d.	Failure to record the acquisition of a fixed asset affects the income statement until the assets is fully depreciated.

10.
easy	During the audit of prepaid insurance, the auditor should keep in mind that the amount in insurance expense is based on:
d	a.	the beginning balance in prepaid insurance.
	b.	the payment of premiums during the year.
	c.	the ending balance in prepaid insurance.
	d.	all three of the above.

11.
easy	Which of the following is not a category of tests commonly associated with the audit of manufacturing equipment?
d	a.	Verification of depreciation expense.
	b.	Analytical procedures.
	c.	Verification of current-period disposals.
	d.	Verification of the beginning balance in accumulated depreciation.

12.
easy	The audit procedure that requires an auditor to “foot the acquisition schedule” relates to which balance-related audit objective?
b	a.	Classification.
	b.	Detail tie-in.
	c.	Existence.
	d.	Accuracy.

13.
easy	Which of the following audit objectives is not typically a major objective in the audit of current year fixed asset additions?
c	a.	Classification.
	b.	Completeness.
	c.	Existence.
	d.	Accuracy.

14.
easy	The extent to which auditors verify current period acquisitions of property, plant and equipment normally depends upon:
c	a.	assessed control risk for acquisitions.
	b.	tolerable misstatement.
	c.	Both a and b.
	d.	Neither a nor b.



15.
easy	Inadequate controls and misstatements discovered through tests of controls and substantive tests of transactions are an indication of the likelihood of misstatements in:
d	a.	the balance sheet.
	b.	the income statement.
	c.	the cash flow statement.
	d.	both the income statement and the balance sheet.

16.
medium	Failure to capitalize a fixed asset at the correct amount affects __________ until the company disposes of the asset.
a	a.	the balance sheet
	b.	the income statement
	c.	the cash flow statement
	d.	both the income statement and the balance sheet

17.
medium	Which of the following tests are typically not necessary when auditing a client’s schedule of recorded disposals?
d	a.	Footing the schedule.
	b.	Tracing schedule totals to the general ledger.
	c.	Tracing cost and accumulated depreciation of the disposals to the property master file.
	d.	All of the above are necessary.

18.	Which of the following is not likely to be a test related to the audit of manufacturing equipment?
medium	a.	Verify current year additions.
b	b.	Observe current year disposals.
	c.	Verify depreciation expense.
	d.	Perform analytical procedures.

19.
medium	A set of records for each piece of equipment that includes descriptive information, date of acquisition, original cost, current year depreciation, and accumulated depreciation is the:
c	a.	acquisitions journal.
	b.	depreciation schedule.
	c.	fixed asset master file.
	d.	file of purchase requisitions.

20.
medium	In the audit of property, plant, and equipment, it is helpful to separate the tests into all but which one of the following categories?
a	a.	Verification of the beginning balance.
	b.	Verification of current year acquisitions.
	c.	Verification of current year disposals.
	d.	Verification of the ending balance.

21.
medium	Methods used to determine if there are legal encumbrances related to fixed assets include all but which of the following?
d	a.	Reading terms of loan and credit agreements.
	b.	Reviewing loan confirmations received from banks.
	c.	Inquiring of the client regarding possible legal encumbrances.
	d.	All of the above may be used to identify legal encumbrances.



22.
medium	The test of details of balances procedure which requires a “recalculation of investment credit” satisfies the audit objective of:
d	a.	classification.
	b.	detail tie-in.
	c.	existence.
	d.	accuracy.

23.
medium
a	The test of details of balances procedure to “examine vendors’ invoices of closely related accounts such as repairs to uncover items that should be property, plant, and equipment” satisfies the audit objective of:
	a.	classification.
	b.	detail tie-in.
	c.	cutoff.
	d.	existence.

24.	The auditor’s starting point for verifying disposals of property, plant, and equipment is the:
medium	a.	equipment account in the general ledger.
c	b.	file of shipping documents.
	c.	client’s schedule of recorded disposals.
	d.	equipment subsidiary ledger.

25.
medium	Failure to capitalize a fixed asset at the correct amount will affect ___________ until the asset is fully depreciated.
d	a.	the balance sheet
	b.	the income statement
	c.	the cash flow statement
	d.	both the income statement and the balance sheet

26.
medium
c	Because the failure to record disposals of property, plant, and equipment can significantly affect the financial statements, the search for unrecorded disposals is essential. Which of the following is not a procedure used to verify disposals?
	a.	Make inquiries of management and production personnel about the possibility of the disposal of assets.
	b.	Review whether newly acquired assets replace existing assets.
	c.	Test the valuation of fixed assets recorded in prior periods.
	d.	Review plant modifications and changes in product line, taxes, or insurance coverage.

27.
medium	In rare cases, the auditor may believe it is necessary that a complete physical inventory of fixed assets be taken to make sure they actually exist. If an inventory is taken, the auditor normally:
c	a.	takes the inventory.
	b.	requires client to take the inventory and provide documentation to the auditor.
	c.	observes the count.
	d.	requires that it be done by an outside, independent third party.

28.
medium
b	A major consideration in verifying the ending balance in fixed assets is the possibility of existing legal encumbrances. Tests to identify possible legal encumbrances would satisfy the audit objective for:
	a.	existence.
	b.	presentation and disclosure.
	c.	detail tie-in.
	d.	classification.



29.
medium	When auditing depreciation expense, the two major concerns related to the accuracy audit objective are:
c	a.	consistent application of depreciation method and useful lives.
	b.	consistent application of depreciation method and classification of assets.
	c.	correctness of calculations and consistent application of depreciation method.
	d.	None of the above.

30.
medium	Which type of audit procedure is often sufficient for purposes of auditing prepaid expenses and deferred charges?
d	a.	Tests of controls.
	b.	Tests of transactions.
	c.	Tests of details of balances.
	d.	Analytical procedures.

31.	Depreciation expense is one of the few expense accounts that is not verified as a part of:
medium	a.	tests of controls.
d	b.	tests of transactions.
	c.	test of details of balances.
	d.	a and b, but not c.

32.
medium	Changing circumstances may require a change in the useful life of an asset. When this occurs, it involves a change in:
a	a.	accounting estimate rather than a change in accounting principle.
	b.	accounting principle rather than a change in accounting estimate.
	c.	both accounting principle and accounting estimate.
	d.	neither accounting principle nor accounting estimate.

33.
medium	The auditor ___________ to test the accuracy or classification of fixed assets recorded in prior periods.
c	a.	normally needs
	b.	never needs
	c.	normally does not need
	d.	none of the above

34.
medium	The auditor normally does not need to test the accuracy or classification of fixed assets recorded in prior periods because:
c	a.	they are rarely material to the audit.
	b.	they rarely contain misstatements.
	c.	they are verified in previous audits.
	d.	none of the above

35.
medium	Internal controls for prepaid insurance are typically categorized into all but which of the following?
d	a.	Controls over the acquisition and recording of insurance.
	b.	Controls over the insurance register.
	c.	Controls over the charge-off of insurance expense.
	d.	All of the above.

36.	A record of insurance policies in force and the due date of each policy is contained in the:
medium	a.	voucher register.
b	b.	insurance register.
	c.	insurance expense account.
	d.	prepaid insurance account.

37.	Insurance expense for the period is a function of which of the following?
medium	a.	The beginning prepaid balance, current premium payments and the ending prepaid balance.
a	b.	The beginning prepaid balance and the current period premium payments.
	c.	The current period premium payments.
	d.	The current period premium payments and the ending prepaid balance.

38.
medium	Expense accounts analysis is closely related to tests of controls and substantive tests of transactions. The major difference is:
b	a.	the difference in the types of underlying documentation which is examined.
	b.	the degree of concentration on an individual account.
	c.	the use or nonuse of cutoff tests.
	d.	that one emphasizes transactions and the other emphasizes amounts.

39.
medium	In connection with a review of the prepaid insurance account, auditors would typically not perform which of the following procedures?
c	a.	Recompute the portion of the premium that expired during the year.
	b.	Prepare excerpts of insurance policies for audit working papers.
	c.	Confirm premium rates with an independent insurance broker.
	d.	Examine support for premium payments.

40.
medium	Which of the following audit procedures would be least likely to lead the auditor to find an unrecorded fixed asset disposal?
b	a.	Examination of insurance policies.
	b.	Review of repairs and maintenance expense.
	c.	Review of property tax files.
	d.	Scanning of invoices for fixed asset additions.

41.
medium	To achieve effective internal accounting control over fixed asset additions, a company should establish procedures that require:
a	a.	authorization and approval of major fixed asset additions.
	b.	capitalization of the cost of fixed asset additions in excess of a specific dollar amount.
	c.	classification, as investments, of those fixed asset additions that are not used in the business.
	d.	performance of recurring fixed asset maintenance work solely by maintenance department employees.

42.
medium	Which of the following is a customary audit procedure for the verification of the legal ownership of real property?
d	a.	Examination of correspondence with the corporate counsel concerning acquisition matters.
	b.	Examination of ownership documents registered and on file at a public hall of records.
	c.	Examination of corporate minutes and resolutions concerning the approval to acquire property, plant, and equipment.
	d.	Examination of deeds and title guaranty policies on hand.

43.
medium
b	Once the initial audit of a newly constructed industrial plant has been performed, with respect to consistency, which of the following is of least concern to the continuing auditor in the following year?
	a.	Prior years’ capitalization policy.
	b.	Prior years’ capitalization costs.
	c.	Prior years’ depreciation methods.
	d.	Prior years’ depreciable life.



44.	Controls over the acquisition and recording of insurance are a part of the ________.
medium	a.	inventory and warehousing cycle
d	b.	capitalization cycle
	c.	treasury cycle
	d.	acquisition and payment cycle

45.	The approach used to verify manufacturing equipment is different than the one used to verify:
challenging	a.	current assets.
a	b.	patents.
	c.	copyrights.
	d.	all other types of property, plant, and equipment.

46.	Which balance-related audit objective is not relevant to an audit of prepaid expenses?
challenging	a.	Rights.
d	b.	Accuracy.
	c.	Detail tie-in.
	d.	Realizable value.

47.
challenging	The failure to capitalize a permanent asset, or the recording of an asset acquisition at the improper amount, affects the balance sheet:
d	a.	forever.
	b.	for the current period.
	c.	for the depreciable life of the asset.
	d.	until the firm disposes of the asset.

48.
challenging	The failure to capitalize a permanent asset, or the recording of an asset acquisition at the improper amount, affects the income statement:
b	a.	for the current period.
	b.	for the depreciable life of the asset.
	c.	until the firm disposes of the asset.
	d.	forever.

49.
challenging	____________ both have the effect of simultaneously verifying balance sheet and income statement accounts.
b	a.	Analytical procedures and substantive tests of transactions
	b.	Tests of controls and substantive tests of transactions
	c.	Tests of details of balances and substantive tests of transactions
	d.	None of the above

50.
challenging
d	The tests of details of balances procedure for fixed assets which require the auditor to examine vendors’ invoices of closely related accounts such as repairs and maintenance to uncover items that should be fixed assets would satisfy the audit objective of:
	a.	accuracy.
	b.	existence.
	c.	detail tie-in.
	d.	completeness.


51.
challenging
a	The erroneous inclusion of transactions that should properly be recorded as assets into accounts such as repairs expense, lease expense, or supplies is a common client error. The auditor should evaluate the likelihood of these types of misclassifications in conjunction with:
	a.	obtaining an understanding of internal control.
	b.	the test of controls.
	c.	the tests of transactions.
	d.	the tests of details of balances.

52.
challenging	If the client fails to record disposals of property, plant, and equipment, both the original cost of the asset account and the net book value will be incorrect.
b	a.	Both will be overstated indefinitely.
	b.	The original cost will be overstated indefinitely, and the net book value will be overstated until the asset is fully depreciated.
	c.	The original cost will be overstated indefinitely, and the net book value will be understated indefinitely.
	d.	The original cost will be overstated indefinitely, and the net book value will be understated until the asset is fully depreciated.

53.	Income statement accounts resulting from allocations are typically verified as a part of:
challenging	a.	tests of controls.
c	b.	substantive tests of transactions.
	c.	analytical procedures.
	d.	all of the above.

54.
challenging	Which of the following explanations might satisfy an auditor who discovers significant debits to an accumulated depreciation account?
a	a.	Extraordinary repairs have lengthened the life of an asset.
	b.	Prior years’ depreciation charges were erroneously understated.
	c.	A reserve for possible loss on retirement has been recorded.
	d.	An asset has been recorded at its fair value.

55.	An auditor would be least likely to use confirmations in connection with the examination of:
challenging	a.	inventories.
c	b.	long-term debt.
	c.	property, plant, and equipment.
	d.	stockholders’ equity.

56.
challenging	Which of the following is the most important internal control procedure over acquisitions of property, plant, and equipment?
b	d.	Requiring acquisitions to be made by user departments.
	b.	Using a budget to forecast and control acquisitions and retirements.
	c.	Analyzing monthly variances between authorized expenditures and actual costs.
	a.	Establishing a written company policy distinguishing between capital and revenue expenditures.

57.
challenging	The auditor interviews the plant manager. The auditor is most likely to rely upon this interview as primary support for an audit conclusion on:
c	a.	capitalization vs. expensing policy.
	b.	allocation of fixed and variable cost.
	c.	the necessity to record a provision for deferred maintenance costs.
	d.	the adequacy of the depreciation expense.



58.
challenging	The audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable because:
d	a.	accrued liability balances are less material than accounts payable balances.
	b.	accrued liabilities at year end will become accounts payable during the following year.
	c.	evidence supporting accrued liabilities is non-existent, whereas evidence supporting accounts payable is readily available.
	d.	accrued liabilities usually pertain to services of a continuing nature, whereas accounts payable are the result of completed transactions.


Essay Questions

59.
easy	Which type of audit procedure (tests of controls, tests of transactions, tests of details, or analytical procedures) is most often sufficient for the audit of prepaid expenses?

	Answer:
	Analytical procedures are often sufficient.


60.
easy	Why does the auditor not normally test the accuracy or classification of fixed assets recorded in prior periods?

	Answer:
	They are presumed to have been verified in prior years’ audits.


61.
easy	Auditors should be aware that the life of certain fixed assets might be reduced due to various circumstances. What circumstances might give rise to a reduction in the useful life of a fixed asset?

	Answer:
	The useful life a of fixed asset may be reduced by:
•	a reduction in customer demand for products or services,
•	unexpected physical deterioration of the asset, or
•	a modification in operations.

62.
easy	Describe the types of information that should be included in the schedule of prepaid insurance that is used by the auditor as the basis for auditing prepaid insurance.

	Answer:
The schedule should include each insurance policy in force, policy number, insurance coverage for each policy, premium amount, premium period, insurance expense for the year, and prepaid insurance at the end of the year.




63.
easy	Describe two ways the verification of existence and tests for omissions of the client’s insurance policies in force can be performed.

	Answer:
The verification of existence and tests for omissions of the insurance policies can be tested in one of two ways: by examining insurance invoices and policies in force or by obtaining a confirmation of insurance information from the company’s insurance agent.


64.
medium	What are several analytical procedures used in the audit of prepaid insurance and insurance expense?

	Answer:
1.	Compare total prepaid insurance and insurance expense with previous years.
2.	Compute the ratio of prepaid insurance to insurance expense and compare with previous years.
3.	Compare the individual insurance policy coverage on the schedule of insurance obtained from the client with the preceding year’s schedule as a test of elimination of certain policies or a change in insurance coverage.
4.	Compare the computed prepaid insurance balance for the current year on a policy-by-policy basis with that of the preceding year as a test of an error in the calculation.


65.
medium	A major issue in verifying the ending balance in property, plant and equipment is the possibility of legal encumbrances. Describe the procedures that auditors may perform to obtain evidence about existing legal encumbrances.

	Answer:
Auditors may obtain evidence about existing legal encumbrances by:
•	reading the terms of loan and credit agreements,
•	mailing loan confirmation requests to banks and other lending institutions,
•	inquiring of the client, and
•	sending letters of inquiry to the client’s legal counsel.

66.
medium	Describe the audit procedures used to verify the accuracy and detail tie-in objectives for prepaid insurance.

	Answer:
The accuracy objective is tested by verifying the total amount of the insurance premium, the length of the policy period, and the allocation of the premium to unexpired insurance. The amount of the premium for a given policy and its time period can be verified simultaneously by examining the premium invoice or the confirmation from an insurance agent. Once these two have been verified, the client’s calculations of unexpired insurance can be tested by recalculation. The schedule of prepaid insurance can then be footed and the totals traced to the general ledger to complete the detail tie-in tests.




67.
medium	What are the auditor’s two main objectives in the audit of the ending balance in accumulated depreciation?


Answer:
1.	Accumulated depreciation as stated in the property master file must agree with the general ledger. This objective can be satisfied by test footing the accumulated depreciation or the property master file and tracing the total to the general ledger.
2.	Accumulated depreciation in the master file must be correct.

68.
medium	Explain allocation and why it is important to have accurate allocation within the financial statements.

	Answer:
	Allocation is the process of assigning a portion of the cost of an asset to a product or a 	period. For example, calculating and then recording depreciation expense is an allocation 	process. It is important to determine when an expenditure is an asset or a current period 	expense so that the financial statements are fairly stated.


69.
challenging	Property, plant, and equipment is normally audited in a different manner than current asset accounts. State three reasons why this is so, and discuss the differences in how property, plant, and equipment is audited compared to current assets.

	Answer:
•	There are usually fewer current period acquisitions of property, plant, and equipment than current assets.
•	The amount of any given acquisition is often material.
•	The equipment is likely to be kept and maintained in the accounting records for several years.
Because of these three differences, the emphasis in auditing property, plant, and equipment is on the verification of current period acquisitions rather than on the balance in the account carried forward from the preceding year. In addition, the expected life of assets over one year requires depreciation and accumulated depreciation accounts, which are verified as a part of the audit of the assets.


70.
challenging	State each of the seven specific balance-related audit objectives for property, plant, and equipment additions and, for each objective, describe one common test of details of balances.

	Answer:
•	Current-year acquisitions in the acquisitions schedule agree with related master file amounts, and the total agrees with the general ledger (detail tie-in). Foot the acquisitions schedule.
•	Current-year acquisitions as listed exist (existence). Physically examine assets.
•	Existing acquisitions are recorded (completeness). Examine vendors’ invoices of closely related accounts such as repairs and maintenance to uncover items that should be property, plant, and equipment.
•	Current-year acquisitions as listed are accurate (accuracy). Examine vendors’ invoices.
•	Current-year acquisitions as listed are properly classified (classification). Examine rent and lease expense for capitalizable leases.
•	Current-year acquisitions are recorded in the proper period (cutoff). Review transactions near the balance sheet date for proper period.
•	The client has rights to current-year acquisitions (rights and obligations). Examine vendors’ invoices.


71.
challenging	Discuss the key internal controls related to the disposal of property, plant, and equipment.

	Answer:
The most important internal control over the disposal of property, plant, and equipment is the existence of a formal method to inform management of the sale, trade-in, abandonment, or theft of recorded machinery and equipment. Another important control to protect assets from unauthorized disposal is a provision for authorization for the sale or other disposal of property, plant, and equipment. Finally, there should be adequate internal verification of recorded disposals to make sure that assets are correctly removed from the accounting records.


72.
challenging	When auditing disposals of property, plant, and equipment, the search for unrecorded disposals is essential. State the four audit procedures frequently used for verifying disposals.

	Answer:
•	Review whether newly acquired assets replace existing assets.
•	Analyze gains and losses on the disposal of assets and miscellaneous income for receipts from the disposal of assets.
•	Review plant modifications and changes in product lines, taxes, or insurance coverage for indications of deletions of equipment.
•	Make inquiries of management and production personnel about the possibility of the disposal of assets.


73.
challenging	Discuss the key internal controls over existing fixed assets that affect the auditor’s extent of testing of fixed assets acquired in prior years.

	Answer:
Important controls include the use of a master file for individual fixed assets, adequate physical controls over assets that are easily movable, assignment of identification numbers to each plant asset, and periodic physical count of fixed assets and their reconciliation by accounting personnel. A formal method of informing the accounting department of all disposals of fixed assets is also an important control over the balance of assets carried forward into the current year.


74.
challenging	Discuss the key internal controls for prepaid insurance that affect the auditor’s extent of testing of the prepaid insurance account.

	Answer:
Important controls include proper authorization for new insurance policies and payment of insurance premiums consistent with the client’s payment procedures. A record of insurance policies in force and the due date of each policy is an essential control to make sure that the company has adequate insurance at all times. The control should include a provision for periodic review of the adequacy of the insurance coverage by an independent qualified person. The detailed records of the information in the insurance register should be verified by someone independent of the person preparing them. A closely related control is the use of monthly standard journal entries for insurance expense.


Other Objective Answer Format Questions

75.
easy
a	When an audit is a first-year engagement, some additional risk is involved and more audit work is required than in subsequent years.
a.	True
b.	False

76.
easy
b	One of the auditor’s primary objectives when auditing manufacturing equipment is accuracy.
a.	True
b.	False

77.
easy
a	Completeness and existence are the auditor’s primary objectives in auditing manufacturing equipment.
a.	True
b.	False

78.
easy
b	Wages expense is normally considered to be associated with the acquisition and payment cycle.
a.	True
b.	False

79.
easy
b	The primary characteristic that distinguishes property, plant, and equipment from inventory, prepaid expenses, and investments is the intention to use property, plant, and equipment as a part of the operations of the client’s business and their expected life of approximately one year.
a.	True
b.	False

80.
easy
b	The emphasis in auditing manufacturing equipment is on the verification of current-period disposals.
a.	True
b.	False

81.
easy
a	The auditor should keep in mind that the amount in insurance expense is a residual amount.
a.	True
b.	False

82.
easy
a	The realizable value audit objective is not applicable when auditing prepaid insurance or insurance expense.
a.	True
b.	False

83.
medium
a	The starting point for the verification of current-year acquisitions of property, plant, and equipment is normally a client-prepared schedule of all acquisitions recorded in the general ledger during the year.
a.	True
b.	False



84.
medium
b	The least common audit test to verify current period acquisitions of property, plant, and equipment is examining vendors’ invoices and receiving reports.
a.	True
b.	False

85.
medium
a	Depreciation expense is normally verified as a part of tests of details of balances rather than as part of tests of controls or substantive tests of transactions.
a.	True
b.	False

86.
medium
a	The most important audit objective for depreciation expense is accuracy.
a.	True
b.	False

87.
medium
a	The audit of insurance expense is normally limited to analytical procedures and a brief test of whether charges to insurance expense arose from credits to prepaid insurance.
a.	True
b.	False

88.
medium
a	Tests of the cutoff objective for prepaid insurance are rarely performed by auditors.
a.	True
b.	False

89.
medium
a	In auditing the current year acquisitions of property, plant and equipment, all balance-related audit objectives except realizable value and disclosure are used as a frame of reference.
a.	True
b.	False

90.
medium
b	While analytical procedures are commonly used when auditing balance sheet accounts, they are rarely used when auditing income statement accounts.
a.	True
b.	False

91.
medium
a	Tests of controls provide an indication of the likelihood of misstatements in both the income statement and the balance sheet, simultaneously.
a.	True
b.	False

92.
medium
a	The auditor’s review of current year acquisition’s cutoff is normally done as part of accounts payable cutoff tests.
a.	True
b.	False

93.
medium
a	The auditor’s tests for proper cutoff of current year acquisitions of property, plant, and equipment are usually done as part of accounts payable cutoff tests.
a.	True
b.	False

94.
medium
b	In deciding the useful life of an asset, the company’s policy is relatively unimportant.
a.	True
b.	False




95.
medium
b	The audit procedure “foot the schedule of fixed assets acquisitions and trace the total to the general ledger” relates most closely to the accuracy objective for fixed assets acquisitions.
a.	True
b.	False

96.
medium
b	Confirmations are commonly used to verify additions of property, plant, and equipment.
a.	True
b.	False

97.
medium
a	When auditing insurance expense, auditors normally rely on analytical procedures and limited testing of the debits to ensure that they arose from credits to prepaid insurance.
a.	True
b.	False

98.
medium
a	One very useful method of auditing depreciation is to use an analytical procedure to test for reasonableness.
a.	True
b.	False

99.
challenging
b
	The approach to auditing patents and copyrights is more similar to that used for current assets than the approach used for property, plant, and equipment accounts.
a.	True
b.	False

100.
challenging
b	Recording an acquisition of a fixed asset at an improper amount affects the balance sheet until the company disposes of the asset, but the income statement is not affected.
a.	True
b.	False

101.
challenging
a	Ordinarily, it is unnecessary to test the accuracy objective or the classification objective for fixed assets acquired in prior years.
a.	True
b.	False

102.
challenging
a	In the audit of accrued property taxes, the two most important balance-related audit objectives are completeness and accuracy.
a.	True
b.	False

103.
challenging
a	Typically, analytical procedures are the primary means of verifying income statement accounts resulting from allocations.
a.	True
b.	False

104.
challenging
b	When auditing acquisitions of property, plant, and equipment, the auditor’s review of lease and rental agreements most closely relates to the cutoff objective.
a.	True
b.	False


CHAPTER 21


Multiple-Choice Questions

1.
easy
b	Receipt of ordered materials by the receiving department will generate the completion of a form called the:
a.	bill of lading.
b.	receiving report.
c.	materials requisition.
d.	inventory acquisition summary.

2.
easy
c	The audit of ______ is often the most difficult and complex part of an audit.
a.	property, plant and equipment
b.	cash
c.	inventory
d.	prepaid insurance

3.
easy
d	Inventory is a complex area to audit for all but which of the following reasons?
a.	Inventory is often in different locations.
b.	There are several acceptable valuation methods and some entities use different methods 	for different types of inventory.
c.	Inventory is often the largest account in working capital.
d.	Inventory valuation includes few estimates.

4.
easy
b	When labor is a significant part of inventory, verifying the proper accounting of these costs should be tested in the:
a.	inventory and warehousing cycle.
b.	payroll and personnel cycle.
c.	acquisitions and payments cycle.
d.	cash cycle.

5.
easy
a	For retail and wholesale businesses, the most important inventory is:
a.	merchandise available for sale.
b.	work-in-process.
c.	raw materials.
d.	all of the above.

6.
easy
b	The audit procedure “observe the client taking a physical inventory count and test the count” is sufficient to determine all of the following except:
a.	whether recorded inventory actually exists.
b.	whether recorded inventory was properly valued by the client.
c.	whether recorded inventory was properly counted by the client.
d.	None of the above answers is correct.

7.
easy
d	In most manufacturing companies, the inventory and warehousing cycle begins with the:
a.	receipt of a customer’s order.
b.	completion of production of a customer’s order.
c.	initiation of production of a customer’s order.
d.	acquisition of raw materials for production of an order.



8.
easy
c	The audit tests to verify that the client is using an inventory method which is generally accepted and to verify that physical counts were correctly summarized are performed during the audit of the:
a.	acquisition and payments cycle.
b.	payroll and personnel cycle.
c.	inventory and warehousing cycle.
d.	sales and collection cycle.

9.
easy
d	Which of the following would not be an appropriate initiation of a purchase requisition?
a.	One initiated by a computer system when raw materials reach a predetermined level.
b.	One initiated based on a periodic count of raw materials.
c.	One initiated by stockroom personnel as raw materials are needed.
d.	Each of the above is an appropriate initiation.

10.
easy
a	Almost all companies need physical controls over their assets to prevent loss. Which of the following is not an example of such a control?
a.	Perpetual inventory master files.
b.	Segregated, limited-access storage areas.
c.	Custody of assets assigned to specific responsible individuals.
d.	Approved prenumbered documents for authorizing movement of inventory.

11.
easy
d	Which department within a manufacturing company is often responsible for the review of production and scrap reports?
a.	Purchasing.
b.	Accounts Payable.
c.	Accounting.
d.	Production.

12.
easy
b	Handling the receipt of ordered goods is a part of the ________ cycle.
a.	purchasing
b.	acquisition and payment
c.	inventory
d.	inventory and warehousing

13.
easy
b	_________ accumulate costs by individual jobs as material is issued into production and labor costs are incurred.
a.	Just-in-time production systems
b.	Job order cost systems
c.	Process cost systems
d.	Manufacturing systems

14.
easy
c	There must be a periodic physical count by the client of the inventory items on hand:
a.	only if the client uses the LIFO method.
b.	only if the client uses a lower-of-cost-or-market method.
c.	regardless of the client’s inventory valuation method.
d.	only if the client uses either the LIFO or FIFO method.

15.
easy
d	With regard to the physical count of inventory, necessary control procedures include:
a.	proper instructions for the physical count.
b.	independent internal verification of the counts.
c.	independent reconciliations of the physical counts with perpetual inventory master files.
d.	all three of the above.



16.
easy
c	If the auditor concludes that physical controls over inventory are so inadequate that the inventory will be difficult to count, the auditor should ordinarily:
a.	withdraw from the engagement.
b.	issue a qualified audit report.
c.	conduct expanded observation tests of physical inventory.
d.	any of the above.

17.
easy
a	From which of the following evidence-gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories?
a.	Observation of physical inventory counts.
b.	Written inventory representations from management.
c.	Confirmation of inventories in a public warehouse.
d.	Auditor’s recomputation of inventory extensions.

18.
easy
a	Johnson Co.’s physical count of inventories was lower than the inventory quantities shown in its perpetual records. This situation could be the result of the failure to record:
a.	sales.
b.	sales returns.
c.	purchases.
d.	purchase discounts.

19.
easy
d	Which of the following is not a function within the inventory and warehousing cycle?
a.	Process the goods.
b.	Store raw materials.
c.	Ship finished goods.
d.	Process invoices for shipped goods.

20.
easy
b	If an auditor were concerned with obtaining evidence about the appropriateness of the value of inventory, which of the following tests would be most appropriate?
a.	Compilation tests.
b.	Price tests.
c.	Confirmation of inventory held by outside parties.
d.	Physical examination of the inventory.

21.
easy
b	Which of the following is the best audit procedure for the discovery of damaged merchandise in a client’s ending inventory?
a.	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 count.
c.	Review the management’s inventory representation letter for accuracy.
d.	Test overall fairness of inventory values by comparing the company’s turnover ratio with the industry average.

22.
medium
c	Which of the following controls would be appropriate regarding the release of materials from a stockroom?
a.	Production employees request materials be delivered to their work areas as they need 	them.
b.	Stockroom employees deliver materials to work areas throughout the day to maintain 	acceptable levels of safety stock – no written records are maintained.
c.	Production employees submit approved requisition forms to the stockroom for materials 	needed.
d.	None of the above is appropriate.



23.
medium
d	Who should maintain the perpetual inventory master files?
a.	Production personnel.
b.	Inventory storeroom personnel.
c.	Inventory receiving personnel.
d.	Accounting department personnel.

24.
medium
a	The inventory and warehousing cycle can be thought of as having two separate but closely related systems, one involving the actual physical flow of goods, and the other the:
a.	related costs.
b.	storage of the goods.
c.	internal control over those goods.
d.	prevention of waste, obsolescence, and theft.

25.
medium
c	In any company involved in manufacturing, an adequate cost accounting internal control system is necessary to indicate the relative profitability of the various products for management planning and control and to:
a.	determine variances from standards.
b.	determine variances from budgets.
c.	value inventories for financial statement purposes.
d.	value inventories for audit verification.

26.
medium
c	Master files, worksheets, and reports that accumulate material, labor, and overhead as the costs are incurred are:
a.	accounting systems.
b.	storeroom documents.
c.	cost accounting records.
d.	finished goods inventory records.

27.
medium
b	The main difference between job order and process costing systems is that:
a.	one accumulates costs by materials issued and the other by labor incurred.
b.	one accumulates costs by individual jobs and the other by particular processes.
c.	one emphasizes costs accumulated in completed products and the other emphasizes costs associated with work-in-process.
d.	one emphasizes costs adding value to the product and the other emphasizes costs incurred because of waste, scrap, and obsolescence.

28.
medium
d	A well-designed computerized system of perpetual inventory master files includes information about the:
a.	units of inventory purchased, sold, and on hand.
b.	unit costs of inventory purchased, sold, and on hand.
c.	units of raw materials, work-in-process, and finished goods.
d.	units and unit costs of inventory purchased, sold, and on hand.

29.
medium
c	Which of the following controls would the auditor consider to be appropriate with respect to physical controls over inventory?
a.	All unused inventory is kept in a locked storeroom.
b.	Competent personnel are assigned to a locked storeroom in which inventory is stored.
c.	Both a and b are correct.
d.	Neither a nor b is correct.

30.
medium
a	Which of the following is a significant audit concern related to the transfer of inventory from one location to another?
a.	Recorded transfers occurred.
b.	Transfers were properly transported.
c.	Transfers were properly planned.
d.	Transfers represent efficient movement of assets.

31.
medium
c	When may auditors test the physical inventory?
a.	At an interim date (e.g., 9/30/08 for a company with a year-end of 12/31/08).
b.	At year-end (e.g., 12/31/08).
c.	Both a and b.
d.	Neither a nor b.

32.
medium
d	Which of the following is not an aspect of concern when auditing the cost accounting system?
a.	Unit cost records.
b.	Physical controls over inventory.
c.	Documents and records for transferring inventory.
d.	Safeguarding the raw materials from point of receipt to the storeroom.

33.
medium
a	The auditor’s tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods must be restricted to:
a.	observation and inquiry.
b.	documentation and observation.
c.	documentation and confirmation.
d.	documentation and inquiry.

34.
medium
a	It is frequently possible to test the physical inventory prior to the balance sheet date when:
a.	there are accurate perpetual inventory master files.
b.	year-end sales are small.
c.	the internal control system is no better at year-end than at an earlier point in time.
d.	the client counts inventory at interim dates.

35.
medium
d	Tests of the perpetual inventory master files for the purpose of reducing the tests of physical inventory or changing their timing are done through the use of:
a.	inquiry.
b.	observation.
c.	confirmation.
d.	documentation.

36.
medium
c	A major difficulty in the verification of inventory cost records is determining reasonableness of:
a.	direct labor’s hourly rate.
b.	raw materials per unit cost.
c.	cost allocations.
d.	all three of the above.

37.
medium
d	When auditing the inventory and warehousing cycle, the use of analytical procedures is:
a.	not important for this cycle.
b.	less important than for any other cycle.
c.	more important than for any other cycle.
d.	as important as their use in any other cycle.

38.
medium
c	Which one of the following analytical procedures would be most helpful in alerting the auditor to the possibility of obsolete inventory?
a.	Compare gross margin percentage with previous years’.
b.	Compare unit costs of inventory with previous years’.
c.	Compare inventory turnover ratio with previous years’.
d.	Compare current year manufacturing costs with previous years’.



39.
medium
a	Which of the following statements is correct regarding the auditor’s responsibility with respect to the year-end inventory procedures of an audit client?
a.	The auditor is responsible for observing the physical counting of inventory.
b.	The auditor is responsible for taking and compiling the inventory.
c.	Both a and b are correct.
d.	Neither a nor b is correct.
40.
medium
a	What occurred at the McKesson & Robbins Company to change the way in which auditors audit inventory?
a.	The company recorded nonexistent inventory.
b.	The auditor did not perform any audit tests of the inventory.
c.	The auditor and company colluded to overstate inventory balances.
d.	All of the above are correct.

41.
medium
c	When a physical count of inventory is performed at an interim date, the auditor observes it at that time and tests the perpetual records for transactions:
a.	throughout the year.
b.	which are a representative sample of the period under audit.
c.	from the date of the count to year-end.
d.	from the date of the count to the end of the audit field work.

42.
medium
b	When there are no perpetual inventory files and inventory is material:
a.	an audit cannot be performed, so the auditor must issue a disclaimer.
b.	a physical inventory must be taken by the client near year-end.
c.	the auditor will have to perform the inventory count and determine valuation.
d.	the auditor need not observe inventory counts but must do test counts.

43.
medium
d	Auditor tests of physical controls over raw materials, work-in-process, and finished goods are limited to:
a.	examination.
b.	observation.
c.	inquiry.
d.	b and c only.

44.
medium
d	The most important part of the observation of inventory is to determine whether:
a.	the counts are accurate.
b.	the inventory-takers are qualified.
c.	obsolete inventory has been identified.
d.	the physical count is being taken in accordance with the client’s instructions.

45.
medium
d	A useful starting point for becoming familiar with the client’s inventory is for the auditor to:
a.	read the AICPA’s Industry Audit Guide.
b.	review accounting theory covering special problems, such as gas and oil accounting, or lease-purchase agreements.
c.	read the client’s Accounting Manual.
d.	tour the client’s facility.

46.
medium
a	A common inventory observation procedure is to select a random sample of tag numbers and identify the tag with that number attached to the actual inventory item. The audit objective being achieved by this procedure is:
a.	inventory as recorded on tags actually exists (existence).
b.	existing inventory is counted and tagged (completeness).
c.	inventory is counted accurately (accuracy).
d.	inventory is classified correctly (classification).



47.
medium
d	If a client intends to count inventory at an interim date, the auditor should expect there to be:
a.	controls over the preparation and maintenance of perpetual inventory records.
b.	competent personnel assigned to count the inventory.
c.	an adequately designed plan to count the inventory.
d.	all of the above.

48.
medium
c	A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is:
a.	classification.
b.	cutoff.
c.	realizable value.
d.	rights.

49.
medium
d	The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been deleted is associated with the audit objective of:
a.	accuracy.
b.	existence.
c.	detail tie-in.
d.	completeness.

50.
medium
d	The test of details of balance procedure which requires the auditor to perform tests of lower-of-cost-or-market, selling price, and obsolescence is an attempt to satisfy the objective of:
a.	existence.
b.	completeness.
c.	accuracy.
d.	realizable value.

51.
medium
a	Most of the audit testing of the storage of finished goods as well as the shipment of merchandise takes place during the testing of the:
a.	sales and collection cycle.
b.	payroll and personnel cycle.
c.	acquisitions and payments cycle.
d.	inventory and warehousing cycle.

52.
medium
b	The auditor’s main concerns in verifying transfers of inventory do not include whether:
a.	recorded transfers exist.
b.	transfers represent appropriate uses of company resources.
c.	all actual transfers are recorded.
d.	the details of the transfer are accurately recorded.

53.
medium
c	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 actually exist.
c.	represented by inventory tags are included in the listing.
d.	included in the listing are represented by inventory tags.

54.
medium
d	Auditors test the quantity of materials charged to work-in-process by tracing these quantities to:
a.	cost ledgers.
b.	perpetual inventory records.
c.	receiving reports.
d.	material requisitions.



55.
medium
a	Which of the following situations would most likely require special audit planning?
a.	Inventory consists of precious stones.
b.	Some items of factory and office equipment do not bear identification numbers.
c.	Depreciation methods used on the client’s tax return differ from those used on the books.
d.	Assets costing less than $500 are expensed even though their expected life exceeds one year.

56.
medium
a	For several years, a client’s physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal control that led to the failure to adjust the accounting records for some:
a.	purchases returned to vendors.
b.	sales returns received.
c.	sales discounts allowed.
d.	cash purchases.

57.
medium
d	The physical counting of inventory may be performed at which of the following times?
a.	Year-end
b.	Interim dates
c.	On a cycle basis during the year
d.	All of the above.

58.
medium
c	When an auditor observes that personnel who are responsible for physically counting inventory are not following the inventory instructions, the auditor should:
a.	contact a supervisor in an attempt to correct the problem.
b.	modify the physical observation procedures.
c.	either a or b.
d.	neither a nor b.

59.
medium
b	The auditor’s objective during an observation of a client’s physical inventory count is to:
a.	discover whether a client has counted a particular inventory item or group of items.
b.	obtain direct knowledge that the inventory exists and has been properly counted.
c.	provide an appraisal of the quality of the merchandise on hand on the day of the physical count.
d.	allow the auditor to supervise the conduct of the count so as to obtain assurance that inventory quantities are reasonably accurate.

60.
medium
a	The audit of year-end physical inventories should include steps to verify that the client’s purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a:
a.	sale in the current period.
b.	sale in the subsequent period.
c.	purchase in the current period.
d.	purchase return in the subsequent period.

61.
medium
b	Which one of the following procedures would not be appropriate for an auditor in discharging his responsibilities concerning the client’s physical inventories?
a.	Confirmation of goods in the hands of public warehouses.
b.	Supervising the taking of the annual physical inventory.
c.	Carrying out physical inventory procedures at an interim date.
d.	Obtaining written representation from the client as to the existence, quality, and dollar amount of the inventory.



62.
medium
d	Pricing manufactured inventory is difficult. Auditors must evaluate the method of allocating manufacturing overhead for all but which of the following?
a.	reasonableness.
b.	computational correctness.
c.	consistency.
d.	Each of the above is important to the auditor.

63.
medium
c	If the perpetual inventory master files show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded:
a.	sales.
b.	sales discounts.
c.	purchases.
d.	purchase discounts.

64.
medium
b	Which of the following is not a generally recognized inventory method?
a.	FIFO
b.	LOFO
c.	LIFO
d.	Specific identification

65.
medium
b	Which of the following control procedures would most likely be used to maintain accurate perpetual inventory records?
a.	Independent storeroom count of goods received.
b.	Periodic independent comparison of records with goods on hand.
c.	Periodic independent reconciliation of control and subsidiary records.
d.	Independent matching of purchase orders, receiving reports, and vendors’ invoices.

66.
challenging
c	Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which:
a.	materials are ordered for purchase until the finished product is sold.
b.	the customer’s order is received until the finished product is shipped.
c.	raw materials are requisitioned until the finished product is sent to storage.
d.	raw materials are requisitioned until the finished product is completely manufactured.

67.
challenging
d	In valuing inventory, the auditor must consider all but which of the following factors?
a.	The valuation method must be in accordance with GAAP.
b.	The valuation method must be applied on a consistent basis.
c.	The inventory must be valued at the lower of cost or market.
d.	All inventory must be valued using the same valuation method under GAAP.

68.
challenging
c	Controls which provide a means of ensuring that the physical counts are properly summarized, priced at the same amount as the unit records, correctly extended and totaled, and included in the general ledger at the proper amount are known as:
a.	standard cost controls.
b.	pricing internal controls.
c.	compilation internal controls.
d.	count quantity internal controls.

69.
challenging
c	Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using first-in, first-out (FIFO). If the most recent acquisition of inventory was for 600 units at $10 per unit and the immediately preceding acquisition was for 700 units at $9 per unit, the inventory item is in error and it is:
a.	understated $400.
b.	understated $300.
c.	overstated $400.
d.	overstated $700.
70.
challenging
d	Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using LIFO. If the most recent acquisition of a layer of inventory was for 600 units at $10 per unit and the immediately preceding layer was for 700 units at $9 per unit, the inventory item is in error and it is:
a.	understated $700.
b.	understated $300.
c.	overstated $400.
d.	overstated $700.

71.
challenging
c	When an outside specialist has assumed full responsibility for taking the client’s physical inventory, reliance on the specialist’s report is acceptable if:
a.	the auditor’s report contains a reference to the assumption of full responsibility.
b.	the auditor is satisfied through application of appropriate procedures as to the reputation and competence of the specialist.
c.	the auditor conducted the same audit tests and procedures as would have been applicable if the client’s employees took the physical inventory.
d.	circumstances made it impracticable or impossible for the auditor either to do the work personally or observe the work done by the inventory firm.

72.
challenging
b	To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditor 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.

73.
challenging
a	Hardy Company mass-produces eight different products. The controller who is interested in strengthening internal controls over the accounting for materials used in production would be most likely to implement a(n):
a.	perpetual inventory system.
b.	job order cost accounting system.
c.	economic order quantity system.
d.	separation of duties among production personnel.

74.
challenging
d	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.	The cycle basis is used for physical counts.
b.	Supplies of relatively little value are expensed when purchased.
c.	Perpetual inventory records are maintained only for items of significant value.
d.	The storekeeper is responsible for maintenance of perpetual inventory records.

75.
challenging
c	When auditing a public warehouse, which of the following is the most important audit procedure with respect to disclosing unrecorded liabilities?
a.	Observation of inventory.
b.	Review of outstanding receipts.
c.	Inspection of receiving and issuing procedures.
d.	Confirmation of negotiable receipts with holders.



Essay Questions

76.
easy	What are two factors affecting the complexity of the audit of inventory?
	Answer:
•	Inventory is often the largest account in the working capital.
•	Inventory is often in different locations.
•	Diverse items in inventory are often difficult to value.
•	Inventory valuation is difficult due to the estimates involved.
•	There are several acceptable methods of valuing inventory and some entities use 	different methods for different types of inventory.


77.
easy	The basis for the auditor’s verification of inventory pricing and compilation is the client’s inventory listing. Describe the information that should be included in this listing.

	Answer:
The inventory listing should include each inventory item’s description, quantity, unit price, and extended value.


78.
medium	In pricing inventory, it is necessary to consider whether replacement cost is lower than historical cost.  When applying lower of cost or market tests, what basis should auditors use for each of the following categories of inventory:
•	Raw materials
•	Work-in-process
•	Purchased finished goods
	Answer:
•	Raw materials – the most recent cost as found on vendor invoices from the period subsequent to year-end
•	Work-in-process – all manufacturing costs from production records from the period subsequent to year-end
•	Purchased finished goods – the most recent cost as found on vendor invoices from the period subsequent to year-end and the sales value of these goods


79.
medium	What must auditors do to meet their obligations under professional auditing standards related to the observation of inventory?
	Answer:
•	Be present at the time the client counts their inventory for determining year-end 	balances.
•	Observe the client’s counting procedures.
•	Make inquiries of client personnel about their counting procedures.
•	Make their own independent tests of the physical counts.

80.
medium	Discuss the auditor’s responsibilities for inventory maintained in public warehouses or with other outside custodians.

	Answer:
Ordinarily the auditor will confirm inventory held by outside custodians. However, the auditor may perform additional procedures if the amounts involved are significant. These additional procedures may include: an investigation of the custodian’s performance, requesting an independent accountant’s report on the custodian’s control procedures over the custody of goods, and observing the physical count of goods held by the custodian.
81.
medium	Discuss the four aspects of the audit of cost accounting with which the auditor is most concerned.

	Answer:
The auditor is most concerned with:
•	Physical controls over inventory.
•	Documents and records for transferring inventory. The auditor’s primary concerns in verifying the transfer of inventory from one location to another are that the recorded transfers exist, the transfers that have actually taken place are recorded, and the quantity, description, and date of all recorded transfers are accurate.
•	Perpetual inventory master files. The adequacy of perpetual inventory master files has a major effect on the timing and extent of the auditor’s physical examination of inventory.
•	Unit cost records.

82.
medium	Identify three analytical procedures commonly used when auditing accounts in the inventory and warehousing cycle.

	Answer:
Common analytical procedures for the inventory and warehousing cycle include:
•	Compare gross margin percentage with previous years’.
•	Compare inventory turnover ratio with previous years’.
•	Compare unit costs of inventory with previous years’.
•	Compare extended inventory value with previous years’.
•	Compare current-year manufacturing costs with previous years’.

83.
medium	Discuss the methodology for designing tests of details of balances for inventory.

	Answer:
The methodology for designing tests of details of balances for inventory is:
1.	Set materiality, and assess acceptable audit risk and inherent risk for the inventory and warehousing cycle.
2.	Assess control risk for several cycles. This risk is assessed for the inventory and warehousing cycle, sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle.
3.	Design and perform tests of controls and substantive tests of transactions for several cycles.
4.	Design and perform analytical procedures for the inventory and warehousing cycle.
5.	Design tests of details of inventory to satisfy balance-related audit objectives. Design sample size, timing of tests, items to select for testing, and audit procedures to be performed.

84.
medium	The design of tests of details of balances for inventory is affected by audit results from multiple cycles. Identify the cycles, other than the inventory and warehousing cycle that affect the audit of inventory.

	Answer:
Tests of details of balances for inventory are affected by the results of tests of controls and substantive tests of transactions in the sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle, as well as the inventory and warehousing cycle.




85.
medium	Discuss the key control procedures relating to the client’s physical count of inventory.

	Answer:
The key control procedures relating to the client’s physical count of inventory include proper instructions for the physical count, supervision by responsible personnel, independent internal verification of the counts, independent reconciliations of the physical counts with perpetual inventory master files, and adequate control over count sheets or tags.


86.
medium	Explain why the audit of work-in-process and finished goods inventory is generally more complex than the audit of purchased inventory.

	Answer:
The need to verify the cost of raw materials, direct labor, and manufacturing overhead in pricing work-in-process and finished goods has the effect of making the audit of work-in-process and finished goods inventory more complex than the audit of purchased inventory.


87.
medium	What types of tests are available to an auditor who wishes to test the physical control over inventory?

	Answer:
	The auditor may either use observation or inquiry to obtain evidence about the physical 	control over inventory.


88.
challenging	State the six functions that make up the inventory and warehousing cycle and, for each function, identify the related documents and/or records that would be used by a manufacturing company.

	Answer:
	The six functions are:
•	Process purchase orders. Related documents are the purchase requisition and the purchase order.
•	Receive raw materials. Related documents are the receiving report and the vendor’s invoice.
•	Store raw materials. Related record is the raw materials perpetual inventory master file.
•	Process the goods. Related documents and records are the raw materials requisition and the cost accounting records.
•	Store finished goods. Related records are the finished goods perpetual inventory master file and the cost accounting records.
•	Ship finished goods. Related documents and records are the shipping document, the finished goods perpetual inventory master file, and the cost accounting records.




89.
challenging	The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor.

	Answer: