Chapter 11 Audit of Acquisition and Payment Cycle and Inventory

Question 1

if there are significant deficiencies or material weaknesses in internal control over acquisitions, the auditor will use these approaches:

1. Testing of subsequent disbursements
2. Request for vendor statements (confirmations of payables and reconcile to recorded amounts)
3. Review unpaid/unrecorded vendor invoices

Answer 1

Substantive tests of Accounts Payable

Question 2

auditor should consider that management is more likely to:

1. understate rather than overstate expenses
2. classify expense items as assets rather than vice versa

Answer 2

Substantive tests of accrued expenses

Question 3

1. Legal expense
2. Travel and entertainment expense
3. Repair and Maintenance expense
4. Income tax expense

Answer 3

4 expense accounts Auditors look at

Question 4

should be examined as a possible indicator of litigation that may require recording and/or disclosure

Answer 4

Legal Expense

Question 5

should be examined for questionable or non-business related items

Answer 5

Travel and entertainment expense

Question 6

should be examined together with fixed-asset additions to assure proper distinction has been made between expenditures that should be expensed and those that should be capitalized

Answer 6

Repair and Maintenance expense

Question 7

should be examined, often by a colleague who is a tax specialist, to assure that tax laws and regulations have been followed

Answer 7

Income tax expense

Question 8

auditor should examine the following:

• all credits to expense accounts
• all other unusual entries to the accounts
• auditor should search for independent validation of all unusual entries to expense accounts

Answer 8

Review of unusual entries to expense accounts

Question 9

systems companies use to assist in controlling costs, streamlining accounting, and costing inventory. auditor should make inquiries about the following:

• method for developing standard costs
• how recently have standards been updated
• method for identifying components of overhead and of allocating overhead to products
• methods for identifying variances

Answer 9

Cost-Accounting system

Question 10

company assertions and audit procedures to test for:

• existence
• completeness
• rights
• valuation
• disclosure

Answer 10

Substantive tests of inventory

Question 11

1. review the client’s proposed physical inventory procedures to determine whether they are likely to result in a complete and correct physical inventory
2. Observe the client’s count of annual physical inventory. perform test counts of the observations and trace to the client’s compilation of inventory

Answer 11

Tests for existence

Question 12

1. perform year end cutoff tests by noting the last shipping and receiving document numbers used before physical inventory is taken. Review the purchase and sales journal for a period of time shortly before and after year end, noting the shipping and receiving document numbers to determine whether goods are recorded in proper period.
2. make inquiries of the client regarding the potential existence of goods on consignment or located in outside warehouses

Answer 12

Tests for completeness

Question 13

1. review vendor invoices when testing disbursements to determine that proper title is conveyed
2. review sales contracts to determine whether the customer has rights to return merchandise, and whether the rights are such that recognition of a sale might not be appropriate

Answer 13

Tests for rights

Question 14

1. inquire of production and warehouse personnel about the existence of obsolete inventory
2. note potentially obsolete inventory while observing the physical inventory counts trace the potentially obsolete items to the client’s inventory compilation, and determine whether they are properly labeled as obsolete

Answer 14

Tests for valuation

Question 15

review client’s financial statement disclosure of:

• inventory valuation methods used
• FIFO cost figures and LIFO liquidation effects if LIFO is used
• the percentage of inventory valued by each different valuation method
• the classification of inventory as raw material, work in process, and finished goods

Answer 15

Tests of disclosure

Question 16

1. observe the client taking inventory to determine the accuracy of the procedures and make selected test counts that can later be traced into the client’s inventory compilation
2. look for evidence of slow-moving, obsolete, or damaged inventory that may need to be written down to lower of cost or market
3. obtain a copy of account sheet. or if using tags obtain a copy of last tag used
4. obtain copies of last 5 or 10 shipping/receiving documents before you leave

Answer 16

Observations, test counts and cutoff procedures for inventory

Question 17

auditor performs this test of receipts and shipments of inventory at year end to determine that all items are recorded in the correct time period

Answer 17

cutoff tests

Question 18

2 populations:

1. receiving report to vendor Bill of Lading
2. Shipping report to Sales/COGS

Answer 18

Inventory cutoff

Question 19

auditor attempts to gather evidence on potential inventory obsolescence from a number of corroborating sources, including the following:

• Noting potential obsolete inventory when observing the client’s physical inventory
• calculating inventory turnover, number of days sales in inventory, date of last sale or purchase, and other analytic techniques

Answer 19

Tests of obsolete inventory (net realizable value tests)