Chapter 14 - Inventory

Question 1

State the six functions of inventory and distribution cycle

Answer 1

1. Process purchase orders
2. Receive raw materials
3. Store raw materials
4. Process the goods
5. Store finished goods
6. Ship finished goods

Question 2

6 functions of inventory and distribution cycle AND their related documents

Answer 2

1. Process PO- RM requisition & PO
2. Receive RM - receiving report & vendor’s invoice
3. Store RM- raw materials master file
4. Process the goods -RM requisition & cost actg records
5. Store FG- FG master file & cost actg records
6. Ship FG - Inv. master file & cost actg records

Question 3

Which three cycles is the inventory cycle interconnected with in a manufacturing company

Answer 3

1. HR and payroll cycle
2. Revenue cycle
3. Acquisition and payments cycle

Question 4

Obtaining an adequate understanding of the client’s business is important in the physical observation of
inventory because
A) it is required by GAAP.
B) it will help the auditor in assessing the risk of theft of inventory.
C) inventory varies significantly for different companies.
D) inventory is normally a significant item.

Answer 4

C

Question 5

The inventory and distribution cycle can be thought of as comprising two separate but closely related systems,
one involving the actual physical flow of goods, and the other the
A) related costs.
B) storing of the goods.
C) internal control over those goods.
D) prevention of waste, obsolescence, and theft.

Answer 5

A

Question 6

The overall objective in the audit of the inventory and distribution cycle is to determine that
A) costs of goods sold and gross profit are correctly stated on the income statement.
B) gross profit and inventory are fairly presented on the financial statements.
C) inventory items on the balance sheet are neither fraudulent nor materially in error.
D) inventory and cost of goods sold are fairly stated on the financial statements.

Answer 6

D

Question 7

The controls over purchase requisitions and the related purchase orders are evaluated and tested as part of the
A) inventory and distribution cycle.
B) acquisitions and payments cycle.
C) capital acquisitions cycle.
D) human resources and payroll cycle.

Answer 7

B

Question 8

The form used to request the purchasing department to place orders for inventory items is the
A) bill of lading. B) materials requisition.
C) purchase order. D) purchase requisition.

Answer 8

D

Question 9

Receipt of ordered materials by the receiving department will generate the completion of a form called the
A) receiving report. B) materials requisition.
C) inventory acquisition summary. D) bill of lading

Answer 9

A

Question 10

Master files, worksheets, and reports that accumulate material, labour, and overhead as the costs are incurred
are
A) cost accounting records. B) finished goods inventory records.
C) storeroom documents. D) accounting system controls.

Answer 10

A

Question 11

Shipping of finished goods is an integral part of the
A) human resources and payroll cycle.
B) acquisitions and payments cycle.
C) sales and collections cycle.
D) inventory and distribution cycle.

Answer 11

C

Question 12

9) When labour is a significant part of the inventory, verifying the proper accounting of these costs should be
tested in the
A) cash cycle.
B) human resources and payroll cycle.
C) acquisitions and payments cycle.
D) inventory and distribution cycle.

Answer 12

B

Question 13

The auditor would like to test the existence and accuracy of the transfer of goods from the raw materials
storeroom to the manufacturing assembly lines. Which of the following audit procedures should be used?
A) Look at overtime records to determine the amount and timing of overtime hours used in the
manufacturing process.
B) Account for a sequence of raw material requisitions, examining details and looking for proper approvals.
C) Inquire with the inventory custodian regarding procedures used to transfer raw materials to the
production line.
D) Conduct a variance analysis of the costs associated with manufacturing, looking for gross profit
fluctuations.

Answer 13

B

Question 14

An auditor has determined that there is a high risk that her client has overvalued inventory. Which audit
assertions would require additional testing?
A) allocation and accuracy
B) valuation and classification
C) accuracy and existence
D) accuracy and valuation

Answer 14

D

Question 15

The bias in recording inventory would be toward
A) understatement.
B) increasing share price.
C) income smoothing.
D) overstatement.

Answer 15

D

Question 16

The auditor evaluates the internal transfer of assets and related costs during the
A) human resources and payroll cycle.
B) inventory and distribution cycle.
C) acquisition and payments cycle.
D) sales and collection cycle.

Answer 16

B

Question 17

The costs used to value the physical inventory must be tested to determine whether the client has correctly
followed an inventory method that is in accordance with an acceptable financial reporting framework and is
consistent with previous years. The audit procedures used to verify these costs are referred to as inventory
A) price tests.
B) compilation tests.
C) consistency tests.
D) cost allocation tests.

Answer 17

A

Question 18

The auditor must verify whether the physical counts were correctly summarized, the inventory quantities and
prices were correctly extended, and the extended inventory was correctly footed. These tests are called
A) price tests.
B) mechanical tests.
C) compilation tests.
D) cost tests.

Answer 18

C

Question 19

To protect the inventory, Globus Corp wants to assign the custody of inventory to a specific responsible
individual. Globus can accomplish this by
A) requiring employees to have photo id cards.
B) performing frequent inventory counts.
C) having a designated employee to authorize the movement of inventory.
D) having restricted access to the production facility.

Answer 19

C

Question 20

A well-designed computerized system of perpetual inventory data files includes information about the
A) units of raw materials, work-in-process, and finished goods.
B) units and unit costs of inventory purchased, sold, and on hand.
C) units of inventory purchased, sold, and on hand.
D) unit costs of inventory purchased, sold, and on hand.

Answer 20

B

Question 21

Cost accounting controls are those related to the physical inventory and the consequent costs from the point at
which
A) raw materials are requisitioned until the finished product is sent to storage.
B) the customer’s order is received until the finished product is shipped.
C) raw materials are requisitioned until the finished product is completely manufactured.
D) materials are ordered for purchase until the finished product is sold.

Answer 21

A

Question 22

XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. What
internal control is required with respect to these costs to ensure proper valuation of inventory?
A) Computer software should be used to make sure that the standard costs are properly updated into the
inventory item master file.
B) Standard costs should be used to provide a value for inventory every month by calculating cost times
quantity on hand.
C) Procedures must be designed to keep the standards updated for changes in production processes and
costs.
D) Input edit routines should be used to help detect input data entry errors for the entry of the standard costs.

Answer 22

C

Question 23

XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. For
the last few months, there have been high variances between total standard costs and actual costs. What is one
of the likely reasons for this variance?
A) There is an increase in inventory quantities on hand.
B) The receiving department has been stockpiling raw materials.
C) Production quantities are different than expected.
D) The accounting department has been developing the costs.

Answer 23

C

Question 24

The existence of an adequate storeroom with a competent custodian in charge results in the orderly storage of
inventory and can protect inventory from theft and misuse. How would an auditor assess these controls?
A) inspection of inventory damage statistics and inquiry of inventory personnel
B) observation during the inventory count and inquiry of inventory personnel
C) observation during the audit and inquiry of the accounting staff
D) inquiry of the accounting staff and inspection of theft statistics

Answer 24

B

Question 25

Joe Buelow is the auditor for Barbara Cosmetics Ltd. (BCL). BCL has recorded a provision for inventory
obsolescence. After completing the risk assessment procedures, Joe is particularly worried about the net
realizable value of BCL’s inventory. Which of the following is a viable risk response procedure to address Joe’s
concerns about valuation?
A) attend the physical inventory count at year-end
B) request a physical inventory count during an interim period and use that count balance as the opening
balance when determining year-end inventory
C) trace inventory costs to supplier invoices for randomly selected inventory items
D) test the process for identifying obsolete inventory and compare the provision to that of prior years

Answer 25

D

Question 26

Tito is the auditor for Riteway Appliances Inc. Tito is concerned about the accuracy of Riteway’s inventory. He
noticed the inventory listing includes a number of gourmet refrigerators but Tito knows demand for these
appliances is high and they are in short supply. To address Tito’s concerns about existence and accuracy, he
should
A) inquire about the process for identifying appliances that need to be written down .
B) trace inventory costs to supplier invoices for randomly selected inventory items .
C) attend the physical inventory count at year-end.
D) select a sample of appliances from the inventory listing and reperform the calculation of their total cost to
ensure mathematical accuracy.

Answer 26

C

Question 27

Segregation of duties between production, inventory control, and accounting are important controls in the
inventory and distribution cycle. How would the auditor test these controls?
A) using observation and reperformance
B) using a discussion with management
C) using observation and inquiry
D) using inquiry and reperformance

Answer 27

C

Question 28

The auditor’s tests of the adequacy of the physical controls over raw materials, work-in-process, and finished
goods are usually limited to
A) observation and inquiry.
B) inspection and inquiry.
C) inspection and confirmation.
D) inspection and observation.

Answer 28

A

Question 29

It is frequently possible to test the physical inventory prior to the balance sheet date when
A) year-end sales are small.
B) client counts inventory at interim dates.
C) there are accurate perpetual inventory master files.
D) the internal control system is no better at year-end than at an earlier point in time.

Answer 29

C

Question 30

The auditor has determined that the perpetual inventory master files are high quality, assessing control risk
related to the physical observation of inventory as low. How does this affect audit testing? The auditor may
A) reduce the extent of the tests of physical inventory.
B) increase assessed inherent risks over the tests of physical inventory.
C) reduce the extent of control tests over data entry to the master file.
D) reduce the extent of control tests with respect to program change controls.

Answer 30

A

Question 31

If the auditor concludes that the physical controls over inventory are so inadequate that inventory will be
difficult to count, the auditor should
A) rely on the perpetual inventory master files rather than the physical count.
B) inquire of management the additional controls that can be put in place to enable a better count to be
carried out.
C) expand the observation of physical inventory tests to ensure that an adequate count is carried out.
D) conduct additional control tests over the pricing and compilation of inventory to obtain a higher degree of
accuracy.

Answer 31

C

Question 32

Selecting a sample of job orders from the job cost summary and matching them to bills of material and the
schedule of production labour requirements is a procedure designed to test the control objective of
A) accounting.
B) accuracy.
C) validity.
D) completeness.

Answer 32

C

Question 33

Reconciling the open production cost reports to the work-in-process inventory control account is a procedure
designed to test the control objective of
A) authorization.
B) accounting.
C) validity.
D) completeness.

Answer 33

D

Question 34

Which one of the following analytical procedures would be most helpful in alerting the auditor to the possibility
of obsolete inventory?
A) comparing inventory turnover with previous years
B) comparing gross margin percentage with previous years
C) comparing unit costs of inventory with previous years
D) comparing current year manufacturing costs with previous years

Answer 34

A

Question 35

To detect an overstatement or understatement of inventory and cost of goods sold, the auditor may perform an
analytical procedure such as comparing
A) current year manufacturing costs with previous years.
B) inventory turnover with previous years.
C) extended inventory value with previous years.
D) gross margin percentage with previous years.

Answer 35

D

Question 35

Which analytical procedures will help an auditor identify possible misstatements in compilation, unit costs, or
extensions that affect inventory and cost of goods sold?
A) comparing gross margin percentage with previous years
B) comparing extended inventory value with previous years
C) comparing unit costs of inventory with previous years
D) comparing inventory turnover with previous years

Answer 35

B

Question 36

From which of the following evidence-gathering audit procedures would an auditor obtain most assurance
concerning the existence of inventories?
A) written inventory representations from management
B) confirmation of inventories in a public warehouse
C) auditor’s recomputation of inventory extensions
D) observation of physical inventory counts

Answer 36

D

Question 37

The auditor has determined that the inventory procedures are highly automated with limited use of a paper or
physical trail. Rather than having people count inventory (since all inventory has RFID tags attached), inventory
is being read using the wireless mesh network. To provide assurance with respect to ending inventory, the
auditor should
A) request that the client implement manual rotating counts to test the quality of the automated systems.
B) bring in additional audit staff and conduct a high level of test counts, matching these counts to the
automated systems.
C) use dollar-unit sampling to identify all high-dollar inventory items and ask the client to physically count
these items using count teams.
D) test the quality of the controls over the programs in use and over tagging inventory items.

Answer 37

D

Question 38

CAS for audit procedures for inventory indicate that the auditor
A) must be present at the inventory count and must receive adequate documentation from the client
regarding the effectiveness of inventory-taking.
B) need not be present at the count but must review the methods followed to determine the quantities and
values.
C) must be present at the inventory count and evaluate the methods followed to determine the quantities and
values.
D) must count the inventory.

Answer 38

C

Question 39

The client has a perpetual inventory system, and takes an inventory count of 100 items every two weeks for
comparison to the perpetual records. There are no plans to have a complete year-end physical count of
inventory. How will the auditor conduct the audit of physical inventory?
A) Conduct test counts and compare the perpetual records with a cyclical count during the interim audit.
B) Use roll-forwards to carry forward the inventory records from the cyclical counts for an attribute sample
of inventory items.
C) Select a dollar unit sample of items to count at the year end for comparison to the perpetual records.
D) Select an attribute sample of items to count at the year end for comparison to the perpetual records.

Answer 39

A

Question 40

A public accountant observes his client’s physical inventory count on December 31. There are eight
inventory-taking teams and a tag system is used. The public accountant’s observation normally may be
expected to result in the detection of which of the following inventory errors?
A) The inventory omits items on consignment to wholesalers.
B) The inventory takers forgot to count all the items in one room of the warehouse.
C) Some of the items included in the inventory had been received on consignment.
D) An error is made in the count of one inventory item

Answer 40

B

Question 41

The test of details of balance procedure that requires the auditor to review contracts with suppliers and
customers and inquire of management for the possibility of the inclusion of consigned or other non-owned
inventory is an attempt to satisfy the objective of
A) realizable value.
B) completeness.
C) rights and obligations.
D) existence.

Answer 41

C

Question 42

The auditor has evaluated the effectiveness of the client’s procedures to count inventory, and has provided
constructive suggestions for improvement. However, the client has not implemented the suggestions, so the
auditor has concluded that the inventory instructions do not provide adequate controls. This means that the
auditor
A) must spend more time ensuring that the physical count is accurate.
B) should increase the level of price and compilation tests to ensure better quality inventory pricing data.
C) must send a management letter informing management of the impact of these weaknesses.
D) should use attribute sampling to select a smaller sample for testing the physical inventory.

Answer 42

A

Question 43

When a physical count of inventory is permitted at an interim date, the auditor observes it at that time, and also
tests the perpetual inventory for transactions
A) from the date of the count to the end of the audit field work.
B) throughout the year.
C) from the date of the count to year-end.
D) which are a representative sample of the period under audit.

Answer 43

C

Question 44

Dishware Distribution Limited uses average costing to cost its inventory. It keeps a perpetual inventory file that
is linked to its sales systems. It orders inventory in for specific customers as needed, and traditionally has a slow
time just before its year-end. Accordingly, inventory at the year-end is about $2000, while materiality is about
$30 000. How should the auditor approach the audit of physical inventory?
A) Use attribute sampling to select a sample of items to count.
B) Use dollar-unit sampling to select a sample of items to count.
C) Exclude testing of physical inventory from the audit program.
D) Count only those items that have a dollar value in excess of $100.

Answer 44

C

Question 45

The test of details of balance procedure that requires the auditor to account for unused inventory tag numbers
to make sure none have been omitted is an attempt to satisfy the objective of

Answer 45

D

Question 46

An inventory observation procedure that compares physical counts with the perpetual inventory master file is
an attempt to satisfy the audit objective of
A) completeness.
B) classification.
C) accuracy.
D) existence

Answer 46

C

Question 47

A common inventory observation procedure is to record the last shipping document number used at year-end
in the working papers for subsequent follow-up. The audit objective being achieved by this procedure is
A) existing inventory is counted and tagged.
B) tags are accounted for to make sure none are missing.
C) inventory as recorded exists.
D) information is obtained to make sure sales and inventory purchases are recorded in the proper period.

Answer 47

D

Question 48

The most important part of the observation of inventory is determining whether
A) the counts are accurate.
B) the inventory-takers are qualified.
C) the physical count is being taken in accordance with the client’s instructions.
D) obsolete inventory has been identified.

Answer 48

C

Question 49

A useful starting point for becoming familiar with the client’s inventory is for the auditor to
A) tour the client’s facility.
B) read the client’s Accounting Manual.
C) review accounting theory covering special problems, such as gas and oil accounting, or lease-purchase
agreements.
D) obtain and review industry ratios

Answer 49

A

Question 50

What is the first step that the auditor takes when auditing the valuation of inventory?
A) Conduct analytical review, comparing gross margin for the current year to the prior year.
B) Clearly establish the valuation method used and how the calculations are being performed.
C) Do an industry analysis to determine whether there is a potential for technology-induced obsolescence.
D) Ask the client about the level of obsolete inventory that was on hand and counted during the inventory
count.

Answer 50

B

Question 51

The auditor is determining which specific inventory items should be selected for pricing tests. The auditor has
selected a representative sample, and those items that have a large dollar amount. In addition, the auditor
should select those items that
A) have wide fluctuations in price.
B) are stored in multiple locations.
C) are likely to have been miscounted during the inventory count.
D) are prone to breakage or theft.

Answer 51

A

Question 52

The test of details of balance procedure that 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) valuation.
B) existence.
C) completeness.
D) accuracy.

Answer 52

A

Question 52

As part of the audit of valuation, the auditor is conducting pricing tests by comparing to supplier invoices. The
auditor is making sure that, for each item tested, sufficient supplier invoices are examined to cover the quantity
of inventory that was on hand during the physical inventory count. What type of pricing error could this detect?
A) The wrong inventory count quantity could have been recorded on the count sheets.
B) The client has used the incorrect accounting method to value its inventory.
C) The client valued their inventory on the basis of the most recent invoice only.
D) Extension errors could occur with numerous different inventory items.

Answer 52

C

Question 53

Which of the following is correct relating to “fraud risk factor”?
A) it is also a material weakness in internal control
B) the planned audit procedures would require modifications
C) if it involves senior management, it will result in resignation of the auditor
D) it may affect the auditors assessment of risks relating to fraud

Answer 53

D

Question 54

When performing a financial statement audit, auditors are required to explicitly assess the risk of material
misstatement due to
A) fraud.
B) illegal acts.
C) business risks.
D) audit risk

Answer 54

A

Question 55

Which of the following statements is true regarding the use of audit data analytics (ADA) to detect fraud in the
inventory and distribution cycle?
A) the auditor is required to presume the risk of fraud for inventory
B) data visualizations are ineffective for identifying unusual journal entries
C) ADA can enhance the detection of suspicious patterns that may hide in large volumes of data
D) data analytics reduces the need for a large sample size

Answer 55

C

Question 56

An auditor refuses to discuss the audit plan with a client and shows up at the client locations for an inventory
count without previously scheduling the visit. Which of the following is the audit likely concerned about?
A) illegal acts
B) business risks
C) fraud
D) audit risk

Answer 56

C