CHAPTER
3
AUDIT OF INVENTORIES AND COST OF GOODS SOLD AUDIT PROGRAM FOR INVENTORIES Audit Objectives To dete!i"e t#$t% a. b. c. d. e. f.
Invent Inventori ories es inclu included ded in the the balanc balance e sheet sheet phy physic sicall ally y exist exist.. Inventorie Inventories s represen representt items items held held for sale sale or use use in the normal normal course course of business. business. Inventory Inventory quantities quantities include include all all product products, s, materia materials, ls, and and suppli supplies es owned owned by the compa company ny (on (on hand, in transit, or stored at outside locations). The entity has legal title or similar rights of ownership to the inventories. Invent Inventori ories es are are proper properly ly stat stated ed at cost cost (exc (except ept when when mark market et is lowe lower) r) Inventorie Inventories s are properly properly described described and classified classified in the the financi financial al statem statements ents and disclo disclosures sures are adequate.
Audit Pocedues .
!bse !bserv rve e phys physic ical al inve invent ntor ory y coun counts ts.. a. Test shippi shipping ng and and recei receivin ving g cutof cutofff proced procedure ures. s. b. "ccount "ccount for all all inventory inventory tags and and count count sheets sheets used used in record recording ing the the physical physical inventory inventory count. c. Test the cler clerica icall accur accuracy acy of inven inventor tory y listi listings ngs.. d. Trace Trace test test counts counts recorded recorded during during the physi physical cal invent inventory ory observ observation ation to the inventory inventory listing. e. #econcile #econcile phys physical ical counts counts to perpetua perpetuall records records and and general general ledger ledger balanc balances es and investigat investigate e significant variations. f. Test invent inventory ory transactio transactions ns between between a prelimin preliminary ary physical physical inventory inventory date and the the balance sheet date.
$.
!btain !btain conf confirm irmati ation on of inven inventor tories ies at at locatio locations ns outsi outside de the the entity entity..
%.
#eview #eview perpetua perpetuall inventory inventory records, records, producti production on records, records, and and purchasi purchasing ng records records for for indicati indications ons of current activities.
&.
"nalytic "nalytically ally review review the relatio relationshi nship p of invento inventory ry balance balances s to recent recent purcha purchasing, sing, production production,, and sales activities, and to anticipated sales volume.
'.
xami xamine ne paid paid vendors vendors invoice invoices, s, consig consignme nment nt agreem agreement ent,, and contra contracts cts..
*.
#evi eview dire direct ct labo laborr rat rates es..
+.
Test the comput computati ation on of standa standard rd overhe overhead ad rates. rates.
.
xamine xamine analysis analysis of purcha purchasing sing and manufactu manufacturing ring standard standard cost variances. variances.
-.
xam xamin ine e inv inven ento tory ry turn turnov over er anal analys ysis is..
.
#eview #eview indust industry ry expe experie rience nce and trends trends..
. .
Tour the plant. plant. Inquire Inquire of productio production n and sales sales personnel personnel concerning concerning possib possible le excess excess or obsolete inventory items.
$.
xamine xamine sales sales after year/end year/end and open open purcha purchase se order order commi commitment tments. s.
%.
!btain !btain confirma confirmation tion of inventori inventories es pledge pledge under under loan agreements agreements..
&.
#eview #eview drafts drafts of of the financ financial ial statem statement ents. s.
'.
0ompare 0ompare the disclos disclosures ures made made in the financia financiall statements statements to the require requirement ments s of generally generally accepted accounting principles.
CHAPTER
3 PRO&LEMS
PRO&LEM NO' ( PASSAGE OF TITLE 1obel 0ompany reviewed its inventories and found the following items2
In the the shipping shipping room was a product product costin costing g 3%,& 3%,& when when the the physical physical count was taken. 4ecause 4ecause it was marked 56old for shipping instructions5, instructions5, it was not included in the count. The customer order was dated 7ecember ', but the product was shipped and the customer billed on 8anuary &, $.
$
!n 7ecembe 7ecemberr $+, $-, merchandise merchandise costing costing 3,*& 3,*& was received received and recorde recorded. d. The invoice invoice accompanying the merchandise was marked 5on consignment.5
%
The company received received merchandise merchandise costing costing 3&,*$' 3&,*$' on 8anuary 8anuary $, $. $. The invoic invoice e which which was recorded on 8anuary %, $ showed shipment was made under 9!4 shipping point on 7ecember %, $-. The merchandise was not included in in the inventory because it was was not on hand when the physical count was taken.
&
" product, product, fabricate fabricated d to order order for for a particu particular lar custome customerr was completed completed and in the shipping shipping room room on 7ecember %. "lthough it was was shipped on 8anuary ', $, the customer was was billed on 7ecember %, $- and it was excluded from the inventory.
'
:erchandis :erchandise e costing costing 3*,*** 3*,*** was was received received on 8anuary 8anuary ', $, and and the related related purchase purchase invoic invoice e was recorded 8anuary *. The shipment of this merchandise was was made on 7ecember %, $-, 9!4 destination.
*
" product product costing costing 3', 3', was was sold sold on on an installme installment nt basis basis on 7ecember 7ecember , $-. It was delivered to the customer on that date. The product was included in inventory because the company still holds legal legal title. The companys experience suggests that that full payment on installment sales is reasonably assured.
+
"n item item costing costing 3*', 3*', was sold and deliv delivered ered to the the custome customerr on 7ecember 7ecember $-, $-, $-. $-. The goods were included in the inventory because the sale was with a repurchase agreement that require 1pbel 0ompany to buyback the inventory on 8anua ry ', $.
RE)UIRED%
Indicate which of the above items are to be included in the inventory balance at 7ecember %, $-. ;tate your reason reason for the treatment you suggest.
;olution2 . Inclu Included ded / :erchandise, :erchandise, except except 5special 5special orders5 orders5 should should be included in the the inventory until shipped. $. xcl xcluded uded / 1obel 0ompany 0ompany does not possess possess legal legal title title because the merchandi merchandise se was received on a consignment basis. %. Inclu Included ded / 4ecaus 4ecause e the purchase purchase was was made under under 9!4 9!4 shipping shipping point point term, term, the merchandise should be included in the inventory on the shipping date. &. xcluded / " product that is manufactured for a particular particular customer (special (special order) is considered sold upon its completion. '. xcluded / The merchandise merchandise was purchased under 9!4 destination destination term and was
not received until 8anuary ', $-. *. xcl xcluded uded / The sale is recogni recogni
PRO&LEM NO' * DETERMINING INVENTOR+ )UANTIT+ The management of =lum 0ompany has engaged you to assist in the preparation of the year/end (7ecember %) financial financial statements. The companys year/end inventory of &%,' units is based on a physical count taken on 7ecember % under your your observation. 7uring the month of 7ecember, 7ecember, sales totaled %,*% units including &, units shipped on consignment to "pple 0orp. " letter letter received from "pple 0orp. indicates that as of 7ecember %, it has sold ',$ units and was still trying to sell the remainder. remainder. " review review of the 7ecember purchase purchase orders to various suppliers suppliers shows the following2 following2 =urchase !rder 7ate
Invoice 7ate
>uantity in ?nits
7ate ;hipped
7ate #eceived
$@%@$@'@$@*@$@@$@$$@% $@$+@-
@$@ @$@ @%@ $@$@@'@ @+@
&,$ %,* +,- , &,* %,'
@$@ $@+@@'@ $@$-@@&@ @'@
@'@ $@$$@@+@ @$@ @*@ @+@
Terms 9!4 7estination 9!4 7estination 9!4 ;hipping point 9!4 ;hipping point 9!4 7estination 9!4 7estination
=lum 0ompany uses the 5passing of legal title5 for inventory recognition.
RE)UIRED%
Co!,ute t#e i"ve"to- .eve. $s o/ Nove!be 30'
;olution2 Inventory, 7ecember % "dd2 7ecember sales 0onsignment sales !ther sales (%,*%/&,) T1"; Aess2 7ecember purchases =! 7ate $@'@$@@Inventory, Bovember %
&%,' ',$ -,*%
%,* ,
%,% '+,%%
,* &',+%
PRO&LEM NO' 3 COMPUTING THE CORRECT ENDING INVENTOR+ INVENTOR+ AMOUNT In your audit of the 7ecember %, $- financial statements of 0hevvy, 0hevvy, Inc., you found the following inventory/related transactions2 a.
1oods 1oods cost costing ing 3$', 3$', are on consi consignm gnment ent with with a custom customer er.. These These good goods s were were not includ included ed in the physical count on 7ecember %, $-.
b.
1oods 1oods cost costing ing 3*,' 3*,' were were deliv delivere ered d to 0hevv 0hevvy y, Inc. Inc. on 8anua 8anuary ry &, $ $.. The invoic invoice e for for these goods was received and recorded recorded on 8anuary , $. The invoice showed the shipment shipment was made on 7ecember $-, $-, 9!4 shipping point.
c.
1oods 1oods cost costing ing 3$,*& 3$,*& were were shipp shipped ed 9!4 9!4 shippi shipping ng poin pointt on 7ecemb 7ecember er %, %, $$- and were were received by the customer on 8anuary $, $. "lthough the sale was was recorded in $-, these goods were included in the $- ending inventory. inventory.
d.
1oods 1oods cost costing ing3, 3,*&' *&' were were shippe shipped d to a custom customer er on 7ecemb 7ecember er %, %, $-, $-, 9!4 destina destinatio tion. n. These goods were delivered to the customer on 8anuary ', $ and were not included in the inventory. inventory. The sale was properly taken up in $.
e.
1oods 1oods cost costing ing 3,* 3,* ship shipped ped by by a vend vendor or under under 9! 9!4 4 desti destinat nation ion term, term, were were receiv received ed on 8anuary %, $, and thus were not included in the physical inventory. inventory. 4ecause the related invoice was received on 7ecember %, $-, this shipment was recorded as a purchase in $-.
f.
1oods 1oods valued valued at 3', 3', were were recei received ved from from a vendor vendor under under consig consignme nment nt term. term. These These goods goods were not included in the physical count.
g.
0hevv 0hevvy y, Inc. Inc. reco recorde rded d as a $$- sale sale a 3*&,% 3*&,% shipm shipment ent of goods goods to to a custo customer mer on 7ece 7ecember mber %, $-, 9!4 destination. This shipment of goods costing 3%+,' was was received by the customer on 8anuary ', $, and was not included in the ending inventory figure.
=rior to any adCustments, 0hevvy, 0hevvy, Inc.s ending inventory is valued at 3&&',%&* and the reported net income for the year is 3,*&,+$%.
RE)UIRED% . 7etermine the correct inventory amount to be reported in the financial statements of 0hevvy, 0hevvy, Inc. for the year ended 7ecember %, $-. $. 0ompute the adCusted net income for the year $-. ;olution2 =er clients book a. 1oods on consignment b. 1oods purchased 9!4 shipping point c. 1oods sold 9!4 shipping point d. 1oods sold 9!4 destination e. 1oods purchased 9!4 destination f. 1oods received on consignment g. 1oods sold 9!4 destination 0orrected balance
() Inventory &&',%&* $', *,' ($,*&) ,*&' %+,' ',%'
($) Bet Income ,*&,+$% $', ($,*&) ,*&' ,* ($*,) ,*&$,'$
PRO&LEM NO' 1 INVENTOR+ VALUATION Debra 6ome Improvements 0ompany installs replacement siding windows, and louvered glass doors for family homes. In your audit of the companys financial financial statements for the year ended 7ecember %, $-, you have gathered the following data concerning inventory. inventory. "t 7ecember %, $-, the balance in Debras #aw :aterials :aterials Inventory account was was 3'$,, and the "llowance "llowance for Inventory Erite/down had a balance of 3%$,*. The relevant inventory cost and market data at 7ecember %, $- are summari
0ost "luminum siding
3-,
#eplace/ ment 0ost 3*,
;ales =rice 3-,'
Bet #e #eali
Bormal =rofit 3*,&
:ahogany siding Aouvered glass doors 1lass windows Total
-&, $', -&, 3'$,
-$, %', &, 3&$+,
-%, $-, $', 3','
', , -+, 3&,
+,&& ,* $,' 3&',-'
RE)UIRED% . 7etermine the proper balance in the "llowance "llowance for Inventory Erite/down at 7ecember %, $-. ;olution2 0ost B#F A0: "luminum siding -, +, +, :ahogany siding -&, ', ', Aouv Ao uver ered ed gl glas ass s do door or $', $ ', , , , , 1lass windows -&, -+, -&, '$, &, &++, #equired allowance ('$,/&++,)
$',
$. Ehat is the entry to recogni
+,* +,* $', %$,* (+,*)
PRO&LEM NO' 2 PERPETUAL INVENTOR+ S+STEM Hour client took a complete physical p hysical inventory under your observation as of 7ecember ' an d adCusted the inventory control account (perpetual inventory method) to agree with physical inventory. inventory. Hou have decided to accept the balance of the control account as of 7ecember %, after reflecting transactions recorded therein from 7ecember * to %, in connection with your financial statement audit fo r the year ended 7ecember %. Hour examination of the sales cut/off as of 7ecember ' and 7ecember % revealed the following items not previously considered.
0ost
;ales =rice
3',*' $,&% *,+
RE)UIRED%
3+,$ &,*' -,$
;hipped
4illed
0redited to Inv. 0ontrol
$@& $@% @%
$@+ $@$ $@%
$@+ $@% $@%
Ehat adCusting Cournal entries, if any a ny,, would you make for each of these itemsG
;olution2 "dCusting 8ournal ntries ntries 7ecember % . Inventory
',*'
Inventory over and short To reverse erroneous adCustment to
',*'
physical count at 7ecember ' $. ;ales
-,$ "ccounts receivable
-,$
To reverse sale recoded $@% not shipped till @$ %. Inventory
*,+
0ost of sales
*,+ To reverse cost of sale recorded $@% but not shipped till @$
PRO&LEM NO' PURCHASES CUTOFF Hou are engage in an audit of the financial statements of 0arnaval 0ompany for the year ended !ctober %, $-, and have observed the physical inventory count on that date. "ll merchandise received received up to and including !ctober %, $- has been included included in the physical count. The following lists lists of invoices are for purchase of merchandise merchandise and are entered in the purchases Cournal for the months of !ctober and Bovember Bovember $-, respectively2 respectively2 7ate 7ate of :erchandise "mount 9!4 Invoice #eceived Octobe *004
3+,$ &,& -,$' %,- $,' ,$' -,$ %,* %&,*
7estination 7estination ;hipping point 7estination 7estination ;hipping point ;hipping point 7estination 7estination
!ctober !ctober $ !ctober $ !ctober $' Bovember & !ctober $' !ctober $' !ctober $ !ctober $-
!ctober $ !ctober $$ !ctober % Bovember % !ctober $!ctober % !ctober % !ctober % !ctober %
7estination 7estination ;hipping point ;hipping point ;hipping point ;hipping point 7estination
!ctober $!ctober % !ctober $+ Bovember $ !ctober $% !ctober $% !ctober $+
Bovember & !ctober % !ctober % !ctober % Bovember % Bovember % Bovember %
Nove!be *004
3$, &,' *,&$ +,$$ $,$ &,$ ',
Bo perpetual inventory records are maintained and the physical inventory count is to be used as a basis for the financial statements.
RE)UIRED% . Ehat adCusting entries would you propose propose in view of the facts adducedG ;olution2 . "dC "dCust usting ing 8our 8ournal nal ntr ntries ies
a. "ccounts payable =urchases To reverse entry made for !ctober $' invoice. b. =urchases "ccounts payable To set up liability for the following !ctober % invoices2 Invoice date !ctober % !ctober $+ Bovember $ !ctober $% !ctober
%$%,- %,-
&',' &','
"mount &,' *,&$ +,$$ $,$ &,$ &','
$. Ehat adCustment, if any, would would you suggest to the physical inventory as originally originally takenG $. The physical physical inventor inventory y at !ctober % should should be increased increased by ?;3%,+. ?;3%,+. Invoice date !ctober % !ctober $% !ctober
%$"mount &,' $,$ &,$ %,+
PRO&LEM NO' 5 CORRECTING INVENTOR+ ERRORS :orning 7ews annual income for the period $'/$$ '/$- is as follows2
Hear
Bet Income (loss)
$' $* $+ $ $-
3&, %&', *&-, (',) $,
" review review of the companys records records reveals the following following inventory errors2 errors2 $' $* $ $-
RE)UIRED%
3%, *, &,' ,
understatement, end of the year ov o verstatement, end of the year understatement, end of the year overstatement, end of the year
0ompute the adCusted net income for each year.
;olution $'
$*
$+
?nadusted net income@ (loss)
&,
%&',
*&-,
$' understatement end inv
%,
(%,)
$* overstatement of end inv
(*,)
*,
$ (',) (
$$,
$ understatement end inv
&,'
(&,')
$- overstatement end inv
(,) ', ' ,
%%*, %% *,
*'', *' ',
(& &', ',' ') )
&, &,' '
PRO&LEM NO' 6 INCOME EFFECT OF INVENTOR+ INVENTOR+ ERRORS The ;ilverado 0ompany reported income before taxes of 3&%,* for $ and 3-*',& for $-. The company takes its annual physical count of inventory every 7ecember %. Hour audit revealed the following information2 a.
The price price used used for for ,' ,' unit units s inclu included ded in in the the $ $ ending ending invent inventory ory was was 3-. 3-. The correc correctt cost cost was 3- per unit.
b.
1oods 1oods costin costing g 3$%, 3$%,* * was receiv received ed from from a vendo vendorr on on 8anua 8anuary ry ', $-. $-. The shipme shipment nt was made on 7ecember $*, $ under 9!4 shipping shipping point term. The purchase was recorded in $, but the shipment was not n ot included in the $ ending inventory. inventory.
c.
:erchan :erchandis dise e costi costing ng 3*&,+' 3*&,+' was was sold sold to a custo customer mer on 7ece 7ecembe mberr $-, $-, $ $.. ;ilver ;ilverado ado was asked by the customer to keep the merchandise until 8anuary %, $-, when the customer could come and pick it up. "lthough the sale was properly properly recorded in $, the merchandise was included in the ending inventory. inventory.
d.
" suppli supplier er sold sold mercha merchandi ndise se valu valued ed at 3&, 3&, to to ;ilv ;ilvera erado do 0omp 0ompany any.. The merc merchand handise ise was was shipped 9!4 shipping point at 7ecember $-, $, $ , and was received by ;overado on 7ecember %, $. The purchase was recorded in $- and the merchandise merchandise was not included in the $ ending en ding inventory. inventory.
RE)UIRED%
0ompute the adCusted net income for $ and $-.
;olution2 #eported income before taxes
$
$-
&%,*
-*',&
$,'
($,')
$%,*
($%,*)
(*&,+')
*&,+'
-$%,-'
','
"dCustments2 a. Transposition error (-/-Jx,') b. 1oods purchased 9!4 shipping point c. 1o 1oods sold in $ d. 1oods purchased 9!4 shipping point
PRO&LEM NO' 4 CORRECTING THE PH+SICAL INVENTOR+ COUNT In your audit of the #ainbow 0ompany, 0ompany, you noted that a physical inventory count on 7ecember %, $-, showed merchandise costing 3', was on hand at that date. Hour examination reveals the following items are all excluded from the inventory per count.
:erchan :erchandis dise e of 3$, 3$, which which was was held held on cons consign ignmen ment. t.
$
1oods costing costing 3%-,' which which was was shipped shipped 9!4 destination destination on 7ecembe 7ecemberr %, %, $-. These goods were delivered to the customer on 8anuary *, $.
%
1oods costing costing 3*, 3*, which which was was shipped shipped 9!4 9!4 shipping shipping point to a custome customerr on 7ecember 7ecember $-, $-. The customer received these these goods on 8anuary $, $.
&
:erchandis :erchandise e costing costing 3+*,' 3+*,' shipped shipped by a seller seller 9!4 destinatio destination n on 7ecember 7ecember $, $-, $-, and received by #ainbow 0ompany on 8anuary %, $.
'
1oods costing costing 3*,&&& 3*,&&& shipped shipped by a vendor vendor 9!4 9!4 seller seller on on 7ecember 7ecember %, %, $-, and received received by #ainbow 0ompany on 8anuary &, $.
RE)UIRED%
0ompute the correct inventory amount at 7ecember %, $-.
;olution2 Inventory per physical count "dd2
',
1oods sold 9!4 destination destination
%-,'
1oods purchased 9!4 seller
*,&&&
'',-&& -',-&&
PRO&LEM NO' (0 CORRECTING INVENTOR+ ERRORS 4aileys 0ompany is a manufacturer of small tools. The following information was was obtained from the companys accounting records for the year ended 7ecember %, $-. Inventory at 7ecember %, $- (based on physical count in 4aileys warehouse at cost on 7ecember %, $ "ccounts payable at 7ecember %, $Bet sales (sales less sales returns)
3,+, ,&', -,*-%,&
Hour audit reveals the following information2
The physical physical count included included tools tools billed billed to a customer customer 9!4 shipping shipping point point on 7ecember 7ecember %, $-. These tools cost 3*&, and were billed billed at 3+,'. They were in the shipping area waiting to be picked up by the customer.
$
1oods shipped shipped 9!4 9!4 shipping shipping point by a vendor vendor were in transit transit on 7ecembe 7ecemberr %, %, $-. $-. These goods with invoice cost of 3-%,& were shipped on 7ecember $-, $%.
%
Eork in in process process inventor inventory y costing costing 3$+, 3$+, was was sent to a Cob Cob contracto contractorr for furthe furtherr processin processing. g.
&
Bot include included d in the the physical physical count were goods returned returned by customers customers on 7ecember 7ecember %, $-. These goods costing 3&-, were inspected and returned to inventory on 8anuary +, $. 0redit memos for3*+, were issued to the customers at that date.
'
In transit transit to a customer customer on on 7ecember 7ecember %, $-, $-, were were tools tools costing costing 3+,+& 3+,+& shipped shipped 9!4 9!4 destination on 7ecember $*, $-. " sales invoice invoice for 3$-,& was issued on 8anuary %, $ when 4aileys company was notified by the customer that the tools had been received.
*
"t exactl exactly y '2 pm on 7ecember 7ecember %, $-, $-, goods goods costing costing 3%,$ were received received from from a vendor vendor.. These were recorded on a receiving receiving report dated 8anuary $, $. The related invoice was was recorded on 7ecember %, $-, but the goods were not included in the physical count.
+
Included Included in in the physical physical count count were goods received received from from a vendor on 7ecember 7ecember $+, $-. $-. 6owever, 6owever, the related invoice for 3%*, was not recorded because the accounting departments copy of the receiving report was lost.
" monthly monthly freight freight bill for 3*, 3*, was received received on on 8anuary 8anuary %, $. $. It is is specific specifically ally related related to merchandise bought in 7ecember $-, one/half of which was still in the inventory at 7ecember %, $-. The freight was not included included in either the inventory inventory or in accounts payable at 7ecember %, $-.
RE)UIRED%
0ompute for the adCusted amount of Inventory, Inventory, "ccounts =ayable, and Bet ;ales
;olution2 "ccounts ?nadCusted balances
Inventory
=ayable
,+,
,&',
Bet ;ales -,*-%,&
.
(+,')
$.
-%,&
%.
$+,
&.
&-,
'.
+,+&
*.
%,$
+.
-%,& (*+,)
%*,
. "dCusted balance
,
*,
$,-*,%&
,'*,&
-,'&+,
PRO&LEM NO' (( COMPUTING INVENTOR+ FIRE LOSS !n ;eptember ', $-, a fire damaged the warehouse of Texas 0ompany. 0ompany. "ll inventory items and many accounting records stored on the warehouse were destroyed. 6owever, 6owever, a portion of the inventory could be sold for scrap. The companys backup files provide the the following information2 information2 0ollection of accounts receivable, 8anuary /;ept. ' "ccounts receivable, 8anuary "ccounts receivable, ;eptember ;eptember ' ;alvage value of inventory 1ross profit ratio Inventory, 8anuary 0ash sales, 8anuary /;ept ' =urchases, 8anuary / ;ept. '
RE)UIRED%
0ompute the inventory loss as a result of the fire
3&,$%, %', '%, ', %$K +', &&', $,++,
