Week 10 Assignment
21-16 (Objectives21-1 , 21-3, 21-5, 21-6, 21-7) Items 1 through 8 are selected questions typically found
in questionnaires used by auditors to obtain an understanding of internal control in the inventory and
warehousing cycle. In using the questionnaire for a client, a “yes” response to a question indicates a
possible internal control, whereas a “no” indicates a potential deficiency.
1. Does the receiving department prepare prenumbered receiving reports and account for
the numbers periodically for all inventory received, showing the description and
quantity of materials?
A) To ensure inventory is recorded when received, payments made are for
goods received, and quantities and descriptions are accurate.
(Completeness and accuracy)
B) Account for receiving reports, match invoices from vendors
C) Understatement of payment for inventory not received
D) Trace quantity description on vendor’s invoice
2. Is a detailed perpetual inventory master file maintained for raw materials inventory?
A) For a proper valuation of inventory. Accuracy
B) Examine receiving and requisition documents.
C) Misstatement of inventory
D) Compare the physical count to the perpetual inventory record
3. Are all shipments to customers authorized by prenumbered shipping documents?
A) To ensure inventory shipments are recorded as sales. Completeness
B) Account for the sequence of shipping orders.
C) Understatement of sales
D) Trace quantity & description on bills to recorded sales.
4. Is all inventory stored under the control of an inventory custodian in areas where access
is limited?
A) To minimize theft or unrecorded shipments of inventory. Existence
B) Discuss with client and observe whether personnel prepare shipping
documents
C) Overstatement of inventory.
D) Compare physical count to perpetual records
5. Are standard cost records used for raw materials, direct labor, and manufacturing
overhead?
A) Assure that reasonable costs are used for inventory and cost. Accuracy
B) Review procedures for determining what the standard cost.
C) Misstatement of inventory is.
D) Trace costs from supporting documents
6. Is there a stated policy with specific criteria for writing off obsolete or slow-moving
goods?
A) To make sure obsolete goods are classified as such. Accuracy
B) Discuss the procedures with the client concerning the policy.
C) Misstatement of inventory
D) Analytical procedures for inventory
7. Are physical inventory counts made by someone other than storekeepers and those
responsible for maintaining the perpetual inventory master file?
A) To make sure physical inventory counts are accurate. Accuracy
B) Observe and discuss the count with personnel.
C) Misstatement of inventory.
D) Compare physical count to perpetual inventory record.
8. Is the clerical accuracy of the final inventory compilation checked by a person
independent of those responsible for preparing it?
A) To make sure inventory compilation is accurate. Accuracy
B) Observe and discuss with the client who compiles the inventory.
C) Misstatement of inventory.
D) Perform clerical tests of inventory.
Required
a) For each of the preceding questions, state the purpose of the internal control.
b) For each internal control, list a test of control to test its effectiveness.
c) For each of the preceding questions, identify the nature of the potential financial
misstatement(s) if the control is not in effect.
d) For each of the potential misstatements in part c., list a substantive audit procedure to
determine whether a material misstatement exists.
21-19 (Objectives 21-1, 21-3, 21-5, 21-6) Following are audit procedures commonly performed in the
inventory and warehousing cycle for a manufacturing company:
1. Account for a sequence of raw material requisitions and examine each requisition for an
authorized approval.
A) Control
B) To ensure that no raw material was issued without proper approval existence
2. Trace the recorded additions on the finished goods perpetual inventory master file to
the records for completed production.
A) Control/Substantive
B) To ensure that additions recorded on the finished goods perpetual records were
recorded on the books as completed production accuracy and classification.
3. Compare the client’s count of physical inventory at an interim date with the perpetual
inventory master file.
A) Substantive
B) To test the accuracy of client’s perpetual inventory records accuracy,
completeness and existence
4. Use audit software to compute inventory turnover by major product line and compare it
to turnover in the prior year.
A) Substantive
B) To see if there is obsolete inventory, identify slow-moving inventory that may
need to be written down realizable value.
5. Read the client’s physical inventory instructions and observe whether they are being
followed by those responsible for counting the inventory.
A) Control
B) To assure proper controls are in place and being followed in the taking of
physical inventory (accuracy, classification, completeness, and existence).
6. Account for a sequence of inventory tags and trace each tag to the physical inventory to
make sure it actually exists.
A) Substantive
B) To ensure that all inventory represented by an inventory tag exists existence.
7. Trace the auditor’s test counts recorded in the audit files to the final inventory
compilation and compare the tag number, description, and quantity.
A) Substantive
B) To test the client's final inventory compilation. Completeness, existence
8. Compare the unit price on the final inventory summary with vendors’ invoices.
A) Substantive
B) To assure final inventory is valued at the proper amount. Accuracy
Required
a) Identify whether each of the procedures is primarily a test of control or a substantive test.
b) State the purpose(s) of each of the procedures.
21-27 (Objective 21-5) In an annual audit at December 31, 2019, you find the following transactions
near the closing date:
1. Merchandise costing $625 was received on December 28, 2019, and the invoice was not
recorded. You located it in the hands of the purchasing agent; it was marked “on consignment.”
A) Excluded
B) Goods held on consignment should not be included in the inventory because they do
not belong to the consignee.
2. A packing case containing products costing $816 was standing in the shipping room when the
physical inventory was taken. It was not included in the inventory because it was marked “Hold
for shipping instructions.” Your investigation revealed that the customer’s order was dated
December 18, 2019, but that the case was shipped and the customer billed on January 10, 2020.
The product was a stock item of your client.
A) Included
B) Title to a stock item does not pass to the customer until it is shipped, even if it's been
set aside
3. Merchandise received on January 3, 2020, costing $720 was entered in the acquisitions journal
on January 4, 2020. The invoice showed shipment was made FOB supplier’s warehouse on
December 31, 2019. Because it was not on hand December 31, it was not included in inventory.
A) Included
B) The Title to merchandise shipped passed to the buyer on delivery to the transportation
agency
4. Merchandise costing $1,822 was received on January 3, 2020, and the related acquisition
invoice recorded January 5. The invoice showed the shipment was made on December 29, 2019,
FOB destination.
A) Excluded
B) This merchandise would be excluded because the Title does not pass to the buyer until
it is delivered.
5. A special machine, fabricated to order for a customer, was finished and in the shipping room on
December 31, 2019. The customer was billed on that date and the machine excluded from
inventory, although it was shipped on January 4, 2020.
A) Excluded
B) This particular machine is fabricated for the customer's order. The item has no shipped
as of December 31, 2019.
Required
Assume that each of the amounts is material.
a. State whether the merchandise should be included in the client’s inventory.
b. Give your reason for your decision on each item.
24-24 (Objectives 24-1, 24-2) Elizabeth Johnson, CPA, has completed the audit of notes payable and
other liabilities for Valley River Electrical Services and now plans to audit contingent liabilities and
commitments.
Required
a. Distinguish between contingent liabilities and commitments and explain why both are
important in an audit.
Contingent liability comes from past events and is the likely future obligation for an
undetermined total to an external party. Commitment is the agreement to set future
terms to the entity, despite variables to price. Both are important to the audit process
because they each affect future cash flows with regard to stockholders and must be
properly disclosed.
b. Identify three useful audit procedures for uncovering contingent liabilities that Johnson
will likely perform in the normal conduct of the audit, even if she had no responsibility
for uncovering contingencies.
Evaluate and review reports of income tax settlements from internal revenue agents,
review board directors' and stockholder's minutes, and confirm lines of credit with used
and unused balances.
c. Identify three other procedures Johnson is likely to perform specifically for the purpose
of identifying undisclosed contingencies to help her obtain evidence about the
presentation audit objective.
Review legal expenses for contingency liability signals, refer to management for
contingency liabilities undisclosed and ask the letter of the attorney regarding other
potential contingency liabilities and the status of proceedings.
d. Identify three useful audit procedures for uncovering commitments that Johnson will
likely perform as part of the audit in other accounts.
Review board director's and stockholder's minutes, be on alert for commitments to
purchase inventory/equipment with purchase transactions and look for sales
commitments with sales transactions.
24-26 (Objective 24-3) In analyzing legal expense for the Boastman Bottle Company, Mary Little, CPA,
observes that the company has paid legal fees to three different law firms during the current year. In
accordance with her CPA firm’s normal operating practice, Little requests standard attorney letters as of
the balance sheet date from each of the three law firms.
On the last day of performing audit procedures, Little notes that one of the attorney letters has not yet
been received. The second letter contains a statement to the effect that the law firm deals exclusively in
registering patents and refuses to comment on any lawsuits or other legal affairs of the client. The third
attorney’s letter states that there is an outstanding unpaid bill due from the client and recognizes the
existence of a potentially material lawsuit against the client but refuses to comment further to protect
the legal rights of the client.
Required
a. Evaluate Little’s approach to sending the attorney letters and her follow-up on the
responses.
Little was aware of the lawsuit because the client provided the information. Since there
is a small window for following up, Little should not have waited until the last day. It
should have been handled immediately.
b. What should Little do about each of the letters?
A follow-up letter should be sent to the attorney and can still include management to
assist the attorney. Auditors must revise their audit report to show a lack of evidence if
not given sufficient information for the lawsuits.
24-27 (Objectives 24-4, 24-8) The field work for the June 30, 2019, audit of Tracy Brewing Company was
finished August 19, 2019, and the completed financial statements, accompanied by the signed audit
reports, were mailed September 6, 2019. In each of the highly material independent events (a. through
h.), state the appropriate action (1 through 4) for the situation and justify your response. The alternative
actions are as follows:
1. Adjust the June 30, 2019, financial statements.
2. Disclose the information in a footnote in the June 30, 2019, financial statements.
3. Request the client to recall the June 30, 2019, statements for revision.
4. No action is required.
The events are as follows:
a. On December 14, 2019, the auditor discovered that a debtor of Tracy Brewing went bankrupt on
July 15, 2019, due to declining financial health. The sale generating the receivable had taken
place January 15, 2019.
#3 Amount should have been known to be uncollectible at the end of fieldwork, but it
was discovered after the issuance of the statements. The financial statements should
have been known to be misstated on 8/19/19. Financial statements will need to be
recalled and restated.
b. On December 14, 2019, the auditor discovered that a debtor of Tracy Brewing went bankrupt on
October 2, 2019. The sale had taken place April 15, 2019, but the amount appeared collectible at
June 30, 2019, and August 19, 2019.
#4 Since amount appeared collectible after fieldwork, there is nothing that needs to be
done since it was discovered after the report issuance date.
c. On August 15, 2019, the auditor discovered that a debtor of Tracy Brewing went bankrupt on
August 1, 2019. The most recent sale had taken place April 2, 2018, and no cash receipts had
been received since that date.
#1 The uncollectible amount was determined before the end of fieldwork, so restate the
financial statements.
d. On July 20, 2019, Tracy Brewing settled a lawsuit out of court that had originated in 2016 and is
currently listed as a contingent liability.
#1 The settlement should be reflected in the 6/30/19 financial statements as this is a
classic type 1 subsequent event. The culmination or resolution of conditions which were
already ongoing at the balance sheet date.
e. On September 14, 2019, Tracy Brewing lost a court case that had originated in 2018 for an
amount equal to the lawsuit. The June 30, 2019, footnotes state that in the opinion of legal
counsel, there will be a favorable settlement.
#4 The financial statements were believed to be fairly sated on 6/30/19 and 8/19/19
f. On July 20, 2019, a lawsuit was filed against Tracy Brewing for a patent infringement action that
allegedly took place in early 2019. In the opinion of legal counsel, there is a danger of a
significant loss to the client.
#2 The cause of the lawsuit occurred before the balance sheet date and the lawsuit
should be included in the 6/30/19 footnotes. If the loss is both probable and can be
reasonably estimated, then answer #1 is correct to adjust the financial statements for
the amount of the expected loss.
g. On May 31, 2019, the auditor discovered an uninsured lawsuit against Tracy Brewing that had
originated on February 28, 2019.
#2 Disclose in the footnotes since the lawsuit was originated in the current year, but the
amount of the loss is unknown.
h. On August 6, 2019, the auditor discovered that a debtor of Tracy Brewing went bankrupt on July
30, 2019. The cause of the bankruptcy was an unexpected loss of a major lawsuit on July 15,
2019, resulting from a product deficiency suit by a different customer.
#2 The cause of the bankruptcy took place after the balance sheet date (6/30/19).
Therefore, the balance sheet was fairly stated at that date. Footnote disclosure is
necessary because the subsequent event is material.
