Chapter AUDIT OF INVENTORIES, COST OF SALES AND TRADE PAYABLES Expected Learning Outcomes After Studying this chapter, you should be able to: 1. Describe the auditor's objectives for the substantive audit of details of balances of inventories, cost of sales and trade Payables Describe the nature of the audit procedures to accomplish the auditor's objectives for the audit of inventories, cost of sales and trade payables. Understand and prepare audit working papers to document audit procedures for inventories, cost of sales and trade payables. WL BS—_—_—_— AUDIT OF INVENTO! INTRODUCTION In a manufacturing production (or conversion) cycle, in whic! assigned to inventories, and the of goods sold. The dete goods sold and has a major impact on net ini reasons why special significance is attache logical to consider the topics in ¢ of their interrelationship. For instance, the fair valuation of inventories are found in the pur .¢ valuation of inventorie: fh various manufacturing costs are CHAPTER 13 AND TRADE PAYA nventories and , the concern, th cost of inventories i: and auditing literature d to inventories in RIES, COST OF SALES BLES cost of goods sold together internal controls that assure rchase (or origination) cycle, s is also affected by the s then transferred to the cost rmination of inventory value therefore affects the cost of come for the year. This is one of the both the accounting AUDIT OF INVENTORIES AND COST OF SALES AUDIT OBJECTIVES AND PROCEDURES The following audit objectives and procedures for the verification of inventories and cost of goods sold are presented below and discussed in detail in the succeeding pages. The audit program is appropriate not only for a trading concern but also for a manufacturing company that takes a complete physical inventory to verify the perpetual inventories at the close of each fiscal year. Assertions Balance-Related Audit Objectives Common Test of Details of Balances Audit Procedures Existence or Occurrence A. To determine whether inventories exist at year- end and represent items held for sale in the ordinary course of business. Obtain listings of inventory and reconcile to ledgers. Observe the taking of physical inventory and conduct test counts. Confirm inventories in public warehouse and with consignees. Completeness To determine whether all transactions related to inventory are recorded in the proper accounting period. B11 Obtain a final inventory listing from the client. A. Trace test counts made during the inventory observation into inventory listing.Audit of Inventories ..__387 and classified in the financial statements in accordance with PASIPERS. 2 ie determine that B. Test the clerical accuracy of inventory listings are the final inventory listing. Accurately compiled and | 5. Review the year-end cutoff of 'nventory quantities purchases and sales include all items on hand transactions. and in transit, 6. Test numerical sequence of inventory purchase requisition. 7. Review entries to cost of goods sold. 8. Perform analytical review related {0 inventories and cost of goods sold. iil Rights and C. Todetermine whether the | 9. Make inquiries of management Obligations company has legal title or regarding inventory ownership ‘ownership rights to and examine consignment inventory items and agreements. inventories exclude items billed to customers or ‘owned by others. WV. Valuation or D. To determine whether the 70. Evaluate the bases and methods Allocation inventories are properly of inventory pricing. stated with respect to 11. Vouch and test inventory pricing. ‘Cost determined by an | 12. Check inventory for quality acceptable method and/or obsolescence. consistently applied. — Slow-moving, excess, defective, and obsolete items identified and reduced to replacement cost or net realizable value if lower than cost. V. Presentation and |. To determine that the 13. Determine the existence of Disclosure inventories and cost of pledged inventory, goods sold are presented 14. Evaluate financial statement presentation of inventories and cost of goods sold, including the adequacy of disclosure.Discussion of Audit Procedures reconcile to ledger edure is to make sure the he financial statement. 1. Obtain listings of inventory and The auditor's objective in performin inventory records agree with what is re! g this proc flected in t 04 ounts. 2. Observe the taking of physical inventory and conduct test counts. The following procedures are followed by the auditor: he physical inventory. a) Review the company's plan for taking | i . b) Scrutinize the care with which client's employees are following the inventory plan. | . c) See that all merchandise is tagged and no items are so tagged. 4) Determine that prenumbered inventory tags and comp! lation sheets are properly controlled. e) Make some test counts f) Be alert for empty containers an may exist when goods are stocke! g) Watch for damaged and obsolete inventory. h) Appraise the general condition of the inventory. Determine the last receiving and shipping documents used and 's and trace quantities to compilation sheets. nd hollow squares (empty spaces) that .d in solid formations. i) determine that goods received during the count are properly segregated. 3) Inquire about / observe existence of slow moving items. 3. Confirm inventories in public warehouses and with consignees. In addition to the examination of warehouse receipts for goods stored in public warehouses, direct written confirmation from the custodians of the inventories should be obtained. If the amounts are material, the auditor should also review the client's evaluation of the warehouses’ internal control relevant to the custody of goods and their performance. For goods in the hands of consignees, the auditor may start their verification by obtaining from the client a list of all consignees and copies of the consignment contracts. Direct written confirmation should also be obtained from the consignee as to the consigned inventory, receivables, unremitted proceeds and accrued expenses and commissions as of the statement of financial position date. Goods being processed by subcontractors should be confirmed with the subcontractors as to quantities and description of client-owned materials for proper inclusion in the statement of financial position.Audit of Inventories .._389 4, Obtain final inventory list from the clis it ic Den Geen fe client, test its clerical accuracy and Exess ay footings on the final inventory listing should be tested to prove Clerical accuracy of the list and discover any misstatements of physical paveatories The auditor should also trace their test counts made during the observation of physical inventory to the completed physical inventory list. The auditor should be alert for any indications that the inventory tags have been altered or that fictitious tags have been included. Clerical accuracy can also be established by reconciling thephysical counts to inventory records. (Figure 13-1 illustrates working paper for Final Inventory List). Figure 13-1: Final Inventory List ¢ | PRTC Bookstore | Final inventory List | 1280K7 oF FIFO Count Cost! Total Document Description Quanity Unit Cost oot ‘Smith, Skousen fr Bemis ‘Accounting, 100+ P3000 30,000 02 Cabrera, €. 8 Principles of Auditing 100" 250" 25,000« 003 Reyes, V. D. | ‘Quizzer in Taxation 100 Piso? 15,000 « ‘ ee ees “| ec ee Agrees with test counts. Verified computation of FIFO cost per unit. Verified extension and traced to perpetual records Footed. Agrees with general ledger, tial balance and financial statements. Count documents on the final inventory listing agree with count documents used for inventory taking on 12/31/X2,,as recorded by us. No unused count documents appear on isting,390 Chapwer 13 ve sactior 5 & 6. Review the year-end cutoff of purchases and sales transactions. Ty numerical sequence of inventory purc med to obtain evidence that all goods Owned by the client at the statement of financial poset ae ee in inventory and that the related liability is rece ee test involves tracing of receiving reports to voucher eet Gisgiees ont vouching recorded entries to receiving reports and ee oo ee es ales cutoff examination aims to determine whether goods so a es ‘ar-end are excluded from the inventory and that the related receivable ; T Cash is recorded. This examination involves tracing of delivery receipts to sales journal entries and verifying recorded entries to delivery receipts and sales invoices. The auditor must give particular attention to inventory in transit. He should note receiving and shipping cutoff date during the taking of the physical inventory. The numerical sequence of inventory purchase requisition hase requisition. A purchase cutoff test is perfor should also be tested. 7. Review entries to cost of goods sold. Substantial evidence on the propriety, accuracy and consistency of costs assigned to cost of goods sold is obtained from tests of sales, purchases and manufacturing transactions and by substantive tests of inventory balances. Substantive tests of cost of goods sold may be limited to 1) scanning entries for possible errors, and 2) performing analytical review procedures. 8 Perform analytical review related to inventory and cost of goods sold. The following financial relationships are frequently drawn when performing analytical review procedures to inventories: Financial Relationship Formula Gross profit rate Gross profit + net sales Inventory turnover Cost of goods sold + average inventory Number of days sales in inventory 365 days ~ Inventory tumover Inventory x total current assets Inventory + Total current assets10 & IL. _ Audit of Inventories 391 i i pared with prior year, budget additional corroborating st et will-enable the auditor to obtain Make inquiries of man . agement regardi . < consignment apreemena garding ownership and examin The auditor should in shipped on consignm stock has been pro} or excluded if it is quire of management as to any goods held as well as nent. He should further ascertain that the consigned erly included in the inventory if it is a consignment out consignment from other firm. Evaluate the bases and methods of inventory pricing. Vouch and test inventory pricing. The auditor must determine whether the basis of pricing used by the client conforms to generally accepted accounting principles and whether it has been applied consistently. Because inventory pricing methods and cost system vary widely, so do the related audit procedures. The audit of a job-order cost system will involve a review of the categories flowing through the control accounts (materials, labor; and overhead) and tests of these costs in the jobs in progress at year-end. The audit of a process cost system concentrate on the flow and accumulation of costs by cost center for the major products. In a standard cost system the audit emphasis is on testing the standard cost buildups for major inventory items and reviewing variances for an approximation of actual costs Cost, however, is only one aspect of inventory pricing. The lower of current replacement cost or net realizable value is generally the proper accounting principle for inventory pricing. Pricing of Merchandise und Materials Test of pricing of merchandise and purchased parts and materials involves the following steps: 1. Prepare a list of items for testing. This will include a description of the inventory items selected, the stock number, the tag or sheet number and the inventory quantity, unit price and extended amount. The working papers should provide sufficient space to accommodate several invoices making up the total of the inventory quantity.392 Chapter 13 4 ; ~ . sonnel could After selection of items for testing. the company Pe i asked to locate sipporing pare ne price paid for recent purchases, To determine market value review the pric ered beneea Coser include suppliers’ price lists and published quotations included in financial and trade publications. 2 i ice test. Figure 13-2 shows an example of raw materials Pr Figure 13-2: Raw Materials Price Test Per Invertory Fors Part Wiumber__Descipton 404 stool pe 1405 Reg paint 10? Gaskets reparea by _taitial | Gate} inal | Date Test of Pricing of Work-in-process and Finished goods inventory The auditor should determine whether the costs included in the final inventory lists are in agreement with those in the supporting cost records as compiled in accordance with the company’s cost system The following procedure may be followed: I Materials: Test of materials by examining supporting invoices or a) by referring to the purchased parts and materials price test.‘ Audit of Inventories 393 ) Labor: Trace char te labor rates and howe 9° jet? Payroll record and time tickets. Both ijt Obetieaa: TS worked should be tested. 1. Determine client rocedi ir compari a tt ? cedures in establishing rates and test 2. Test application of overhead 5 termi r di ® deen sete! & proper disposition was made of any over- plied manufacturing overhead for the period. 2. Market price for ite i . ested en 1OF items in work-in-process or finished goods should be a) For Work in Process, the . market price or net reali: determined as follows: Price or net realizable value may be Selling price when completed r P xx Less: Estimated cost to complete and sell XX Net realizable value Bas b) For Finished Goods: Selling price Pxx Less: Estimated cost to sell x Net realizable value Pas Selling price of the items may be obtained from the company's price list, from contracts, from catalogs or from recent sales invoices. Estimated cost to sell may be determined by dividing selling expenses by sales. As previously mentioned, the auditor should determine whether provision for losses for damaged, slow-moving and obsolete inventories has been made. 12. Check inventory for quality and/or obsolescence. The auditor should determine whether the inventory appears to be in iti le, use, or consumption and whether there are any obsolete, Soraving e damaged goods. He obtains evidence of general condition or obsolescence by324 Chapter 13 es le we (a) Observing the client's inventory taking (b) Scanning perpetual records for slow moving items (c) Reviewing quality control production reports (4) Making inquiries of client when the evidence suggests a dcting the utility of the goods. Such items should be reduced to then ral realizable value. Assistance of an outside expert may be required by the auditor When client assertions about the nature of the inventory pertain to hight technical matters. The auditor may use the work of a specialist aS an audit procedure to obtain competent evidential matter, providing he is Satisfied about the qualifications and independence of the expert 413. Determine the existence of pledged inventory and examine Purchases and sales commitments. The inventory audit procedure designed to detect liens and Pledges of inventories include review of minutes of board of directors’ Meeting, debt instrument (promissory note), confirmation with financial institution with which the client does business, and inquiry of management. The auditor should also discuss with company officials the existence of any binding contracts for future purchases of goods for quantities jn excess of normal requirements or prices in excess of current market, Likewise, sales contracts for future deliveries should be examined to determine whether provision for losses from such commitments is required. 14. Evatuate financial statement presentation of inventories and cost of goods sold including adequacy of disclosure. The major categories of inventory should be identified in the statement of financial position and the cost of goods sold in the statement of comprehensive income. There should also be disclosure of the inventory costing method(s) used, the pledging inventories and the existence of major purchase commitment. In addition to the evidence provided by the other substantive tests described, further evidence may be obtained from a review of the minutes of the board of directors’ meeting and inquiries of management.“ Audit of Inventories ..__ 395 possible errors that may result due to control w i fc rol transactions follow: eaknesses over inventory internal Control Weaknesses or Factors That Increase the Risk of the Misstatement Examples of Fraud / Error oe ustaem cena 7 Ineffective board of a. Intentional misstatement | 1. Misstatement of inventory directors, audit committee, Of production costs costs or internal audit function; assigned to inventory. top management action not | 1b. Intentional misstatement conducive to ethical conduct; undue pressure to meet earings targets. of inventory prices. Ja. Ineffective cost accounting | 2a system; failure to update standard costs on a timely The assignment of @irect | 2. Misstatement of inventory labor costs, direct material costs Costs, or factory overhead basis. to inventory items is 2. Ineffective input validation inaccurate. controls on the database of | 2b. Erroneous pricing of inventory costs; ineffective inventory supervision of the personnel that enter the costs on the final inventory schedule. 3a,_Ineffective physical 3a. tems are stolen with no | 3, _ Misstatement of inventory controls over inventories journal entry reflecting the quantities 3b._ Ineffective board of thet directors, audit committee, | 3b. Inventory quantities in or internal audit function; locations not visited by top management action not auditor are systematically conducive to ethical overstated, conduct; undue pressure to meet earnings targets. 4 Ineffective controls or 4. Miscounting of inventory by | 4. Misstatement of inventory supervision of physical personnel involved in quantities inventory. physical inventory. 5. _ Ineffective board of 5. _ Intentional recording of 5. Early (late) recognition of directors, audit committee, purchases in the purchases — “cutoff | or internal audit function; subsequent period. problems” | top management action not | conducive to ethical | conduct; undue pressure to |__meet earnings targets. 5 Ineffective accounting 6. Recording purchases of the | 6 Early late) recognition of procedures that do not tie ‘current period in the purchases — "cutoff recorded purchases to subsequent period. problems” |___ receiving data. L(396 Chapter 13 AUDIT OF TRADE ACCOUNTS / NOT! If tests of controls and related substantive te: are operating effectively, the auditor may be and tests of details of balances for accoun! accounts payable tend to be material for many com| ind some perform extensive analytical procedures a these accounts AUDIT OBJECTIVES AND PROCEDURES Figure 13-3 shows the bal procedures will vary considerably dependin; materiality of accounts payable, the nature an and inherent risk. Figure 13-3: Balance-Related Audit Objectives and Tests of Details of Balances for Accounts Payable ES PAYABLE sts of transactions show that Controls able to reduce analytical procedures ts / notes payable. However, because panies, auditors almost alway, tests of details of balances of lance-related audit objectives and common tests of details of balances procedures for trade accounts / notes payable. The actual audit gon the nature of the entity, the d effectiveness of internal controls, Balance-Related Audit Assertion Objective ‘Common Tests of Details of Balances Procedures ‘A. To determine that payables exist as of the statement of financial position date. |. Existence or Occurrence 1. Obtain from the client a listing of accounts and notes payable as of year-end and reconcile to the general ledger. Vouch recorded liabilities to vendors’ statements. Confirm recorded liabilities directly with suppliers and creditors. Investigate differences in liabilities Teported in the confirmations with the recorded book amounts. Examine bank confirmations for loans. N 2 = B. To determine that all transactions relating to payables have been property recorded. Il, Completeness a Perform purchases cutoff examination. Test for unrecorded liabilities. Perform analytical procedures Nowi Rights and Obligation | ¢ — tudit of Invermories 397 To determine tha payables | & in addition to audit ‘represent valid and legal procedures no 3, review Claims of third parties from documentation in chent’s the client files 9. Examine subsequent = 1D Toda —— | payments to creditors. W ‘ ae D. To determine that Payables / 10. Vouch accounts payable are recorded at the proper schedule amount 11. Test computation of accrued E __of prepaid interest. V._ Presentation and E To determine that Payables | 12. Scan list of payables to Disclosure are presented and disclosed | determine that each major according to PFRS. type of ubligation is properly described and classified Determine that contingent liabilities are property disclosed, 13. Obtain client’s representation letter Discussion of Audit Procedures 1&2. Obtain from the client a ng of accounts and notes payable as of year- end. Vouch recorded liabilities to vendors’ statements. For a sample of items from the listing, examine supporting documentary evidence (supplies invoice, receiving report, etc.) nothing that the item is a Proper account payable as of year-end and that the account distribution (i.e. the account to be debited) is appropriate. Trace the posting of the entry recording the account payable at year-end to the general ledger. Figure 13-4 illustrates the working papers for Accounts Payable. 3&4. Confirm recorded liabilities directly with suppliers / creditors. Examine bank confirmations for loans. Confirmation of accounts payable is optional but recommended (1) when control risk is high, (2) when there are individual creditors with relatively large balances and (3) the client is experiencing difficulties in meeting its obligations.alhdeaeanocnuailateat 98 Chapver 13 When confirmation is undertaken, 60! mation should be sent to alances because they may be 1) accounts with zero or small understand than accounts with large 2) major vendors who do not send monthly si 4 vest control the preparation and mailing of the requests and should receive the responses. directly from the respondent. Figure 13-§ illustrates the positive form of confirmation request Figure 13-6 illustrates another positive form of confirmation request balance: . ly statement, and the auditor Figure 13-4: Accounts Payable XYZ Corporation Accounts Payable 1x7 ‘Subsequent Poyment Supplies Amount up to 245)x8 Yalung Tracing 301 UN Ave , Manila P 5,000 C 5,000 ~ Union Trading Port Area, Manila, 15,000 C . Sunlight Express 400 Rizal Ave. Mania 10,000 C 10,000 ~ 5,000 C 5,000 ~ Champion Enterprises 211 CM Recto, Manila Serra ct ee ee SS P.80,000/ 75.009 i ~ Traced to cash disbursement voucher Traced to general ledger Confirmed Footed -a~ [Revewedby —]Audit of Inventories .. 399 Figure 13-5: Positive Form of Accounts Payable Confirmation Request WXY Comporaion 1997 Star Avenue Makati Cty December 31, 20X7 ‘ABC Company ‘72 Aquino Avenue Parataque, Mev Manila Dear Ses: Please confi directo our auditors K. B. Cabrera and Company 6705 Aya'a Avenue Makat City the comeciness ofthe balance of our account payable lo you as shown below and on the encised stzrement at December 31, 20X7. ithe amount i notin agreement with your records at that da‘e please rovde any infomation which wil ad our ‘audlors in reconciling the dflrence ‘Your prompl return ofthis form in the enclosed stamped envelope s essental to ne completion of the auditors ‘examination of ur financial stalements and wil be apprecisted WY Comeration By Miquel dete Cruz (Controller) — ‘The statement of our account showing a balance of P40,000 due from WXY Corporatior at December 31, 20X7 is ‘correct except as noted below: _ ABC Company Daw: Janwary 16, 20X8 ay Aan Santos (Controter) Exceptions’ None Lo400 Chapter 13 ie Figure 13-6: Accounts Payable Confirmation ea ——, Company Bulacan ‘Iradi Valenzuela, Bulacan January 7, 20X7 Sunset Company 305 Kalayaan Avenue Makati City cial statements for Our auditors, Flores, Cruz and Cabrera, CPAs, are auditing our fina 20X6. Will you please furnish them with the following information as of December 3), 20X6. * An itemized statement of amounts that we owe you. An itemized statement of any merchandise that you have consigned to us. An itemized list of any notes, acceptances, or other obligations that we owe you, Please reply directly to our auditors. An envelope addressed to our auditors is enclosed. Efren Santos Controller Bulacan Trading Company For notes payable, the auditor can have the client prepare an analysis for the year. The schedule should reflect: Balance, beginning of the year Notes issued during the year Payments (principal) during the year Balance, end of year Accrued interest payable, beginning of the year Interest paid during the year Interest expense Accrued interest payable, end of year FR meaogp The analysis should also reflect the payee of the note, the date of the note, the interest rate, and the details of any security or collateral arrangement. Figure 13-7 presents a sample workin paper for Notes Payable. ° a'SEMOL Gupes) ees 481g hewn . Guunpeynuew seny 1 000'0S1 “09 BursipueyaieW ZAX alon0 ee) cover ‘09 sesudvaua ON fora ee UT KITE ‘09 Gulpeii De suayonpag __suompny §—gx'yezt IP BIG SION 0107) ~eak ag bum sabueizy =o dg mag Seem © AwmeW —j0.a1eC) beret ape, jgeked SION “uy BuurypeynueW 2BV ajqudeg SHON :L-€1 240814 ov warionaauy Jo HpNYa Paes» $. Perform purchases cutoff examination. The auditor tests purchases cutoff to determine uneed eee and corresponding payables are recorded in the appropriate period. Cutoff tests of purchase transactions involve examining a sample of purchase entries on or at year-end, the corresponding receiving reports and purchase invoices, Cutoff Tests Cutoff tests for accounts payable are intended to Sefer ne whether transactions recorded a few days before and after the balance sheet date are included in the correct period Coordinate cutoff tests with the observation of inventory At this time, the auditor should review the procedures in the receiving department to determine that all inventory received was counted, and the auditor should record in his or her working papers the last receiving report number of inventory included in the physical count. During the year-end field work, the auditor should then test the accounting records for cutoff. The auditor should trace receiving report numbers to the accounts payable records to verify that they are correctly included or excluded. Inventory in transit A distinction in accounts payable must be made between acquisitions of inventory that are on an FOB destination basis and those that are made FOB origin. With the former, title passes to the buyer when it is received for inventory. Therefore, only inventory received on or before the balance sheet date should be included in inventory and accounts payable at year-end. When an acquisition is on an FOB origin basis, the inventory and related accounts payable must be recorded in the current period if shipment occurred on or before the balance sheet date. Determining whether inventory has been acquired on an FOB destination or origin basis is done by examining vendors’ invoices. The auditor should examine invoices for merchandise received shortly after year-end to determine whether they were on an FOB origin basis. For those that were, and when the shipment dates were on or before the balance sheet date, the inventory and related accounts payable must be recorded in the current period if the amounts are material= es, 6. Test for unrecorded liabilities, rene Audit of Inventories ..__403 The auditor's search for unrec iabiliti . . recordes i following steps: d liabilities will normally include the Reconci iers’ - ae aad Suppliers’ statements to the accounts payable trial balance. . Fansactions recorded after the statement of financial position date to determine whether any signi ctions a iod Sader audie 'Y significant transactions apply to the perio c. Examine receiving Teports for items received before and after the statement of financial position date for which no payment has been made or any liability set up. d. Inquire of accounting and purchasing personnel whether they have any knowledge of any significant unrecorded liabilities. e, Inquire about consignment sales to ascertain whether the liability and re elated expenses have been recorded in the proper period for all sales made from consigned share. 7. Perform analytical procedures, To assess the reasonableness of recorded liabili ies, the auditor can perform analytical procedures by studying the financial relationship between a) Accounts payable to purchases b) Accounts payable to total liabilities c) Current liabilities to total liabilities d) Interest expense to notes payable By comparing these ratios and amounts to those from prior years, the auditor might discover significant differences caused by errors or irregularities in the recording of accounts payable and notes payable. 8. Review documentation in client's files. The client's files should contain documents that support the validity of creditor claims-against assets. These include documentation required under a voucher system (i.e., purchase order, receiving report, and vendor's invoice), copies of notes and loan agreements. The auditor can also examine creditor's monthly statement received by the client and vouch payments made to them.404 Chapter 13 9. Examine subsequent payments (0 creditors. Pere , nd of Ti work The auditor can schedule this procedure eee consists of tracing further substantiate the validity of the pant date to the list of payables at 5 stater 5 vouchers or checks issued after the stal oe comparison will also enable to the statement of financial position date. auditor to identify: . 7 a) Large disbursements pertaining to the prior period not included in the list of payables. tate ne net of payables or t b) Large disbursements that clearly liabilities incurred subsequent to the : c ¢) Significant listed balances that remain unpaid. he statement date. 10. Vouch accounts payable schedule. he obligations, the auditor should vouch To determine proper valuation of th in the schedule of accounts payable to amounts owed to creditors shown supporting documentation. 11. Test computation of accrued or prepaid interest. The auditor should prove the mathematical accuracy of interest computations, accrued as well as prepaid. 12. Scan list of payables to determine that each type of obligation is properly described and classified. Determine that contingent liabilities are properly disclosed. Each major type of obligation, such as accounts payable, accrued expenses payable, etc. should be identified in the current liabilities section. For short- term notes payable, there should be disclosure of interest rates and the existence of any assets pledged as collateral. Evidence pertaining to this objective may be obtained through inquires of management and a review of debt contracts. Inquire of legal counsel and management of any contingencies. The auditor then compares the statement presentation and disclosures with PAS/PFRS. 13. Obtain from client a letter of representation concerning liabilities. yo) obtain a liability representation is a standard Practice which serves as an effective reminder to executives that management is primarj il : ri the fairness of financial statements, e Oa teat— y Adit of nvr’... 405 justrative Audit Case 13-1: Goods to Include in Invento ry gall Company’s inventory at December 3), 20X7, was P1,500,000 based on a hysical count of goods priced at {gjustment relating to the following: “"@ before any necessary year-end (1) Included in the physical cou yoods bil z shoniog poem ees int were goods billed to a customer F.0.B: er 31, 20X7. These goods has a cost of ay on Were picked up by the carrier on January 10, 20X8, (2) oo epee FOB. shipping joint on December 28, 20X7, from a 750.000.” ’eeived on January 4, 20X8. The invoice cost was Required: What amount should Ball re 7 ort as inventory on its December 31, 20X7 statement of financial position? r Y " Solution: Mustrative Audit Case 13-1 Inventory, 12/31/X7 per physical count 1,500,000 Add: Inventory in transit, shipped FOB shipping point 50,000 Inventory to be reported in the statement of financial position 1,550,000 Illustrative Audit Case 13-2: Sales Cutoff Examination Mindoro Auto Parts sells new parts for foreign automobiles to auto dealers. Company policy requires that a prenumbered shipping document be issued for each sale. At the time of pickup or shipment, the shipping clerk writes the date on the shipping document. The last shipment made in the fiscal year ended August 31, 20X7, was recorded on document 2167. Shipments are billed in the order the billing clerk receives the shipping documents. For late August and early September, shipping documents are billed on sales invoices as follows: Shipping Document No. [Sales Invoice No. August 2163 4332 August 2164 4326 August 2165 4327 [aagut 2166 4330 August 2167 4331 September 2168 4328 September 2168 4329 September 2170 4333 September 2171 4335 ‘September 2172 4334 i eerie