Substantive Testing for Inventories

Problem 1: The Makati Company is on a calendar year basis. The following data
were found during your audit:

a. Goods in transit shipped FOB destination by a supplier, in the amount of

P100,000, had been excluded from the inventory, and further testing revealed that
the purchase had been recorded.

b. Goods costing P50,000 had been received, included in inventory, and recorded as
a purchase. However, upon your inspection the goods were found to be defective
and would be immediately returned.

c. Materials costing P250,000 and billed on December 30 at a selling price of

P320,000, had been segregated in the warehouse for shipment to a customer. The
materials had been excluded from inventory as a signed purchase order had been
received from the customer. Terms, FOB destination.

d. Goods costing P70,000 was out on consignment with Hermie Company. Since the
monthly statement from Hermie Company listed those materials as on hand, the
items had been excluded from the final inventory and invoiced on December 31 at
P80,000.

e. The sale of P150,000 worth of materials and costing P120,000 had been shipped
FOB point of shipment on December 31. However, this inventory was found to
be included in the final inventory. The sale was properly recorded in 2005.

f. Goods costing P100,000 and selling for P140,000 had been segregated, but not
shipped at December 31, and were not included in the inventory. A review of the
customer’s purchase order set forth terms as FOB destination. The sale had not
been recorded.

g. Your client has an invoice from a supplier, terms FOB shipping point but the
goods had not arrived as yet. However, these materials costing P170,000 had
been included in the inventory count, but no entry had been made for their
purchase.

h. Merchandise costing P200,000 had been recorded as a purchase but not included
as inventory. Terms of sale are FOB shipping point according to the supplier’s
invoice which had arrived at December 31.

Further inspection of the client’s records revealed the following December 31, 2006
balances: Inventory, P1,100,000; Accounts receivable, P580,000; Accounts payable,
P690,000; Net sales, P5,050,000; Net purchases, P2,300,000; Net income, P510,000.

QUESTIONS:

Based on the above and the result of your audit, determine the adjusted balances of
following as of December 31, 2006:
1. Inventory
a. P1,230,000 c. P1,550,000
b. P1,650,000 d. P1,480,000
2. Accounts payable
a. P710,000 c. P810,000
b. P540,000 d. P760,000
3. Net sales
a. P4,550,000 c. P4,730,000
b. P4,650,000 d. P4,970,000
4. Net purchases
a. P2,370,000 c. P2,150,000
b. P2,420,000 d. P2,320,000
5. Net income
a. P220,000 c. P540,000
b. P290,000 d. P550,000

Problem 2 : Manila Company has been having difficulty obtaining key raw materials
for its manufacturing process. The company therefore signed a long-term
noncancelable purchase commitment with its largest supplier of this raw material on
November 30, 2013, at an agreed price ofP400,000. At December 31, 2013, the raw
material had declined in price toP375,000.

Instructions
What entry would you make on December 31, 2013, to recognize these facts?

Problem 3: At December 31, 2013, Bulacan Company has outstanding noncancelable

purchase commitments for 40,000 gallons, at P3.00 per gallon, of raw material to be
used in its manufacturing process. The company prices its raw material inventory at
cost or market, whichever is lower.
Instructions
(a) Assuming that the market price as of December 31, 2013, is P3.30, how would
this matter be treated in the accounts and statements? Explain.
(b) Assuming that the market price as of December 31, 2013, is P2.70, instead of
P3.30, how would you treat this situation in the accounts and statements?
(c) Give the entry in January 2014, when the 40,000-gallon shipment is received,
assuming that the situation given in (b) above existed at December 31, 2013, and that
the market price in January 2014
was P2.70 per gallon. Give an explanation of your treatment.

Problem 4
You were engaged by Asingan Corporation for the audit of the company’s financial
statements for the year ended December 31, 2006. The company is engaged in the
wholesale business and makes all sales at 25% over cost.

The following were gathered from the client’s accounting records:

SALE S PURC HAS ES

Date Reference Amount Date Reference Amount
Balance forwarded P7,800,000 Balance forwarded P4,200,000
12/27 SI No. 965 60,000 12/28 RR #1059 36,000
12/28 SI No. 966 225,000 12/30 RR #1061 105,000
12/28 SI No. 967 15,000 12/31 RR #1062 63,000
12/31 SI No. 969 69,000 12/31 RR #1063 96,000
12/31 SI No. 970 102,000 12/31 Closing entry
(4,500,000)
12/31 SI No. 971 24,000 P -
12/31 Closing entry
(8,295,000)
P -
Note: SI = Sales Invoice RR = Receiving Report

Accounts receivable P750,000

Inventory 900,000
Accounts payable 600,000

You observed the physical inventory of goods in the warehouse on December 31 and
were satisfied that it was properly taken.

When performing sales and purchases cut-off tests, you found that at December 31,
the last Receiving Report which had been used was No. 1063 and that no shipments
had been made on any Sales Invoices whose number is larger than No. 968. You also
obtained the following additional information:

a) Included in the warehouse physical inventory at December 31 were goods which

had been purchased and received on Receiving Report No. 1060 but for which the
invoice was not received until the following year. Cost was P27,000.

b) On the evening of December 31, there were two trucks in the company siding:
 Truck No. XXX 888 was unloaded on January 2 of the following year and
received on Receiving Report No. 1063. The freight was paid by the vendor.
 Truck No. MGM 357 was loaded and sealed on December 31 but leave the
company premises on January 2. This order was sold for P150,000 per Sales
Invoice No. 968.

c) Temporarily stranded at December 31 at the railroad siding were two delivery

trucks enroute to ABC Trading Corporation. ABC received the goods, which were
sold on Sales Invoice No. 966 terms FOB Destination, the next day.

d) Enroute to the client on December 31 was a truckload of goods, which was

received on Receiving Report No. 1064. The goods were shipped FOB
Destination, and freight of P2,000 was paid by the client. However, the freight
was deducted from the purchase price of P800,000.

Based on the above and the result of your audit, determine the following
QUESTIONS:

1. Sales for the year ended December 31, 2006

a. P8,100,000 c. P7,875,000
b. P7,725,000 d. P8,025,000
2. Purchases for the year ended December 31, 2006
a. P4,500,000 c. P5,631,000
b. P5,727,000 d. P4,527,000
3. Accounts receivable as of December 31, 2006
a. P330,000 c. P525,000
b. P555,000 d. P180,000
4. Inventory as of December 31, 2006
a. P1,452,000 c. P1,200,000
b. P1,221,000 d. P1,296,000
5. Accounts payable as of December 31, 2006
a. P600,000 c. P 531,000
b. P627,000 d. P1,827,000

Problem 5
Balungao Company engaged you to examine its books and records for the fiscal year
ended June 30, 2006. The company’s accountant has furnished you not only the copy
of trial balance as of June 30, 2006 but also the copy of company’s balance sheet and
income statement as at said date. The following data appears in the cost of goods sold
section of the income statement:

Inventory, July 1, 2005 P 500,000

Add Purchases 3,600,000
Total goods available for sale 4,100,000
Less Inventory, June 30, 2006 700,000
Cost of goods sold P3,400,000

The beginning and ending inventories of the year were ascertained thru physical count
except that no reconciling items were considered. Even though the books have been
closed, your working paper trial balance show all account with activity during the
year. All purchases are FOB shipping point. The company is on a periodic inventory
basis.

In your examination of inventory cut-offs at the beginning and end of the year, you
took note of the following:

July 1, 2005

a. June invoices totaling to P130,000 were entered in the voucher register in June.
The corresponding goods not received until July.
b. Invoices totaling P54,000 were entered in the voucher register in July but the
goods received during June.

June 30, 2006

c. Invoices with an aggregate value of P186,000 were entered in the voucher register
in July, and the goods were received in July. The invoices, however, were date
June.
d. June invoices totaling P74,000 were entered in the voucher register in June but the
goods were not received until July.
e. Invoices totaling P108,000 (the corresponding goods for which were received in
June) were entered the voucher register, July.
f. Sales on account in the total amount of P176,000 were made on June 30 and the
goods delivered at that time. Book entries relating to the sales were made in June.

QUESTIONS:
Based on the above and the result of your cut-off tests, answer the following:
1. How much is the adjusted Inventory as of July 1, 2005?
a. P500,000 c. P576,000
b. P630,000 d. P370,000
2. How much is the adjusted Purchases for the fiscal year ended June 30, 2006?
a. P3,840,000 c. P3,894,000
b. P3,600,000 d. P3,914,000
3. How much is the adjusted Inventory as of June 30, 2006?
a. P784,000 c. P892,000
b. P500,000 d. P960,000
4. How much is the adjusted Cost of Goods Sold for the fiscal year ended June 30,
2006?
a. P3,316,000 c. P3,510,000
b. P3,970,000 d. P3,564,000
5. The necessary compound adjusting journal entry as of June 30, 2006 would
include a net adjustment to Retained Earnings of
a. P130,000 c. P76,000
b. P184,000 d. P54,000

Problem 6
your audit of the records of the Atlanta Corporation for the year ended December 31,
2015, the following facts were disclosed:
Raw materials inventory, 1/1/2015 P720,200
Raw materials purchases 5,232,800
Direct labor 6,300,000
Manufacturing overhead applied(150% of direct labor) 9,450,000
Finished goods inventory, 1/1/2015 1,240,000
Selling expenses 8,112,800
Administrative expenses 7,377,200

Your examination disclosed the following additional information:

a) Purchases of raw materials
Month Units Unit Price Amount
January - February 55,000 P17.76 P976,800
March – April 45,000 20.00 900,000
May - June 25,000 19.60 490,000
July – August 35,000 20.00 700,000
September - October 45,000 20.40 918,000
November – December 60,000 20.80 1,248,000
265,000 P5,232,800
b) Data with respect to quantities are as follows:
Units
Explanation 1/1/15 12/31/15
Raw materials 35,000 ?
Work in process (80% 0 25,000
completed)
Finished goods 15,000 40,000
Sales, 205,000 units
c) Raw materials are issued at the beginning of the manufacturing process. During
the year, no returns, spoilage, or wastage occurred. Each unit of finished goods
contains one unit of raw materials.
d) Inventories are stated at cost as follows:
• Raw materials - according to the FIFO method
• Direct labor - at an average rate determined by correlating total direct labor
cost with effective production during the period
• Manufacturing overhead - at an applied rate of 150% ofdirect labor cost

QUESTIONS:

Based on the above and the result of your audit, answer the following:
1. The raw materials inventory as of December 31, 2015 is
A. P897,800 C. P1,352,000
B. P936,000 D. P1,976,000

2. The work in process inventory as of December 31, 2015 is

A. P1,751,294 C. P1,780,000
B. P1,776,000 D. P1,885,565

3. The finished goods inventory as of December 31, 2015 is

A. P3,284,588 C. P3,352,000
B. P3,334,000 D. P3,553,130

4. The cost of goods sold for the year ended December 31, 2015 is
A. P15,857,000 C. P16,875,000
B. P16,568,304 D. P16,897,000

5. When testing the valuation assertion, the auditor would most likely
A. Confirm inventory on consignment.
B. Observe the taking of physical inventory.
C. Perform price tests to the related cost flow assumption.

Problem 7

The following accounts were included in the unadjusted trial balance of Bani
Company as of December 31, 2006:

Cash P 481,600
Accounts receivable 1,127,000
Inventory 3,025,000
Accounts payable 2,100,500
Accrued expenses 215,500
During your audit, you noted that Bani held its cash books open after year-end. In
addition, your audit revealed the following:

1. Receipts for January 2007 of P327,300 were recorded in the December 2006 cash
receipts book. The receipts of P180,050 represent cash sales and P147,250
represent collections from customers, net of 5% cash discounts.

2. Accounts payable of P186,200 was paid in January 2007. The payments, on

which discounts of P6,200 were taken, were included in the December 2006 check
register.

3. Merchandise inventory is valued at P3,025,000 prior to any adjustments. The

following information has been found relating to certain inventory transactions.

a. Goods valued at P137,500 are on consignment with a customer. These goods

are not included in the inventory figure.

b. Goods costing P108,750 were received from a vendor on January 4, 2007.

The related invoice was received and recorded on January 6, 2007. The goods
were shipped on December 31, 2006, terms FOB shipping point.

c. Goods costing P318,750 were shipped on December 31, 2006, and were
delivered to the customer on January 3, 2007. The terms of the invoice were
FOB shipping point. The goods were included in the 2006 ending inventory
even though the sale was recorded in 2006.

d. A P91,000 shipment of goods to a customer on December 30, terms FOB

destination are not included in the year-end inventory. The goods cost
P65,000 and were delivered to the customer on January 3, 2007. The sale was
properly recorded in 2007.

e. The invoice for goods costing P87,500 was received and recorded as a
purchase on December 31, 2006. The related goods, shipped FOB destination
were received on January 4, 2007, and thus were not included in the physical
inventory.

f. Goods valued at P306,400 are on consignment from a vendor. These goods

are not included in the physical inventory.

QUESTIONS:

Based on the above and the result of your audit, determine the adjusted balances of
the following as of December 31, 2006:

1. Cash
a. P481,600 c. P334,300
b. P340,500 d. P346,700
2. Accounts receivable
a. P1,454,300 c. P1,127,000
b. P1,282,000 d. P1,274,250
3. Inventory
a. P3,017,500 c. P2,930,000
b. P3,040,000 d. P2,505,000
4. Accounts payable
a. P2,395,450 c. P2,286,500
b. P2,307,950 d. P2,301,750
5. Current ratio
a. P2.00 c. P1.84
b. P1.83 d. P2.01

Problem 8

The Bolinao Company values its inventory at the lower of FIFO cost or net realizable
value (NRV). The inventory accounts at December 31, 2005, had the following
balances.

Raw materials P 650,000

Work in process 1,200,000
Finished goods 1,640,000

The following are some of the transactions that affected the inventory of the Bolinao
Company during 2006.

Jan. 8 Bolinao purchased raw materials with a list price of

P200,000 and was given a trade discount of 20% and 10%;

terms 2/15, n/30. Bolinao values inventory at the net

invoice price

Feb. 14 Bolinao repossessed an inventory item from a customer who

was overdue in making payment. The unpaid balance on the

sale is P15,200. The repossessed merchandise is to be

refinished and placed on sale. It is expected that the item

can be sold for P24,000 after estimated refinishing costs of

P6,800. The normal profit for this item is considered to be

P3,200.

Mar. 1 Refinishing costs of P6,400 were incurred on the

repossessed item.

Apr. 3 The repossessed item was resold for P24,000 on account,

20% down.

Aug. 30 A sale on account was made of finished goods that have a

list price of P59,200 and a cost P38,400. A reduction of

P8,000 off the list price was granted as a trade-in allowance.

The trade-in item is to be priced to sell at P6,400 as is. The

normal profit on this type of inventory is 25% of the sales

price.

QUESTIONS:

Based on the above and the result of your audit, answer the following: (Assume the
client is using perpetual inventory system)
1. The entry on Jan. 8 will include a debit to Raw Materials Inventory of
a. P200,000 c. P141,120
b. P144,000 d. P196,000
2. The repossessed inventory on Feb. 14 is most likely to be valued at
a. P14,000 c. P17,200
b. P24,000 d. P14,400
3. The journal entries on April 3 will include a
a. Debit to Cash of P24,000.
b. Debit to Cost of Repossessed Goods Sold of P14,000.
c. Credit to Profit on Sale of Repossessed Inventory of P3,600.
d. Credit to Repossessed Inventory of P20,400.
4. The trade-in inventory on Aug. 30 is most likely to be valued at
a. P8,000 c. P6,000
b. P4,800 d. P6,400
5. How much will be recorded as Sales on Aug. 30?
a. P51,200 c. P57,200
b. P56,000 d. P57,600

Problem 9
In conducting your audit of Mangatarem Corporation, a company engaged in import
and wholesale business, for the fiscal year ended June 30, 2006, you determined that
its internal control system was good. Accordingly, you observed the physical
inventory at an interim date, May 31, 2006 instead of at June 30, 2006.

You obtained the following information from the company’s general ledger.

Sales for eleven months ended May 31, 2006 P1,344,000

Sales for the fiscal year ended June 30, 2006 1,536,000
Purchases for eleven months ended May 31, 2006
(before audit adjustments) 1,080,000
Purchases for the fiscal year ended June 30, 2006 1,280,000
Inventory, July 1, 2005 140,000
Physical inventory, May 31, 2006 220,000

Your audit disclosed the following additional information.

(1) Shipments costing P12,000 were received in May and included in the physical
inventory but recorded as June purchases.

(2) Deposit of P4,000 made with vendor and charged to purchases in April 2006.
Product was shipped in July 2006.

(3) A shipment in June was damaged through the carelessness of the receiving
department. This shipment was later sold in June at its cost of P16,000.

QUESTIONS:
In audit engagements in which interim physical inventories are observed, a frequently
used auditing procedure is to test the reasonableness of the year-end inventory by the
application of gross profit ratio. Based on the above and the result of your audit, you
are to provide the answers to the following:
1. The gross profit ratio for eleven months ended May 31, 2006 is
a. 20% c. 30%
b. 35% d. 25%

2. The cost of goods sold during the month of June, 2006 using the gross profit ratio
method is
a. P132,000 c. P148,000
b. P144,000 d. P160,000

3. The June 30, 2006 inventory using the gross profit method is
a. P264,000 c. P268,000
b. P340,000 d. P260,000

Substantive Testing – Inventories

1. Otso Manufacturing Corporation mass produces eight different products. The

controller, who is interested in strengthening internal controls over the accounting
for materials used in production, would be most likely to implement
a. A separation of duties among production personnel.
b. A perpetual inventory system.
c. An economic order quantity (EOQ) system.
d. A job order cost accounting system.

2. Which of the following control procedures would most likely be used to maintain
accurate perpetual inventory records?
a. Independent matching of purchase orders, receiving reports, and vendors'
invoices.
b. Independent storeroom count of goods received.
c. Periodic independent reconciliation of control and subsidiary records.
d. Periodic independent comparison of records with goods on hand.

3. The accuracy of perpetual inventory records may be established in part by

comparing perpetual inventory records with
a. Purchase requisitions. c. Receiving reports.
b. Purchase orders. d. Vendor payments.
4. The auditor tests the quantity of materials charged to work in process by tracing
these quantities to
a. Receiving reports. c. Materials requisition forms.
b. Perpetual inventory records. d. Cost ledgers.

5. An auditor would analyze inventory turnover rates to obtain evidence concerning

management’s assertion about
a. Valuation or allocation. c. Presentation and disclosure.
b. Rights and obligations. d. Completeness

6. In auditing inventories, a major objective relates to the existence assertion. Of the

following audit procedures relating to inventories, which does not support the
existence assertion?
a. The auditor reviews the client's inventory-taking instructions for such matters
as proper arrangement of goods, separation of consigned goods, and limits on
movements of goods during inventory.
b. The auditor observes the client's inventory and performs test counts as
appropriate.
c. The auditor confirms inventories not on the premises.
d. The auditor performs a lower of cost or market test for major categories of
inventory.

7. In a manufacturing company, which one of the following audit procedures would

give the least assurance of the valuation of inventory at the audit date?
a. Obtaining confirmation of inventories pledged under loan agreements.
b. Testing the computation of standard overhead rates.
c. Examining paid vendors' invoices.
d. Reviewing direct labor rates.

8. When auditing merchandise inventory at year end, the auditor performs a purchase
cutoff test to obtain evidence that
a. No goods held on consignment for customers are included in the inventory
balance.
b. No goods observed during the physical count are pledged or sold.
c. All goods owned at year end are included in the inventory balance
d. All goods purchased before year end are received before the physical
inventory count.
9. Which of the following items should not be included in a physical inventory?
a. Materials in transit from vendors.
b. Goods in a private warehouse.
c. Goods received for repairs under warranty.
d. Consignment to an agent.
10. You were engaged to conduct an annual examination for the fiscal year ended
October 31, 2006. Because of the expected holiday, you were able to convince your
client to take a complete physical inventory, in which you were present on October
15. Perpetual inventory records are kept and the client considers a sale to be made
in the period in which goods are shipped. You had a sales cut-off test worksheet
prepared. Which item among those listed below will not require an adjusting entry to
reconcile the client's detailed inventory record with the physical inventory?
a. b. c. d.
Date Goods Shipped Oct 31 Nov 2 Oct 14 Oct 10
Transaction Recorded as Sale Nov 2 Oct 31 Oct 16 Oct 19
Date Inventory Control Oct 31 Oct 31 Oct 16 Oct 12
Credited

Auditing Theory
1. Alpha Company uses its sales invoices for posting to perpetual inventory
records. Inadequate internal control procedures over the invoicing function
allow goods to be shipped that are not yet invoiced. The inadequate
controls could cause an

A. understatement of revenues, receivables, and inventory.

B. overstatement of revenues and receivables, and an understatement of
inventory.
C. understatement of revenues and receivables, and an overstatement of
inventory.
D. overstatement of revenues, receivables, and inventory.

2. Which of the following control procedures may prevent the failure to bill
customers for some shipments?

A. Each shipment should be supported by a pre-numbered sales invoice that is

accounted for.
B. Each sales order should be approved by authorized personnel.
C. Sales journal entries should be reconciled to daily sales summaries.
D. Each sales invoice should be supported by a shipping document.

3. The most effective control for ensuring that customers are billed only for
goods shipped is to

A. require that carriers sign properly completed bills of lading.

B. implement a policy that prevents the mailing of sales invoices to customers
in the absence of a properly approved shipping order and a bill of lading
signed by the carrier.
C. require that all shipments be approved by an accounting personnel.
D. prevent goods from leaving the warehouse without being accompanied by a
signed bill of lading and a properly approved shipping order.

4. A company policy should clearly indicate that defective merchandise

returned by customers is to be delivered to the

A. Sales clerk.
B. Receiving clerk.
C. Inventory control clerk.
D. Accounts receivable clerk.

5. During the review of a small business client's internal control system, the
auditor discovered that the accounts receivable clerk approves credit memos
and has access to cash. Which of the following controls would be most
effective in offsetting this weakness?

A. The owner reviews errors in billings to customers and postings to the

subsidiary ledgers.
B. The controller receives the monthly bank statement directly and reconciles
the checking accounts.
C. The owner reviews credit memos after they are recorded.
D. The controller reconciles the total of the detailed accounts receivable to the
amount shown in the ledger.

6. The most effective control to prevent unbilled and unrecorded shipments of

finished goods is to

A. require all outgoing shipments to be accompanied by a prenumbered

shipping order and bill of lading (signed by the carrier). Forward a copy of
these documents to accounting, to be placed in an open file awaiting receipt
of the customer invoice copy.
B. forward a copy of the shipping order and bill of lading to billing.
C. implement a policy that prevents sales invoices from being mailed to
customers in the absence of a properly approved shipping order and bill of
lading signed by the carrier.
D. forward a copy of the signed bill of lading to the stores manager.

7. Controls over approving credit relate to the:

A. completeness assertion.
B. rights and obligation.
C. valuation or allocation.
D. occurrence.
8. To determine whether internal control operates effectively to minimize
errors of failure to bill a customer for a shipment, the auditor would select a
sample of transactions from the population represented by the

A. customer order file.

B. shipping records file.
C. subsidiary customer accounts ledger.
D. sales invoice.

9. To verify that all sales transactions have been recorded, a test of transactions
should be completed on a representative sample drawn from

A. entries in the sales journal.

B. the billing clerk’s file of sales orders.
C. a file of duplicate copies of sales invoices for which all prenumbered forms
in the series have been accounted for.
D. the shipping clerk’s file of duplicate copies of shipping documents

10. To gather audit evidence about the proper credit approval of sales, the
auditor would select sample of documents from the population represented
by the

A. customer order file.

B. bill of lading file.
C. subsidiary customers’ account ledger.
D. sales invoice file.

11. The purpose of tests of controls over shipping is to determine whether

A. billed goods have been shipped.

B. shipments are billed.
C. shipping department personnel are competent.
D. credit is approved before goods are shipped.

12. The purpose of tests of controls over billing is to determine whether

A. billed goods have been shipped.

B. shipments are billed.
C. billing department personnel are competent.
D. credit is approved before goods are billed.

13. An effective procedure to test for unbilled shipments is to trace from the
A. sales journal to the shipping documents.
B. shipping documents to the sales journal.
C. sales journal to the accounts receivable ledger.
D. sales journal to the general ledger sales account.

14. To determine whether refunds granted to customers were properly

approved, the auditor should trace accounts receivable entries to:

A. Sales invoices.
B. Remittance advices.
C. Shipping documents.
D. Credit memos.