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Test Item File for Arens, Auditing, 13CE

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Chapter 14 Audit of the Inventory and Distribution Cycle 14.1 Identify the accounts and the classes of transactions in the inventory cycle 1) Obtaining an adequate understanding of the client's business is important in physical observation of inventory because A) it is required by GAAP. B) it will help the auditor in assessing the risk of theft of inventory. C) inventory is normally a significant item. D) inventory varies significantly for different companies. Answer: D Diff: 2 Type: MC Page Ref: 464 Learning Obj.: 14-1 Identify the accounts and the classes of transactions in the inventory cycle 2) The inventory and distribution cycle can be thought of as comprising two separate but closely related systems, one involving the actual physical flow of goods, and the other the A) internal control over those goods. B) related costs. C) storing of the goods. D) prevention of waste, obsolescence, and theft. Answer: B Diff: 2 Type: MC Page Ref: 464 Learning Obj.: 14-1 Identify the accounts and the classes of transactions in the inventory cycle 3) The overall objective in the audit of the inventory and distribution cycle is to determine that A) costs of goods sold and gross profit are correctly stated on the income statement. B) inventory items on the balance sheet are neither fraudulent nor materially in error. C) gross profit and inventory are fairly presented on the financial statements. D) inventory and cost of goods sold are fairly stated on the financial statements. Answer: D Diff: 2 Type: MC Page Ref: 464 Learning Obj.: 14-1 Identify the accounts and the classes of transactions in the inventory cycle 4) The controls over purchase requisitions and the related purchase orders are evaluated and tested as part of the A) inventory and distribution cycle. B) acquisitions and payments cycle. C) human resources and payroll cycle. D) capital acquisitions cycle. Answer: B Diff: 1 Type: MC Page Ref: 464 Learning Obj.: 14-1 Identify the accounts and the classes of transactions in the inventory cycle

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Test Item File for Arens, Auditing, 13CE

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14.2 Describe the business functions, documents, and records of the inventory cycle 1) The form used to request the purchasing department to place orders for inventory items is the A) purchase order. B) purchase requisition. C) materials requisition. D) bill of lading. Answer: B Diff: 1 Type: MC Page Ref: 464-465 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle 2) Receipt of ordered materials by the receiving department will generate the completion of a form called the A) receiving report. B) materials requisition. C) bill of lading. D) inventory acquisition summary. Answer: A Diff: 1 Type: MC Page Ref: 465 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle 3) Master files, worksheets, and reports that accumulate material, labour, and overhead as the costs are incurred are A) accounting system controls. B) storeroom documents. C) finished goods inventory records. D) cost accounting records. Answer: D Diff: 2 Type: MC Page Ref: 465 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle 4) Shipping of finished goods is an integral part of the A) acquisitions and payments cycle. B) inventory and distribution cycle. C) sales and collections cycle. D) human resources and payroll cycle. Answer: C Diff: 1 Type: MC Page Ref: 465 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle

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Test Item File for Arens, Auditing, 13CE

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5) State the six functions that make up the inventory and distribution cycle and, for each function, identify the related documents and/or records that would be used by a manufacturing company. Answer: The six functions are: 1. Process purchase orders. Related documents are the purchase requisition and the purchase order. 2. Receive raw materials. Related documents are the receiving report and the vendor's invoice. 3. Store raw materials. Related record is the raw materials perpetual inventory master file. 4. Process the goods. Related documents and records are the raw materials requisition and the cost accounting records. 5. Store finished goods. Related records are the finished goods perpetual inventory master file and the cost accounting records. 6. Ship finished goods. Related documents and records are the shipping document, the finished goods perpetual inventory master file, and the cost accounting records. Diff: 3 Type: ES Page Ref: 465 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle 6) The audit of the inventory and distribution cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor. Answer: The five parts are: 1. Acquire and record raw materials, labour, and overhead. This is tested during the audits of the acquisition and payment cycle, and the human resources and payroll cycle. 2. Internal storage, production, and transfer of inventory and costs. This is tested in the inventory and distribution cycle. 3. Ship goods and record revenue and costs. This is tested during the audit of the sales and collection cycle. 4. Physically observe inventory. This is tested in the inventory and distribution cycle. 5. Price and compile inventory. This is tested in the inventory and distribution cycle. Diff: 3 Type: ES Page Ref: 465-466 Learning Obj.: 14-2 Describe the business functions, documents, and records of the inventory cycle

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Test Item File for Arens, Auditing, 13CE

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14.3 Assess inherent risk and fraud risk for the inventory cycle 1) An auditor has determined that there is a high risk that her client has overvalued inventory. Which audit assertions would require additional testing? A) accuracy and existence B) allocation and accuracy C) accuracy and valuation D) valuation and classification Answer: C Diff: 3 Type: MC Page Ref: 466 Learning Obj.: 14-3 Assess inherent risk and fraud risk for the inventory cycle 2) The bias in recording inventory would be toward A) overstatement. B) understatement. C) increasing share price. D) income smoothing. Answer: A Diff: 2 Type: MC Page Ref: 467 Learning Obj.: 14-3 Assess inherent risk and fraud risk for the inventory cycle 3) Discuss the methodology for designing tests of details of balances for inventory. Answer: The methodology for designing tests of details of balances for inventory is: 1. Set performance materiality and assess audit risk and inherent risk for the inventory and distribution cycle. Conduct analytical review for planning purposes. 2. Assess control risk for several cycles. This risk is assessed for the inventory and distribution cycle, sales and collection cycle, acquisition and payment cycle, and human resources and payroll cycle. 3. Identify assertions where substantive testing is insufficient, risk of material misstatement and significance. 4. Design and perform tests of controls for several cycles. 5. Design and perform analytical procedures as substantive tests for the inventory and distribution cycle. 6. Design tests of details of inventory to satisfy balance-related audit objectives. Design sample size, timing of tests, items to select for testing, and audit procedures to be performed. Diff: 2 Type: ES Page Ref: 467 Learning Obj.: 14-3 Assess inherent risk and fraud risk for the inventory cycle

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Test Item File for Arens, Auditing, 13CE

4) Describe the major risks of error or fraud in the inventory and distribution cycle using the headings of i) risks of error, ii) risks of misappropriation of assets, other fraud, or illegal acts, and iii) risks of inadequate disclosure or incorrect presentation of financial information, including fraudulent financial reporting. Ans wer :

Risks of Inadequate Disclosure or Incorrect Presentation of Financial Risks of Misappropriation Information, Including of Assets, Other Fraud, or Fraudulent Financial Reporting Risks of Error Illegal Acts Incorrect calculation Intentional overstatement (or Intentional inclusion of used to determine understatement) of inventory inventory held on inventory cost on consignment or on hand consignment as owned inventory Valuation of obsolete Intentional cutoff errors (e.g., Omission of disclosure that value at full price excluding returns from inventory is being used as inventory or including collateral for debt shipments already sold) Incorrect valuation Employee theft of inventory Misallocation of inventory method used to between raw material and determine cost of finished goods inventory Inventory counts done Unauthorized journal entries Accounting policy used for poorly, resulting in used to overstate inventory, so calculating inventory values is described in a confusing way incorrect quantity on subsidiary records do not hand being recorded agree to the general ledger Diff: 3 Type: ES Page Ref: 467-468 Learning Obj.: 14-3 Assess inherent risk and fraud risk for the inventory cycle

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Test Item File for Arens, Auditing, 13CE

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14.4 Explain the five different parts of the audit of the inventory cycle 1) The auditor evaluates the internal transfer of assets and related costs during the A) acquisition and payments cycle. B) human resources and payroll cycle. C) sales and collection cycle. D) inventory and distribution cycle. Answer: D Diff: 1 Type: MC Page Ref: 469 Learning Obj.: 14-4 Explain the five different parts of the audit of the inventory cycle 2) When labour is a significant part of inventory, verifying the proper accounting of these costs should be tested in the A) inventory and distribution cycle. B) human resources and payroll cycle. C) acquisitions and payments cycle. D) cash cycle. Answer: B Diff: 1 Type: MC Page Ref: 469 Learning Obj.: 14-4 Explain the five different parts of the audit of the inventory cycle 3) The costs used to value the physical inventory must be tested to determine whether the client has correctly followed an inventory method that is in accordance with an acceptable financial reporting framework and is consistent with previous years. The audit procedures used to verify these costs are referred to as inventory A) price tests. B) compilation tests. C) cost allocation tests. D) consistency tests. Answer: A Diff: 1 Type: MC Page Ref: 470 Learning Obj.: 14-4 Explain the five different parts of the audit of the inventory cycle 4) The auditor must verify whether the physical counts were correctly summarized, the inventory quantities and prices were correctly extended, and the extended inventory was correctly footed. These tests are called A) price tests. B) compilation tests. C) cost tests. D) mechanical tests. Answer: B Diff: 1 Type: MC Page Ref: 470 Learning Obj.: 14-4 Explain the five different parts of the audit of the inventory cycle

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Test Item File for Arens, Auditing, 13CE

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5) What are inventory price tests and inventory compilation tests? Provide an example of each. Answer: Audit procedures used to verify inventory costs are referred to as inventory price tests. An example would be tracing inventory costs to supplier invoices for particular inventory items purchased. In addition, the auditor must verify whether the physical counts were correctly summarized, the inventory quantities and prices were correctly extended, and the extended inventory was correctly footed. These tests are called inventory compilation tests. Diff: 2 Type: ES Page Ref: 470 Learning Obj.: 14-4 Explain the five different parts of the audit of the inventory cycle 14.5 Understand key controls for the inventory cycle and design and perform tests of controls 1) Segregation of duties between production, inventory control, and accounting are important controls in the inventory and distribution cycle. How would the auditor test these controls? A) using inquiry and reperformance B) using observation and inquiry C) using observation and reperformance D) using discussion with management Answer: B Diff: 3 Type: MC Page Ref: 470 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 2) To protect the inventory, Globus Corp wants to assign the custody of inventory to a specific responsible individual. Globus can accomplish this by A) having a designated employee to authorize movement of inventory. B) requiring employees to have photo id cards. C) having restricted access to the production facility. D) performing frequent inventory counts. Answer: A Diff: 3 Type: MC Page Ref: 470 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 3) A well-designed computerized system of perpetual inventory data files includes information about the A) units of inventory purchased, sold, and on hand. B) unit costs of inventory purchased, sold, and on hand. C) units and unit costs of inventory purchased, sold, and on hand. D) units of raw materials, work-in-process, and finished goods. Answer: C Diff: 2 Type: MC Page Ref: 470-471 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls

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Test Item File for Arens, Auditing, 13CE

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4) The auditor has determined that the inventory procedures are highly automated with limited use of a paper or physical trail. Rather than having people count inventory (since all inventory has RFID tags attached), inventory is being read using the wireless mesh network. To provide assurance with respect to ending inventory, the auditor should A) bring in additional audit staff and conduct a high level of test counts, matching these counts to the automated systems. B) use dollar-unit sampling to identify all high-dollar inventory items and ask the client to physically count these items using count teams. C) test the quality of the controls over the programs in use and over tagging inventory items. D) request that the client implement manual rotating counts to test the quality of the automated systems. Answer: C Diff: 3 Type: MC Page Ref: 470-472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 5) Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which A) materials are ordered for purchase until the finished product is sold. B) raw materials are requisitioned until the finished product is sent to storage. C) raw materials are requisitioned until the finished product is completely manufactured. D) the customer's order is received until the finished product is shipped. Answer: B Diff: 3 Type: MC Page Ref: 470-472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 6) XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. What internal control is required with respect to these costs to ensure proper valuation of inventory? A) Procedures must be designed to keep the standards updated for changes in production processes and costs. B) Computer software should be used to make sure that the standard costs are properly updated into the inventory item master file. C) Input edit routines should be used to help detect input data entry errors for the entry of the standard costs. D) Standard costs should be used to provide a value for inventory every month by calculating cost times quantity on hand. Answer: A Diff: 3 Type: MC Page Ref: 471 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls

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Test Item File for Arens, Auditing, 13CE

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7) XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. For the last few months, there have been high variances between total standard costs and actual costs. What is one of the likely reasons for this variance? A) The accounting department has been developing the costs. B) Production quantities are different than expected. C) There is an increase in inventory quantities on hand. D) The receiving department has been stockpiling raw materials. Answer: B Diff: 2 Type: MC Page Ref: 471 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 8) The auditor's tests of the adequacy of the physical controls over raw materials, work-inprocess, and finished goods are usually limited to A) observation and inquiry. B) inspection and observation. C) inspection and confirmation. D) inspection and inquiry. Answer: A Diff: 2 Type: MC Page Ref: 471-472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 9) The auditor would like to test the existence and accuracy of the transfer of goods from the raw materials storeroom to the manufacturing assembly lines. Which of the following audit procedures should be used? A) Conduct a variance analysis of the costs associated with manufacturing, looking for gross profit fluctuations. B) Account for a sequence of raw material requisitions, examining details and looking for proper approvals. C) Look at overtime records to determine the amount and timing of overtime hours used in the manufacturing process. D) Inquire with the inventory custodian regarding procedures used to transfer raw materials to the production line. Answer: B Diff: 3 Type: MC Page Ref: 471-472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls

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Test Item File for Arens, Auditing, 13CE

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10) The existence of an adequate storeroom with a competent custodian in charge results in the orderly storage of inventory and can protect inventory from theft and misuse. How would an auditor assess these controls? A) observation during the audit and inquiry of the accounting staff B) inquiry of the accounting staff and inspection of theft statistics C) observation during the inventory count and inquiry of inventory personnel D) inspection of inventory damage statistics and inquiry of inventory personnel Answer: C Diff: 3 Type: MC Page Ref: 472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 11) It is frequently possible to test the physical inventory prior to the balance sheet date when A) there are accurate perpetual inventory master files. B) year-end sales are small. C) the internal control system is no better at year-end than at an earlier point in time. D) client counts inventory at interim dates. Answer: A Diff: 2 Type: MC Page Ref: 472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 12) The auditor has determined that the perpetual inventory master files are high quality, assessing control risk related to physical observation of inventory as low. How does this affect audit testing? The auditor may A) reduce the extent of control tests over data entry to the master file. B) reduce the extent of the tests of physical inventory. C) reduce the extent of control tests with respect to program change controls. D) increase assessed inherent risks over the tests of physical inventory. Answer: B Diff: 2 Type: MC Page Ref: 472 Learning Obj.: 14-5 Understand key controls for the inventory cycle and design and perform tests of controls 13) If the auditor concludes that the physical controls over inventory are so inadequate that inventory will be difficult to count, the auditor should A) inquire of management the addition...