Ch. 9 HW Solutions - Edward Lynch PDF

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Summary

CHAPTER 09Production CycleLEARNING OBJECTIVESReview Checkpoints Multiple ChoiceExercises, Problems, and Simulations Describe the production cycle, including typical source documents. 1, 2, 3, 4, 23, 24, 25 Identify significant accounts and relevant assertions related to the production cycle. 5, 6, 7...

Description

Chapter 09 - Production Cycle

CHAPTER 09 Production Cycle LEARNING OBJECTIVES Review Checkpoints

Exercises, Problems, and Simulations

Multiple Choice

1. Describe the production cycle, including typical source documents.

1, 2, 3, 4,

23, 24, 25

2. Identify significant accounts and relevant assertions related to the production cycle.

5, 6, 7

27, 38

3. Discuss the risk of material misstatement in the production cycle.

8, 9

30

10, 11, 12

26, 28, 32

47, 49

13, 14

39, 40, 43

48

15, 16, 17, 18, 19, 20, 21, 22

29, 31, 33, 34, 35, 36, 37, 41, 42, 44, 45, 46

51, 52, 53, 54, 55, 56, 57, 58

4. Identify important internal control activities present in a properly designed system to mitigate the risk of material misstatements for each relevant assertion in the production cycle. 5. Give examples of tests of controls to test the operating effectiveness of internal controls in the production cycle. 6. Give examples of substantive procedures in the production cycle and relate them to assertions about significant account balances at the end of the period. 7. Apply your knowledge to perform audit procedures in the production cycle and evaluate the findings of your tests.

59, 60, 61, 62, 63, 64, 65, 66

SOLUTIONS FOR REVIEW CHECKPOINTS 9.1

Production planning Production Cost accounting

9.2

GAAP recognizes specific identification, weighted average, FIFO, and LIFO methods of accounting for inventory.

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Chapter 09 - Production Cycle

9.3

The auditor performs a walkthrough by talking to employees about their duties, observing performance, and examining documents produced and agreeing them to related documents. A walkthrough of a production transaction will collect the following documents:          

Production order. Bill of materials. Materials requisitions. Inventory record (raw materials issue). Journal entry (moving raw materials to work in process). Labor report (time records). Journal entry (charging labor to work in process). Production cost analysis. Inventory record (finished goods addition). Journal entry (moving work in process to inventory).

Documents should be agreed to production orders based on the bill of materials. The requisitions should also agree to the inventory record, which is agreed to the journal entry. The labor report would be agreed to time records and the journal entry. The journal entries would be summarized and agreed to the production cost. The finished goods addition would be agreed to the production cost and the journal entry. Controls: The auditor would look for the following:    

Approval signatures on requisitions, and time records. Approvals of journal entries. Tests of accuracy of calculations. Separation of a. Custody of the inventory. b. Record keeping. c. Authorization of use of materials and incurring time. d. Reconciliation of inventory records to physical counts.

9.4

Some work to obtain assurance about the reasonableness of the client’s sales forecast needs to be performed. The auditors need to learn about the assumptions built into the forecast for the purpose of ascertaining their reasonableness. The auditor may gain an understanding as to how production is determined and the flow of product through the warehouse to the customer. In addition, some work on the mechanical accuracy of the forecast should be performed to avoid embarrassing reliance on faulty calculations. If sales forecasts appear to be flawed or inaccurate, finished goods may be produced that may not sell in a timely manner. This finished goods inventory may result in slow moving or overvalued inventory.

9.5

Company produce good in accordance with the sales forecast. If actual sales do not meet sales forecasts, all the finished goods produced will not sell and will remain in finished goods inventory. The auditor must determine if these goods will sell in the future and if so at what price. If substantial finished goods remain in inventory and there is a question of the salability of the goods, the auditor may require the client to write down the value of finished goods inventory.

9.6

The cost accounting department uses director labor, direct materials and an application of overhead costs to determine product costs. Risks included in this process include inaccurate reporting of labor hours or labor rates, an overstatement of materials used, inaccurate scrap rates (scrap materials are usually charged to the production run), and an inappropriate overhead rate.

9.7

Management asserts that

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Chapter 09 - Production Cycle

      9.8   

inventory exists (existence), the company owns this inventory (rights), the inventory is properly valued (valuation), all inventory is included this amount (completeness), the valuation method for inventory is disclosed (presentation and disclosure), only inventory is included in this amount (presentation and disclosure). The recording of the valuation is difficult for many reasons: it is often difficult to get an accurate count of inventory because often inventory is purchased at many different times at many different values inventory valuation assumptions are necessary (e.g. LIFO) all inventory items may not be usable and therefore have no value. For example, if a company has an inventory of 200,000 bottle caps, some (say 400) may be defective and not useable.

9.9

Inventory errors are pervasive because the ending inventory number appears on the balance sheet and is also used to calculate cost of goods sold. In turn, cost of goods sold is used to calculate profit and income numbers. Therefore errors in inventory affect multiple items on the financial statements.

9.10

Failure to record materials used should be prevented by matching documents. For example, dated raw materials inventory issues not matched to materials in the production cost analysis indicate a possible omission of material used in production. Use of prenumbered documents and reports to account for a numerical sequence is also a primary means of preventing omission of transactions.

9.11

Auditors are looking for the separation of duties in authorization of transactions, custody of assets, recording of transactions, and periodic reconciliation. In the production cycle, these duties are separated as follows: a)

Initial authorization is a production order prepared in production planning and control; authorizations of labor hours and material to be used are given by the supervisor when job time tickets are given to employees and material requisitions are sent to raw materials stores.

b) Cost accounting clerks analyze independent recording of labor and materials in production cost from records after comparing two sources. c)

Raw materials stores maintain physical custody of raw materials, none of which are released without authorization (requisition) and record of withdrawal. The supervisor maintains custody of work-in-process inventory.

9.12

The production order record provides a control over the quantity of product manufactured by the production department. Used in combination with the bill of materials, this record provides an approved list of materials that should be used. This list can be compared to the actual materials used as recorded by the cost accounting department.

9.13

This is a question about the direction of tests of controls. a.

To determine whether all authorized production was completed and placed in inventory or written off as scrap, the auditors should select a sample of approved production orders from the production planning department files and then trace them forward through cost accounting to inventory or write-offs.

b.

To determine whether finished goods inventory was actually produced and costs were properly accumulated, the auditors should select a sample of production put in the Inventory account and then vouch these production reports to approved production orders and cost calculations of material, labor, and overhead.

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Chapter 09 - Production Cycle

9.14

Any document is prenumbered in order to account for the items and ensure that no document is missing. A missing receiving report would allow physical items to be entered into inventory without being entered into the inventory records. Such an inaccurate inventory record may result in unnecessary purchases by the company. In addition, if goods were received that had “street” value (e.g. computers) these items could be stolen and the receiving report destroyed. A Prenumbering of the receiving reports would allow management to determine that goods were unaccounted. The auditor could trace receiving reports to the inventory records to determine that these items were properly recorded in the inventory records (valuation and completeness). The auditor could trace the receiving report to the actual items receiving (e.g. equipment, parts, etc.) (existence). The auditor could vouch the receiving reports to the purchase orders to ensure these goods were actual ordered by the client (occurrence and rights).

9.15

9.16

The auditor considers these characteristics in a review of the client’s inventory-taking instructions: a.

Names of client personnel responsible for the count.

b.

Dates and times of inventory taking.

c.

Names of client personnel who will participate in the inventory taking.

d.

Instructions for recording accurate descriptions of inventory items, for count and double-count, and for measuring or translating physical quantities (such as counting by measures of gallons, barrels, feet, dozens).

e.

Instructions for making notes of obsolete or worn items.

f.

Instructions for the use of tags, punched cards, count sheets, computers, or other media devices and for their collection and control (a typical inventory count sheet is illustrated at Exhibit 9.7).

g.

Plans for shutting down plant operations or for taking inventory after store closing hours and plans for having goods in proper places (such as on store shelves instead of on the floor or of raw materials in a warehouse rather than in transit to a job).

h.

Plans for counting or controlling movement of goods in receiving and shipping areas if those operations are not shut down during the count.

i.

Instructions for computer compilation of the count media (such as tags, count sheets) into final inventory listings or summaries.

j.

Instructions for review and approval of the inventory count; notations of obsolescence or other matters by supervisory personnel.

k.

Instructions for making changes and corrections to count tickets.

Dual-direction sampling in the context of inventory test counts proceeds as follows: a.

In one direction, a sample of inventory items can be chosen from the perpetual records or inventory count tags for test count to ascertain that recorded inventory was counted (existence).

b.

In the other direction, the auditor can count a sample of items in their locations, record them, and later trace them to the perpetual records and inventory summary count sheets to ascertain whether all inventory in place was recorded and counted (completeness).

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Chapter 09 - Production Cycle

9.17

Amounts on inventory count sheets and tickets become the amounts in the inventory, so a fictitious item on the count sheet or ticket becomes a fictitious item in inventory. If the auditors do not obtain control information, the client can easily add amounts to the inventory count without the auditors’ knowledge.

9.18

The auditor should document:  Whether the client’s personnel were following the inventory instructions.  Test counts taken, including description, and quantity.  The ticket or count sheet numbers that were used as well as the numbers of voided and unused tickets.  The last receiving reports and shipping documents used and the number of the next unused item.  The condition of the inventory.  Any inventory on hand that is not owned by the client.  Any unusual items noticed during the count.

9.19

The auditor must obtain shipping and receiving cutoff information during the physical inventory observation to ensure that items recorded as receipts or shipments in the accounting records match purchases included and sales excluded from inventory in the perpetual records. The perpetual records are compared to the count to determine the book to physical inventory adjustment.

9.20

In this type of situation, the auditor will arrange to be present during one more of the test counts, and importantly, he or she will evaluate the cycle or statistical plan for validity. During his or her observation of the inventory taking, the auditor will employ the usual inventory audit procedures, perform test counts and be responsible for a conclusion concerning the reasonable accuracy of perpetual quantity records.

9.21

The client’s managers may be making record of the auditors’ test counts so they can fraudulently change the counts on items the auditors did not count.

9.22

Obsolete or slow-moving inventory is often indicated by:  Inventory turnover ratios.  Trend analysis of inventory levels.  Days sales in inventory ratio.  Sales trend analysis. Note: All of these procedures are more powerful as you disaggregate the data.

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Chapter 09 - Production Cycle

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS 9.23

9.24

9.25

9.26

9.27

9.28

9.29

a.

Incorrect

b.

Incorrect

c.

Incorrect

d.

Correct

a.

Incorrect

b. c. d.

Incorrect Correct Incorrect

a.

Incorrect

b.

Incorrect

c.

Correct

d.

Incorrect

a. b. c.

Incorrect Incorrect Correct

d.

Incorrect

a.

Incorrect

b.

Incorrect

c. d.

Correct Incorrect

a. b. c.

Incorrect Incorrect Correct

d.

Incorrect

a. b. c.

Incorrect Incorrect Incorrect

Raw materials and supplies purchased are linked through the acquisition and expenditure cycle. Labor and costs are linked through the payroll cycle. Cost of goods sold and reduction to finished goods inventory is linked through the revenue and collection cycle. The finance and investment cycle is not directly linked to the production cycle, although it is indirectly linked through investments in property, plant, and equipment. This is what the company plans to sell, not produce. Some of the planned sales may come from existing inventory, and some of the production may be sold in future periods. These reports indicate what was actually produced. The production plan shows what is planned to be actually produced. The purchases journal shows what was actually purchased during the period. The job cost sheet indicates the costs used in production and would provide weak evidence as to the occurrence of any transactions or events The job cost sheet indicates the costs used in production and would provide no evidence that production or any related accounts were complete. The job cost sheets indicate the cost used in determining the accuracy of inventory produced. The job cost sheet indicates the costs used in production and would provide no evidence regarding the proper classification of transactions This is a common practice that enhances efficiency. See answer (a). This weakness is an improper combination of inventory custody and recordkeeping responsibilities. See answer (a). The most meaningful analytical procedures are performed at the most disaggregated level, in this case, the product level. The most meaningful analytical procedures are performed at the most disaggregated level, in this case, the product level. This is the most disaggregated level of the choices given. The most meaningful analytical procedures are performed at the most disaggregated level, in this case, the product level. This might detect the theft but wouldn’t prevent it. This wouldn’t necessarily detect the theft. The separate space facilitates security, and the frequent counts enable company personnel to detect shortages in a timely manner. This would account for legitimately moved inventory, but those people stealing inventory would not file proper forms. This step would not provide evidence of whether the items are owned. This step would not detect obsolescence. Ensuring physical presence would require tracing from the listing to inventory tickets.

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Chapter 09 - Production Cycle

9.30

9.31

9.32

9.33

9.34

9.35

d.

Correct

If the sample is from the inventory in the physical location, the tracing has the objective of auditing the completeness of the final inventory schedule.

a. b.

Incorrect Correct

c. d.

Incorrect Incorrect

This would make the count lower than the perpetual records. Unrecorded credit memos means that the returned inventory is not in the perpetual records; thus, the recorded amount will be smaller than the amount on hand. This would make the perpetual records higher than the physical count This would make both the physical count and perpetual records too low.

a. b.

Incorrect Correct

c. d.

Incorrect Incorrect

a.

Incorrect

b. c.

Incorrect Correct

d.

Incorrect

a.

Correct

b. c.

Incorrect Incorrect

d.

Incorrect

a. b. c.

Incorrect Incorrect Correct

d.

Incorrect

a. b.

Incorrect Correct

c. d.

Incorrect Incorrect

Controls must be strong for the roll-forward to be reliable. Auditors rely on accurate perpetual records to maintain an accurate inventory balance during the intervening period between the ph...