Excelling in Financial Accounting: Key Concepts and Quiz
AUDIT OF PRICING AND COMPILATION
Auditors must verify that the physical counts or perpetual record quantities are correctly priced and compiled. Inventory price tests include all the tests of the client’s unit prices to determine whether they are correct. Inventory compilation tests include testing the client’s summarization of the inventory counts, recalculating price times quantity, footing the inventory summary, and tracing the totals to the general ledger. Adequate internal controls surrounding the tracking of unit costs that are integrated with production and other accounting records provides assurance that clients use reasonable costs for valuing ending inventory. Standard cost records that indicate variances in material, labor, and overhead costs are helpful to evaluate the reason - ableness of production records if management has procedures in place to keep the standards updated for changes in production processes and costs. Management should also have someone independent of the department responsible for determining the costs review them for reasonableness. To prevent including or overstating the value of obsolete inventory, clients should have a formal review and reporting of obsolete, slow-moving, damaged, and overstated inventory items. The review should be done by a knowledgeable employee who reviews perpetual inventory master files for inventory turnover and holds discussions with engineering or production personnel. Clients need inventory compilation internal controls to ensure that the physical counts are correctly summarized, priced at the same amount as the unit records, correctly extended and totaled, and included in the perpetual inventory master file and related general ledger inventory accounts at the proper amount. The most important internal control for accurate unit costs, extensions, and footings is internal verification by a competent, independent person, who relies on adequate documents and records that were used for taking the physical count. If the physical inventory counts are recorded by the client on prenumbered tags and carefully reviewed before the personnel who counted the inventory are released from the physical examination of inventory, there should be little risk of misstatement in summarizing inventory count tags. Table 21-3 (p. 695) lists the audit objectives and related tests for inventory pricing and compila tion, except for the cutoff objective. As we’ve already discussed, physical observation is a major source of cutoff information for sales and purchases. Tests of the accounting records for cutoff are done as a part of sales (sales and collection cycle) and acquis itions (acquisition and payment cycle). Auditors can apply the objectives using information obtained from the client as a frame of reference, including each inventory item’s description, quantity, unit price, and extended value. We assume the information reflected in the inventory perpetual
listing is recorded in inventory item description order, with raw material, work-inprocess, and finished goods listed separately. The listing totals should equal the general ledger balance. In performing inventory valuation tests (often called price tests), the auditor has three concerns. First, the method must be in accordance with accounting standards. Second, the application of the method must be consistent from year to year. Third, inventory
cost versus market value (replacement cost or net realizable value) must be considered. Because the method of verifying the pricing of inventory depends on whether inventory items are acquired or manufactured, these two categories are discussed separately. Pricing Purchased Inventory The primary types of inventory included in this category are raw materials, purchased parts, and supplies. As a first step in verifying the valuation of purchased inventory, the auditor must determine whether the client uses LIFO, FIFO, weighted average, or some other valuation method. Auditors must also determine which costs should be included in the valuation of an item of inventory. For example, the auditor must find out whether freight, storage, discounts, and other costs are included and the auditor must compare the findings with the preceding year to make sure that the costs are determined consistently
In selecting specific inventory items for pricing, auditors should focus on larger dollar amounts and on products that are known to have wide fluctuations in price. They should also test a representative sample of all types of inventory and depart ments. Stratified variables or monetary unit sampling is commonly used for these tests. The auditor should list the inventory items to be verified for pricing and request the client to locate the appropriate vendors’ invoices. The auditor must examine sufficient invoices to account for the entire quantity of inventory for the item being tested, especially for the FIFO valuation method. Assume that the client values an inventory item at $12.00 per unit for 1,000 units, using FIFO. When the auditor examines the most recent invoices for acquisitions of that inventory item, she finds that the most recent acquisition of the inventory item in the year being audited was for 700 units at $12.00 per unit, and the immediately preceding acquisition was for 600 units at $11.30 per unit. Using correct FIFO valuation techniques, the inventory items should be included at $11,790 (700 units at $12 and 300 at $11.30). The client’s calculations overstates inventory by $210.00 ($12,000 – $11,790). Assuming the client makes this same error on many inventory items, the misstatement amount can be material. When the client has perpetual inventory master files that include unit costs of acquisitions, it is usually much faster to test the pricing by tracing the unit costs to the perpetuals rather than to vendors’ invoices. Naturally, when perpetual inventory records are used to verify unit costs, auditors must test the unit costs recorded in the perpetual records to vendors’ invoices as a part of the tests of the acquisition and payment cycle transactions. Pricing Manufactured Inventory In pricing work-in-process and finished goods, the auditor must consider the cost of raw materials, direct labor, and manufacturing overhead. The need to verify each of these makes the audit of work-in-process and finished goods inventory more complex than the audit of purchased inventory. Nevertheless, several considerations that apply to the audit of purchased inventory still apply, such as selecting the items to be tested, testing for whether cost or market value is lower, and evaluating the possibility of obsolescence. In pricing raw materials in manufactured products, auditors must consider both the unit cost of the raw materials and the number of units required to manufacture a unit of output. The unit cost can be verified in the same manner as that used for other purchased inventory, by examining vendors’ invoices or perpetual inventory master files. Auditors must examine engineering specifications, inspect the finished product, or find a similar method to determine the number of units it takes to manufacture a product. Similarly, while testing direct labor, auditors must verify the hourly costs of direct labor and the number of hours it takes to manufacture a unit of output. Hourly labor costs can be verified by examining labor payroll or union contracts. Auditors can determine the number of hours needed to manufacture the product from engineering specifications or similar sources. The proper manufacturing overhead in work-in-process and finished goods depends on the approach the client uses to allocate manufacturing overhead. Auditors must evaluate the method being used for consistency and reasonableness and recom - pute the costs to determine whether the overhead is correct. For example, if the rate is based on direct labor dollars, the auditor can divide the total manufacturing overhead by the total direct labor dollars to determine the actual overhead rate. This rate can then be compared with the overhead rate used by the client to determine unit costs. Testing of pricing for work-in-process and finished goods is often done in conjunction with tests of standard costs. When auditors have tested standard costs with satisfactory results, they can limit testing of the unit costs of ending inventory to tracing the price used to value ending inventory to the standard cost records. When the client has standard costs records, an efficient and useful method of determining valuation is to review and analyze variances. Small variances in material, labor, and manufacturing overhead are evidence of reliable cost records. Cost or Market In pricing inventory, auditors must consider whether replacement cost or net realizable value is lower than historical cost. For purchased finished goods and raw materials, auditors can test for replacement cost by examining vendor invoices of the subsequent period or recent invoices if no purchases of an inventory item were made after year-end. All manufacturing costs must be considered in evaluating realizable value for work-in-process and finished goods for manufactured inventory. Auditors must consider the sales value of inventory items and the possible effect of rapid fluctuation of prices to determine net realizable value.
(Objective 21-7)
Figure 21-4 (p. 698) and the discussions that follow summarize and illustrate the audit of the inventory and warehousing cycle as a series of integrated tests. Tests of the Acquisition and Payment Cycle When auditors verify inventory acquisitions as part of the tests of the acquisition and payment cycle, they are also obtaining evidence about the accuracy of raw materials acquired and all manufacturing overhead costs incurred except labor. These acquisition costs either flow directly into cost of goods sold or become the largest part of the ending inventory of raw material, work-in-process, and finished goods. In audits where clients have perpetual inventory master files, auditors commonly test these as a part of tests of controls and substantive tests of transactions procedures performed in the acquisition and payment cycle. Similarly, if manufacturing costs are assigned to individual jobs or processes, they are usually tested as a part of the same cycle. Tests of the Payroll and Personnel Cycle When auditors verify labor costs, the same conditions apply as for acquisitions. In most cases, the cost accounting records for direct and indirect labor costs can be tested as part of the audit of the payroll and personnel cycle. Tests of the Sales and Collection Cycle The relationship between the sales and collection cycle and the inventory and warehousing cycle is not as interwoven as the two
cycles we just discussed. Nonetheless, most of the audit testing in the storage of finished goods, as well as the shipment and recording of sales, takes place when the sales and collection cycle is tested. When the client uses standard cost records, auditors may be able to test the standard cost of goods sold at the same time that sales tests are performed. Tests of Cost Accounting Tests of cost accounting records are meant to verify the controls affecting inventory that auditors did not verify as part of testing in the preceding three cycles. Auditors test the physical controls, transfers of raw material costs to work-in-process, transfers of costs of completed goods to finished goods, perpetual inventory master files, and unit cost records. Physical Inventory, Pricing, and Compilation Physical inventory, pricing, and compilation are each equally important in the audit of inventory because a mis statement in any one activity results in misstated inventory and cost of goods sold. In most audits, cost of goods sold is a residual of beginning inventory plus acquisitions of raw materials, direct labor, and other manufacturing costs minus ending inventory. Because cost of goods sold is a residual and often one of the largest accounts on the income statement, the importance of auditing ending inventory becomes obvious. In testing physical inventory, auditors may rely heavily on the perpetual inventory master files if they have been tested as a part of one or more of the cycles we’ve dis - cussed and are considered reliable. When that is the case, auditors can observe and test the physical count at a time other than year-end and rely on the perpetuals to keep adequate records of the quantities. When testing the unit costs, auditors may also rely, to some degree, on the tests of the cost records made during the substantive tests of transactions. Standard cost records are also useful for comparison with the actual unit costs. When standard costs are used to represent historical cost, they must be tested for reliability. Finally, as auditors test controls and perform substantive tests related to inventory transactions and balances, they also integrate tests related to balance-related audit objectives with tests performed to satisfy the four presentation and disclosure objectives. Accounting standards require disclosure of inventory valuation methods and other relevant inventory information, such as LIFO reserve information, in the footnotes. The auditor should obtain an understanding of client controls related to inventory dis - closures and perform tests of those controls and other substantive tests to obtain sufficient appropriate evidence for each of the four presentation and disclosure objectives.
Please correct the wrong entries.
Minden Company is a wholesale distributor of premium European chocolates. The company's balance sheet as of April 30 is given below: Minden Company Balance Sheet April 3 Assets Cash 9,500 Accounts receivable 56,500 Inventory 53,250 234,000 Buildings and equipment, net of depreciation 353,250 Total assets Liabilities and Stockholders' Equity 79,000 Accounts payable Note payable 20,000 Common stock 180,000 74,250 Retained earnings 353,250 Total liabilities and stockholders' equity The company is in the process of preparing a budget for May and has assembled the following data a. Sales are budgeted at S299,000 for May. Of these sales, $89,700 will be for cash, the remainder will be credit sales. One-half of a month's credit sales are collected in the month the sales are made, and the remainder is collected in the following month. All of the April 30 accounts receivable will be collected in May b- Purchases of inventory are expected to total $169,000 during May. These purchases will all be on account. Forty percent of all purchases are paid for in the month of purchase; the remainder are paid in the following month. All of the April 30 accounts payable to suppliers will be paid during May c. The May 31 inventory balance is budgeted at $42,000 d. Selling and administrative expenses for May are budgeted at S89,700, exclusive of depreciation. These expenses will be paid in cash. Depreciation is budgeted at $2,250 for the month e. The note payable on the April 30 balance sheet will be paid during May, with $320 in interest. (All of the interest relates to May.) f. New refrigerating equipment costing $7,200 will be purchased for cash during May g. During May, the company will borrow $25,200 from its bank by giving a new note payable to the bank for that amount. The new note will be due in one year.
P6-6 Determining Bad Debt Expense Based on Aging Analysis and Interpreting Ratios LO6-4
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P6-6 Determining Bad Debt Expense Based on Aging Analysis and Interpreting Ratios L06-4 IceKreme Inc. makes ice cream machines for sale to ice cream parlours. The following events occurred between April 1 and June 30, 2017 April 10: Received an order from Peter's Appliances, a wholesaler, for 44 machines April 30: Sold 66 machines to Yuri Inc. on credit. May 1 The purchasing manager of Peter's Appliances visited IceKreme's factory and purchased 48 machines on credit, instead of the 44 machines that were previously ordered May 5: Yuri Inc. paid for the machines purchased on April 30 May 7: Sold 20 machines to Cheng Ltd. on credit. May 10: Wrote off $20,000 of accounts receivable that were considered uncollectible. These receivables May 15: June 1: June 30: relate to sales made prior to April 1, 2017 Peter's Appliances returned three defective machines and paid the amount due Received $128,000 from Cheng Ltd. on account. Recovered $4,100 from the receivables that were written off on May 10 Additional information is as follows . IceKreme sold all machines at $8,000 per unit. . All of IceKreme's sales were on credit with terms 3/10, n/30 IceKreme's records included the following items and their balances as at March 31, 2017 Accounts receivable Allowance of doubtful accounts (credit balance) Net sales S 82,000 25,200 820,000 Required: 1. Prepare the journal entries to record the transactions that occurred from April 1 to June 30, 2017. (If no entry is required for a transaction/event, select "No journal entry required" in the first account le View transaction list X: 1 Record the receipt of order from Peter Appliance 2 Record the sale of machines on credit to Yuri Ltd 3 Record the sale of machines to Peter Appliance 4 10 Record payment received for sale on credit to Yuri Ltod Record the sale of machines on credit to Cheng Ltd Record the entry to write-off uncollectible accounts 5 6 receivable
45. Physical distribution activities include all of the following EXCEPT _______ a. Warehousing b. ...
Physical distribution activities include all of the following EXCEPT _______ a. Warehousing b. Order processing c. Materials handling d. Transportation e. Order getting Answer Essay Questions Explain the three layers of the product? Define marketing?
46. 94. Owner's equity is best depicted by the following: a. Assets = Liabilities. b. Liabilities +.
94. Owner's equity is best depicted by the following:
a. Assets = Liabilities.
b. Liabilities + Assets.
c. Residual equity + Assets.
d. Assets – Liabilities.
95. The basic accounting equation may be expressed as
a. Assets = Equities.
b. Assets – Liabilities = Stockholders' Equity.
c. Assets = Liabilities + Stockholders' Equity.
d. all of these.
96. Liabilities
a. are future economic benefits.
b. are existing debts and obligations.
c. possess service potential.
d. are things of value used by the business in its operation.
97. Liabilities of a company would not include
a. notes payable.
b. accounts payable.
c. salaries and wages payable.
d. cash.
98. Liabilities of a company are owed to
a. debtors.
b. benefactors.
c. creditors.
d. underwriters.
99. Stockholders' equity can be described as
a. creditorship claim on total assets.
b. ownership claim on total assets.
c. benefactor's claim on total assets.
d. debtor claim on total assets.
100.Stockholders' equity is often referred to as
a. residual equity.
b. leftovers.
c. spoils.
d. second equity.
101.When assets are distributed to the owners of a corporation, these distributions are termed
a. depletions.
b. consumptions.
c. dividends.
d. a credit line.
102.A dividend is
a. a distribution of the company's earnings to its stockholders.
b. equal to liabilities minus stockholders' equity.
c. equal to assets minus stockholders' equity.
d. equal to revenues less expenses
103.Revenues would not result from
a. sale of merchandise.
b. issuance of common stock.
c. performance of services.
d. rental of property.
47. 1. Which of these considerations would not be relevant in determining the entity’s functional...
1. Which of these considerations would not be relevant in determining the entity’s functional currency? (a) The currency that influences the costs of the entity. (b) The currency in which finance is generated. (c) The currency in which receipts from operating activities are retained. (d) The currency that is the most internationally acceptable for trading. 2. Foreign operations that are an integral part of the operations of the entity would have the same functional currency as the entity. Where a foreign operation functions independently from the parent, the functional currency will be (a) That of the parent. (b) Determined using the guidance for determining an entity’s functional currency. (c) That of the country of incorporation. (d) The same as the presentation currency.
48. Which of the following events is not recorded in the accounting records?
Which of the following events is not recorded in the accounting records?
(a) Equipment is purchased on account.
(b) An employee is terminated.
(c) A cash investment is made into the business.
(d) Company pays dividend to stockholders.
Remittances from a branch to its home office are recognized by the home office as:IncomeAn increase in the Investment in Branch accountYesYesNoNoYesNoNoYes
50. 21.All but one of the following are true about daily business manager lists – a.they provide a diary
21.All but one of the following are true about daily business manager lists –
a.they provide a diary or reminder system for things to do
b.they are dated automatically for one week past the session date
c.they are activated at startup from the maintenance menu
d.double click any detail and the journal entry appears for posting
22.Recurring entries may not be –
a.recalled from daily business manager lists and removed at that point
b.recalled from daily business manager lists for purchases and sales
c.recalled from daily business manager lists and posted in the appropriate journal
d.listed in the daily business manager to provide a summary for checking on upcoming transactions
23.Payments Due in daily business manager lists contain date information that shows –
a.the number of days remaining till the invoice is due
b.the date that the payment is due
c.with negative numbers that the invoice is overdue
d.with positive numbers that the discount is still available
24.Which of the following general statements is not correct –
a.double click any detail in daily business manager lists to select the journal entry for posting
b.recall a recurring entry by double clicking the journal from the daily business manager list
c.payments can be made directly from daily business manager list screens
d.you can remove a stored entry from the daily business manager lists screen
25. From the daily business manager lists screens –
a.recurring entries can be removed
b.double clicking any detail will not open a journal entry
c.payment of an invoice does not allow discounts
d.none of the above
a.you should choose to review or display the journal entry before posting
b.you should post the transactions one at a time so you can review them before posting
c.the program confirms the number of transactions that were posted correctly
d.you cannot post sales from the business manager because you must first add the correct invoice number
27.From the daily business manager Recurring tab screen list, you can post directly (without opening a journal) to –
a.the sales journal
b.the receipts journal
c.the purchases journal
d.the general journal
28.To enter additional information in journal transactions, you must –
a.set up the additional transactions details field for each journal
b.select the option to track additional transactions details in the System settings screen
c.select the option to track additional transactions details in the User Preferences settings screen
d.do nothing, the program automatically allows you to track these details
29.You can post directly from the daily business manager –
a.any recurring purchase transaction
b.any customer receipt
c.any payment
d.to fill any purchase order
30.When a regular account customer makes a deposit with a sales order, you should remember –
a.to cancel the deposit when you fill the order
b.to add the deposit amount again when you fill the order
c.to change the method of payment when you fill the order
d.you do not need to do anything special, you can fill the order in the same way as when there is no deposit
31.When you change a purchase quote to a purchase order, you cannot change –
a.the purchase/quote number on the order
b.the quantity ordered
c.the amount or price on the order
d.you can change any of these
32.The Convert drop-down list of options for sales and purchases journals allows you –
a.to remove a quote so you can change it to an order
b.to remove an order so you can change it to an invoice
c.convert orders to quotes before filling them
d.convert quotes or orders to invoices
33.To add a deposit amount to a sales order after recording the order, you would –
a.reverse the original order and create a new order with the deposit added
b.bring the order to the screen and adjust it to change the payment method and enter the deposit amount
c.bring the order to the screen, fill it and add the deposit as a partial payment
d.you cannot change the payment method so you must enter the deposit in the receipts journal
a.that you are removing the quote
b.that you are filling the quote
c.that the quote number may not be used again
d.that you are converting the quote to an order
35.When using quotes and orders, Sage 50 Accounting –
a.updates sales quote numbers automatically
b.updates sales order numbers automatically
c.updates purchase quote and purchase order numbers automatically
d.all of the above