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Inventory Accounting, Auditing, and Balance Sheet Components

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1. Inventories are properly stated at the lower of cost or market.

2. Inventories included in the balance sheet are present in the warehouse on the balance sheet date.

3. Inventory quantities include all products, materials, and supplies on hand.

4. Liens on the inventories are properly disclosed in notes to the financial statements.

5. The client has legal title to the inventories.

6. The financial statements disclose the amounts of raw materials, work in progress, and finished goods.

7. Inventories include all items purchased by the company that are in transit at the balance sheet date and that have been shipped to customers on consignment.

8. Inventories received on consignment from suppliers have been excluded from inventory.

9. Quantities times prices have been properly extended on the inventory listing, the listing is properly totaled, and the total agrees with the general ledger balance for inventories.

10. Slow-moving items included in inventory have been properly identified and priced.

11. Inventories are properly classified in the balance sheet as current assets.

Identify the assertion for items 1 through 11 above.

(Assertions) In planning the audit of a client’s financial statements, an auditor identified the following issues that need audit attention.

1. The allowance for doubtful accounts is fairly presented in amount.

2. All accounts payable owed as of the balance sheet date are included in the financial statements.

3. All purchase returns recorded in the general ledger are valid.

4. There is a risk that purchases made in the last week of the month might be recorded in the following period.
5. The client may have factored accounts receivable.

6. The client has used special-purpose entities to finance a building. Neither the building nor the debt is included in the financial statements.

7. A retail client values its inventory using the retail method of accounting.

8. A construction client uses the percentage of completion method for recognizing revenues.

9. A client has a defined benefit pension plan and does not have competent employees to write footnote disclosures.

10. A client acquired a subsidiary company and paid a high amount of goodwill when the stock market, and resulting values, were at all-time highs.

11. A client financed the acquisition of assets using preferred stock that pays a 3 percent dividend and must be redeemed from the shareholders next year.

Identify the assertion for items 1 through 11 above.

Ch. 6: Comprehensive Questions:

Audit evidence 6-20 (Audit evidence) The third GAAS of field work requires that the auditor obtain sufficient competent audit evidence to afford a reasonable basis for an opinion regarding the financial statements under audit. In considering what constitutes sufficient competent evidential matter, a distinction should be made between underlying accounting records and other information available to the auditor.

a. Discuss the nature of audit evidence to be considered by the auditor in terms of the underlying accounting records, other corroborating information available to the auditor, and the methods by which the auditor tests or gathers competent evidence.

b. State the presumptions that can be made about the validity of audit evidence with respect to (1) other information and (2) underlying accounting records. AICPA (adapted)

6-21 (Audit evidence) In an audit of financial statements, an auditor must judge the validity of the audit evidence obtained.

a. In the course of an audit, the auditor asks many questions of client officers and employees. 1. Describe the factors that the auditor should consider in evaluating inquiry and oral evidence provided by client officers and employees. 2. Discuss the validity and limitations of inquiry and oral evidence.

b. An audit may include computation of various balance sheet and operating ratios for comparison to prior years and industry averages. Discuss the validity and limitations of ratio analysis in an audit.

c. In connection with his audit of the financial statements of a manufacturing company, an auditor is observing the physical inventory of finished goods, which consists of expensive, highly complex electronic equipment. Discuss the validity and limitations of the audit evidence provided by the procedure.


6-22 (Audit evidence) During the course of an audit, the auditor examines a wide variety of documentation. Listed below are some forms of documentary evidence and the sources from which they are obtained.

1. Bank statement sent directly to the auditor by the bank.
2. Creditor monthly statement obtained from client’s files.
3. Vouchers in client’s unpaid voucher file.
4. Duplicate sales invoices in filled order file.
5. Time tickets filed in payroll department.
6. Credit memo in customer’s file.
7. Material requisitions filed in storeroom.
8. Bank statement in client’s files.
9. Management working papers in making accounting estimates.
10. Paid checks returned with bank statement in (1) above.
11. Letter in customer file from collection agency on collectibility of balance.
12. Memo in customer file from treasurer authorizing the write-off of the account.

a. Classify the evidence by source into one of four categories: (1) directly from outsiders, (2) indirectly from outsiders, (3) internal but validated externally, and (4) entirely internal. b. Comment on the reliability of the four sources of documentary evidence.

Ch. 7: Comprehensive Questions: Understanding the entity and its environment

7-22 (Understanding the entity and its environment) You have just been assigned as in-charge accountant on HipStar, Inc. a new audit client in the recording industry. HipStar is an emerging growth company that finds new recording artists, records their music, and distributes the music directly to consumers exclusively over the Internet. The company does not produce CDs or tapes and does not distribute the artist’s music through traditional distribution channels. In order to better understand HipStar, you have set out to understand the following: 1. Industry conditions

2. The regulatory environment
3. Other external factors affecting the business
4. The entity’s business operations
5. The entity’s investing activities and financing activities
6. The entity’s financial reporting activities
7. The entity’s objectives, strategies, and related business risks
8. How the entity measures and reviews its financial performance.

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