AUDIT OF INVENTORIES

3 AND COST OF GOODS SOLD

AUDIT PROGRAM FOR INVENTORIES

Audit Objectives
To determine that:

a. Inventories included in the statement of financial position physically exist.

b. Inventories represent items held for sale or use in the normal course of business.
c. Inventory quantities include all products, materials, and supplies owned by the company (on
hand, in transit, or stored at outside locations).
d. The entity has legal title or similar rights of ownership to the inventories.
e. Inventories are properly stated at cost (except when market is lower)
f. Inventories are properly described and classified in the financial statements and disclosures
are adequate.

Audit Procedures
1. Observe physical inventory counts.
• Test shipping and receiving cutoff procedures.
• Account for all inventory tags and count sheets used in recording the physical inventory
count.
• Test the clerical accuracy of inventory listings.
• Trace test counts recorded during the physical inventory observation to the inventory
listing.
• Reconcile physical counts to perpetual records and general ledger balances and
investigate significant variations.
• Test inventory transactions between a preliminary physical inventory date and the
end of the reporting period.

2. Obtain confirmation of inventories at locations outside the entity.

3. Review perpetual inventory records, production records, and purchasing records for
indications of current activities.

4. Analytically review the relationship of inventory balances to recent purchasing, production,

and sales activities, and to anticipated sales volume.

5. Examine paid vendors' invoices, consignment agreement, and contracts.

6. Review direct labor rates.

7. Test the computation of standard overhead rates.

8. Examine analysis of purchasing and manufacturing standard cost variances.

9. Examine inventory turnover analysis.

10. Review industry experience and trends.

11. Tour the plant. Inquire of production and sales personnel concerning possible excess or
obsolete inventory items.

12. Examine sales after year-end and open purchase order commitments.

13. Obtain confirmation of inventories pledge under loan agreements.

14. Review drafts of the financial statements.

15. Compare the disclosures made in the financial statements to the requirements of generally
accepted accounting principles.
3 Eye Openers
1. Define inventories.

2. Explain the two classes of inventory.

3. What are the goods includible in inventory?

4. Explain FOB destination and FOB shipping point.

5. Explain freight prepaid and freight collect.

6. What is consignment?

7. Explain the two systems of accounting for inventories.

8. Distinguish trade discounts and cash discounts.

9. What are the components of the cost of inventories?

10. Explain FIFO, weighted average method, moving average method,

specific identification, and LIFO?

11. Explain standard cost.

12. Explain the relative sales price method of allocating inventory cost.

13. What is net realizable value?

14. How is the measurement of LCNRV applied to inventory?

15. What are purchase commitments?

16. Explain the use of estimate in inventory valuation.

17. What is the basic formula for the gross profit method?

18. Why is the method called "gross profit method"?

19. Explain the computation of cost of goods sold under the gross profit
method.
20. Explain the use of retail inventory method.
 3 problems
Problem 3-1
Correcting Inventory Errors

The Tilbert Corporation has adjusted and closed its books at the end of 2016. The company
arrives at its inventory position by a physical count taken on December 31 of each year.
In March 2017, the following errors were discovered:

a. Merchandise that cost $7,500 was sold for $10,200 on December 30, 2016. The order
was shipped December 31, 2016 with terms FOB shipping point. The merchandise was
not included in the ending inventory. The sale was recorded on January 15,2017, when
the customer made payment on the sale.

b. On January 2, 2017, Tilbert Corporation received merchandise that had been

shipped to it on December 31, 2016. The terms of the purchase were FOB shipping
point. Cost of the merchandise was $5,250. The purchase was recorded and the
goods included in the inventory on January 2, 2017.

c. On January 8, 2017, merchandise that had been included in the ending inventory
was returned to Tilbert Corporation because the consignee had not been able to
sell. The cost of this merchandise was $3,600 with selling price of $5,400.

d. Merchandise costing $2,250, located in a separate warehouse, was overlooked

and excluded from the 2016 inventory count.

e. On December 27, 2016, Tilbert corporation purchased merchandise costing $3,525

from a supplier. The order was shipped December 28, terms FOB destination and
was still "in-transit" on December 31. Because the invoice was received on
December 31, the purchase was recorded in 2016. The merchandise was not
included in the inventory count.

f. The corporation failed to make an entry for purchase on account of $2,505 at the
end of 2016, although it included this merchandise in the inventory count. The
purchase was recorded when payment was made to the supplier in 2017.

g. The corporation included in its 2016 ending inventory merchandise with a cost of
$4,050. This merchandise had been custom built and was being held according
to customer's written request until the customer could come and pick up the
merchandise. The sale for $5,475, was recorded in 2017.
Required:
Give the entry in 2017 (2016 books are closed) to correct each error. Assume that
the errors were made during 2016, all amounts are material, and the periodic
inventory system is used.

Problem 3-2
Correcting Inventory Errors

Wallstreet Co., asks you to review its December 31, 2016, inventory values and prepare
necessary adjustments to the books. The following information is given to you.

1. Wallstreat Co. uses the periodic method of recording inventory. A physical count
reveals $704,670 of inventory on hand at December 31, 2016.

2. Not included in the physical count of inventory is $31,260 of merchandise purchased

on December 15 from Bengor Company. This merchandise was shipped FOB
shipping point on December 29 and arrived in January. The invoice arrived and was
recorded on December 31.

3. Included in inventory is merchandise sold to Busher Company on December 30,

FOB destination. This merchandise was shipped after it was counted. The invoice
was prepared and recorded as a sale on account for $38,400 on December 31. The
merchandise cost $22,050, and Busher Company received it on January 3.

4. Included in inventory was merchandise received from Doom Co., on December 31

with an invoice price of $46,890. The merchandise was shipped FOB destination.
The invoice, which has not yet arrived has not been recorded.

5. Not included in inventory is $25,620 of merchandise purchased from Molly Inc. This
merchandise was received on December 31 after the inventory had been counted.
The invoice was received and recorded on December 30.

6. Included in inventory was $31,314 of inventory held by Wallstreet Co., on

consignment from Jack Corporation.

7. Included in inventory is merchandise sold to Simon Co., FOB shipping point. This
merchandise was shipped after it was counted. The invoice was prepared and
recorded as a sale for $56,700 on December 31. The cost of this merchandise
was $34,560, and Simon Co., received the merchandise on January 5.

8. Excluded from inventory was a carton labeled "Please accept for credit". This
carton contains merchandise costing $4,500 which had been sold to a customer
for $7,800. No entry had been made to the books to reflect the return, but none
of the returned merchandise seemed damaged.
Required:
a. Compute the correct inventory balance for Wallstreet Co., at December 31, 2016.

b. Prepare any correcting entries to adjust inventory and related accounts to their
proper amounts at December 31, 2016. Assume the books have not been closed.

Problem 3-3
Computation of Adjusted Sales and Inventories

In testing the sales cut-off for the Big Bang Company in connection with an audit for the
year ended October 31, 2016, you find the following information:

A physical inventory was taken as of the close of business on October 31, 2016. All
customers are within a three-day delivery area of the company's plant. The unadjusted
balances of Sales and Inventories are $7,500,000 and $330,000, respectively.

Invoice Date
Number FOB Terms Shipped Date Recorded Sales

6671 Destination Oct. 20 Oct. 31 $ 3,000

6672 Shipping point Oct.31 Nov. 2 7,500
6673 Shipping point Oct. 25 Oct. 31 5,400
6674 Destination Oct. 31 Oct. 29 12,600
6675 Destination Oct. 31 Nov. 2 27,600
6676 Shipping point Nov. 2 Oct. 23 19,500
6677 Shipping point Nov. 5 Nov. 6 22,500
6678 Destination Oct. 25 Nov. 3 11,700
6679 Shipping point Nov. 4 Oct. 31 25,800
6680 Destination Nov. 5 Nov. 2 15,000

Required:
Bases on the foregoing information, compute the October 31, 2016 adjusted balances
of the following accounts: (a) Sales (b) Inventories

Problem 3-4
Cut-off Test for Purchases

You are conducting a financial statement audit of the of Beckerly Company for the year
ended December 31, 2016. You have observed the taking of physical inventory and have
noted that all merchandise actually received up to the close of business on December 28,
2016, has been recorded on the inventory sheets. The total invoice cost of the items
included in the physical count is $300,000.
The following purchases invoices have been recorded in the Purchases Journal as follows:

December 2016
Invoice Invoice
Number Amount Date FOB Term
251 $ 10,248 Dec. 23 Destination
252 8,136 Dec. 23 Destination
253 3,123 Dec. 26 Shipping point
254 12,600 Dec. 26 Shipping point
255 13,833 Jan. 2 Destination
256 6,309 Dec. 31 Destination
257 3,486 Dec. 27 Shipping point
258 21,162 Jan. 8 Shipping point
259 34,866 Dec. 22 Destination
260 11,331 Dec. 28 Destination

January 2017
261 $ 3,672 Dec. 28 Destination
262 11,391 Dec. 30 Destination
263 17,712 Dec. 29 Shipping point
264 14,700 Jan. 2 Shipping point
265 41,400 Dec. 28 Shipping point
266 17,877 Dec. 30 Destination

Required:
1. Auditor's adjusting entries, if any, required by the above information.
2. Show the detailed composition of the value of the inventory to be used on the financial
statements. Transportation-in charges on purchases average 6% during the year and
are to be included in the inventory valuation.

Problem 3-5
Inventory Valuation

You are engaged in an audit of the Kumatsu Company for the year ended December 31,
2016. To reduce the workload at year-end, the company took its annual physical inventory
under your observation on November 30, 2016.

The company's inventory account, which includes raw materials and work in process, is on
a perpetual basis and it uses the first-in, first out method of pricing. It has no finished goods
inventory.

The company's physical inventory revealed that the book inventory of $181,710 was
understated by $9,000. To avoid distorting the interim financial statements, the company
decided not to adjust the book inventory until year-end except for obsolete inventory items.

Your audit revealed this information about the November 30 inventory:

a. Pricing tests showed that the physical inventory was overpriced by $6,600.
b. Footing and extension errors resulted in a $450 understatement of the physical inventory.
c. Direct labor included in the physical inventory amounted to $30,000. Overhead was
included at the rate of 200% of direct labor. You determined that the amount of direct
labor was correct and the overhead rate was proper.
d. The physical inventory included obsolete materials recorded at $750. During December
these materials were removed from the inventory account by a charge to cost of sales.
Your audit also disclosed the following information about the December 31, 2016
inventory.
e. Total debits to certain accounts during December are:
Purchases
Direct labor
Manufacturing overhead expense
Cost of sales
f. The cost of sales of $205,800 included direct labor of $41,400.
g. Normal scrap loss on established product lines is negligible. However, a special order
started and completed during December had excessive scrap loss of $2,400, which was
charged to Manufacturing overhead expense.

Required:
Compute the following:
1. Inventory per physical count on November 30, 2016.
2. Correct amount of the physical count at November 30, 2016.
3. Without prejudice to your answers to question 1 and 2, assume that the correct amount
of the inventory at November 30, 2016 was $173,100 compute:
a. Materials inventory at December 31, 2016
b. Amount of direct labor cost included in the December 31, 2016 inventory.
c. Correct inventory amount at December 31, 2016.

Problem 3-6
FIFO Costing Method
Gabriel Co., sells electric stoves. It uses the perpetual inventory system and allocates cost
to inventory on a first-in, first-out basis. The company's reporting date is December 31. At
December 1, 2016, inventory on hand consisted of 350 stoves at $820 each and 43 stoves
at $850 each. During the month ended December 31, 2016, the following inventory
transactions occurred (all purchases and sales transactions are on credit);
2016
Dec. 1. Sold 300 stoves for $1,200 each.
3. Five stoves were returned by customers. They had originally cost $820 each
and were sold for $1,200 each.
9. Purchased 55 stoves at $910 each.
10. Purchased 76 stoves at $960 each.
15. Sold 86 stoves for $1,350 each.
17. Returned one damaged stove to the supplier. This stove had been purchased on
December 9.
22. Sold 60 stoves for $1,250 each.
26. Purchased 72 stoves at $980 each.

Required:
1. What is the FIFO cost of Gabriel Co.'s inventory on December 31, 2016.
2. What is the cost of goods sold on December 31, 2016?
3. What is Gabriel Co.'s gross profit in December 2016?

Problem 3-7
Correcting inventory Errors: Perpetual Inventory System

Charles Company uses perpetual inventory system and reports inventory at a lower of FIFO
or net realizable value. Charles Company's inventory control account balance at June 30,
2016, was $442,000. A physical count conducted on that day found inventory on hand worth
$440,400. Net realizable value of each inventory item held for sale exceeded cost. Your
investigation of the discrepancy disclosed the following:

1. Goods worth $13,200 held on consignment for Burton Co., had been included in the
physical count.

2. Goods costing $2,400 were purchased on credit from Amy Company on June 27, 2016,
on FOB shipping point terms. The goods were shipped on June 28, 2016, but as they
had not arrived by June 30, 2016, were not included in the physical count. The purchase
invoice was received and processed on June 30, 2016.

3. Goods costing $4,800 were sold on credit to Acer Co. for $7,800 on June 28, 2016, on
FOB destination terms. The goods were still in transit on June 30, 2016. The sales
invoice was processed and recorded on June 29, 2016.

4. Goods costing $5,460 were purchased on credit (FOB destination) from Sonny Company
on June 28, 2016. The goods were received on June 29, 2016, and included in the
physical count. The purchase invoice was received on July 2, 2016.

5. On June 30, 2016, Charles Company sold goods costing $12,600 on credit (FOB
shipping point) terms to Picasso Corp., for $19,200. The goods were dispatched from
 the warehouse on June 30, 2016, but the sales invoice had not been processed at that
date.

6. Damaged inventory items valued at $5,300 were discovered during the physical count.
These items were still recorded on June 30, 2016, but were omitted from the physical
count records pending their write-off.

Required:
What is the adjusted inventory balance on June 30, 2016?

Problem 3-8
Correcting Inventory Turnover and Average Days to Sell Inventory

The following information was taken from the audited financial statements of Horseshoe Inc.

Inventories:
December 31, 2016
December 31, 2015
December 31, 2014

2016
Sales $ 10,832,000
Cost of goods sold 4,482,000
Net profit 952,800

Required:
Based on the preceding information, compute for the following:
1. 2015 inventory turnover 3. 2015 average days to sell inventory
2. 2016 inventory turnover 4. 2016 average days to sell inventory

Problem 3-9
Retail Inventory Method

You were checking the books and records of inventory of Cornblue Shop for the month of
December:

Sales
Sales returns
Additional markups
Markup cancellations
Markdowns
Markdown cancellations
 Freight-in
Purchases at cost
Purchases at retail
Purchase returns at cost
Purchase returns at retail
Beginning inventory at cost
Beginning inventory at retail

Required:
What is the cost of Cornblue Shop's ending inventory under the retail inventory (average cost)
method?

Problem 3-10
Inventory Fire Loss

Cathy Company began operations in 2011. On July 15, 2016, a fire broke out in the company's
warehouse destroying all inventory and many accounting records. The following information
was assembled from the microfilmed records. All sales and purchases are on account.

Jan. 1, 2016
Inventory $ 287,700
Accounts receivable 261,180
Accounts payable 176,280
Collections from customers - 1/1/16 - 7/15/16
Payments to suppliers - 1/1/16 - 7/15/16
Goods out on consignment on July 15, 2016, at cost
Goods in transit at July 15, 2016, purchased FOB
shipping point (included in the July 15 accounts
payable balance)

The following is a summary of prior years' sales and gross profit on sales:
2013 2014

Sales $ 1,252,000 $ 1,410,000

Gross profit 375,600 366,600

Required:
What is the estimated inventory fire loss?

Problem 3-11
Correcting Inventory and Related Accounts

A general ledger account is maintained by Lizardo Company for each class of inventory. Such
inventory accounts are debited for increases during the period and credited for decreases. The
following transactions relate to Lizardo Company's raw materials inventory account, which is
debited for the purchases of raw materials and credited when they are requisitioned for use.

1. An invoice for $48,600 , terms FOB destination, was received and entered January 2, 2017.
The receiving report shows that the materials were received December 29, 2016.

2. Materials costing $168,000, shipped FOB destination , were not entered by December 31,
2016, 'because they were in a railroad car on the company's siding on that date and had not
been unloaded".

3. Materials costing $43,800 were returned on December 29, 2016, to the creditors, and were
shipped FOB shipping point. The return was entered on that date, even though the materials
are not expected to reach the creditor's place of business until January 7, 2017.

4. An invoice for $45,000, terms FOB shipping point, was received and entered December 31,
2016. The receiving report shows that the materials were received January 4, 2017, and the
bill of lading shows that they were shipped January 2, 2017.

5. Materials costing $118,800 were received December 31, 2016, but no entry was made for
them because "they were ordered with a specified delivery of no earlier than January 9,
2017".

Required:
Prepare correcting entries required at December 31, 2016, assuming that the books have not
been closed. Ignore income taxes.
ecting Inventory Errors

016. The company

1 of each year.

2016. The order

e merchandise was
ary 15,2017, when

e FOB shipping
rded and the

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stination and

2,505 at the

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ecting Inventory Errors

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ember 31. The

December 31
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Molly Inc. This

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er 31, 2016.

been closed.

d Sales and Inventories

an audit for the

, 2016. All
he unadjusted

Cost

$ 2,700
6,000
3,600
9,300
24,000
15,300
17,400
6,000
24,600
12,000

ted balances

-off Test for Purchases

ny for the year

ventory and have
on December 28,
of the items
ournal as follows:

Date
Received
Dec. 24
Dec. 29
Dec. 30
Jan. 5
Dec. 31
Jan. 4
Dec. 21
Jan. 2
Dec. 28
Dec. 27

Jan. 4
Dec. 28
Dec. 31
Jan. 5
Jan. 4
Jan. 6

d on the financial
ing the year and

Inventory Valuation

d December 31,
physical inventory

k in process, is on
s no finished goods

81,710 was
ts, the company
e inventory items.

e physical inventory.
Overhead was
amount of direct

During December
e to cost of sales.
er 31, 2016

$ 74,100
36,300
75,600
205,800

r, a special order
$2,400, which was

he correct amount

016 inventory.

FIFO Costing Method

and allocates cost
December 31. At
ach and 43 stoves
g inventory
y cost $820 each

d been purchased on

etual Inventory System

at a lower of FIFO
ance at June 30,
ntory on hand worth
eded cost. Your

included in the

on June 27, 2016,

2016, but as they
ount. The purchase

une 28, 2016, on

16. The sales

om Sonny Company
ncluded in the

credit (FOB
dispatched from
processed at that

e physical count.
om the physical

Days to Sell Inventory

s of Horseshoe Inc.

$ 791,000
744,000
720,800

2015
$ 10,053,400
4,246,000
734,800

s to sell inventory
s to sell inventory

etail Inventory Method

for the month of

$ 198,000
4,000
20,000
3,000
18,600
5,600
 4,800
96,000
176,000
4,000
6,000
60,000
93,000

entory (average cost)

Inventory Fire Loss

e out in the company's

ollowing information
re on account.

July 15, 2016

$ 257,780
245,700
1,507,600
975,000
97,500

34,750

2015

$ 1,360,000
462,400

and Related Accounts

ss of inventory. Such
ed for decreases. The
ry account, which is
quisitioned for use.

ered January 2, 2017.

er 29, 2016.

ed by December 31,
n that date and had not

he creditors, and were

en though the materials

entered December 31,

anuary 4, 2017, and the

o entry was made for

er than January 9,

t the books have not