Auditing A Risk Based-Approach To Conducting A Quality Audit 10th Edition Johnstone Test Bank 1

Chapter 11 - Auditing Inventory, Goods and Services, and Accounts Payable: The Acquisition and
Payment Cycle
Test Bank for Auditing A Risk Based Approach to Conducting a

Quality Audit 10th Edition Johnstone Gramling Rittenberg
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1. The acquisition and payment cycle includes processes for identifying products or services to be acquired,
purchasing goods and services, receiving the goods, approving payments, and paying for goods and services
received.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.140 - Introduction
STATE STANDARDS: United States - AK - AACSB-Analytical skills
United States - AK - AICPA BB-Critical thinking
2. The major accounts in the acquisition and payment cycle are inventory, cost of goods sold, accounts payable,
and other expense accounts.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.141 - Payment and Acquisition Cycle
3. An indication of potential inventory fraud is that inventory levels are growing faster than sales.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.142 - Fraud
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Payment Cycle
4. The acquisition process begins with a purchase of goods or services.

a. True
b. False
ANSWER: False
POINTS: 1
5. Supply chain management has helped many companies improve the efficiency of operations.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.143 - Supply Chain
6. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
a. True
b. False
ANSWER: True
POINTS: 1
7. Most organizations use a perpetual inventory system to manage inventory.

a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.144 - Analytics
8. Inventory turnover is often calculated by the auditor for proper disclosure in client financial statements.
a. True
b. False
ANSWER: False
POINTS: 1
Payment Cycle
9. A networked software system linking a company’s information system to vendors whose offerings and prices
have been preapproved by appropriate management is called an automated purchasing system.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.11-01 - LO: 11-01
NATIONAL STANDARDS: United States - BUSPORG: Analytic
TOPICS: Identify the Significant Accounts, Disclosures, and the Relevant Assertions in the
Acquisition and Payments Cycle
10. A major control benefit of a centralized purchasing department is the segregation of the authorization
function from the custody and recording functions.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.145 - Processes and Controls
11. A purchase order identifies the quantity and description of products that have been received.
a. True
b. False
ANSWER: False
POINTS: 1
12. For proper control, the receiving department should receive a copy of the purchase order that has the
quantities blanked out.
a. True
b. False
ANSWER: True
POINTS: 1
Payment Cycle
13. A new vendor should be added to an authorized vendor database by an individual in the purchasing
department.
a. True
b. False
ANSWER: False
POINTS: 1
TOPICS: Identify and Assess Control Risks in the Acquisition and Payment Cycle
14. The auditor's primary concern with accounts payable is that of existence.
a. True
b. False
ANSWER: False
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.146 - Testing Accounts Payable
15. Reconciliation of vendor statements to recorded payables provides assurance related to the completeness
assertion.
a. True
b. False
ANSWER: True
POINTS: 1
16. Approval of items for payment usually involves a three-way match among the vendor invoice, the purchase
order, and the receiving report.
a. True
b. False
ANSWER: True
POINTS: 1
Payment Cycle
17. The purchasing department should make sure that only authorized goods are received, the goods meet order
specifications, an accurate count of the goods received is taken, and that accountability is established to assure
that all receipts are recorded.
a. True
b. False
ANSWER: False
POINTS: 1
18. In an audit where there is a heightened risk of fraud related to inventory, the auditor may want to observe all
inventory locations simultaneously.
a. True
b. False
ANSWER: True
POINTS: 1
19. The use of analytical review procedures applied to related expense accounts would not be used to determine
if accounts payable were understated.
a. True
b. False
ANSWER: False
POINTS: 1
20. Analytical review of related expense accounts when auditing accounts payable would be used when control
risk is assessed as low.
a. True
b. False
ANSWER: True
POINTS: 1

Payment Cycle
21. Testing cash disbursements subsequent to the year under audit allows the auditor to determine certain
payables that may not have been recorded previously.
a. True
b. False
ANSWER: True
POINTS: 1
22. When auditing accounts payable, the auditor would most likely review a sample of cash disbursements
throughout the year end to determine whether disbursements for goods and services are applicable to the
subsequent year.
a. True
b. False
ANSWER: False
POINTS: 1
23. The auditor tests significant repairs and maintenance expenses to ensure that an item that should be
capitalized has not been expensed.
a. True
b. False
ANSWER: True
POINTS: 1
24. The lower of cost or market assumption is not important to valuation of inventory.
a. True
b. False
ANSWER: False
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.147 - Inventory Procedures
Payment Cycle
25. Proper internal control over the inventory account would require that inventory items should be reviewed
for obsolescence and proper accounting treatment.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.148 - Inventory Controls
26. Many frauds are committed by overstating inventory accounts.

a. True
b. False
ANSWER: True
POINTS: 1
27. Inventory may become obsolete because of technological advances even though there are no signs of
physical wear.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.149 - Inventory Complexity
28. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
a. True
b. False
ANSWER: True
POINTS: 1
29. The auditor is required by generally accepted accounting principles (GAAP) to observe the taking of
physical inventory.
a. True
Payment Cycle
b. False
ANSWER: False
POINTS: 1
30. One reason the inventory observation is performed is for the purpose of determining the accuracy of client
counting procedures.
a. True
b. False
ANSWER: True
POINTS: 1
TOPICS: Obtaining Substantive Evidence in the Acquisition and Payment Cycle
31. Test counts are performed by the auditor to give the impression of control and they are not used for
substantive testing.
a. True
b. False
ANSWER: False
POINTS: 1
32. It is likely in the acquisition and payment cycle that audit evidence from substantive analytical procedures
alone will be sufficient enough for the auditor.
a. True
b. False
ANSWER: False
POINTS: 1
33. During the counting process of inventory, the client arranges not to ship or receive goods or segregates all
goods received during the process to be labeled and counted as “after inventory.”
a. True
Payment Cycle
b. False
ANSWER: True
POINTS: 1
34. Legal expenses are reviewed by auditors for possible litigation and related FAS 5 treatment.
a. True
b. False
ANSWER: True
POINTS: 1
35. A walkthrough is typically not a useful means of obtaining information about controls in the acquisition and
payment cycle.
a. True
b. False
ANSWER: False
POINTS: 1
36. The cash account is not part of the acquisitions and payment cycle.
a. True
b. False
ANSWER: False
POINTS: 1
37. The auditor may test a manufacturing client's cost system to substantiate the valuation of inventory.
a. True
b. False
ANSWER: True

Payment Cycle
POINTS: 1
38. Valuation is the most complex assertion related to inventory.

a. True
b. False
ANSWER: True
POINTS: 1
39. Generally accepted auditing standards (GAAS) require the auditor to observe the taking of the physical
inventory at year-end.
a. True
b. False
ANSWER: True
POINTS: 1
40. The acquisition cycle begins with the receipt of goods and services and ends with their payment as reflected
in cash disbursements.
a. True
b. False
ANSWER: False
POINTS: 1
41. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
a. True
b. False
ANSWER: True
POINTS: 1

Payment Cycle
42. In computerized purchase operations the computer matches three documents, the purchase order, the
receiving report, and the monthly statement, and if the three match within a prespecified tolerable limit, the
invoice is approved for payment.
a. True
b. False
ANSWER: False
POINTS: 1
43. The tracing of a sample of receiving reports through the recording process tests the completeness assertion.
a. True
b. False
ANSWER: True
POINTS: 1
44. Substantive tests of accounts payable and related expense accounts for valuation usually involve simply
verifying the mathematical accuracy of the accounts, and agreeing them to general ledger and supporting
documentation.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.150 - Testing of Expense Accounts
45. In observing the client’s inventory at year-end the auditor makes test counts that are later traced into the
client’s inventory compilation.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.151 - Test of Inventory

Payment Cycle
46. Stable relationships are expected between specific accounts (for example, cost of goods sold and sales) that
can be investigated for unusual discrepancies.
a. True
b. False
ANSWER: True
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.152 - Testing of Expenses
47. The acquisition and payment process consists of each of the following phases except which of the
following?
a. Receipts of goods and services.
b. Approval of items for payment.
c. Application of cash receipts.
d. Authorized request for goods and services.
ANSWER: c
POINTS: 1
48. Which of the following accounts is NOT a major account in the acquisition and payment cycle?
a. Inventory.
b. Cost of goods sold.
c. Accounts payable.
d. All of the above are major accounts.
ANSWER: d
POINTS: 1
49. Which of the following is not a rationale for purchasing to be a separate function?
a. Purchasing promotes efficiency and effectiveness.
b. Purchasing eliminates potential favoritism.
c. Purchasing reduces the opportunity for fraud.
d. Purchasing decentralizes control.
ANSWER: d
Payment Cycle
POINTS: 1
50. When a purchasing agent benefits personally by accepting payment from a vendor, the purchasing agent is
guilty of which of the following?
a. Performing kiting.
b. Committing embezzlement.
c. Receiving kickbacks.
d. Stealing company assets.
ANSWER: c
POINTS: 1
51. Reduction of the risk of understated payables can be accomplished by focusing on which assertion?
a. Existence.
b. Rights.
c. Presentation and disclosure.
d. Completeness.
ANSWER: d
POINTS: 1
52. Which of the following is not a management assertion relevant to inventory?

a. Existence or occurrence.
b. Completeness.
c. Rights and obligations.
d. Reporting.
ANSWER: d
POINTS: 1

Payment Cycle
53. Which of the following is NOT an example of fraud in the acquisition and payment cycle?
a. Theft of inventory by employees.
b. Inventory shrinkage.
c. Large manual adjustments to inventory accounts.
d. Excess inventory because of a production slowdown.
ANSWER: d
POINTS: 1
54. The internal control that requires that “checks are pre-numbered and accounted for” satisfies which
assertion?
a. Accuracy.
b. Existence.
c. Completeness.
d. Posting and summarization.
ANSWER: c
POINTS: 1
55. Which of the following would meet the need for additional control procedures when using computer-
generated purchase orders?
a. Establishment of a maximum quantity limits that can be ordered within a given time period.
b. Automated acceptance for high dollar levels.
c. Purchase order copies sent by purchasing to receiving.
d. Accounts payable department entering new vendors into the system.
ANSWER: a
POINTS: 1
56. Which of the following signals a potential fraud that may occur for the overstatement of inventory accounts?
a. Reserves for contingencies are reducing rapidly.
b. Inventory amounts are growing faster than sales.
c. Repairs and maintenance accounts have significant credit entries.
d. The purchase of manufacturing equipment is occurring at a rapid rate.
ANSWER: b

Payment Cycle
POINTS: 1
57. Accounting for inventories is a major consideration for many companies because of its significance to
which of the following financial statements?
a. Balance sheet.
b. Income statement.
c. Statement of Cash Flow
d. Both A and B.
ANSWER: d
POINTS: 1
58. What is the primary reason for management's ability to easily overvalue inventory without rapid detection
by auditors?
a. The limited volume of transactions in the inventory accounts.
b. The auditor's assessment of inventory as a low-risk area.
c. Complexity in the valuation of inventory.
d. Consideration by the auditor of non-financial indicators of inventory fraud.
ANSWER: c
POINTS: 1
59. Which of the following is an example of the type of analytics that an auditor would use for inventory?
a. Number of day's sales in receivables compared to industry averages.
b. Inventory turnover for the previous five years.
c. Days outstanding in accounts payable.
d. Salaries of marketing personnel as a percent of total inventory.
ANSWER: b
POINTS: 1
TOPICS: Preliminary Analytical Procedures in the Acquisition and Payment Cycle

Payment Cycle
60. Which relationship might suggest a heightened risk of fraud in the acquisition and payment cycle?
a. Unexpected increases in the number of suppliers.
b. A reduction in raw material costs.
c. Maturing capital assets with no plan for replacement.
d. Sales expenses growing in proportion to sales revenue.
ANSWER: a
POINTS: 1
TOPICS: Preliminary Analytical Procedures in the Acquisition and Payment Cycle
61. During your audit of Brown Company you are trying to determine whether all accounts payable were
recorded. Which assertion are you gathering evidence for?
a. Occurrence.
b. Presentation and Disclosure..
c. Completeness.
d. Valuation or allocation.
ANSWER: c
POINTS: 1
62. Which of the following procedures would the auditor perform in testing the completeness assertion for
accounts payable?
a. Examine a sample of cash disbursements made after year end to determine whether the
disbursements were for goods applicable to the previous year.
b. Reconcile vendor's statements with the accounts receivable trial balance.
c. Examine production equipment for useful lives.
d. Gather purchase orders immediately previous to and subsequent to year-end.
ANSWER: a
POINTS: 1
63. Why should the client’s legal expenses be examined?

a. To compare with previously released attorney's letters.
b. To determine the types of fraud occurring in the organization.

Payment Cycle
c. To ensure proper recording of vendor payables.
d. To determine if there is any litigation pending or threatened.
ANSWER: d
POINTS: 1
64. Which assertion has the greatest emphasis when auditing accounts payable?
a. Existence.
b. Completeness.
c. Presentation.
d. Disclosure.
ANSWER: b
POINTS: 1
65. An auditor may best test commissions expense for salespeople when control risk is low by performing
which of the following procedures?
a. Analytical procedures.
b. Tagging and tracing.
c. Alternative procedures.
d. Subsequent proof of cash.
ANSWER: a
POINTS: 1
66. An internal control benefit of centralized purchasing in an organization includes which of the following?
a. Separation of authorization from the custody and recording function.
b. An increase in the number of vendors used.
c. Increased compensation of agents through side agreements.
d. Mathematically accurate vendor invoices.
ANSWER: a
POINTS: 1

Payment Cycle
TOPICS: Identify the Significant Accounts, Disclosures, and Assertions in the Acquisition
and Payment Cycle
67. A primary feature of automated control in the acquisition cycle includes which of the following?
a. That authorization is no longer required.
b. Limits as to the number of items that can be received by the warehouse.
c. Calculated order quantities based on set criteria.
d. Funds transfer at the request of the controller.
ANSWER: c
POINTS: 1
68. Bar code scanning may best be utilized in the receiving process to accomplish which of the following?
a. Identify goods arriving automatically in conjunction with a count.
b. Notify the shipper that product has arrived.
c. Order new items on behalf of the purchasing department.
d. Record inventory that has been written off the books.
ANSWER: a
POINTS: 1
69. When auditing expense accounts, which of the following would the auditor be least likely to subject to a
detailed test of transactions?
a. Legal expense.
b. Utilities expense.
c. Repairs and maintenance expense.
d. Travel expense.
ANSWER: b
POINTS: 1
70. Please indicate the proper sequence of the acquisition cycle:

1. Approval of items for payment.
2. Authorized requisition for goods or services.
Payment Cycle
3. Cash disbursements.
4. Receipt of goods and services.
5. Authorized purchase of goods or services.
a. 2, 5, 4, 1, 3
b. 2, 4, 5, 1, 3
c. 2, 1, 4, 5, 3
d. 2, 5, 1, 4, 3
ANSWER: a
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.153 - Acquisition cycle
71. Which one of the following accounts would an auditor most likely test by performing analytical procedures?
a. Sales commissions expense.
b. Legal expenses.
c. Repairs and maintenance expense.
d. Travel expense.
ANSWER: a
POINTS: 1
72. Which of the following is NOT a reason why inventory is a complex accounting and auditing area?
a. Diversity of items in inventory.
b. Low volume of activity.
c. Easily transportable.
d. Difficulty in applying the lower of cost or market principle.
ANSWER: b
POINTS: 1
73. Which of the following is a reason why an automated purchasing system is beneficial?
a. It applies preloaded specifications and materials lists to the system.
b. It automatically flags invoices that do not reconcile with purchase orders.
c. It creates change orders and analyzes variances from purchase orders.
d. All of the above.
ANSWER: d

Payment Cycle
POINTS: 1
74. Which of the following is not an inherent risk associated with inventory?
a. Inventory accounts typically have a high volume of activity.
b. Inventory is easily transportable
c. Inventory may become obsolete.
d. Inventory costing methods frequently change from one year to the next.
ANSWER: d
POINTS: 1
TOPICS: Identify and Asses the Risk of Misstatement in the Acquisition and Payment Cycle
75. Which of the following is NOT a element of internal controls for inventory?
a. Authorization for all purchases.
b. Proper accounting for receipt of inventory.
c. Perpetual inventory system.
d. Rapid introduction of new products without market studies.
ANSWER: d
POINTS: 1
76. Which of the following would the auditor most likely do when testing the existence assertion for inventory?
a. Observe the client's count of the annual physical inventory and perform test counts.
b. Review vendor invoices for the amounts recorded.
c. Review open purchase orders at year end.
d. Trace raw material purchases to invoices and to the general ledger.
ANSWER: a
POINTS: 1
Payment Cycle
77. Which of the following would the auditor most likely do when testing the valuation assertion for inventory?
a. Confirm inventory on consignment.
b. Examine receiving reports for inventory, tracing the recorded amounts.
c. Observe the taking of physical inventory.
d. Vouch inventory purchases to vendor invoices..
ANSWER: d
POINTS: 1
78. The auditor may discover that the recorded cost of inventory exceeds the designated market price when
testing which assertion?
a. Existence.
b. Cutoff.
c. Valuation.
d. Rights.
ANSWER: c
POINTS: 1
79. Which of the following procedures will usually be performed by the auditor to determine if obsolete
inventory exists?
a. Confirmation of inventory with customers.
b. Footing the inventory subsidiary ledger.
c. Tracing inventory ordered by the client to receiving reports.
d. Analysis of inventory turnover and sales reports.
ANSWER: d
POINTS: 1
TOPICS: Obtaining Substantive Evidence in The Acquisition and Payment Cycle
80. A perpetual inventory system is preferable to a periodic system if adequately controlled and maintained
because of which of the following?
Payment Cycle
a. It requires that a full inventory count be taken at year-end by all warehouse employees.
b. It allows management to calculate cost of goods sold at year end.
c. It provides information to management where book inventory is continuously in agreement with
inventory on hand within specified time periods.
d. It better controls the receipt of goods.
ANSWER: c
POINTS: 1
81. Which of the following is NOT a procedure that the auditor should perform related to the physical inventory
count?
a. Document the first and last tag numbers used.
b. Take notations of all items that appear to be obsolete or are in questionable condition.
c. Make counts of all items and record the counts for subsequent tracing into the client‘s inventory
compilation.
d. Observe whether there is any physical movement of goods during the counting of the inventory.
ANSWER: c
POINTS: 1
82. The principle of lower of cost or market and the potential obsolescence of inventory are a concern for the
audit team because of which of the following?
a. They are uncommon and may not exist.
b. They are a burden to the auditor in the undue amount of work caused.
c. They are likely to occur in the last month of the year and cause cutoff problems.
d. They are an inherent component of complexity related to valuation.
ANSWER: d
POINTS: 1
83. An auditor reviews purchase contracts to assess the conditions for the return of merchandise as a test related
to which management assertion?
a. Existence
b. Completeness
c. Rights and Obligations
d. Valuation
Payment Cycle
ANSWER: c
POINTS: 1
84. Which of the following is not an item reviewed by the auditor to test the client’s assertion related to the
presentation and disclosure of inventory?
a. The inventory valuation methods used.
b. The amount of obsolete inventory on hand.
c. The existence of contingent losses associated with long-term purchase commitments.
d. The classification of inventory as raw material, work in process or finished goods.
ANSWER: b
POINTS: 1
85. Which of the following is a procedure used in an audit where there is a heightened risk of fraud related to
accounts payable and other related expense accounts?
a. Send blank confirmations to vendors that ask them to furnish information about all outstanding
invoices, payment terms, and payment histories.
b. Scan journals for unusual or large year-end transactions and adjustments.
c. Obtain and examine documentation for payments of invoices that are for amounts just under the limit
that typically requires some level of approval.
d. All the above.
ANSWER: d
POINTS: 1
86. Auditing the valuation assertion for inventory of a client utilizing the FIFO cost flow assumption will
require the auditor to examine which of the following?
a. Invoices representing the more recent purchases of inventory.
b. Invoices representing the purchase of base year inventory in the year of inception.
c. Shipping documents for a sample of cost of goods sold transactions during the year.
d. Shipping documents for a sample of units on hand in the interim period.
Payment Cycle
ANSWER: a
POINTS: 1
87. When testing a standard cost system, the auditor does not normally make which of the following inquiries?
a. The method for developing standard costs.
b. The method for identifying components of overhead and of allocating overhead to products.
c. The method for identifying sales cutoff.
d. The method used for allocating variances to inventory and cost of goods sold.
ANSWER: c
POINTS: 1
88. The acquisition cycle begins with which of the following?

a. A payment.
b. A purchase order.
c. A requisition.
d. A receiving report.
ANSWER: c
POINTS: 1
89. Which of the following is not a potential fraud indicator in the acquisition cycle?
a. Expenses that are significantly above or below industry norms.
b. Expense accounts that have significant debit entries.
c. Unexpected increases in gross margin.
d. Capital assets that seem to be growing faster than the business.
ANSWER: b
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.154 - Business Analysis
90. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?

Payment Cycle
a. Observe the client taking inventory.
b. Make selected test counts and trace into client’s inventory compilation.
c. Look for slow-moving, obsolete or damaged inventory.
d. Review disclosure of inventory valuation.
ANSWER: d
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.151 - Test of Inventory
91. Which of the following is a condition which would not create a conducive situation for a client to take a
physical inventory at an interim date before year end?
a. The control risk over inventory is high.
b. The auditor will be able to review material transactions in the roll-forward period.
c. The auditor can effectively test the year-end balance through a combination of analytical procedures
and selective testing of transactions between the physical count and the year-end.
d. The auditor reviews the intervening transactions for evidence of any manipulation or unusual
activity.
ANSWER: a
POINTS: 1
92. Which of the following might an auditor do in testing for the existence of accounts payable?
a. Review client’s financial statement disclosure.
b. Review long-term purchase commitments.
c. Perform a cutoff test of purchases and cash disbursements.
d. Perform analytical review of related expense accounts.
ANSWER: c
POINTS: 1
LEARNING OBJECTIVES: AUDT.JOHN.16.155 - Substantive Tests of Accounts Payable
93. Acquisition and payment processes

What are the five major phases of the acquisition and payment process?
ANSWER: The five phases of the acquisition and payment process are:
1. Requisition for goods or services.
Payment Cycle
2. Purchase of goods or services according to company policies.
3. Receipt of goods and services.
4. Approval of items for payment.
5. Cash disbursements.
POINTS: 1
United States - AK - AACSB-Communication skills
94. Centralized purchasing

List the advantages for implementing a centralized purchasing function. What are the disadvantages (if any)?
ANSWER: The advantages for creating a separate purchasing function include the following:
∙ Promotes efficiency and effectiveness.
Eliminates potential favoritism that could take place if individual
∙
department heads were allowed to place orders.
Reduces the opportunity for fraud by segregating the authorization to
∙
purchase from the custody and recording functions.
∙ Centralizes control in one function.
The possible disadvantages include:
∙ Potential kickbacks to agents from vendors and suppliers.
∙ Variations from traditional purchase orders.
POINTS: 1
95. Cost accounting systems

When auditing a manufacturing concern, what major inquiries might be made by the auditor about the cost
accounting system?
ANSWER: An auditor would be likely to make the following inquiries about a cost accounting
system used by a manufacturing concern:
∙ The method for developing standards costs.
∙ How recently the standards have been updated.
The method for identifying components of overhead and allocating
∙
overhead to products.
The methods used for identifying variances, following up on their
∙
causes, and allocating them to inventory and cost of goods sold.
POINTS: 1
Payment Cycle
96. Preparing for an inventory observation

In the audit of inventory the auditor must perform important procedures prior to the actual observation. Identify
the steps the auditor must take prior to the day the inventory is actually counted.
ANSWER: Prior to inventory-taking day the auditor should:
∙ Meet with the client to discuss procedures, timing, location, and personnel
involved in the taking of inventory.
∙ Review the client's plans for counting and tagging inventory items; determine that
the procedures are sufficient to ensure an accurate inventory.
∙ Review the inventory taking procedures with all audit personnel; familiarize them
with the nature of the inventory, potential problems, and any other information
they may need.
∙ Determine whether specialists are needed to identify, test, or assist in correctly
identifying inventory items.
POINTS: 1
97. Physical inventory procedures

Discuss the procedures that the audit team will most likely perform upon arrival at each site right before
physical inventory is taken.
ANSWER: ∙ Obtain a map of the area and a schedule of inventory counts to be made for each area.
∙ Obtain a list of sequential tag numbers to be used.
∙ Observe the procedures the client has implemented to shut down receipt or shipment of
goods.
∙ Observe that the client has shut down production.
∙ Obtain document numbers for the last shipment and receipt of goods before inventory is
taken.
POINTS: 1
98. Auditing accounts payable

What are the procedures available to auditors in auditing accounts payable and what level of assurance is
obtained by each? Describe at least three. Which primary assertion is tested through these approaches?
ANSWER: When auditing accounts payable, the auditor may:
Reconcile vendor statements or returned confirmations with recorded
1.
payables. This yields a higher level of assurance.
Test subsequent disbursements for proper recording as a payable as of
2. either the balance sheet date under audit or in the subsequent period,
as appropriate. This yields a moderate level of assurance.
Payment Cycle
Analytical review of related expense accounts to determine which
accounts appear to be understated. This yields a very low level of
3.
assurance and should only be used where control risk and fraud risk are
assessed as low for payables.
The primary assertion tested using the three approaches above is that of
completeness.
POINTS: 1
99. Physical inventory procedures
Discuss the procedures the audit team will most likely perform during the physical observation of inventory.
ANSWER: The audit team will observe the counting of inventory and note the following on
inventory count working papers.
∙ The first and last tag number used in the section.
∙ All tag numbers and the disposition of all tag numbers in the sequence.
∙ The product identification, product description, units of measure, and number of items on
a count sheet.
∙ Items that appear to be obsolete or of questionable value.
∙ All high-dollar-value items included in inventory.
∙ Movement of goods into or out of the company during the process of inventory taking.
POINTS: 1
100. Inventory obsolescence procedures

Identify and describe at least four procedures the audit team may perform in order to determine potential
obsolescence of items in the inventory balances.
ANSWER: Below are seven audit procedures that may be performed by the audit team for
determining obsolete inventory items:
Noting potential obsolete inventory when observing the client’s
1.
physical inventory.
Calculating inventory turnover, number of days’ sales in inventory,
2. date of last sale or purchase, and other similar analytic techniques to
identify potential obsolescence.
Calculating net realizable value for products by referring to current
3.
selling prices, cost of disposal, sales commissions, and so on.
Monitoring trade journals and the Internet for information regarding the
4.
introduction of competitive products.
Inquiring of management about its approach to identifying and
5.
classifying obsolete items.

Payment Cycle
6. Comparing current sales with budgeted sales.
Adjusting for poor condition of inventory, reported as part of periodic
7.
cycle counts.
POINTS: 1
101. Inventory controls

What are some of the important controls that are expected to be included in a well-conceived inventory control
system?
ANSWER: A well-conceived inventory control system should ensure the following:
All purchases are authorized.
There is a timely, accurate, and complete recording of inventory

transactions.
Receipt of inventory is properly accounted for and independently tested.
Costs are properly identified and assigned to products; variances are

analyzed,
investigated and properly allocated to inventory and cost of goods sold.
A perpetual inventory system serves as the basis for management’s

reports and
assists in managing inventory.
Products are systematically reviewed for obsolescence, and appropriate

accounting
action is taken.
Inventory is periodically reviewed by management and appropriate

action taken for
excess inventory and technological obsolescence.
Market studies and quality control tests are ran before new products are
introduced.
Long-term contracts are closely monitored.

POINTS: 1

Payment Cycle
102. Comparison of Controls in Traditional and Automated Systems
Discuss the differences between a traditional receiving system and an automated integrated receiving system.
ANSWER: Traditional Receiving System
∙ Purchase orders are prepared and sent to vendors.
∙ Purchase orders are based on projected sales or production, or current inventory levels.
∙ Price is either negotiated or competitively bid among a number of vendors.
∙ Independent receiving function exists.
∙ Independent, sequentially numbered receiving documents are prepared.
∙ Accounts payable department matches purchase order, receiving document, and invoice
and accrues accounts payable.
∙ Differences between goods received and goods ordered are identified before payments
are made.
Automated Integrated Receiving System
∙ Long-term contract is signed with vendor.
∙ Quantities are based on production plans or sales programs. Quantities and delivery
times are updated monthly or biweekly depending on scheduling and shipping constraints.
∙ Price is locked in with a preferred vendor.
∙ Goods are delivered to production line.
∙ Accruals are set up based on contract.
∙ Payments are electronically transferred to vendor based on contractual terms.
∙ Processes are described in the contract to resolve difference between goods received
and goods that were shipped by vendor.
POINTS: 1

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Chapter 11 - Auditing Inventory, Goods and Services, and Accounts Payable: The Acquisition and

Test Bank for Auditing A Risk Based Approach to Conducting a

4. The acquisition process begins with a purchase of goods or services.

7. Most organizations use a perpetual inventory system to manage inventory.

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26. Many frauds are committed by overstating inventory accounts.

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38. Valuation is the most complex assertion related to inventory.

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52. Which of the following is not a management assertion relevant to inventory?

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63. Why should the client’s legal expenses be examined?

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70. Please indicate the proper sequence of the acquisition cycle:

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88. The acquisition cycle begins with which of the following?

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93. Acquisition and payment processes

94. Centralized purchasing

95. Cost accounting systems

96. Preparing for an inventory observation

97. Physical inventory procedures

98. Auditing accounts payable

99. Physical inventory procedures

100. Inventory obsolescence procedures

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101. Inventory controls

All purchases are authorized.

There is a timely, accurate, and complete recording of inventory

Receipt of inventory is properly accounted for and independently tested.

Costs are properly identified and assigned to products; variances are

A perpetual inventory system serves as the basis for management’s

Products are systematically reviewed for obsolescence, and appropriate

Inventory is periodically reviewed by management and appropriate

Long-term contracts are closely monitored.

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102. Comparison of Controls in Traditional and Automated Systems

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