CHAPTER 14

MULTIPLE CHOICE

b 1. To strengthen control procedures over the custody of heavy mobile equipment, the client would
most likely institute a policy requiring a periodic
a. Increase in insurance coverage.
b. Inspection of equipment and reconciliation with accounting records.
c. Verification of liens, pledges, and collateralizations.
d. Accounting for work orders. (AICPA ADAPTED)

c 2. To improve accountability for fixed asset retirements, management most likely would implement an
internal control structure that includes
a. Continuous analysis of the repairs and maintenance account.
b. Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been
retired.
c. Continuous utilization of serially numbered retirement work orders.
d. Periodic inspection of insurance policies by internal auditors. (AICPA ADAPTED)

b 3. From the auditor's point of view, inventory counts are more acceptable prior to the year-end, when
a. Internal control is deficient.
b. Accurate perpetual inventory records are maintained.
c. Inventory is slow moving.
d. Significant amounts of inventory are held on consignment. (AICPA ADAPTED)

c 4. Apex Manufacturing Corporation mass produces eight different products. The controller who is
interested in strengthening control procedures over the accounting for materials used in production
would be most likely to implement
a. An economic order quantity (EOQ) system.
b. A job order cost accounting system.
c. A perpetual inventory system.
d. A separation of duties among production personnel. (AICPA ADAPTED)

a 5. For several years, a client's physical inventory count has been lower than what was shown on the
books at the time of the count so that downward adjustments to the inventory account were
required. Contributing to the inventory problem could be deficiencies in internal control that led to
the failure to record some
a. Purchases returned to vendors.
b. Sales returns received.
c. Sales discounts allowed.
d. Cash purchases. (AICPA ADAPTED)

a 6. When perpetual inventory records are maintained in quantities and in dollars, and internal control
procedures over inventory are deficient, the auditor would probably
a. Want the client to schedule the physical inventory count at the end of the year.
b. Insist that the client perform physical counts of inventory items several times during the year.
c. Increase the extent of tests for unrecorded liabilities at the end of the year.
d. Have to disclaim an opinion on the income statement that year. (AICPA ADAPTED)

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a 7. Purchase cutoff procedures should be designed to test whether or not all inventory
a. Purchased and received before the year-end was recorded.
b. Was carried at the lower of cost or market on the year-end balance sheet.
c. Was paid for by the company on the year-end balance sheet.
d. Owned by the company is in the possession of the company. (AICPA ADAPTED)

c 8. In tests of property, plant, and equipment, the auditor tries to determine all of the following except
the
a. Adequacy of the internal control.
b. Extent of property abandoned during the year.
c. Adequacy of replacement funds.
d. Reasonableness of depreciation. (AICPA ADAPTED)

b 9. An auditor has accounted for a sequence of inventory tags and is now going to trace information on
a representative number of tags to the physical inventory sheets. The purpose of this procedure is
to obtain assurance that
a. The final inventory is valued at cost.
b. All inventory represented by an inventory tag is listed on the inventory sheets.
c. All inventory represented by an inventory tag is bona fide.
d. Inventory sheets do not include untagged inventory items. (AICPA ADAPTED)

b 10. The physical count of inventory of a retailer was higher than shown by the perpetual records.
Which of the following could explain the difference?
a. Inventory items had been counted, but the tags placed on the items had not been taken off the items
and added to the inventory accumulation sheets.
b. Credit memos for several items returned by customers had not been recorded.
c. No journal entry had been made on the retailer's books for several items returned to its suppliers.
d. An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had
not been reflected in the perpetual records. (AICPA ADAPTED)

c 11. A client's physical count of inventories was higher than the inventory quantities per the perpetual
records. This situation could be the result of the failure to record
a. Sales.
b. Sales discounts.
c. Purchases.
d. Purchase returns. (AICPA ADAPTED)

d 12. The controller of Excello Manufacturing, Inc., wants to use ratio analysis to identify the possible
existence of idle equipment or the possibility that equipment has been disposed of without having
been written off. Which of the following ratios would best accomplish this objective?
a. Depreciation expense divided by book value of manufacturing equipment.
b. Accumulated depreciation divided by book value of manufacturing equipment.
c. Repairs and maintenance cost divided by direct labor costs.
d. Gross manufacturing equipment cost divided by units produced. (AICPA ADAPTED)

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b 13. The accuracy of perpetual inventory records may be established, in part, by comparing inventory
records with
a. Purchase requisitions.
b. Receiving reports.
c. Purchase orders.
d. Vendor payments. (AICPA ADAPTED)

d 14. The audit procedure of analyzing the repairs and maintenance accounts is primarily designed to
provide evidence in support of the audit proposition that all
a. Expenditures for plant assets have been recorded in the proper period.
b. Capital expenditures have been properly authorized.
c. Noncapitalizable expenditures have been properly expensed.
d. Expenditures for plant assets have been capitalized. (AICPA ADAPTED)

a 15. Which of the following explanations might satisfy an auditor who discovers significant debits to an
accumulated depreciation account?
a. Extraordinary repairs have lengthened the life of an asset.
b. Prior years' depreciation charges were erroneously understated.
c. A reserve for possible loss on retirement has been recorded.
d. An asset has been recorded at its fair value. (AICPA ADAPTED)

c 16. Which of the following activities is not common to the conversion cycle?
a. Maintaining perpetual inventory records.
b. Accounting for fixed asset disposals and retirements.
c. Implementing a just-in-time order entry system.
d. Recording depreciation allocations.

d 17. When an outside specialist has assumed full responsibility for taking the client's physical inventory,
reliance on the specialist's report is acceptable if
a. The auditor is satisfied about the specialist's reputation and competence.
b. Circumstances make it impracticable or impossible for the auditor either to do the work personally
or to observe the specialist's work.
c. The auditor performs the same tests and procedures as would have been applicable if the client's
employees took the physical inventory.
d. The auditor's report assumes full responsibility. (AICPA ADAPTED)

d 18. An auditor's tests of a client's cost accounting system are designed primarily to determine that
a. Quantities on hand have been computed based on acceptable methods that reasonably approximate
actual quantities on hand.
b. Physical inventories substantially agree with book inventories.
c. The system complies with generally accepted accounting principles and functions as planned.
d. Costs have been assigned properly to finished goods, work in process, and cost of goods sold.
(AICPA
ADAPTED)

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d 19. Sanbor Corporation's parts inventory consists of thousands of different items that are small in
value individually, but quite significant in total. Sanbor could establish effective control over the
parts by requiring
a. An officer's approval of requisitions for inventory parts.
b. Maintaining inventory records for all parts included in the inventory.
c. Physical counts on a cycle basis rather than at year-end.
d. Separation of the storekeeping function from the production and inventory record-keeping
functions. (AICPA ADAPTED)

c 20. When verifying debits to a manufacturing company's perpetual inventory records, an auditor would
be most interested in testing a sample of purchase
a. Approvals.
b. Requisitions.
c. Invoices.
d. Orders. (AICPA ADAPTED)

c 21. Assets may suffer an impairment in value for a variety of reasons, but not likely as a result of:
a. A corporate restructuring.
b. Slumping demand for uncompetitive products.
c. Significant increases in market share.
d. Obsolescence.

a 22. Which of the following is not likely a motive for management to manipulate the timing and amount
of impaired asset writedowns?
a. Steady increases in earnings per share over the past 5 years.
b. Income smoothing.
c. A "big bath."
d. An abnormally unprofitable year.

c 23. The audit of year-end physical inventories should include steps to verify that the client's purchases
and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise
included in the physical count at year-end was not recorded as a
a. Sale in the subsequent period.
b. Purchase in the current period.
c. Sale in the current period.
d. Purchase return in the subsequent period. (AICPA ADAPTED)

d 24. An auditor would be most likely to learn of slow-moving inventory through

a. Inquiry of sales personnel.
b. Inquiry of stores personnel.
c. Physical observation of inventory.
d. Review of perpetual inventory records. (AICPA ADAPTED)

b 25. Which of the following internal control efficiencies relates to factory equipment?
a. Checks issued in payment of purchases of equipment are not signed by the controller.
b. All purchases of factory equipment are required to be made by the department that needs the
equipment.
c. Factory equipment replacements are generally made when estimated useful lives have expired.
d. Proceeds from sales of fully depreciated equipment are credited to other income.
(AICPA ADAPTED)
c 26. When auditing fixed assets, an auditor attempts to determine all of the following except
a. Control risk.

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 b. Property abandoned during the year.
c. Adequacy of replacement funds.
d. Reasonableness of depreciation. (AICPA ADAPTED)

c 27. Which of the following is the best evidence that an entity owns real estate at the balance sheet date?
a. Title insurance policy.
b. Original deed.
c. Paid real estate tax bills.
d. Closing statement. (AICPA ADAPTED)

b 28. Which of the following procedures would least likely lead the auditor to detect unrecorded fixed
asset disposals?
a. Examine insurance policies.
b. Review repairs and maintenance expense.
c. Review property tax files.
d. Scan invoices for fixed asset additions. (AICPA ADAPTED)

c 29. The auditor may conclude that depreciation charges are insufficient by noting
a. Insured values greatly in excess of book values.
b. Large amounts of fully depreciated assets.
c. Continuous trade-ins of relatively new assets.
d. Excessive recurring losses on assets retired. (AICPA ADAPTED)

d 30. In violation of company policy, Lowell Company erroneously capitalized the cost of painting its
warehouse. An auditor would most likely detect this when
a. Discussing capitalization policies with Lowell's controller.
b. Examining maintenance expense accounts.
c. Observing that the warehouse had been painted.
d. Examining construction work orders that support items capitalized during the year.
(AICPA
ADAPTED)

SHORT ANSWER

1. Explain the conversion cycle.

Answer:
The conversion cycle encompasses the production of finished products for sale, and relates directly
to two other cycles. It uses resources and information provided by the
expenditure/disbursement cycles and provides resources and information to the revenue/receipt
cycle.

2. To control inventory recording what controls should management have in place?

Answer:
To avoid misstated or misplaced inventory used or transferred inventory should be recorded in the
correct amounts, be recognized in the proper period, and be classified properly. To control
inventory recording, management could establish processing and recording procedures, prenumber
and control material release forms and production orders, and maintain logs of inventory movement
into and out of storerooms and production.

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3. How should management safeguard inventory from fraud or misappropriation?

Answer:
Access to inventory should be restricted to personnel authorized by management. Management
could establish physical control over inventory, maintain insurance, both for inventory and for
inventory personnel in the form of fidelity bonds and segregate responsibility for handling
inventory from inventory recording, cost accounting, and general accounting. Management should
also restrict access to production, cost accounting, and perpetual inventory records, preventing
misuse, destruction, or loss of inventory or inventory records.

4. Explain the internal controls management can use to assure control over the transaction
authorization of fixed assets. Address the separate controls for transaction authorization, execution,
and recording.

Answer:
To control unauthorized transactions, management could develop written procedures for all
additions, disposals, and retirements, and periodically compare scrap sale prices with published
price lists.
Transaction Authorization – Prepare written procedures for all additions, disposals, and
retirements. Periodically compare prices received for scrap with published prices.
Transaction Execution – Establish procedures for operating, using, moving, and otherwise
controlling fixed assets. Restrict access to movable fixed assets.
Recording – Establish procedures for processing and recording fixed asset transaction. Establish
procedures for identifying fixed assets eligible for disposal. Maintain detailed fixed assets records.
Periodically reconcile fixed asset records with existing assets and investigate differences. Establish
policies for determining depreciation methods and for calculating depreciation on all categories of
fixed assets.

5. Describe the preliminary review process as it pertains to obtaining an understanding of a client’s

inventory controls relating to inventory.

Answer:
An auditor performs the preliminary review for inventory by reading the client’s procedures
manuals and by interviewing client personnel who are responsible for perpetual inventory records,
cost records, and inventory accounting. Assuming the existing controls appear potentially reliable
in assessing control risk below the maximum, an auditor proceeds by documenting the system.

PROBLEMS

1. Complete the table below as it concerns to the related assertions and audit procedures of inventory
and fixed assets accounts.

Assertions Inventory Fixed Assets

Existence or Occurrence

Completeness

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 Rights and Obligations
Valuation or allocation
Presentation and Disclosure
Answer:
Assertions
Existence or Occurrence
Completeness
Rights and Obligations
Valuation or allocation
Presentation and Disclosure
2. Complete the questionnaire with applicable questions that an auditor may use to address fixed
assets control procedures. Give at least two questions for each of the following categories:
 Fixed Asset Records
 Additions
 Disposals and Retirements
 Depreciation
Question
Answer:
Students’ answers may include the following possibilities.
Question
Inventory
Observe physical inventory
Confirm off-premises inventory
Test cutoff
Observe physical inventory
Confirm off-premises inventory
Test cutoff
Perform analytical procedures
Confirm off-premises inventory
Test cutoff
Review consignment and
purchase commitments
Test final priced inventory
Review physical inventory for
obsolete, slow moving,
otherwise unsalable goods
Compare statement presentation
and disclosures with those
required by GAAP
Answer, Yes,
No, or N/A
Answer, Yes,
No, or N/A
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Fixed Assets
Observe asset additions
Test cutoff
Observe asset additions
Test cutoff
Perform analytical procedures
Test additions
Test cutoff
Examine contracts and other
documentation
Verify accuracy of recorded
fixed assets and depreciation
expense
Test additions and disposals
Compare statement presentation
and disclosures with those
required by GAAP
Remarks
Remarks
Fixed Asset Records
1. Are detailed records maintained for each class
of fixed assets?
2. Is responsibility for maintaining fixed asset
records segregated from responsibility for
physically controlling fixed assets and from
general accounting?
3. Are detailed records reconciled periodically
with general ledger control accounts?
4. Are procedures followed to determine whether
recorded fixed assets actually exist?
5. Is access to and the use of fixed assets restricted
to authorized personnel?
6. Is insurance coverage maintained and reviewed
for all fixed assets?
7. Are fixed assets physically safeguarded from
deterioration and theft?

Additions
1. Do procedures require authorization by the board
of directors or senior management for fixed asset
additions?
2. Are actual expenditures for fixed assets compared
with amounts authorized?
3. Are procedures established to assure that fixed
assets purchased are delivered in accordance with
orders placed?
4. Are fixed asset additions promptly recorded in
fixed asset records?
5. Are fixed asset additions promptly reported to
general accounting?
6. Are insurance companies notified of fixed asset
additions in order to increase insurance coverage?
7. Is construction in progress – whether internally
or externally contracted – authorized and
periodically inspected?

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 Answer, Yes,
Question No, or N/A Remarks

Disposals and Retirements

1. Do procedures require authorization by the board
of directors or senior management for fixed asset
disposals and retirements?
2. Are procedures established to assure that the
proceeds from fixed asset disposals are recorded
properly and deposited?
3. Are fixed asset disposals and retirements promptly
record in fixed asset records?
4. Are fixed asset additions promptly reported to
general accounting for recording gains or losses?
5. Are insurance companies notified of fixed asset
disposals and retirements to assure that insurance
coverage is altered accordingly?

Depreciation
1. Are procedures established to assure that additions
are added to depreciation records and that
disposals/retirements are deleted?
2. Are procedures established to assure that
depreciation is recorded only for those fixed assets
actually in service during the period?
3. Are procedures established for determining
depreciation methods, estimated useful lives, and
salvage values?

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