AUD 2 Inventory

MABALACAT CITY COLLEGE AUD 02| Auditing And Assurance Concepts
And Application 1
Teacher’s Guide Week No. 6-7
Audit of Inventory
After the lesson, the students can be able to:
1. Refresh on the Generally Accepted Accounting

Principles and the Philippine Financial Reporting
Standards relating to inventories.
2. Identify and explain the audit objectives on

inventories. Learning Materials
Laptop, pen, calculator, & book

3. Perform audit procedures and solve auditing
problems on inventories.
4. Prepare audit working papers on inventories.
Lesson Preview/Review
REVIEW ON GAAP/ PFRS RELATING TO INVENTORY
Inventory
Inventories are assets held for sale in the ordinary course of business, in the process of production for such
sale or in the form of materials or supplies to be consumed in the production process or in the rendering of
services.
Two classes of Inventory:
1. Trading inventory- goods purchased and held for resale.
2. Inventory of manufacturing concern.
And Application 1
The term inventory refers to the raw materials used in production as well as the goods produced
that are available for sale. A company's inventory represents one of the most important assets it has
because the turnover of inventory represents one of the primary sources of revenue generation and
subsequent earnings for the company's shareholders. There are three types of inventory, including raw
materials, work-in-progress, and finished goods. It is categorized as a current asset on a company's
balance sheet.
Inventory is a very important asset for any company. It is defined as the array of goods used in production or
finished goods held by a company during its normal course of business. There are three general categories of
inventory, including raw materials (any supplies that are used to produce finished goods), work-in-progress
(WIP), and finished goods or those that are ready for sale.
As noted above, inventory is classified as a current asset on a company's balance sheet, and it serves as a
buffer between manufacturing and order fulfillment. When an inventory item is sold, its carrying cost transfers
to the cost of goods sold (COGS) category on the income statement.
Inventory can be valued in many ways. These methods are the:
• First-in, first-out (FIFO) method, which says that the cost of goods sold is based on the cost of the
earliest purchased materials. The carrying cost of remaining inventory, on the other hand, is based on
the cost of the latest purchased materials
• Last-in, first-out (LIFO) method, which states that the cost of goods sold is valued using the cost of
the latest purchased materials, while the value of the remaining inventory is based on the earliest
purchased materials.
• Weighted average method, which requires valuing both inventory and the COGS based on the
average cost of all materials bought during the period.
• Specific Identification- means that specific costs are attributed to identified items of inventory.
• Standard costs are predetermined product costs established on the basis of normal levels of materials
and supplies, labor efficiency and capacity utilization.
• Relative sales price method- when different commodities are purchased at lump sum, the single cost
is apportioned among the commodities based on their respective sale price. This is based on the
philosophy that cost is proportionate to selling price.
Maritime Shipping terms
FAS or Free alongside- a seller who ships FAS must bear all expenses and risked involved in delivering the
goods to the dock next to or alongside the vessel on which the goods are to be shipped.
And Application 1
The buyer bears the cost of loading and shipments, and title passes to the buyer when carrier takes possession
of the goods
CIF or Cost, insurance, and freight- under this shipping contract, the buyer agrees to pay in a lump sum the
cost of the goods, insurance cost, and freight charge. The shipping contract may be modified as CF which
means that the buyer agrees to pay in lump sum the cost of the goods and freight charge only.
The seller bears the cost of loading and shipments, and title passes to the buyer when carrier takes possession
of the goods.
Ex-ship- a seller who delivers the goods ex-ship bears all expenses and risk of loss until the goods are
unloaded at which time title and risk of loss shall pass to the buyer.
Consignment
Consignment is a method of marketing goods in which the owner called the consignor transfers
physical possession of certain goods to an agent called the consignee who sells on the owner’s behalf.
Accounting for inventory:

1. Periodic Method -physical counting of goods on hand at the end of the accounting period to determine
quantities.
2. Perpetual Method-requires maintenance of records called stock cards that usually offer running
summary of the inventory inflow and outflow.
Trade discounts and cash discounts

Trade discounts are deductions from the list or catalog price to arrive at the invoice price which is the
amount actually charged to the buyer (not recorded).
Cash discounts are deductions from the invoice price when payment is made within the discount
period. Recorded as purchase discount.
Purchase discount is deducted from purchases to arrive at net purchases and sales discount is deducted
from sales to arrive at net sales revenue.
Gross method- recording the purchase discount once the discount is made within the discount period.
Net method- the recording of purchases and accounts payable is already in net account.
And Application 1
Subsequent measurement
PAS 2, paragraph 9, provides that “inventories shall be measured at the lower of cost and net realizable
value.
Net realizable value (NRV) is the estimated selling price in the ordinary course of business less the
estimated cost completion and the estimated cost of disposal. Inventories are usually written down to NRV
item by item or individual basis.
Accounting for inventory writedown
• Cost< NRV=no accounting problem because the inventory is stated at cost and the increase in
value is not recognized.
• Cost>NRV= the inventory is measured at net realizable value. In this case, the problem is the
proper treatment of the writedown of the inventory to net realizable value. Accounting method
for writedown may be: direct method (cost of good sold method) and allowance method (loss
method).
Estimating Inventories
Companies sometimes need to determine the value of inventory when a physical count is impossible or
impractical. For example, a company may need to know how much inventory was destroyed in a fire.
Companies using the perpetual system simply report the inventory account balance in such situations, but
companies using the periodic system must estimate the value of inventory. Two ways of estimating
inventory levels are the gross profit method and the retail inventory method.
Gross profit method. The gross profit method estimates the value of inventory by applying the company's
historical gross profit percentage to current‐period information about net sales and the cost of goods
available for sale. Gross profit equals net sales minus the cost of goods sold. The gross profit
margin equals gross profit divided by net sales. If a company had net sales of $4,000,000 during the
previous year and the cost of goods sold during that year was $2,600,000, then gross profit was $1,400,000
and the gross profit margin was 35%.
And Application 1
Net Sales $ 4,000,000

Less: Cost of Goods Sold (2,600,000)
Gross Profit $ 1,400,000
If gross profit margin is 35%, then cost of goods sold is 65% of net sales.
Suppose that one month into the current fiscal year, the company decides to use the gross profit margin from
the previous year to estimate inventory. Net sales for the month were $500,000, beginning inventory was
$50,000, and purchases during the month totaled $300,000. First, the company multiplies net sales for the
month by the historical gross profit margin to estimate gross profit.
Next, estimated gross profit is subtracted from net sales to estimate the cost of goods sold.
Net Sales $ 500,000

Gross Profit (175,000)
Cost of Goods Sold $ 325,000
Alternatively, cost of goods sold may be determined by multiplying net sales by 65% (100% – gross profit
margin of 35%).
Finally, the estimated cost of goods sold is subtracted from the cost of goods available for sale to estimate
the value of inventory.
Beginning Inventory $ 50,000

And Application 1
Purchases 300,000
Cost of Goods Available for Sale 350,000
Less: Cost of Goods Sold (325,000)
Ending Inventory $ 25,000
The gross profit method produces a reasonably accurate result as long as the historical gross profit margin
still applies to the current period. However, increasing competition, new market conditions, and other factors
may cause the historical gross profit margin to change over time.
Retail inventory method. Retail businesses track both the cost and retail sales price of inventory. This
information provides another way to estimate ending inventory. Suppose a retail store wants to estimate the
cost of ending inventory using the information shown below.
Cost Retail
Beginning Inventory $ 49,000 80,000
Purchases 209,000 350,000
Goods Available for Sale $ 258,000 430,000
Net Sales $ 400,000
The first step is to calculate the retail value of ending inventory by subtracting net sales from the retail value
of goods available for sale.
Cost Retail
Purchases 209,000 350,000
Net Sales 400,000
Ending Inventory (Retail) $ 30,000
Next, the cost‐to‐retail ratio is calculated by dividing the cost of goods available for sale by the retail value
of goods available for sale.
Cost Retail
And Application 1
Cost Retail
Purchases 209,000 350,000
Net Sales 400,000
Cost to Retail Ratio ($ 258,000 + $ 430,000 = 60%)
Then, the estimated cost of ending inventory is found by multiplying the retail value of ending inventory by
the cost‐to‐retail ratio.
Cost Retail
Purchases 209,000 350,000
Net Sales 400,000
Cost to Retail Ratio ($ 258,000 + $ 430,000 = 60%)
Ending Inventory (Cost) ($ 30,000 × 60%) $ 18,000
One limitation of the retail inventory method is that a store's cost‐to‐retail ratio may vary significantly from
one type of item to another, but the calculation simply uses an average ratio. If the items that actually sold
have a cost‐to‐retail ratio that differs significantly from the ratio used in the calculation, the estimate will be
inaccurate.
Treatment of items
Items Cost Retail Sales
Purchase discount -
Purchase Return - -
Freight-in +
Departmental transfer in + +
or debit
Departmental transfer - -
out or credit
Sales discount and sales disregard
allowance
And Application 1
Sales return -
Employee discount +
Normal shortage, -
shrinkage, spoilage,
breakage
Abnormal shortage, - -
shrinkage, spoilage,
breakage
Items related to retail method
1. Initial markup
2. Original retail
3. Additional markup
4. Mark up cancellation
5. Net additional markup or net markup
6. Mark down
7. Mark down cancellation
8. Net markdown
9. Maintained markup (Markon)
Biological Assets
Agriculture means farming or the process of producing crops and raising livestock. PAS 41 prescribes the
accounting and disclosures for agricultural and related activity.
PAS 41 applies to the following when they relate to agricultural activity:
a. Biological assets, except bearer plants;
b. Agricultural produce at the point of harvest; and
c. Unconditional government grants related to a biological asset measured at its fair value less cost to sell
Biological assets
- Only living animal or plant
Biological assets can be either:
a. Consumable biological assets – those that are harvested as agricultural produce or sold as biological
assets
b. Bearer biological assets-those that are held to bear produce. Only the produce is harvested while the
bearer biological asset remain. Bearer plants are classified as PPE.
And Application 1
Bearer plant is a living plant that:

a. Is used in the production or supply of agricultural produce
b. Is expected to bear produce for more than one period
c. Has a remote likehood of being sold as agricultural produce, except for incidental scrap sales.
Agricultural produce
- The harvested produce of the entity’s biological assets.
- Harvest is the detachment of produce from biological asset or the cessation of biological asset’s life
processes.
Common features of agricultural activity
a. Capability to change
b. Management of change
c. Measurement of change
Biological Transformation
Assets changes through:
a. Growth
b. Procreation
c. Degeneration
Measurement
Biological assets
• Biological assets are initial measured at fair value less cost to sale.
• If can’t measured reliably: initially measured at cost and subsequently measured at cost and
accumulated impairment losses. Once the fair value becomes reliably measurable, the biological
asset is measured at its fair value less costs to sell.
• The gain or loss arising from initial measurement and subsequent changes in fair value less costs
to sell are recognized in profit or loss.
And Application 1
AUDIT ON INVENTORY (OBJECTIVE & ASSERTIONS)

An audit of inventory is a process used to evaluate and verify the existence, condition, quantity,
and value of a company's inventory. This is typically done to ensure that the inventory records are
accurate and complete, and to identify any discrepancies or potential issues that need to be
addressed.
The following are some steps that can be taken to conduct an audit of inventory:
1. Establish the scope and objective of the inventory audit: Determine the specific areas and
items that need to be audited, and set a clear objective for the audit.
2. Review inventory records: Collect and review inventory records such as purchase orders,
sales invoices, and shipping documents. This will help identify the quantities and values of
items that should be in inventory.
3. Perform physical inventory count: Conduct a physical count of inventory to compare the
actual quantities of goods with the recorded quantities in the inventory records. This can be
done using manual or automated methods.
4. Verify inventory valuation: Verify the accuracy of inventory valuation by checking the unit
prices and determining the method used for costing the inventory (e.g., First-In, First-Out
(FIFO), Last-In, First-Out (LIFO), or weighted average).
5. Analyze inventory turnover: Analyze inventory turnover to identify slow-moving, obsolete,
or excess inventory that may need to be written off or disposed of.
6. Reconcile inventory records: Reconcile inventory records to identify any discrepancies
between the physical inventory count and the inventory records, and investigate any
discrepancies to determine the cause.
7. Evaluate inventory control systems: Evaluate the effectiveness of the company's inventory
control systems and make recommendations for improvements.
8. Prepare a report: Prepare a report summarizing the findings of the inventory audit,
including any discrepancies or issues identified, and recommendations for improving
inventory control processes.
Overall, an audit of inventory is an important process that can help ensure the accuracy and
completeness of a company's inventory records, and identify areas for improvement in inventory
control processes.
And Application 1
Assertions about inventory are statements made by management about the accuracy,
completeness, and existence of inventory. These assertions are important in the audit of inventory
as they provide a framework for the auditor to evaluate the inventory records and determine the
extent of testing required.
The following are some common assertions about inventory:
1. Existence: This assertion confirms that the inventory recorded in the company's records
actually exists and is owned by the company.
2. Completeness: This assertion confirms that all inventory that should be recorded in the
company's records is actually recorded and nothing is missing.
3. Valuation: This assertion confirms that inventory is valued accurately, taking into account
factors such as purchase cost, net realizable value, and obsolescence.
4. Rights and Obligations: This assertion confirms that the company has legal title to the
inventory and that there are no encumbrances or restrictions on its use.
5. Presentation and Disclosure: This assertion confirms that the inventory is presented and
disclosed in the company's financial statements in accordance with applicable accounting
standards.
When auditing inventory, the auditor will typically test the accuracy of these assertions through
various procedures, such as physical inventory counts, examination of documentation, and analysis
of inventory valuation methods.
Overall, assertions about inventory provide a framework for auditors to evaluate the accuracy and
completeness of inventory records, and to identify any potential issues or discrepancies that need
to be addressed.
Questions:
1. Shipping orders are forwarded from the revenue process to

A. The materials requisitions department
B. Finished goods stores
C. Raw materials stores
D. Inventory management
And Application 1
2. Which of the following departments typically approves purchase requisitions?

A. Raw materials stores
B. Cost accounting
C. Inventory management
D. IT
3. Which of the following best describes the occurrence assertion for inventory?
A. Purchase requisitions initiated by authorized personnel
B. Recorded inventory actually exists
C. Inventory properly accumulated from journals and ledgers
D. All inventory is recorded
4. Auditors are most likely to ensure that no production activity is scheduled prior to
A. Determining standard costs
B. Observing physical inventory
C. Completing the book to physical adjustment
D. Determining the amount of consigned inventory
5. The safeguarding of inventory most likely includes

A. Comparison of the information contained on the purchase requisitions, purchase orders,
receiving reports, and vendors' invoices
B. Periodic reconciliation of detailed inventory records with the actual inventory on hand by
taking a physical count
C. Analytical procedures for raw materials, goods in process, and finished goods that
identify unusual transactions, theft and obsolescence
D. Application of established overhead rates on the basis of direct labor hours or direct
labor costs
6. Which of the following is not a misstatement related to the occurrence assertion for inventory?
A. Consigned goods are included as part of inventory
B. Unauthorized production activity
C. Fictitious inventory
D. Recorded inventory is not on hand because of theft
And Application 1
7. Failure to record inventory in the proper period can affect all of the following accounts except
A. Sales
B. Receivables
C. Cost of Goods Sold
D. Prepaid Expenses
8. Which of the following audit procedures would provide the least reliable evidence that the client
has legal title to inventories?
A. Confirmation of inventories at locations outside the client's facilities
B. Analytical review of inventory balances compared to purchasing and sales activities
C. Observation of physical inventory counts
D. Examination of paid vendors' invoices
9. 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
10. For the purpose of determining proper cutoff for inventory, the auditor will select a sample
from which of the following for a few days before and after year-end?
A. Materials requisitions
B. Production schedules
C. Receiving documents
D. Purchase orders
And Application 1
11. Which of the following auditing procedures most likely would provide assurance about a
manufacturing entity's inventory valuation?
A. Vouching the raw materials costs to vendors' invoices
B. Obtaining confirmation of inventories pledged under loan agreements
C. Reviewing shipping and receiving cutoff activities for inventories
D. Tracing test counts to the entity's inventory listing
12. An auditor will usually trace the details of the test counts made during the observation of the
physical inventory count to a final inventory schedule. This audit procedure is undertaken to
provide evidence that items physically present and observed by the auditor at the time of the
physical inventory count are
A. Owned by the client
B. Not obsolete
C. Physically present at the time of the preparation of the final inventory schedule
D. Included in the final inventory schedule
13. A client's physical count of inventories was lower than the inventory quantities shown in its
perpetual records. This situation could be the result of the failure to record
A. Sales
B. Sales returns
C. Purchases
D. Purchase discounts
14. 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
And Application 1
15. 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
16. If the perpetual inventory records show lower quantities of inventory than the physical count,
an explanation of the difference might be unrecorded
A. Sales
B. Sales discounts
C. Purchases
D. Purchase discounts
17. An auditor selected items for test counts while observing a client's physical inventory. The
auditor then traced the test counts to the client's inventory listing. This procedure most likely
obtained evidence concerning management's assertion of
A. Rights and obligations
B. Completeness
C. Existence
D. Valuation
18. While observing a client's annual physical inventory, an auditor recorded test counts for several
items and noticed that certain test counts were higher than the recorded quantities in the client's
perpetual records. This situation could be the result of the client's failure to record
A. Purchase discounts
B. Purchase returns
C. Sales
D. Sales returns
And Application 1
19. In a manufacturing company, which one of the following audit procedures would give the least
assurance about the valuation of inventory at the audit date?
A. Testing the computation of standard overhead rates
B. Examining paid vendors' invoices
C. Reviewing direct labor rates
D. Obtaining confirmation of inventories pledged under loan agreements
20. Which of the following is least likely to be a possible cause of book-to-physical differences in
inventory quantities?
A. Inventory cutoff errors
B. Misapplication of LIFO
C. Unreported scrap or spoilage
D. Theft
21. An auditor most likely would make inquiries of production and sales personnel concerning
possible obsolete or slow-moving inventory to support management's financial statement
assertion of
A. Valuation
B. Rights and obligations
C. Existence
D. Completeness
22. Which of the following is a plausible explanation for a large increase in the number of days
outstanding in inventory?
A. Obsolete inventory
B. New product line where sales exceed production
C. Manufacturing overhead was not allocated to the production process
D. Manufacturing salaries were recorded as administrative expenses
And Application 1
23. Key segregations of duties in the inventory management process include all of the following
except separating
A. Cost accounting from review of variance reports
B. Inventory management from cost accounting
C. Cost accounting from the general ledger function
D. Supervision of physical inventory from inventory management
24. An auditor generally tests physical security controls over inventory by

A. Test counts and cutoff procedures
B. Examination and reconciliation
C. Inspection and recomputation
D. Inquiry and observation
25. When perpetual inventory records are maintained in quantities and in dollars and internal
control over inventory is weak, 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 for that year
26. A client maintains perpetual inventory records in both quantities and dollars. If the assessed
level of control risk is high, an auditor would probably
A. Increase the extent of tests of controls for the inventory cycle
B. Request that the client schedule the physical inventory count at the end of the year
C. Insist that the client perform physical counts of inventory items several times during the
year
D. Apply gross profit tests to ascertain the reasonableness of the physical counts
And Application 1
27. In obtaining an understanding of a manufacturing entity's internal control concerning

inventory balances, an auditor most likely would
A. Review the entity's description of inventory policies and procedures
B. Perform test counts of inventory during the entity's physical count
C. Analyze inventory turnover statistics to identify slow-moving and obsolete items
D. Analyze monthly production reports to identify variances and unusual transactions
28. 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 weaknesses in internal controls that led
to the failure to record some
A. Purchases returned to vendors
B. Sales returns received
C. Sales discounts allowed
D. Cash purchases
29. Which of the following control activities would most likely be used to maintain accurate
perpetual inventory records?
A. Independent storeroom count of goods received
B. Periodic independent reconciliation of control and subsidiary records
C. Periodic independent comparison of records with goods on hands
D. Independent matching of purchase orders, receiving reports and vendors' invoices
30. An inventory turnover analysis is useful to the auditor because it may detect
A. Inadequacies in inventory pricing
B. Methods of avoiding cyclical holding costs
C. The optimum automatic reorder points
D. The existence of obsolete merchandise
And Application 1
31. Tracing costs used to price inventory to vendors' invoices tests which of the following
assertions?
A. Occurrence
B. Cutoff
C. Accuracy
D. Classification
32. The auditor tests the quantity of materials charged to work-in-process by tracing these
quantities to
A. Cost ledgers
B. Perpetual inventory records
C. Receiving reports
D. Material requisitions
33. Purchase cutoff activities should be designed to test that merchandise is included in the
inventory of the client company if the company
A. Has paid for the merchandise
B. Has physical possession of the merchandise
C. Holds legal title to the merchandise
D. Holds the shipping documents for the merchandise issued in the company's name
34. Which one of the following procedures would not be appropriate for an auditor in discharging
his or her responsibilities concerning the client's physical inventories?
A. Confirmation of goods in the hands of public warehouses
B. Supervising the annual physical inventory count
C. Carrying out physical inventory procedures at an interim date
D. Obtaining written representation from the client as to the existence, quality and dollar
amount of the inventory
And Application 1
35. When outside firms of non-accountants specializing in physical inventory counts are used to
count, list, price and subsequently compute the total dollar amount of inventory on hand at the
date of the physical count, the auditor will ordinarily
A. Consider the report of the outside inventory firm to be an acceptable alternative
procedure to the observation of physical inventories
B. Make or observe some physical counts of the inventory, recompute certain inventory
calculations, and test certain inventory transactions
C. Increase the extent of work on the physical count of inventory
D. Consider the reduced audit effort with respect to the physical count of inventory as a
scope limitation
36. Which of the following is the best audit procedure for the discovery of damaged merchandise
in a client's ending inventory?
A. Compare the physical quantities of slow-moving items with corresponding quantities of
the prior year
B. Observe the condition of merchandise and raw materials during the client's physical
inventory count
C. Review the management's inventory representation letter for accuracy
D. Test overall fairness of inventory values by comparing the company's turnover ratio with
the industry average
37. 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 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 prepared
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
And Application 1
38. In an audit of inventories, an auditor would least likely verify that

A. All inventory owned by the client is on hand at the time of the count
B. The client has used proper inventory pricing
C. The financial statement presentation of inventories is appropriate
D. Damaged goods and obsolete items have been properly accounted for
Problems
Problem 1
XYZ Corporation is a wholesaler of electronics goods. As of December 31, 2022, the company's inventory balance
was $3,000,000, and the cost of goods sold for the year was $10,000,000. The company uses a periodic inventory
system and had the following inventory transactions during the year:
• January 1: Beginning inventory - $2,500,000

• March 1: Purchase - $4,000,000
• May 1: Purchase - $2,500,000
• July 1: Purchase - $1,500,000
• September 1: Purchase - $3,000,000
• December 1: Purchase - $1,500,000
The auditor selected a sample of 50 items from the inventory balance as of December 31, 2022, for testing. The
cost of the items in the sample was $100,000. The auditor determined that the actual count of the sample items
was $90,000. The auditor also noted that the company did not have any significant write-offs or write-downs of
inventory during the year.
Required:
a) Calculate the estimated inventory balance as of December 31, 2022, using the gross profit method.
b) State the conclusion the auditor should make regarding the company's inventory.
Answer:
And Application 1
a) The estimated inventory balance can be calculated using the gross profit method as follows:
• Calculate the gross profit percentage: Gross profit percentage = (Sales - Cost of goods sold) / Sales =
($10,000,000 - $3,000,000) / $10,000,000 = 70%
• Calculate the estimated cost of goods sold: Estimated cost of goods sold = Sales x (1 - Gross profit
percentage) = $10,000,000 x (1 - 70%) = $3,000,000
• Calculate the estimated ending inventory: Estimated ending inventory = Beginning inventory + Purchases
- Estimated cost of goods sold = $2,500,000 + $4,000,000 + $2,500,000 + $1,500,000 + $3,000,000 +
$1,500,000 - $3,000,000 = $11,000,000
• Calculate the estimated inventory balance: Estimated inventory balance = Estimated ending inventory -
Actual inventory count = $11,000,000 - $90,000 = $10,910,000
Therefore, the estimated inventory balance as of December 31, 2022, using the gross profit method is
$10,910,000.
b) The auditor should conclude that the company's inventory balance is materially misstated. The actual count of
the sample items was lower than the recorded amount, indicating that there may be additional inventory
shortfalls. The estimated inventory balance using the gross profit method is also significantly higher than the
recorded amount, suggesting that the company may have overstated its inventory balance. The auditor should
perform additional procedures to determine the extent of the misstatement and evaluate the impact on the
financial statements.
And Application 1
Problem 2
Listed below are some items of inventory from Anecito Company that are in question during
the audit. The company stores a substantial portion of the merchandise in a separate
warehouse and transfer damaged goods to a special inventory account.
1. Items in receiving department returned by customer, no

communication received from customer 20,000
2. Items ordered and in receiving department, invoice not yet
received from supplier 50,000
3. Items counted in warehouse by the inventory crew 70,000
4. Invoice received for goods ordered, goods shipped but not received
(Anecito Company pays freight) 5,000
5. Items, shipped today, fob destination, invoice mailed to customer 5,000
6. Items currently used for window displays 10,000
7. Items on counter for sale per inventory count [not in (3)] 90,000
8. Items in shipping department, invoice not mailed to customer 6,000
9. Items in receiving department, refused by Anecito because of
Damage [(not in (3)] 3,000
10. Items shipped today, fob shipping point, invoice mailed to customer 4,000
11. Items included in warehouse count, damaged, not returnable 8,000
12. Items included in warehouse count, specifically crafted and
segregated for shipment to customer in five days per sales

contract, with return privilege. 18,000
Question:
1. If the recorded inventory in the balance sheet is P289,000, the year-end inventory will
be overstated by:
a. P 41,000 b. P 23,000 c. P 18,000 d. P 3,000
2. The following should be included from the inventory, except:

a. Inventory shipped today, f.o.b. shipping point, invoice mailed to customer.
b. Inventory counted in warehouse by the inventory crew.
c. Inventory shipped today, f.o.b. destination, invoice mailed to customer.
d. Inventory in warehouse count, specifically crafted and segregated for shipment to
customer with return privilege.
3. The inventory per audit at year-end is:

a. P 286,000 b. P 271,000 c. P 266,000 d. P 248,000
And Application 1
Problem 3
In your audit of MENDOZA COMPANY for the past calendar year, you find the following
accounts:
ACCOUNTS RECEIVABLES
Jan. 1, 2002 P 800,000 Jan. – Dec. 1992 collections P 5,900,000
Jan. – Dec. Sales 6,300,000 Jan. – Dec. write-off 100,000
ALLOWANCE FOR BAD DEBTS

Jan. – Dec. Write-off of Jan. 1, 2002 P 95,000
last year’s receivables P 85,000 Dec. 31 provisions 315,000
Write-off of this year’s

Receivables 15,000
In your examination, you find that the balance of Accounts Receivable represents sales of the
current audit year only; that credit balances in the subsidiary ledger for accounts receivable
totaled P80,000; and that the current year’s provision for bad debts expense was5% of sales
(as compared with 4½% last year, 4% of the year before, and 3½% the next previous year).
Sequential to aging the accounts receivable, you and the company’s
References
• Ngina, M. A. B., & Escala, R. F. A. (2018). Applied Auditing (2018th ed., Vol. 1). Real Excellence
Publishing.
• CPA REVIEW SCHOOL OF THE PHILIPPINES Manila (AUDITING PROBLEM-Inventories)
OFFICIAL MCC TEACHER’S GUIDE DISCLAIMER
It is not the intention of the author/s nor the publisher of this teacher’s guide to have monetary gain in
using the textual information, imageries, and other references used in its production. This guide is only for the
exclusive use of a bona fide student of Mabalacat City College.
In addition, this teacher’s guide or no part of it thereof may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means, electronic, mechanical, photocopying, and/or otherwise, without
the prior permission of Mabalacat City College.
And Application 1
Compiled/Prepared by: Recommending Approval: Approved by:
Pauline R. Dela Cruz, CPA

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MABALACAT CITY COLLEGE AUD 02| Auditing And Assurance Concepts

1. Refresh on the Generally Accepted Accounting

2. Identify and explain the audit objectives on

Laptop, pen, calculator, & book

4. Prepare audit working papers on inventories.

REVIEW ON GAAP/ PFRS RELATING TO INVENTORY

Accounting for inventory:

Trade discounts and cash discounts

Net Sales $ 4,000,000

Net Sales $ 500,000

Beginning Inventory $ 50,000

Bearer plant is a living plant that:

AUDIT ON INVENTORY (OBJECTIVE & ASSERTIONS)

The following are some common assertions about inventory:

1. Shipping orders are forwarded from the revenue process to

2. Which of the following departments typically approves purchase requisitions?

5. The safeguarding of inventory most likely includes

24. An auditor generally tests physical security controls over inventory by

27. In obtaining an understanding of a manufacturing entity's internal control concerning

38. In an audit of inventories, an auditor would least likely verify that

• January 1: Beginning inventory - $2,500,000

1. Items in receiving department returned by customer, no

segregated for shipment to customer in five days per sales

2. The following should be included from the inventory, except:

3. The inventory per audit at year-end is:

ALLOWANCE FOR BAD DEBTS

Write-off of this year’s

OFFICIAL MCC TEACHER’S GUIDE DISCLAIMER

Compiled/Prepared by: Recommending Approval: Approved by:

Pauline R. Dela Cruz, CPA

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