AUDIT OF INVENTORIES
PROBLEM NO. 1
Presented below is a list of items that may or may not reported as inventory in a company’s
December 31 balance sheet.
1. Goods out on consignment at another company’s store
2. Goods sold on installment basis
3. Goods purchased f.o.b. shipping point that are in transit
at December 31
4. Goods purchased f.o.b. destination that are in transit at
December 31
5. Goods sold to another company, for which our company
has signed an agreement to repurchase at a set price that
covers all costs related to the inventory
6. Goods sold where large returns are predictable
7. Goods sold f.o.b. shipping point that are in transit
December 31
8. Freight charges on goods purchased
9. Factory labor costs incurred on goods still unsold
10. Interest cost incurred for inventories that are routinely
manufactured
11. Costs incurred to advertise goods held for resale
12. Materials on hand not yet placed into production
13. Office supplies
14. Raw materials on which a the company has started
production, but which are not completely processed
15. Factory supplies
16. Goods held on consignment from another company
17. Costs identified with units completed but not yet sold
18. Goods sold f.o.b. destination that are in transit at
December 31
19. Temporary investment in stocks and bonds that will be
resold in the near future
P800,000
100,000
120,000
200,000
300,000
280,000
120,000
80,000
50,000
40,000
20,000
350,000
10,000
280,000
20,000
450,000
260,000
40,000
500,000
Question:
How much of these items would typically be reported as inventory in the financial statements?
a. P2,300,000
c. P2,260,000
b. P2,000,000
d. P2,220,000
Suggested Solution:
PAS 2
a.
b.
c.
par. 6 defines “Inventories” as 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.
Par. 10 further states that the cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their present location and condition.
Therefore, items 1, 3, 5, 8, 9, 12, 14, 15, 17 and 18 would be reported as inventory in the financial
statements.
The other items will be reported as follows:
Item
Item
Item
Item
Item
Item
Item
2
4
6
7
10
11
13
-
Item 16
Item 19
-
Cost of goods sold in the income statement
Not reported in the financial statements
Cost of goods sold in the income statement
Cost of goods sold in the income statement
Interest expense in the income statement
Advertising expense in the income statement
Office supplies in the current asset section of the balance
sheet
Not reported in the financial statements
Trading securities in the current asset section of the balance
sheet
Answer: A
1
PROBLEM NO. 2
In connection with your audit of the Alcala Manufacturing Company, you reviewed its inventory as
of December 31, 2016 and found the following items:
(a) A packing case containing a product costing P100,000 was standing in the shipping room when
the physical inventory was taken. It was not included in the inventory because it was marked
“Hold for shipping instructions.” The customer’s order was dated December 18, but the case
was shipped and the costumer billed on January 10, 2017.
(b) Merchandise costing P600,000 was received on December 28, 2016, and the invoice was
recorded. The invoice was in the hands of the purchasing agent; it was marked “On
consignment”.
(c) Merchandise received on January 6, 2017, costing P700,000 was entered in purchase register
on January 7. The invoice showed shipment was made FOB shipping point on December 31,
2016. Because it was not on hand during the inventory count, it was not included.
(d) A special machine costing P200,000, fabricated to order for a particular customer, was finished
in the shipping room on December 30. The customer was billed for P300,000 on that date and
the machine was excluded from inventory although it was shipped January 4, 2017.
(e) Merchandise costing P200,000 was received on January 6, 2017, and the related purchase
invoice was recorded January 5. The invoice showed the shipment was made on December 29,
2016, FOB destination.
(f) Merchandise costing P150,000 was sold on an installment basis on December 15. The customer
took possession of the goods on that date. The merchandise was included in inventory because
Alcala still holds legal title. Historical experience suggests that full payment on installment sale
is received approximately 99% of the time.
(g) Goods costing P500,000 were sold and delivered on December 20. The goods were included in
the inventory because the sale was accompanied by a purchase agreement requiring Alcala to
buy back the inventory in February 2017.
Question:
Based on the above and the result of your audit, how much of these items should be included in the
inventory balance at December 31, 2016?
a. P1,300,000
c. P1,650,000
b. P 800,000
d. P1,050,000
Suggested Solution:
Unshipped goods
Purchased merchandise shipped
FOB shipping point
Goods used as collateral for a loan
Total
P 100,000
700,000
500,000
P1,300,000
Reasons for including and excluding the items:
a)
b)
c)
d)
e)
f)
g)
Included - Merchandise should be included in the inventory until shipped. An exception would be
special orders.
Excluded - Alcala Manufacturing has the merchandise on a consignment basis and therefore does
not possess legal title.
Included - The merchandise was shipped FOB shipping point and therefore would be included in
the inventory on the shipping date.
Excluded - Title may pass on special orders when segregated for shipment.
Excluded - The merchandise was shipped FOB destination and was not received until January 3,
2016.
Excluded - Historical experience suggests that Alcala will collect the full purchase price, so the sale
is recognized even though legal title has not passed.
Included - This is not a sale of inventory but instead is a loan with the inventory as collateral.
Answer: A
2
PROBLEM NO. 3
You were engaged by Asingan Corporation for the audit of the company’s financial statements for
the year ended December 31, 2016. The company is engaged in the wholesale business and makes
all sales at 25% over cost.
The following were gathered from the client’s accounting records:
SALES
Date
Reference
Balance forwarded
12/27
SI No. 965
12/28
SI No. 966
12/28
SI No. 967
12/31
SI No. 969
12/31
SI No. 970
12/31
12/31
PURCHASES
Amount
P7,800,000
60,000
225,000
15,000
69,000
102,000
SI No. 971
Closing entry
Date
Reference
Balance forwarded
12/28
RR #1059
12/30
RR #1061
12/31
RR #1062
12/31
RR #1063
12/31
Closing entry
Amount
P4,200,000
36,000
105,000
63,000
96,000
(4,500,000)
P
-
24,000
(8,295,000)
P
-
Note: SI = Sales Invoice
RR = Receiving Report
Accounts receivable
Inventory
Accounts payable
P750,000
900,000
600,000
You observed the physical inventory of goods in the warehouse on December 31 and were satisfied
that it was properly taken.
When performing sales and purchases cut-off tests, you found that at December 31, the last
Receiving Report which had been used was No. 1063 and that no shipments had been made on any
Sales Invoices whose number is larger than No. 968. You also obtained the following additional
information:
a)
Included in the warehouse physical inventory at December 31 were goods which had been
purchased and received on Receiving Report No. 1060 but for which the invoice was not received
until the following year. Cost was P27,000.
b) On the evening of December 31, there were two trucks in the company siding:
 Truck No. XXX 888 was unloaded on January 2 of the following year and received on
Receiving Report No. 1063. The freight was paid by the vendor.
 Truck No. MGM 357 was loaded and sealed on December 31 but leave the company
premises on January 2. This order was sold for P150,000 per Sales Invoice No. 968.
c)
Temporarily stranded at December 31 at the railroad siding were two delivery trucks enroute to
ABC Trading Corporation. ABC received the goods, which were sold on Sales Invoice No. 966
terms FOB Destination, the next day.
d) Enroute to the client on December 31 was a truckload of goods, which was received on Receiving
Report No. 1064. The goods were shipped FOB Destination, and freight of P2,000 was paid by
the client. However, the freight was deducted from the purchase price of P800,000.
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Sales for the year ended December 31, 2016
a. P8,100,000
c. P7,875,000
b. P7,725,000
d. P8,025,000
2. Purchases for the year ended December 31, 2016
a. P4,500,000
c. P5,631,000
b. P5,727,000
d. P4,527,000
3. Accounts receivable as of December 31, 2016
a. P330,000
c. P525,000
b. P555,000
d. P180,000
4. Inventory as of December 31, 2016
a. P1,452,000
b. P1,221,000
c. P1,200,000
d. P1,296,000
5. Accounts payable as of December 31, 2016
a. P600,000
c. P 531,000
b. P627,000
d. P1,827,000
3
Suggested Solution:
Questions No. 1 to 5
Unadjusted
balances
AJE No. 1
AJE No. 2
AJE No. 3
AJE No. 4
AJE No. 5
AJE No. 6
Adjusted
balances
Sales
Purchases
AR
Inventory
AP
P8,295,000
(195,000)
(225,000)
-
P4,500,000
27,000
-
P750,000
(195,000)
(225,000)
-
P900,000
96,000
120,000
180,000
P600,000
27,000
-
P7,875,000
P4,527,000
P330,000
P1,296,000
P627,000
Adjusting entries:
1) Sales (P69,000+P102,000+P24,000)
Accounts receivable
P195,000
P195,000
To adjust unshipped goods recorded as sales (SI No. 969, 970 and 971)
2) Purchases
Accounts payable
P27,000
P27,000
To take up unrecorded purchases (RR No. 1060)
3) Inventory
Cost of sales
P96,000
P96,000
To take up goods under RR No. 1063
4) Inventory (P150,000/1.25)
Cost of sales
P120,000
P120,000
To take up unshipped goods under SI No. 968
5) Sales
Accounts receivable
P225,000
P225,000
To reverse entry made to record SI No. 966
6) Inventory (P225,000/1.25)
Cost of sales
P180,000
P180,000
To take up goods under SI No. 966
Answers: 1) C; 2) D; 3) A; 4) D, 5) B
PROBLEM NO. 4
The Mangaldan Merchandising Company is a leading distributor of kitchen wares. The company
uses the first-in, first-out method of calculating the cost of goods sold. The following information
concerning two of the company’s products is taken from the month of May:
May 1, beginning inventory
PANS
No. of
Unit
units
cost
10,000
P 60
Purchases:
May 15
May 25
14,000
6,000
Sales for the month
65
75
20,000
(@ P80)
KETTLES
No. of
Unit
units
cost
6,000
P 40
9,000
P 42
10,000
(@ P44)
On May 31, Mangaldan’s suppliers reduced their price from the last purchase price by the following
percentages:
Pans…………………..25%
Kettles…………………20%
Accordingly, the company agreed to reduce selling prices by 15% on all items beginning June 1.
Mangaldan Merchandising Company’s selling costs are calculated at 10% of selling price.
products have a normal profit of 30% on sales prices (after selling costs).
QUESTIONS:
Based on the above and the result of your audit, answer the following:
4
Both
1. Total cost of Pans as of May 31 is
a. P710,000
b. P653,300
c. P600,000
d. P612,000
2. Total cost of Kettles as of May 31 is
a. P210,000
b. P206,000
c. P200,000
d. P168,300
3. The inventory at May 31 should be valued at
a. P768,300
c. P920,000
b. P780,300
d. P890,000
4. The loss on inventory write down for the month of May is
a. P139,700
c. P29,300
b. P137,300
d. P27,600
5. The cost of sales, before loss on inventory write down, for the month of May is
a. P1,778,000
c. P1,797,700
b. P1,685,600
d. P1,658,000
Suggested Solution:
Question No. 1
4,000 units @ P65
6,000 units @ P75
Total cost of Pans
P260,000
450,000
P710,000
Question No. 2
Total cost of Kettles (5,000 units @ P42)
P210,000
Question No. 3
Item
Pans
Kettles
Units
4,000
6,000
5,000
Unit Cost
P65
75
42
NRV*
P61.20
61.20
33.66
Inventory
Amount**
P244,800
367,200
168,300
P780,300
* Estimated selling price – Estimated cost to sell
** Lower of cost or NRV
Question No. 4
Total cost of inventory (P710,000 + P210,000)
Less inventory value (see no. 3)
Required allowance for inventory writedown
Less allowance, May 1 (6,000 x P0.40)
Loss on inventory writedown for May
P920,000
780,300
139,700
2,400
P137,300
Question No. 5
Pans:
10,000 units @ P60
10,000 units @ P65
Kettles:
6,000 units @ P40
4,000 units @ P42
Total cost of sales
Alternative computation:
Inventory, 5/1:
Pans (10,000 units x P60)
Kettles (6,000 units x P40)
Add purchases:
Pans [(14,000 units x P65) +
(6,000 x P75)]
Kettles (9,000 units x P42)
Total goods available for sale
Less inventory, 5/31 (at cost)
Cost of sales, before inventory
writedown
P600,000
650,000
240,000
168,000
P600,000
240,000
1,360,000
378,000
P1,250,000
408,000
P1,658,000
P 840,000
1,738,000
2,578,000
920,000
P1,658,000
Answers: 1) A; 2) A; 3) B; 4) B, 5) D
5
PROBLEM NO. 5
On March 31, 2016 San Fabian Company had a fire which completely destroyed the factory building
and inventory of goods in process; some of the equipment was saved.
After the fire, a physical inventory was taken.
finished goods at P620,000.
The material was valued at P750,000 and the
The inventories on January 1, 2016 consisted of:
Materials
Goods in process
Finished goods
Total
P 310,000
1,215,000
1,700,000
P3,225,000
A review of the accounting records disclosed that the sales and gross profit on sales for the last
three years were:
2013
2014
2015
Sales
P8,000,000
7,600,000
5,000,000
Gross profit
P2,400,000
2,215,000
1,776,000
The sales for the first three months of 2016 were P3,000,000. Material purchases were P1,250,000,
transportation on purchases was P100,000 and direct labor cost for the three months was
P1,000,000. For the past two years, factory overhead cost has been 80% of direct labor cost.
QUESTIONS:
Based on the above and the result of your audit, compute the following:
1. The most likely gross profit rate to be used in estimating the inventory of goods in process
destroyed by fire
a. 31.55%
c. 35.52%
b. 32.76%
d. 36.00%
2. Total cost of goods placed in process
a. P2,710,000
b. P973,500
c. P3,925,000
d. P4,375,000
3. Total cost of goods manufactured
a. P3,133,500
b. P 973,500
c. P 854,400
d. P3,014,400
4. Inventory of goods in process lost
a. P 791,500
b. P1,360,600
c. P 119,100
d. P2,951,500
Suggested Solution:
Question No. 1
Gross profit
Divide by Sales
Gross profit rate
Average gross profit rate
2013
P2,400,000
P8,000,000
30.00%
2014
P2,215,000
P7,600,000
29.14%
2015
P1,776,000
P5,000,000
35.52%
31.55%
Questions No. 2 to 4
Raw materials, 1/1/16
Purchases
Freight-in
Raw materials available for use
Raw materials, 3/31/16
Raw materials used
Direct labor
Factory overhead (P1,000,000 x 80%)
Total manufacturing cost
Work-in-process, 1/1/16
Total cost placed in process
Less work-in-process, 3/31/16 (squeeze)
Cost of goods manufactured
Finished goods, 1/1/16
P 310,000
1,250,000
100,000
1,660,000
(750,000)
910,000
1,000,000
800,000
2,710,000
1,215,000
3,925,000
(2,951,500)
973,500
1,700,000
6
(2)
(4)
(3)
Total goods available for sale
Less finished goods, 3/31/16
Cost of goods sold (P3,000,000 x 68.45%)
2,673,500
(620,000)
P2,053,500
Answers: 1) A; 2) C; 3) B; 4) D
PROBLEM NO. 6
You obtained the following information in connection with your audit of Villasis Corporation:
Beginning inventory
Sales
Purchases
Freight in
Mark ups
Mark up cancellations
Markdown
Markdown cancellations
Cost
P1,987,200
4,688,640
94,560
Retail
P2,760,000
7,812,000
6,512,000
720,000
120,000
240,000
40,000
Villasis Corp. uses the retail inventory method in estimating the values of its inventories and costs.
QUESTIONS:
Based on the above and the result of your audit, answer the following:
1. The cost ratio to be used considering the provisions of PAS 2 is
a. 68.58%
c. 70.00%
b. 69.20%
d. 75.78%
2. The estimated ending inventory at retail is
a. P2,300,000
c. P1,940,000
b. P2,060,000
d. P1,860,000
3. The estimated ending inventory at cost is
a. P1,412,786
c. P1,302,000
b. P1,275,588
d. P1,287,120
4. The estimated cost of goods sold is
a. P5,468,400
b. P5,494,812
c. P5,357,614
d. P4,685,117
Suggested Solution:
Question No. 1
Beginning inventory
Purchases
Freight in
Net mark up (P720,000 - P120,000)
Net mark down (P240,000 - P40,000)
Goods available for sale
Cost
P1,987,200
4,688,640
94,560
___________
P6,770,400
Cost ratio (P6,770,400/P9,672,000)
Retail
P2,760,000
6,512,000
720,000
120,000
P9,672,000
70%
PAS 2 par. 22 states that the retail inventory method is often used in the retail industry for
measuring inventories of large numbers of rapidly changing items with similar margins for which it
is impracticable to use other costing methods. The cost of inventory is determined by reducing the
sales value of the inventory by the appropriate percentage gross margin. The percentage used
takes into consideration inventory that has been marked down to below its original selling price.
An average percentage for each retail department is often used.
Previously, the conventional approach (lower of average cost or market valuation) is often used if
the problem is silent. The conventional approach ignores markdown in the computation of cost
ratio. However, since PAS 2 specifically states that the percentage should take into
consideration inventory that has been marked down to below its original selling price,
the cost ratio was computed using the average method.
Question No. 2
Goods available for sale at retail
Less sales
Ending inventory, at retail
P9,672,000
7,812,000
P1,860,000
7
Question No. 3
Ending inventory, at cost (P1,860,000 x 70%)
P1,302,000
Question No. 4
Goods available for sale at cost
Less ending inventory, at cost
Estimated cost of sales
P6,770,400
1,302,000
P5,468,400
Answers: 1) C; 2) D; 3) C; 4) A
8