Chapter 11: Auditing Inventory, Goods and Services, and Accounts Payable: The Acquisition and
Chapter 11: Auditing Inventory, Goods and Services,
and Accounts Payable: The Acquisition and Payment Cycle
Payment Cycle
Student: ___________________________________________________________________________
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.
True False
2. The major accounts in the acquisition and payment cycle are inventory, cost of goods sold, accounts payable,
and other expense accounts.
True False
3. An indication of potential inventory fraud is that inventory levels are growing faster than sales.
True False
4. The acquisition process begins with a purchase of goods or services.
True False
5. Supply chain management has helped many companies improve the efficiency of operations.
True False
6. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
True False
7. Most organizations use a perpetual inventory system to manage inventory.
True False
8. Inventory turnover is often calculated by the auditor for proper disclosure in client financial statements.
True False
9. A networked software system linking a company’s Web site to other vendors whose offerings and prices have
been preapproved by appropriate management is call an automated purchasing system.
True False
10. A major control benefit of a centralized purchasing department is the segregation of the authorization
function from the custody and recording functions.
True False
11. A purchase order identifies the quantity and description of products that have been received.
True False
12. For proper control, the receiving department should receive a copy of the purchase order that has the
quantities blanked out.
True False
13. An individual outside of the purchasing department should be the only individual with access to the vendor
tables in the database.
True False
14. The auditor's primary concern with accounts payable is that of existence.
True False
15. Reconciliation of vendor statements to recorded payables provides assurance related to the completeness
assertion.
True False
16. Approval of items for payment usually involves a three-way match among the vendor invoice, the purchase
order, and the receiving report.
True False
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.
True False
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.
True False
19. The use of analytical review procedures applied to related expense accounts would not be used to determine
if accounts payable were understated.
True False
20. Analytical review of related expense accounts when auditing accounts payable would be used when control
risk is assessed as low.
True False
21. Testing cash disbursements subsequent to the year under audit allows the auditor to determine certain
payables that may not have been recorded previously.
True False
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.
True False
23. The auditor tests significant repairs and maintenance expenses to ensure that an item that should be
capitalized has not been expensed.
True False
24. The lower of cost or market assumption is not important to valuation of inventory.
True False
25. Proper internal control over the inventory account would require that inventory items should be reviewed
for obsolescence and proper accounting treatment.
True False
26. Many frauds are committed by overstating inventory accounts.
True False
27. Inventory may become obsolete because of technological advances even though there are no signs of
physical wear.
True False
28. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
True False
29. The auditor is required by generally accepted accounting principles (GAAP) to observe the taking of
physical inventory.
True False
30. The inventory observation is performed for the purpose of determining the accuracy of client counting
procedures.
True False
31. Test counts are performed by the auditor to give the impression of control and they are not used for
substantive testing.
True False
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.
True False
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.”
True False
34. Legal expenses are reviewed by auditors for possible litigation and related FAS 5 treatment.
True False
35. In order to gain an understanding of internal controls, an auditor will use walkthrough of the process,
inquiry, observation, and review of the client’s documentation.
True False
36. The cash account is not part of the acquisitions and payment cycle.
True False
37. The auditor may test a manufacturing client's cost system to substantiate the valuation of inventory.
True False
38. Valuation is the most complex assertion related to inventory.
True False
39. Generally accepted auditing standards (GAAS) require the auditor to observe the taking of the physical
inventory at year-end.
True False
40. The acquisition cycle begins with the receipt of goods and services and ends with their payment as reflected
in cash disbursements.
True False
41. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
True False
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.
True False
43. The tracing of a sample of receiving reports through the recording process tests the completeness assertion.
True False
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.
True False
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.
True False
46. Stable relationships are expected between specific accounts (for example, cost of goods sold and sales) that
can be investigated for unusual discrepancies.
True False
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.
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.
49. Which of the following is not a rationale that purchasing is a separate function in many organizations?
A. Purchasing promotes efficiency and effectiveness.
B. Purchasing eliminates potential favoritism.
C. Purchasing reduces the opportunity for fraud.
D. Purchasing decentralizes control.
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.
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.
52. Which of the following management assertions is NOT relevant to inventory?
A. Existence or occurrence.
B. Completeness.
C. Rights and obligations.
D. Reporting.
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.
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.
55. Which of the following would meet the need for additional control procedures when using computergenerated 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.
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.
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. Accounts receivable statement.
D. Both A and B.
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.
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. Number of obsolete units this period compared to last.
D. Salaries of marketing personnel as a percent of total inventory.
60. Which of the following is an example of a reasonableness test?
A. Estimate the account balance and determine whether that amount is close to what the client recorded.
B. Inquire whether significant changes have been made.
C. Tour the production facilities.
D. Send confirmations to major vendors.
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.
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.
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.
C. To ensure proper recording of vendor payables.
D. To determine if there is any litigation pending or threatened.
64. Which assertion has the greatest emphasis when auditing accounts payable?
A. Existence.
B. Completeness.
C. Presentation.
D. Disclosure.
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.
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. Favorite vendors used multiple times.
C. Increased compensation of agents through side agreements.
D. Mathematically accurate vendor invoices.
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.
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.
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.
70. Please indicate the proper sequence of the acquisition cycle:
1. Approval of items for payment.
2. Authorized requisition for goods or services.
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
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.
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.
73. Which of the following is a reason why an automated purchasing system is beneficial?
A. Apply preloaded specifications and materials lists to the system to start the process.
B. Automatically flag invoices that do not reconcile with purchase orders.
C. Create change orders and analyze variances from purchase orders.
D. All of the above.
74. A risk to the auditor due to the complexity of physical inventory includes the possibility of which of the
following?
A. Overstatement of individual items across multiple locations for cutoff testing.
B. Utility of the items exceeding their cost for existence testing.
C. Movement of goods during existence testing.
D. Stocking of only one type of inventory in the warehouse for presentation and disclosure testing.
75. Which of the following is NOT a system of internal financial accounting 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.
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 test count.
B. Review vendor invoices for the amounts recorded.
C. Perform year-end tests of invoices received in the final month.
D. Trace raw material purchases to invoices and to the general ledger.
77. Which of the following would the auditor most likely do when testing the valuation assertion?
A. Confirm inventory on consignment.
B. Examine receiving reports for inventory, tracing the recorded amounts.
C. Observe the taking of physical inventory.
D. Trace raw material purchases to vendor invoices.
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.
79. Which of the following procedures will usually be performed by the auditor to actively determine obsolete
inventory?
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.
80. A perpetual inventory system is preferable to a periodic system if adequately controlled and maintained
because of which of the following?
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.
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.
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.
83. The inventory of Brown Company is distributed between 85 stores throughout the United States, Puerto
Rico and Mexico. Brown has a calendar year-end, uses a periodic inventory system and performs a physical
count on January 1st of each year. In the planning of the audit of Brown, the engagement team must consider
which of the following?
A. Whether or not the finance departments in Mexico and Puerto Rico are available to perform the audit testing
on January 1st.
B. Which of the stores to randomly visit and how many items to test.
C. The risk of the company transporting items from Maine to Mexico between audit counts.
D. Coordinating with the client which stores will be visited for inventory observation.
84. When the auditor reviews vendor invoices while testing disbursements to determine whether the client
actually owes a liability for the accounts payable, the auditor is testing for which assertion?
A. Completeness.
B. Existence.
C. Rights and Obligations.
D. Valuation.
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 information about all outstanding invoices, payment
terms, payment histories, and so forth.
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.
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.
87. The auditor in making inquiries regarding the standard cost systems normally does not 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 identifying variances, following up on their causes, and allocating them to inventory
and cost of goods sold.
88. The acquisition cycle begins with which of the following?
A. A payment.
B. A purchase order.
C. A requisition.
D. A receiving report.
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.
90. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?
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.
E. All of the above are standard audit procedures in the observation of inventory.
91. All of the following are required by the auditor before allowing the client to take inventory before year-end
except which one?
A. Absence of “red flags”.
B. Internal control is weak.
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.
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.
93. Acquisition and payment processes
What are the five major phases of the acquisition and payment process?
94. Centralized purchasing
List the advantages for implementing a centralized purchasing function. What are the disadvantages (if any)?
95. Cost accounting systems
When auditing a manufacturing concern, what major inquiries might be made by the auditor about the cost
accounting system?
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.
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.
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?
99. Physical inventory procedures
Discuss the procedures the audit team will most likely perform during the physical observation of inventory.
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.
101. Inventory controls
What are some of the important controls that are expected to be included in a well-conceived inventory control
system?
102. Comparison of Controls in Traditional and Automated Systems
Discuss the differences between a traditional receiving system and an automated integrated receiving system.
Chapter 11: Auditing Inventory, Goods and Services, and Accounts
Payable: The Acquisition and Payment Cycle Key
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.
TRUE
2. The major accounts in the acquisition and payment cycle are inventory, cost of goods sold, accounts payable,
and other expense accounts.
TRUE
3. An indication of potential inventory fraud is that inventory levels are growing faster than sales.
TRUE
4. The acquisition process begins with a purchase of goods or services.
FALSE
5. Supply chain management has helped many companies improve the efficiency of operations.
TRUE
6. Management may intentionally misstate inventory balances by overvaluing items that are obsolete.
TRUE
7. Most organizations use a perpetual inventory system to manage inventory.
TRUE
8. Inventory turnover is often calculated by the auditor for proper disclosure in client financial statements.
FALSE
9. A networked software system linking a company’s Web site to other vendors whose offerings and prices have
been preapproved by appropriate management is call an automated purchasing system.
TRUE
10. A major control benefit of a centralized purchasing department is the segregation of the authorization
function from the custody and recording functions.
TRUE
11. A purchase order identifies the quantity and description of products that have been received.
FALSE
12. For proper control, the receiving department should receive a copy of the purchase order that has the
quantities blanked out.
TRUE
13. An individual outside of the purchasing department should be the only individual with access to the vendor
tables in the database.
TRUE
14. The auditor's primary concern with accounts payable is that of existence.
FALSE
15. Reconciliation of vendor statements to recorded payables provides assurance related to the completeness
assertion.
TRUE
16. Approval of items for payment usually involves a three-way match among the vendor invoice, the purchase
order, and the receiving report.
TRUE
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.
FALSE
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.
TRUE
19. The use of analytical review procedures applied to related expense accounts would not be used to determine
if accounts payable were understated.
FALSE
20. Analytical review of related expense accounts when auditing accounts payable would be used when control
risk is assessed as low.
TRUE
21. Testing cash disbursements subsequent to the year under audit allows the auditor to determine certain
payables that may not have been recorded previously.
TRUE
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.
FALSE
23. The auditor tests significant repairs and maintenance expenses to ensure that an item that should be
capitalized has not been expensed.
TRUE
24. The lower of cost or market assumption is not important to valuation of inventory.
FALSE
25. Proper internal control over the inventory account would require that inventory items should be reviewed
for obsolescence and proper accounting treatment.
TRUE
26. Many frauds are committed by overstating inventory accounts.
TRUE
27. Inventory may become obsolete because of technological advances even though there are no signs of
physical wear.
TRUE
28. Sources of information regarding a client's inventory obsolescence can be partially noted during the
inventory observation.
TRUE
29. The auditor is required by generally accepted accounting principles (GAAP) to observe the taking of
physical inventory.
FALSE
30. The inventory observation is performed for the purpose of determining the accuracy of client counting
procedures.
TRUE
31. Test counts are performed by the auditor to give the impression of control and they are not used for
substantive testing.
FALSE
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.
FALSE
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.”
TRUE
34. Legal expenses are reviewed by auditors for possible litigation and related FAS 5 treatment.
TRUE
35. In order to gain an understanding of internal controls, an auditor will use walkthrough of the process,
inquiry, observation, and review of the client’s documentation.
TRUE
36. The cash account is not part of the acquisitions and payment cycle.
FALSE
37. The auditor may test a manufacturing client's cost system to substantiate the valuation of inventory.
TRUE
38. Valuation is the most complex assertion related to inventory.
TRUE
39. Generally accepted auditing standards (GAAS) require the auditor to observe the taking of the physical
inventory at year-end.
TRUE
40. The acquisition cycle begins with the receipt of goods and services and ends with their payment as reflected
in cash disbursements.
FALSE
41. Prenumbered receiving documents establish the completeness of the population and are useful in
determining that all goods are recorded in the correct period.
TRUE
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.
FALSE
43. The tracing of a sample of receiving reports through the recording process tests the completeness assertion.
TRUE
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.
TRUE
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.
TRUE
46. Stable relationships are expected between specific accounts (for example, cost of goods sold and sales) that
can be investigated for unusual discrepancies.
TRUE
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.
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.
49. Which of the following is not a rationale that purchasing is a separate function in many organizations?
A. Purchasing promotes efficiency and effectiveness.
B. Purchasing eliminates potential favoritism.
C. Purchasing reduces the opportunity for fraud.
D. Purchasing decentralizes control.
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.
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.
52. Which of the following management assertions is NOT relevant to inventory?
A. Existence or occurrence.
B. Completeness.
C. Rights and obligations.
D. Reporting.
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.
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.
55. Which of the following would meet the need for additional control procedures when using computergenerated 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.
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.
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. Accounts receivable statement.
D. Both A and B.
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.
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. Number of obsolete units this period compared to last.
D. Salaries of marketing personnel as a percent of total inventory.
60. Which of the following is an example of a reasonableness test?
A. Estimate the account balance and determine whether that amount is close to what the client recorded.
B. Inquire whether significant changes have been made.
C. Tour the production facilities.
D. Send confirmations to major vendors.
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.
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.
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.
C. To ensure proper recording of vendor payables.
D. To determine if there is any litigation pending or threatened.
64. Which assertion has the greatest emphasis when auditing accounts payable?
A. Existence.
B. Completeness.
C. Presentation.
D. Disclosure.
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.
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. Favorite vendors used multiple times.
C. Increased compensation of agents through side agreements.
D. Mathematically accurate vendor invoices.
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.
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.
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.
70. Please indicate the proper sequence of the acquisition cycle:
1. Approval of items for payment.
2. Authorized requisition for goods or services.
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
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.
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.
73. Which of the following is a reason why an automated purchasing system is beneficial?
A. Apply preloaded specifications and materials lists to the system to start the process.
B. Automatically flag invoices that do not reconcile with purchase orders.
C. Create change orders and analyze variances from purchase orders.
D. All of the above.
74. A risk to the auditor due to the complexity of physical inventory includes the possibility of which of the
following?
A. Overstatement of individual items across multiple locations for cutoff testing.
B. Utility of the items exceeding their cost for existence testing.
C. Movement of goods during existence testing.
D. Stocking of only one type of inventory in the warehouse for presentation and disclosure testing.
75. Which of the following is NOT a system of internal financial accounting 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.
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 test count.
B. Review vendor invoices for the amounts recorded.
C. Perform year-end tests of invoices received in the final month.
D. Trace raw material purchases to invoices and to the general ledger.
77. Which of the following would the auditor most likely do when testing the valuation assertion?
A. Confirm inventory on consignment.
B. Examine receiving reports for inventory, tracing the recorded amounts.
C. Observe the taking of physical inventory.
D. Trace raw material purchases to vendor invoices.
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.
79. Which of the following procedures will usually be performed by the auditor to actively determine obsolete
inventory?
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.
80. A perpetual inventory system is preferable to a periodic system if adequately controlled and maintained
because of which of the following?
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.
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.
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.
83. The inventory of Brown Company is distributed between 85 stores throughout the United States, Puerto
Rico and Mexico. Brown has a calendar year-end, uses a periodic inventory system and performs a physical
count on January 1st of each year. In the planning of the audit of Brown, the engagement team must consider
which of the following?
A. Whether or not the finance departments in Mexico and Puerto Rico are available to perform the audit testing
on January 1st.
B. Which of the stores to randomly visit and how many items to test.
C. The risk of the company transporting items from Maine to Mexico between audit counts.
D. Coordinating with the client which stores will be visited for inventory observation.
84. When the auditor reviews vendor invoices while testing disbursements to determine whether the client
actually owes a liability for the accounts payable, the auditor is testing for which assertion?
A. Completeness.
B. Existence.
C. Rights and Obligations.
D. Valuation.
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 information about all outstanding invoices, payment
terms, payment histories, and so forth.
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.
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.
87. The auditor in making inquiries regarding the standard cost systems normally does not 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 identifying variances, following up on their causes, and allocating them to inventory
and cost of goods sold.
88. The acquisition cycle begins with which of the following?
A. A payment.
B. A purchase order.
C. A requisition.
D. A receiving report.
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.
90. Which of the following is not a standard procedure that the auditor normally should follow in the
observation of inventory at year-end?
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.
E. All of the above are standard audit procedures in the observation of inventory.
91. All of the following are required by the auditor before allowing the client to take inventory before year-end
except which one?
A. Absence of “red flags”.
B. Internal control is weak.
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.
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.
93. Acquisition and payment processes
What are the five major phases of the acquisition and payment process?
The five phases of the acquisition and payment process are:
1.
2.
3.
4.
5.
Requisition for goods or services.
Purchase of goods or services according to company policies.
Receipt of goods and services.
Approval of items for payment.
Cash disbursements.
94. Centralized purchasing
List the advantages for implementing a centralized purchasing function. What are the disadvantages (if any)?
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.
95. Cost accounting systems
When auditing a manufacturing concern, what major inquiries might be made by the auditor about the cost
accounting system?
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.
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.
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.
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.
·
·
·
·
·
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.
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?
When auditing accounts payable, the auditor may:
1.
2.
3.
Reconcile vendor statements or returned confirmations with recorded payables. This yields a higher level of assurance.
Test subsequent disbursements for proper recording as a payable as of either the balance sheet date under audit or in the subsequent
period, as appropriate. This yields a moderate level of assurance.
Analytical review of related expense accounts to determine which accounts appear to be understated. This yields a very low level of
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.
99. Physical inventory procedures
Discuss the procedures the audit team will most likely perform during the physical observation of inventory.
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.
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.
Below are seven audit procedures that may be performed by the audit team for determining obsolete inventory
items:
1.
2.
3.
4.
5.
6.
7.
Noting potential obsolete inventory when observing the client’s physical inventory.
Calculating inventory turnover, number of days’ sales in inventory, 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 selling prices, cost of disposal, sales commissions, and so on.
Monitoring trade journals and the Internet for information regarding the introduction of competitive products.
Inquiring of management about its approach to identifying and classifying obsolete items.
Comparing current sales with budgeted sales.
Adjusting for poor condition of inventory, reported as part of periodic cycle counts.
101. Inventory controls
What are some of the important controls that are expected to be included in a well-conceived inventory control
system?
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.
102. Comparison of Controls in Traditional and Automated Systems
Discuss the differences between a traditional receiving system and an automated integrated receiving system.
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.