1. An auditor takes a sample of purchase requisitions andtraces the purchased items through the accountinginformation system, making sure that the requisitionagrees with the purchase order, the receiving report,the vendor's invoice, the accounts payable voucher, andthe canceled check.

What assertion is the auditor testing?: Typically, when anauditor starts at the source level in an accounting informationsystem and traces various documents through the system, thatauditor is making certain that nothing was lost in the actualtransaction process. Thus, the auditor's primary interest is in thecompleteness assertion. The auditor wants to answer thequestion: Has this transaction been reported in the financialstatements?

2. What departments and documents are involved whenauditing inventory and accounts payable? (Assume thatthere is a sale of an item of stocked inventory.):Departments:1. Requesting department.2. Purchasing department.3. Receiving department.4. Warehouse.5. Accounts (or Vouchers) payable.6. Cash disbursements.

Documents:1. Purchase requisition.2. Purchase order.3. Receiving report.4. Vendor's invoice.5. Accounts payable voucher.6. Check.

3. Analytical procedures must be carried out early in anaudit as part of the assessment of the risk of materialmisstatement. Analytical procedures must be carriedout at the end of the audit to make certain that anyunexpected fluctuations or changes in the financialstatements have been noticed and addressed by theauditor. Analytical procedures are quite important atthis stage of the audit process in order for the auditor tosatisfy the financial statement presentation anddisclosure-related objectives (i.e., occurrence andrights and obligations, completeness, accuracy andvaluation, and classification and understandability).

In performing analytical procedures for inventory andaccounts payable, what types of comparisons are mostlikely to be made?: Analytical procedures for inventory andaccounts payable would include the following:1. Comparisons of the absolute amount of inventory and accountspayable. As one example, the auditor would be especiallyconcerned to see an unexplained reduction in accounts payablewhen addressing the completeness assertion.2. Comparisons of the gross profit percentage (gross profitdivided by sales).3. Comparisons of inventory turnover (cost of goods sold dividedby the average inventory) would also be looked at by the auditor.4. Comparison of any changes in age of the average inventorybalance (365 divided by the inventory turnover). This indicatorcan also be called the average inventory processing period.

4. An auditor is beginning substantive testing on inventoryand accounts payable.

What are several general potential problems the auditorshould anticipate when auditing inventory andaccounts payable?: The following are the types of problemswith inventory and accounts payable that might lead to materialmisstatements if not detected by the internal controls or theauditor:1. Inventory may be damaged or obsolete, and therefore notsalable.2. Inventory may have been miscounted or misidentified.3. Year-end cut-off of purchase, receipts and consumption ofinventory are incorrect.4. Inventory physically on hand is not owned by the client, whileinventory not on hand may be on consignment at a customer'slocation.

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5. An auditor is concerned that the ending inventory countwas performed incorrectly.

If inventory is intentionally or unintentionallyovercounted, what effect does that misstatement haveon net income for that year?

If inventory is intentionally or unintentionallyundercounted, what effect does that misstatement haveon net income for that year?: 1. If inventory is overcounted,ending inventory will be reported too high. Ending inventory is anegative component of cost of good sold. If ending inventory istoo high, then cost of goods sold (an expense) will be reported asbeing too low. Net income will be artificially inflated, causing thecompany to overstate and misrepresent both its assets and netincome.2. If inventory is undercounted, ending inventory will be reportedtoo low. Ending inventory is a negative component of cost ofgoods sold. If ending inventory is too low, then cost of goods sold(an expense) will be reported too high. Net income and inventorywill be understated, causing the company to understate andmisrepresent both its ending inventory and net income for theyear.

6. A department needs a particular item of inventory or anew asset, such as a computer.

What document is initially generated when there isneed for such items?: When an item or a new asset is needed,a requisition form is prepared by the requesting department. Therequisition form for the inventory item is sometimes known as amaterials requisition.

7. A company needs a certain item of inventory or a newasset, such as a computer. A requisition form iscompleted. The requisition is reviewed and authorizedby the appropriate individual in the department.

What happens to this requisition form?: Once arequisition is approved, it is sent or transmitted to the purchasingdepartment for fulfillment. If the item being requested iscommonly in stock, then the physical goods are sent to therequisitioning department. If the item being requested must beordered from an outside vendor, the purchasing departmentprepares a purchase order from an appropriate vendor, afterperhaps securing competitive bids from several possible vendors.

8. After the purchasing department receives the purchaserequisition, what is the next step in the purchasingprocess?: After the purchasing department receives thepurchase requisition, it does the following:1. Scans the request to make sure it is within the authority of thedepartment making the request. This may necessitate checkingon budget authorizations.2. Checks the authorization signatures to make sure thatappropriate approval has been received.3. Follows a set procedure for placing an order, such as solicitingbids.

9. After a purchase order is generated by the purchasingdepartment and the order is placed with a pre-approved vendor, where does the purchase order go?: Acopy of the purchase order goes to the receiving department toserve as approval for accepting the merchandise when it arrives.On this copy, the quantities are generally blanked out toencourage a more accurate count of the merchandise when it isreceived.

Another copy of the purchase order goes to the accounts (orvouchers) payable department as documentation of the purchase.

10. When goods arrive at the receiving department, whatare the appropriate procedures for these entitypersonnel?: Based on the purchase order, the receivingdepartment should:1. Verify the description of the physical goods with the purchaseorder.2. Count the goods.3. Check the condition of the goods.

There should be a company policy in place about rejecting goodsthat do not fit the description of the purchase order or handlingitems that are obviously damaged in shipment to the entity.

11. What happens to goods after they have been accepted bythe receiving department?: Goods are then transferred fromthe receiving department to the warehouse (or supply room) or tothe department that has specifically requested the item.

When the goods are conveyed, the warehouse should once againcheck the condition and description and quantity of the itemsbeing conveyed.

The receiving department should get a signed receipt or othersign-off for this in-house delivery.

12. How should the handling of an entity's merchandise beorganized?: Normally, three, but quite possibly four,independent departments are involved with inventory and othermerchandise received or shipped:1. Receiving department.2. Shipping department.3. Warehouse.4. Requisitioning department.

13. What documents are generated and sent from thevendor after goods are ordered by the entity?: Both anorder acknowledgement and eventually an invoice should be sentfrom the vendor. These documents identify the company that hasplaced the purchase order with the vendor, the address where theitem(s) are to be shipped, and either acknowledge or invoice thecompany for the item(s) ordered and received:1. Price of the item(s).2. Quantity ordered.3. Description of the item(s) ordered.4. Terms of the sale (such as 2/10, n/30) and the due date of theinvoice.

14. Which department receives the vendor's invoice, andwhat actions should be taken with it?: The accounts (orvouchers) payable department gets the vendor's invoice. Thisdocument is reviewed to make sure that the terms and otherinformation on it are accurate.

The vendor's invoice is then compared to the purchaserequisition, the purchase order, and the receiving report to ensurethat all steps in the purchase order process have been properlyauthorized and that all documents are in agreement.

15. What documentation takes place once all purchasedocuments are reconciled and all authorizations areverified?: An accounts payable voucher is generated to handlethe processing of the vendor's invoice for final payment.Oftentimes, the purchase documentation is attached to orcombined with the voucher to form a voucher package.

16. After receiving the approved voucher, what roles andresponsibilities does the cash disbursementsdepartment have?: The accounts payable voucher is usuallyfiled by due date, taking into consideration any discount termsthat might be available. On the voucher payment date, the cashdisbursements department prepares a check. The check iscompared to the documentation and then both the check andaccounts payable voucher are delivered to the individual who isauthorized to sign the check. Generally, a check register will becreated when the check is processed that will also be delivered tothe check signer. The check is then mailed under the auspices ofthe check signer.

17. An auditor takes a sample of cleared checks written forpurchases and then finds individual support for themby looking at the related voucher, vendor's invoice,receiving report, purchase order, and requisition.

What assertion(s) is the auditor testing?: Whenever theauditor takes an item that is part of the accounting records andseeks to substantiate that item by looking at the supportingdocumentation, the auditor is primarily interested in theoccurrence, completeness, classification, and accuracyassertions.

The auditor is attempting to answer: "Does this transactionpertain to the entity?", "Are all components of this transactionrecorded that should have been recorded?", "Are the amountsrecorded appropriately?", and "Is the item properly classified?".

18. An auditor is examining inventory to determine iffreight-in has been properly recognized.

What assertion is being tested?: In this case, the auditor isconcerned with the cost that is being reported for the inventoryvalue. Therefore, the valuation assertion is being tested.

Note:1. If the question is "Did the transaction get recorded?", then thecompleteness assertion is being tested.2. If the question is "Did too many transactions get recorded?",then, the existence or occurrence assertion is being tested.3. If the question is "Did the right number get recorded for thetransaction?", then, the accuracy assertion is being tested.

19. An auditor usually confirms accounts receivable.

Does the auditor also typically confirm accountspayable?: Accounts payable can be confirmed and is confirmedon infrequent occasions. However, with accounts payable, theauditor is concerned more with the completeness assertion,rather than the existence assertion. Confirmation is not atraditional test when reported balances might be subject to eitherunderreporting or no reporting at all.

20. An auditor takes a sample of accounts payabletransactions recorded during the three to five daysprior to the end of Year 1 and verifies that they were notsupposed to be reported in Year 2.

What assertion is being tested?: The auditor is investigatingwhether or not these transactions actually occurred and shouldbe recognized in the reporting period. Thus, this test is made tosubstantiate the existence, the occurrence, and the cutoffassertions.

21. When a check is prepared to pay an account payablevoucher, what takes place within the accountingrecords?: The check should be supported by the check registeror cash disbursements journal. The total of the check register orcash disbursements journal becomes a credit item for cash and adebit item for accounts payable in the general ledger.

22. An auditor takes a sample of accounts payabletransactions recorded during the three to five daysimmediately after the end of Year 1 and verifies thatthey were not supposed to be reported in Year 1.

What assertion(s) is being tested?: The auditor isinvestigating whether these transactions should be included inYear 1 or Year 2. Whenever an auditor is investigating whethertransactions were left out of a reporting period, the auditor istesting the completeness and cutoff assertions.

23. The subsequent period is the time period between theend of the reporting company's fiscal year and the lastday of the auditor's field work. The auditor looks foraudit evidence during this period of time.

What types of evidence might an auditor examineduring this time period in substantiating inventory andaccounts payable amounts?: In the subsequent period, theauditor should look at each of the following:1. Cash payments that might indicate year-end liabilities thatwere not recorded.2. Receipt of inventory that might have belonged to the companyat year-end, but was not recorded as such at year-end.3. Invoices received by the company that might indicate year-endliabilities.4. Perishable and other inventory that fails to sell, which mightindicate that it should have been written down at year-end.

24. An auditor is concerned that the reporting entity mighthave inventory out on consignment at year-end.

How might the auditor gather evidence in this matter?:In searching for consigned inventory, the auditor:1. Reviews the contracts file for any documentation of such anarrangement. The auditor could also check the prior year's auditfile for any information on consigned inventory and how it wasinvestigated in that audit.2. Watches for suspicious receivable transactions where cashpayments were made in periodic or random intervals. theconsignee company may be making payments to the client as theitems are sold.3. Reviews all returned accounts receivable confirmations todetermine if there is any mention of goods being held onconsignment.

25. When should a company take its physical inventorycount?: If a company is using a periodic inventory system suchthat there are no records to indicate the account balance ininventory, the physical inventory count must be taken at or nearthe end of the reporting period.

If a company is using a perpetual inventory system such thatthere are records of inventory items continually available, thephysical count can be taken at virtually any time during the year.However, if the auditor's assessment of either inherent risk orcontrol risk is relatively high, the auditor will probably demandthat the physical count be accomplished on the last day of thereporting period.

26. What is the independent auditor's role in connectionwith the physical inventory count?: The auditor should bepresent to observe the inventory count in order to ensure that thecompany has performed this task accurately. The auditor wouldremain available throughout the process to answer questionsfrom or concerns of those individuals who are engaged in thecount.

27. In observing the inventory count, the auditor expects tosee all obsolete and damaged inventory separated fromthe salable inventory.

Why is this important? What assertion is being tested?:Obsolete and damaged inventory (as well as any other inventorythat might be unsalable) should be valued at its net realizablevalue (expected sales price less any cost to sell). the auditor istesting the valuation assertion when he considers what items ofinventory might be obsolete, damaged, or otherwise unsalable.

28. In observing the physical inventory at year-end, theauditor takes and records test counts.

What is the purpose of this audit step?: The test counts ofinventory items are taken to verify the accuracy of the client'scount.

The test counts are recorded so they can be reconciled with thecosting figures later documented by the client. For example, if theclient asserts that the 20 sofas on hand at year-end have a cost of$198 each, the auditor wants to make sure that 20 was thenumber of sofas on hand at year-end.

The client's inventory valuation (and, hence, the cost of goodssold and net income) can be manipulated simply by increasing ordecreasing the number of units that were supposedly on handand counted at year-end.

29. Which management assertion is affected when thenumber of units of inventory is understated?

Which management assertion is affected when thenumber of units of inventory is overstated?: Understatedinventory means that certain transactions have been left off thefinancial statements at year-end, which affects the completenessassertion. This situation could involve the underreporting ofinventory that is physically present at year-end.

Overstated inventory means that extra transactions wereincluded in the financial statements, which affects the existenceand perhaps the cutoff assertions.

30. The inventory turnover rate has decreased rathersignificantly during the current reporting year.

What types of problems might this indicate?: If theinventory rate has declined during the current reporting period,either the cost of goods sold amount has declined or the averageinventory amount has increased, which might indicate thefollowing problems:1. Obsolete or damaged inventory or just excess inventory isbeing held, which is inflating the inventory figure.2. Year-end inventory cut-off transactions were perhaps handledincorrectly, and some of the ending inventory items should nothave been included.3. The application of FIFO or LIFO inventory valuation iscomputed incorrectly, causing inventory and cost of goods sold tobe incorrectly stated.

31. After a check is written, signed, and mailed, whathappens to the accounts payable voucher?: Because anaccounts payable voucher is an approval to disburse a payment,the company is concerned that a voucher could be reused totrigger the processing of additional checks. Therefore,immediately after the check is signed, the voucher should bedefaced or marked in some way so as to prevent its reuse. "Paid"can be stamped on the voucher in obvious places, or the vouchercould be perforated mechanically with the date paid clearlyindicated.

32. What management assertion is most important when anauditor examines accounts payable?: Companies oftenunderstate their liabilities because this understatement improvesnet income, current ratio, and net worth. Recording of accountspayable is predicated upon the receipt of a document that comesform outside the company.

Whenever the auditor is concerned that transactions have beenleft off of the financial statements, the auditor is testing thecompleteness assertion.

33. When placing an order, the purchasing departmentmust prepare a purchase order.

What information should be found on a purchaseorder?: The purchase order should contain the following:1. Vendor's name.2. Quantity and price of the item ordered.3. Description of item ordered.4. Proposed terms of the invoice document.5. Destination and timing as to where and when the goods are tobe shipped.

34. The requisitioning department produces a purchaserequisition to indicate that an item (such as a computeror certain type of inventory) is needed.

What department gets this document?: The purchaserequisition is sent to the purchasing department, the departmentthat is in charge of orchestrating the company's purchasetransactions.

35. What is an approved vendor list and its purpose?: Anapproved vendor list is an authorized list or file of vendors thatthe purchasing department can buy from without additionalapproval.

By limiting the authorized vendors that the purchasingdepartment can use in its day-to-day purchasing decisions, thecompany can ensure that each vendor is legitimate and of goodquality and reputation, which helps prevent items of poor quality,perhaps higher prices, and perhaps kickbacks from unauthorizedor unscrupulous vendors.

36. What document is prepared by the receivingdepartment when goods are received?

Who gets a copy of this document?: The receivingdepartment prepares a receiving report, which lists the item'squantity, description, and condition as it was received. Copies ofthe receiving report are sent to a number of departments within acompany, including:1. Accounts (or vouchers) payable, as documentation for thereceipt of the merchandise.2. Inventory, to update its current records of the on-hand itemquantity.3. The purchasing department.

37. What happens after the accounts payable voucher hasbeen prepared, reviewed, and approved?: The accountspayable voucher should be recorded in a voucher register, whichdocuments the date and the amount of the liability and what wasacquired. The voucher register is usually totaled on a daily basis,with the appropriate records being transmitted to the generalledger. The accounts payable voucher is then physically sent tothe cash disbursements department.