Philippine School of Business Administration - Manila

Manila

Integrated Review - Auditing BLD

2nd Semester 2020-2021

Audit of Inventories

Summary of Accounting Principles for Inventories

DEFINITION:
Inventories are assets:
(a) Held for sale in the ordinary course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be consumed in the production process or in the
rendering of services.

MEASUREMENT:
Measured at lower of cost or net realizable value

Net realizable value is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.

Cost of Inventories
• Costs of purchase
• Costs of conversion
• Other costs incurred in bringing the inventories to their present location and condition.

Costs of Purchase
The costs of purchase of inventories comprise the purchase price, import duties and other non
recoverable taxes and transport, handling and other costs directly attributable to the acquisition of
finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in
determining the costs of purchase.

Costs of Conversion
• Direct labor
• Variable production overhead is allocated to each unit using the actual use of production facilities.
• Fix production overhead allocated using the normal operating capacity of production facilities.

Other Costs
Ø Other costs are included in the cost of inventories only to the extent that they are incurred in bringing
the inventories to their present location and condition. For example, it may be appropriate to include
non-production overheads or the costs of designing products for specific customers in the cost of
inventories.

Inventory cost should exclude:

• Abnormal waste
• Storage costs
• Administrative overheads unrelated to production
• Selling costs
• Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a
foreign currency
• Interest cost when inventories are purchased with deferred settlement terms.

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Cost Formulas
• The cost of inventories of items that are not ordinarily interchangeable and goods or services produced
and segregated for specific projects shall be assigned by using specific identification of their individual
costs.

• The cost of inventories, other than those that are not ordinarily interchangeable, shall be assigned by
using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost
formula for all inventories having a similar nature and use to the entity. For inventories with a different
nature or use, different cost formulas may be justified.

FIFO Perpetual and Periodic Illustrated

Units Unit Cost Total Cost
Jan. 1 Beginning balance 8,000 70.00 560,000
6 Purchase 3,000 81.00 243,000
Feb. 5 Sale 10,000
Mar. 5 Purchase 11,000 73.50 808,500
Mar. 8 Purchase return 800 73.50 58,800
Apr. 10 Sale 7,000
Apr. 30 Sale return 300

Ø If periodic FIFO is used, the ending inventory will be unit cost from the March 8 purchase and will be
deducted from the accumulation of the beginning inventory and net purchase, known as the total
goods available for sale.

Beginning balance (8,000 x 70) 560,000

Jan. 6 Purchase (3,000 x 81) 243,000
Mar. 5 Net Purchase (10,200 x 73.50) 749,700
Total goods available for sale 1,552,700
Less: Ending Inventory* (4,500 x 73.50) 330,750
Cost of goods sold 1,221,950

*Ending inventory in units (21,200 – 16,700) 4,500

Ø COGS computation under perpetual

Feb. 5 Costs of goods sold:

Jan. 1 Inventory (8,000 x 70) 560,000

Jan. 6 Inventory (2,000 x 81) 162,000
Total 722,000

April 10 Net Costs of goods sold:

Jan.6 Inventory (1,000 x 81) 81,000

Mar. 5 Inventory (5,700 x 73.50) 418,950
Total 499,950

Jan. 1 Inventory 560,000

6 Purchase 243,000
Total 803,000
Feb. 5 COGS (722,000)
Balance 81,000
Mar. 5 Net Purchase 749,700
Total 830,700
Apr. 10 Net COGS (499,950)
Apr. 30 Inventory balance 330,750

Ø Periodic Average or Weighted Average

Beginning balance (8,000 x 70) 560,000

Jan. 6 Purchase (3,000 x 81) 243,000

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Mar. 5 Net Purchase (10,200 x 73.50) 749,700
Total goods available for sale 1,552,700
Less: Ending Inventory* (4,500 x 73.24**) 329,580
Cost of goods sold 1,223,120

Total cost 1,552,700

Divide by total number of units 21,200
**Weighted average cost per unit 73.24

Ø Perpetual Average or Moving Average

Jan. 1 Inventory 560,000

6 Purchase 243,000
Total 803,000
Feb. 5 COGS (10,000 x 73.00***) (730,000)
Balance 73,000
Mar. 5 Net Purchase 749,700
Total 822,700
Apr. 10 Net COGS (6,700 * 73.46****) (492,182)
Apr. 30 Inventory balance 330,518

*** Feb 5. Average cost (803,000 / 11,000) 73.00

**** April 10 Average cost (822,700 / 11,200) 73.46

Measurement of Inventories
Ø Inventories are required to be stated at the lower of cost and net realizable value (NRV). Inventories
are usually written down to net realizable value item by item. In some circumstances, however, it may
be appropriate to group similar or related items.

EXAMPLE:

Cost NRV LCNRV

Product A 200,000 180,000 180,000
Product B 300,000 250,000 250,000
Product C 100,000 130,000 100,000
Total 600,000 560,000 530,000
Ø The total carrying amount of inventories shall be 530,000, which is the most conservative amount by
applying the LCNRV approach.

Write-Down to Net Realizable Value

Ø If the ending inventory is recorded outright at 530,000, the writedown shall be immediately recognized
in cost of goods sold. This is the direct or cost of sales method.
Ø If the ending inventory is recorded first at the cost of 600,000, a loss of 70,000 with a corresponding
credit to an allowance account shall be recognized. This is the loss/allowance method.
Ø Any write-down to NRV should be recognized as an expense in the period in which the write-down
occurs.
Ø Any reversal should be recognized in the income statement in the period in which the reversal occurs.

Recognition as an Expense
Ø When inventories are sold, the carrying amount of those inventories shall be recognized as an expense
in the period in which the related revenue is recognized.
Ø The amount of any write-down of inventories to net realizable value and all losses of inventories shall
be recognized as an expense in the period the write-down or loss occurs.
Ø The amount of any reversal of any write-down of inventories, arising from an increase in net realizable
value, shall be recognized as a reduction in the amount of inventories recognized as an expense in the
period in which the reversal occurs.
Ø Some inventories may be allocated to other asset accounts, for example, inventory used as a component
of self-constructed property, plant or equipment. Inventories allocated to another asset in this way are
recognized as an expense during the useful life of that asset.

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Required disclosures:
• Accounting policy for inventories.
• Carrying amount, generally classified as merchandise, supplies, materials, work in progress, and
finished goods. The classifications depend on what is appropriate for the enterprise.
• Carrying amount of any inventories carried at fair value less costs to sell.

• Amount of any write-down of inventories recognized as an expense in the period.

• Amount of any reversal of a writedown to NRV and the circumstances that led to such reversal.
• Carrying amount of inventories pledged as security for liabilities.
• Cost of inventories recognized as expense (cost of goods sold).

Inventory Estimation Techniques

Ø Gross Method – Based on the assumption that the gross profit applied by an entity to its products
remains approximately the same from period to period and therefore the relationship between cost of
goods sold and sales is constant.

Goods available for sale X

Less: Estimated cost of goods sold
Net sales* X
Less: Gross profit X X
Estimated ending inventory X

The cost of goods sold can also be computed if the net sale is multiplied by 1 less the GP rate if the gross
profit rate based on sales or net sales divided by 1 plus the gross profit rate if the gross profit rate is
based on cost.

*Net sales shall be gross sales less “sales returns and allowance” or “sales returns” only in order for the
estimate in ending inventory not to be overstated.

Ø Retail Method – Employed by retailers dealing with numerous different items for sale with varying mark
up percentages to keep track unit cost.

Ø Conservative Cost Ratio = GAS at cost divided by GAS at retail before net markdown
Ø Average Cost Ratio = GAS at cost divided by GAS at retail (after net markdown)
Ø FIFO Cost Ratio = Purchases at cost divided by Purchases at retail after net markdown
Ø Net sales similar to the “gross profit method” of estimation is computed by ignoring the sales
discount and sales allowance if it is separated from sales returns.

Cost Retail
Inventory, beg + +
Purchases + +
Transportation in/Freight in + NA
Purchase return - -
Purchase discount - NA
Purchase allowance - NA
Departmental transfer in + +
Departmental transfer out - -
Abnormal losses - -
Net Markup (Mark up – NA +
Mark up cancellation)
TGAS XX XX LCNRV/ Conservative
Method
Net Markdown(Mark down – NA -
Mark down cancellation)
TGAS XX XX Average Method
Less: Inventory, beg. - -
TGAS XX XX FIFO Method

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Total Goods available for sale at retail X
Less: Net sales X
Employee discounts X
Normal losses X X
Estimated ending inventory at retail X
Multiplied by the cost ratio %
Estimated ending inventory at cost X

Total Goods available for sale at cost X

Less: Estimated ending inventory at cost X
Cost of goods sold X

MULTIPLE CHOICE QUESTIONS

THEORY

1. Which of the following audit procedures probably provides the most reliable evidence concerning the entity’s
assertion of rights and obligations related to inventories?
a. Trace test counts noted during the entity’s physical count to the entity’s summarization of quantities.
b. Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens.
c. Select the last few shipping advices used before the physical count and determine whether shipments were
recorded as sales.
d. Inspect the open purchase order file for significant commitments that should be considered for disclosure.

2. An auditor most likely to inspect loan agreements under which an entity’s inventories are pledged to support
management’s financial statement assertion of
a. Existence or occurrence. c. Presentation and disclosure.
b. Completeness. d. Valuation or allocation.

3. An auditor selected items for test counts while observing a client’s physical inventory. The auditor then
traced the test counts to the client’s inventory listing. This procedure most likely obtained evidence concerning
a. Existence or occurrence. c. Rights and obligations.
b. Completeness. d. Valuation.

4. A client maintains perpetual inventory records in both quantities and pesos. If the assessed level of control
risk is high an auditor will probably
a. Apply gross profit tests to ascertain the reasonableness of the physical counts.
b. Increase the extent of tests of controls relevant to the inventory cycle.
c. Request the client to schedule the physical inventory count at the end of the year.
d. Insist that the client perform physical counts of inventory items several times during the year.

5. After accounting for a sequential of inventory tags, an auditor traces a sample of tags to the physical
inventory listing to obtain evidence that all items
a. Included in the listing have been counted.
b. Represented by inventory tags are included in the listing.
c. Included in the listing are represented by inventory tags.
d. Represented by inventory tags are bona fide.

6. If the perpetual inventory records show lower quantities of inventory that the physical count an explanation
of the difference might be unrecorded
a. Sales. c. Purchases.
b. Purchase returns. d. Purchase discounts.

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

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8. An auditor is most likely to learn of slow-moving inventory through
a. Inquiry of sales personnel
b. Inquiry of warehouse personnel
c. Physical observation of inventory
d. Review of perpetual inventory records.

9. Purchase cut-off procedures should be designed to test whether all inventory

a. Purchased and received before year-end was paid for.
b. Ordered before year-end was received.
c. Purchased and received before year-end was recorded.
d. Owned by the company is in the possession of the company at year-end.

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

11.An auditor’s observation of physical inventories at the main plant at year-end provides direct evidence to
support which of the following objectives?
a. Accuracy of the priced-out inventory.
b. Evaluation of lower of cost or market test.
c. Identification of obsolete or damaged merchandise to evaluate allowance (reserve) for obsolescence.
d. Determination of goods on consignment at another location.

PRACTICAL QUESTIONS

Problem 1
1. In the shipping room was a product costing P13,400 when the physical count was taken. Because it was
marked "Hold for shipping instructions", it was not included in the count. The customer order was dated
December 15, but the product was shipped and the customer billed on January 4, 2021.

2. On December 27, 2020, merchandise costing P11,000 was received and recorded. The invoice accompanying
the merchandise was marked "on consignment."

3. The company received merchandise costing P4,600 on January 2, 2021. The invoice, which was recorded on
January 3, 2021, showed shipment was made under FOB shipping point on December 31, 2020. The
merchandise was not included in the inventory because it was not on hand when the physical count was taken.

4. A product, fabricated to order for a particular customer, was completed and in the shipping room on
December 31. Although it was shipped on January 5, 2021, the customer was billed on December 31, 2020, and
it was excluded from the inventory.

5. Merchandise costing P16,000 was received on January 5, 2021, and the related purchase invoice was
recorded January 6. The shipment of this merchandise was made on December 31, 2020, FOB destination.

6. A product costing P150,000 was sold on an installment basis on December 10, 2020. It was delivered to the
customer on that date. The product was included in inventory because Option still holds legal title. The
company's experience suggests that full payment on installment sales is reasonably assured.

7. An item costing P65,000 was sold and delivered to the customer on December 29, 2020. The goods were
included in the inventory because the sale was with a repurchase agreement that requires Option to buy back
the inventory on January 15, 2021.

Determine if the inventory should be included / excluded.

Problem 2
The management of CONTROL, INC. has engaged you to assist in the preparation of year-end (December 31)
financial statements. You are told that on November 30, the correct inventory level was 145,730 units. During

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the month of December, sales totaled 138,630 units including 40,000 units shipped on consignment to PAGE
DOWN Corp. A letter received from PAGE DOWN indicates that as of December 31, it has sold 15,200 units and
was still trying to sell the remainder.

A review of the December purchase orders to various suppliers shows the following:
Purchase Invoice Date Quantity in Date Shipped Date Received Terms
Order Date Units
12/31/20 1/2/21 4,200 1/2/21 1/5/21 FOB
Destination
12/5/20 1/2/21 3,600 12/17/20 12/22/20 FOB
Destination
12/6/20 1/3/21 7,900 1/5/21 1/7/21 FOB Shipping
point
12/18/20 12/20/20 8,000 12/29/20 1/2/21 FOB Shipping
point
12/22/20 1/5/21 4,600 1/4/21 1/6/21 FOB
Destination
12/27/20 1/7/21 3,500 1/5/21 1/7/21 FOB
Destination

CONTROL, Inc. uses the 'passing of legal title" for inventory recognition.
1. Goods purchased during December totaled.
2. How many units were sold during December?
3. How many units should be included in Control, Inc.'s inventory at December 31, 2020?

Problem 3
The Emily Company is a wholesale distributor of automobile replacement parts. Initial amounts taken from
Emily’s accounting records are as follows:

Inventory at December 31, 2020 (based on physical

count on December 31, 2020) P400,000

Accounts payable at December 31, 2020:

Vendor Terms Amount
Anito Company Net 30 P 9,000
Victoria Company Net 30 36,500
Winston Company Net 30 48,000
Sogo Company Net 30 74,000
Rotonda Company Net 30 -
P167,500

Sales in 2020 P5,000,000

Additional information follows:

1. Parts held on consignment from Anito to Emily amounting to P9,000, were included in the physical count
of goods in Emily’s warehouse on December 31, 2020, and in accounts payable at December 31, 2020.

2. P15,000 worth of parts which were purchased from Sogo and paid for in December 2020 were sold in the
last week of 2020 and appropriately recorded as sales of P21,000. The parts were included in the physical
count on December 31, 2020, because the parts were on the loading dock waiting to be picked up by the
customer.

3. Parts in transit on December 31, 2020, to customers, shipped FOB destination, December 28, 2020,
amounted to P11,000. The customers received the parts on January 6, 2021. Sales of P15,000 to the
customers for the parts were recorded by Emily on January 2, 2021.

4. Retailers were holding P50,000, at cost, of goods on consignment from Emily, at their stores on December
31, 2020.

5. Goods were in transit from Rotonda to Emily on December 31, 2020. The cost was P8,000 and these were
shipped FOB shipping point on December 29, 2020.

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Determine the adjusted balances at year-end of

1. Inventory
2. Accounts Payable
3. Sales

Problem 4
You were engaged by Bryan Corporation for the audit of the company’s financial statements for the year ended
December 31, 2020. 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 PURCHASES
Date Reference Amount Date Reference Amount
Balance forwarded P5,200,000 Balance forwarded P2,800,000
Dec. 27 SI No. 965 40,000 Dec. 28 RR No. 1059 24,000
Dec. 28 SI No. 966 150,000 Dec. 30 RR No. 1061 70,000
Dec. 28 SI No. 967 10,000 Dec. 31 RR No. 1062 42,000
Dec. 31 SI No. 969 46,000 Dec. 31 RR No. 1063 64,000
Dec. 31 SI No. 970 68,000 Dec. 31 Closing entry (3,000,000)
Dec. 31 SI No. 971 16,000 P -
Dec. 31 Closing entry (5,530,000)
P -
Note: SI = Sales Invoice RR = Receiving Report

Note: SI = Sales Invoice RR = Receiving Report

Accounts receivable P500,000

Inventory 600,000
Accounts payable 400,000

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 P18,000.

b) On the evening of December 31, there were two trucks in the company siding:
• Truck No. WEE 475 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. JKR 262 was loaded and sealed on December 31 but leave the company premises on January
2. This order was sold for P100,000 per Sales Invoice No. 968.

c) Temporarily stranded at December 31 at the railroad siding were two delivery trucks enroute to Brooks
Trading Corporation. Brooks 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.

Based on the above and the result of your audit, determine the following:

1. Sales for the year ended December 31, 2020

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2. Purchases for the year ended December 31, 2020
3. Inventory as of December 31, 2020
4. Accounts receivable as of December 31, 2020
5. Accounts payable as of December 31, 2020

Problem 5
The physical inventory of Canon Company as of December 26, 2020 totaled P1,965,000. You agreed on the
December 26 count as the company has a good internal control system. In trying to establish the December 31
inventory, you noted the following transactions from December 27 to December 31, 2020.

Sales (20% markup on cost) P 600,000

Credit memos issued:
For goods returned on:
December 15 27,000
December 20 35,000
December 29 36,000
For goods delivered to customers not in
accordance with specifications 9,500
Credit memos received:
For goods returned on:
December 10 17,000
December 26 23,000
December 28 8,000
Purchases:
Placed in stock 120,000
In transit, FOB shipping point 50,000
In transit, FOB destination 33,000

Inventory as of December 31, 2020.

Problem 6
You were engaged to perform an audit of the accounts of the Arvin Company for the year ended December 31,
2020, and you observed the taking of the physical inventory of the company on December 30, 2020. Only
merchandise shipped by the company to customers up to and including December 30, 2020 have been
eliminated from inventory. The inventory as determined by physical inventory count has been recorded on the
books by the company’s controller. No perpetual inventory records are maintained. All sales are made on an
FOB shipping point basis. You are to assume that all purchase invoices have been correctly recorded. The
inventory was recorded through the cost of sales method.

The following lists of sales invoices are entered in the sales books for the month of December 2020 and January
2021, respectively.

DECEMBER 2020
Sales Sales Cost of
invoice amount invoice date merchandise sold Date shipped
a) P 150,000 Dec. 21 P 100,000 Dec. 31, 2020
b) 100,000 Dec. 31 40,000 Nov. 03, 2020
c) 50,000 Dec. 29 30,000 Dec. 30, 2020
d) 200,000 Dec. 31 120,000 Jan. 03, 2021
e) 500,000 Dec. 30 280,000 Dec. 29, 2020
(shipped to
consignee)
JANUARY 2020
Sales invoice amount Sales invoice date Cost of merchandise sold Date shipped
f) P 300,000 Dec. 31 P 200,000 Dec. 30, 2020
g) 200,000 Jan. 02 115,000 Jan. 02, 2021
h) 400,000 Jan. 03 275,000 Dec. 31, 2020

1. Determine the effect of the errors on the following as of December 31, 2020 (indicate whether overstated or
understated).
a. Inventory

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b. Sales
c. Profit
d. Working capital

Problem 7
You were assigned to audit the inventories of Magic Flakes Corp. for the period ended December 31, 2020. In
your review of the client's controls over inventory, you ascertained that controls are effective thus you allowed
the client to render physical count at an interim date, October 30, 2020. Inventory per count on December 31,
2019 was at P450,000. The result of the count as well as other relevant information as of October 31, 2020 and
as of December 31, 2020 respectively, were as follows:

October 31 December 31.

Inventory, per, count (October 30, 2020) 550,000 -
Purchases per books 2,450,000 3,410,000
Purchase discount 45,000 70,000
Freight in 60,000 90,000
Purchase returns and allowance 70,000 100,000
Sales 4,765,000 6,750,000
Sales discount 200,000 300,000
Sales returns and allowances 300,000 375,000
Employee discounts 150,000 150,000
Normal breakages (at selling price) 50,000 50,000

Additional information:
a. Deliveries in transit invoiced at P75,000 were delivered to customer on October 31 and were recorded as sales
upon delivery. The goods however were still in transit as of October 31 and Freight term is FOB destination.

b. Goods invoiced by supplier at P90,000 were in transit as of October 31 and were received on November 3
from the supplier. The said invoice was recorded in November. Freight terms however is FOB shipping point.

c. Merchandise received in December with a cost of P100,000 were damaged while in transit (FOB SP) from a
supplier. The same were sold at a 10% markup based on cost.

d. The physical count as of October 30, 2020 included all merchandise on hand on the same date.

(hint: round off cost % to 2 decimal places e.g. XX%)

1. What is the gross profit percentage based on sales for 10 months ended October 31?
2. What is the cost of sales for the last 2 months ended December 31?
3. What is the estimated cost of sales for the entire year 2020?
4. What is the cost of ending inventories as of December 31, 2020?

Problem 8
Colgate Inc. reported inventory of P360,000 at December 31, 2020. The following data were gathered to confirm
the reported inventory figure.

Inventory, December 31, 2019 P 320,000

Purchases during 2020 1,410,000
Cash sales during 2020 350,000
Shipment received on December 26, 2020 included in
physical inventory but not recorded as purchases 10,000
Deposit made with suppliers, entered as purchased. goods
were not received during 2020 20,000
Collections on accounts receivable during 2020 1,800,000
Accounts receivable, December 31, 2019 250,000
Accounts receivable, December 31, 2020 300,000
Gross profit percentage on sales 40%

What is the estimated inventory shortage at December 31, 2020?

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Problem 9
The work-in-process inventories of Kenneth Company were completely destroyed by fire on June 1, 2020. You
were able to establish physical inventory figures as follows:

January 1, 2020 June 1, 2020

Raw materials P60,000 P120,000
Work-in-process 200,000 -
Finished goods 280,000 240,000

Sales from January 1 to May 31, were P546,750. Purchases of raw materials were P200,000 and freight on
purchases, P30,000. Direct labor during the period was P160,000. It was agreed with insurance adjusters than
an average gross profit rate of 35% based on cost be used and that direct labor cost was 160% of factory
overhead.

Based on the above and the result of your audit, you are to determine:

1. Raw materials used

2. The total value of goods put in process
3. The value of goods manufactured and completed as of June 1, 2020
4. The work in process inventory destroyed as computed by the adjuster

Problem 10
JK Inc., owner of a trading company, engaged your services as auditor. There is a discrepancy between the
company’s income and the sales volume. The owner suspects that the staff is committing theft. You are to
determine whether or not this is true. Your investigations revealed the following.

1. Physical inventory, taken December 31, 2020 under your observation showed that cost was P265,000 and
net realizable value (NRV), P244,000. The inventory on January 1, 2020 showed cost of P390,000 and net
realizable value of P375,000. It is the corporation’s practice to value inventory at “lower of cost or NRV.”
Any loss between cost and NRV is included in “Other expenses.”

2. The average gross profit rate was 40% of net sales.

3. The accounts receivable as of January 1, 2020 were P135,000. During 2020, accounts receivable written
off during the year amounted to P10,000. Accounts receivable as of December 31, 2020 were P375,000.

4. Outstanding purchase invoices amounted to P300,000 at the end of 2020. At the beginning of 2020 they
were P375,000.

5. Receipts from customers during 2020 amounted to P3,000,000.

6. Disbursements to merchandise creditors amounted to P2,000,000.

Based on the above and the result of your audit, determine the following:

1. The total sales for 2020 is

2. The total purchases for 2020 is
3. The amount of inventory shortage is

Problem 11
Your client, Nivea Company, is an importer and wholesaler. Its merchandise is purchased from several suppliers
and is warehoused until sold to customers.

In conducting your audit for the year ended December 31, 2020, you were satisfied that the system of internal
control was good. Accordingly, you observed the physical inventory at an interim date, November 30, 2020
instead of at year end. You obtained the following information from your client's general ledger.

Inventory, January 1, 2020 P 1,312,500

Physical inventory, November 30, 2020 1,425,000
Sales for 11 months ended Nov. 30, 2020 12,600,000
Sales for the year ended Dec. 31, 2020 14,400,000

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Purchases for 11 months ended Nov. 30, 2020
(before audit adjustments) 10,125,000
Purchases for the year ended Dec. 31, 2020
(before audit adjustments) 12,000,000

Your audit disclosed the following information

a) P112,500 - Shipments received in November and included in the physical inventory but recorded as
December purchases.
b) - Shipments received in unsalable condition and excluded from physical inventory. Credit
memos had not been received nor chargebacks to vendors been recorded:

15,000 - Total at November 30, 2020

22,500 - Total at December 31, 2020 (including the November unrecorded chargebacks)

c) 30,000 - Deposit made with vendor and charged to purchases in October, 2020. Product was
shipped in January, 2021

d) 82,500 - Deposit made with vendor and charged to purchases in November, 2020. Product was
shipped FOB destination, on November 29, 2020 and was included in November 30,
2020 physical inventory as goods in transit

e) 150,000 - Through the carelessness of the receiving department shipment in early December 2020
was damaged by rain. This shipment was later sold in the last week of December at cost.

The company is using the gross profit method.

1. How much is the adjusted inventory on November 30, 2020?

2. How much is the total purchases for 11 months January to November?
3. How much is the total purchases for 12 months January to December?
4. How much is the adjusted inventory on December 31, 2020?

Problem 12
On April 21, 2020, a fire damaged the office and warehouse of Von Company. The only accounting record saved
was the general ledger, from which the trial balance below was prepared.

Von Company
Trial Balance
March 31, 2020
DEBIT CREDIT
Cash P 180,000
Accounts receivable 400,000
Inventory, December 31, 2019 750,000
Land 350,000
Building 1,100,000
Accumulated depreciation P 413,000
Other assets 56,000
Accounts payable 237,000
Accrued expenses 180,000
Common stock, P100 par 1,000,000
Retained earnings 520,000
Sales 1,350,000
Purchases 520,000
Operating expenses 344,000 .
Totals P3,700,000 P3,700,000

The following data and information have been gathered:

a. The company’s year-end is December 31.

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b. An examination of the April bank statement and cancelled checks revealed that checks written during the
period April 1 to 21 totaled P130,000: P57,000 paid to accounts payable as of March 31, P34,000 for April
merchandise purchases, and P39,000 paid for other expenses. Deposits during the same period amounted
to P129,500, which consisted of receipts on account from customers with the exception of a P9,500
refund from a vendor for merchandise returned in April.

c. Correspondence with suppliers revealed unrecorded obligations at April 21 of P106,000 for April
merchandise purchases, including P23,000 for shipments in transit on that date.

d. Customers acknowledged indebtedness of P360,000 at April 21, 2020. It was also estimated that
customers owed another P80,000 that will never be acknowledged or recovered. Of the acknowledged
indebtedness, P6,000 will probably be uncollectible.

e. The insurance company agreed that the fire loss claim should be based on the assumption that the overall
gross profit ratio for the past two years was in effect during the current year. The company’s audited
financial statements disclosed the following information:

2019 2018
Net sales P 5,300,000 P 3,900,000
Net purchases 2,800,000 2,350,000
Beginning inventory 500,000 660,000
Ending inventory 750,000 500,000

f. Inventory with a cost of P70,000 was salvaged and sold for P35,000. The balance of the inventory was a
total loss.

Based on the above and the result of your audit, answer the following:

1. How much is the adjusted balance of Accounts Receivable as of April 21, 2020?
2. How much is the sales for the period January 1 to April 21, 2020?
3. How much is the adjusted balance of Accounts Payable as of April 21, 2020?
4. How much is the net purchases for the period January 1 to April 21, 2020?
5. How much is the cost of sales for the period January 1 to April 21, 2020?
6. How much is the estimated inventory on April 21, 2020?
7. How much is the estimated inventory fire loss?

Problem 13
The Samsung Corporation uses the lower of cost or net realizable value inventory. Data regarding
the items in work-in-process inventory are presented below:
Markers Pens Pencils
Historical cost P24,000 P18,880 P30,000
Selling price 36,000 21,800 38,000
Estimated cost to complete 3,000 2,620 6,200
Replacement cost 20,800 16,800 16,800
Normal profit margin as a % of selling price 20% 20% 20%
Cost to sell based on selling price 5% 10% 10%

1. What is the loss on write-down under the direct write-off method?

2. What is the loss on write-down under the allowance method, assuming that the unadjusted balance of the
allowance for inventory write-down is at P2,000?
3. What is the gain on recovery of previous under the allowance method, assuming that the unadjusted balance
of the allowance for inventory write-down is at P5,000?
4. What is the correct carrying value of inventories as of December 31?

Problem 14
You are engaged in the regular annual examination of the accounts and records of Tomador Co. for the year
ended December 31, 2020. To reduce the workload at year end, the company, upon your recommendation,
took its annual physical inventory on November 30, 2020. You observed the taking of the inventory and made
tests of the inventory count and the inventory records.

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Audit of Inventories
The company’s inventory account, which includes raw materials and work-in-process is on perpetual basis.
Inventories are valued at cost, first-in, first-out method. There is no finished goods inventory.

The company’s physical inventory revealed that the book inventory of P1,695,960 was understated by P84,000.
To avoid delay in completing its monthly financial statements, the company decided not to adjust the book
inventory until year-end except for obsolete inventory items.

Your examination disclosed the following information regarding the November 30 inventory:

a. Pricing tests showed that the physical inventory was overstated by P61,600.

b. An understatement of the physical inventory by P4,200 due to errors in footings and extensions.

c. Direct labor included in the inventory amounted to P280,000. Overhead was included at the rate of
P200% of direct labor. You have ascertained that the amount of direct labor was correct and that the
overhead rate was proper.

d. The physical inventory included obsolete materials with a total cost of P7,000. During December, the
obsolete materials were written off by a charge to cost of sales.

Your audit also disclosed the following information about the December 31 inventory:

a. Total debits to the following accounts during December were:

Cost of sales P1,920,800

Direct labor 338,800
Purchases 691,600

b. The cost of sales of P1,920,800 included direct labor of P386,400.

Based on the above and the result of your audit, determine the following:

1. Adjusted amount of physical inventory at November 30, 2020

2. Adjusted amount of inventory at December 31, 2020
3. Cost of materials on hand, and materials included in work in process as of December 31, 2020
4. The amount of direct labor included in work in process as of December 31, 2020
5. The amount of factory overhead included in work in process as of December 31, 2020

“A lot of us would like to move mountains, but few of us are willing to practice on small hills.” – Anonymous

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