Chapter 5 – Audit of Inventory

APPLIED AUDITING

EXERCISE 1 – CORRECT INVENTORY BALANCE (v10)

Procter & Gamble Co., provided the following data with respect to its inventory. As the senior auditor
responsible for inventory valuation, you examine the following disclosed information:

Items counted in the bodega 4,000,000

Items included in the count specifically segregated per sale contract 100,000
Items in receiving department, returned by customer in good condition 50,000
Items ordered and in receiving department, invoice not received 400,000
Items ordered, invoice received but goods not received. Freight is on
account of seller 300,000
Items shipped today, invoice mailed, FOB shipping point 250,000
Items shipped today, invoice mailed, FOB destination 150,000
Items currently being used for window display 200,000
Items on counter for sale 800,000
Items in receiving department, refused by P&G Co. because of damage 180,000
Items included in count, damaged and unusable 50,000
Items in the shipping department 250,000

Required: What is the correct amount of inventory?

EXERCISE 2 – CORRECT INVENTORY BALANCE (v10)

Nestle Company included the following items under inventory:

Materials 1,400,000
Advance for materials ordered 200,000
Goods in process 650,000
Unexpired insurance on inventory 60,000
Advertising catalogs and shipping cartons 150,000
Finished goods in factory 2,000,000
Finished goods in entity-owned retail store, including 50% profit on cost 750,000
Finished goods in hands of consignees including 40% profit on sales 400,000
Finished goods in transit to customers, shipped FOB destination at cost 250,000
Finished goods out on approval, at cost 100,000
Unsalable finished goods, at cost 50,000
Office supplies 40,000
Materials in transit, shipped FOB shipping point, excluding freight
of P30,000 330,000
Goods held on consignment, at sales price, cost P150,000 200,000

Required: What is the correct amount of inventory?

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EXERCISE 3 – CORRECT INVENTORY BALANCE (sn10)

Steel Tech Corporation conducted a physical inventory count on December 31, 2016. You observed the
count on this date to be able to establish the existence of inventory balance. A copy of the inventory
summary was furnished to you and below is a summary of your findings:

STEEL TECH CORPORATION

Inventory Summary
December 31, 2016

Items which require possible adjustment:

Tag No. Description Quantity Unit Price Amount

43 Wood clamps 43 pcs P274 each P11,782 _____________
561 Electric pumps 6 pcs P4,000 each 24,000 _____________
1764 Rubber facing 312 pcs P15 each 4,860 _____________
1765 Rubber facing 300 pcs P12 each 3,600 _____________
2264 Air hose, 1” 96 dozen P240/gross 23,040 _____________
3126 Metal struts 126 pcs P120 each 15,120 _____________
3447 Metal chips 150 pcs P25 each 3,750 _____________
3682 Braces, #107 50 boxes P90/box 4,500 _____________
3777 Pressure washer 10 pcs P5,000 each 10,000 _____________
4822 Pipe, 3” 356 meters P25/meter 8,900 _____________
5118 Metal ribs 564 pcs P50/pc 28,800 _____________
Subtotal P138,352
Other inventory items 476,364 P 476,364
Total inventory P614,716

During the inventory observation, you noted the following inventory tag control information:
Count Team Assigned Tags Last Tag Used Voided Tags
A 1 to 750 609 75, 532
B 751 to 2000 1824 854, 1265, 1764
C 2001 to 4000 3776 2009, 2723
D 4001 to 5500 5200 nill
E 5501 to 6000 5784 5901

Results of your test counts disclosed the following:

Tag No. Description Measuring Unit Quantity
561 Electric Pumps Piece 6
2264 Air Hose, 1” Gross 8
3126 Metal Struts, 6” Piece 126
3447 Metal Chips Piece 120
3682 Braces, #107 Box 50

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 Chapter 5 – Audit of Inventory
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You traced several items from the inventory summary to the stock cards and you noted the following
differences:
Tag No. Inventory Summary Stock Cards Explanation
5118 564 1,264 700 pcs stored in Manila
Brokerage Warehouse
4822 356 322 Unlocated difference
561 6 -0- Goods received on consignment

Required: Determine the adjusted balance of inventory at December 31, 2016.

EXERCISE 4 – CORRECT INVENTORY BALANCE & INVENTORY SHORTAGE (sn10)

Rowell Marasigan, 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 investigation revealed the following:

(a) The physical taken on December 31, 2016 under your observation showed that cost was P26,500.
The inventory on January 01, 2016 showed a cost of P39,000
(b) The accounts receivable written off amounted to P1,000. Accounts receivable as of December 31,
2016 were P37,500.
(c) Outstanding purchases invoices amounted to P30,000 at the end of 2016. At the beginning of
2016, they were P37,500.
(d) Receipts from customers during 2016 amounted to P300,000.
(e) Disbursement to merchandise creditors amounted to P200,000.
(f) The average gross profit rate was 40% of net sales.

REQUIRED:
1. Total Sales
2. Total Purchases
3. Inventory Shortage

EXERCISE 5 – INTERIM AUDIT, SALES & PURCHASE CUT-OFF TESTING (sn10)

HUMAN NATURE is an importer and wholesaler. Its merchandise is purchased from a number of suppliers
and is warehoused until sold to customers. In conducting his audit for the year ended December 31, 2016,
the company’s CPA determined that the system of internal control was good. Accordingly, he observed
the physical inventory at an interim date, November 30, 2016, instead of at year-end. The following
information was obtained from the general ledger:

Inventory, January 01, 2016 P 90,000

Inventory, November 30, 2016 225,000
Sales for eleven months ended November 30, 2016 800,000
Sales for year-ended December 31, 2016 950,000
Purchases for eleven months ended November 30, 2016
(before audit adjustment) 720,000
Purchases for year-ended December 31, 2016 (before audit adjustments) 810,000

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Additional information:
(1) Goods received on November 28 but recorded as purchases in December 10,000
(2) Deposits made in October 2016 for purchases to be made in 2017, but charged
to Purchases 14,000
(3) Defective merchandise to be returned to suppliers:
Total at November 30, 2016 5,000
Total at December 31, 2016 (excluding November items) 7,000

The returns have not been recorded pending receipt of credit memos from the suppliers. The defective
goods were not included in the physical count.

(4) Goods shipped November under FOB destination and received in December,
were recorded as purchase in November 18,500
(5) Through the carelessness of the clients warehouseman, certain goods were
damaged in December and sold in December at its cost 20,000
(6) Audit of the client’ November inventory summary revealed the following:
Items duplicated 3,000
Purchase in transit (included in the summary)
Under FOB shipping point 12,000
Under FOB destination 18,500
Items counted but not included in the inventory summary 7,000
Errors in extension that overvalued the items 4,000

In audit engagements in which interim physical inventories are observed, a frequently used auditing
procedure is to test the reasonableness of the year-end inventory by the application of gross profit ratios:

REQUIRED:
1. Adjusted net purchase from January 01 to November 30, 2016
2. Adjusted net purchase from January 01 to December 31, 2016
3. Gross profit ratio for eleven months ended November 30, 2016
4. The cost of goods sold during December 2016
5. The December 31, 2016 ending inventory

EXERCISE 6 – INVENTORY ESTIMATION (sn10)

You were engaged to audit the inventory of Universal Robina Corporation on April 30, 2016 to determine
amount of raw materials destroyed by fire that occurred that day.
(a) Work in process and finished goods were placed in a different warehouse not affected by the fire.
A physical count was immediately conducted on April 30, 2016 and the following balances were
obtained:
Work in process P10,000
Finished goods 85,000
(b) A copy of 2015 financial statements indicated the following inventory balances at December 31,
2015:
Raw Materials P20,000; Work in process P60,000; Finished goods P70,000

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(c) Purchases for the period January 01 to April 30, 2016 amounted to P32,000 and goods are sold to
a mark-up of 50% based on cost. Universal Robina was not able to provide you with other
information about 2016 transactions because the Company’s records were also destroyed by fire.
(d) Based on your inquiry from the client’s personnel, you determined that raw materials used was
equivalent to 20% of the total manufacturing costs; and that total manufacturing cost was 60% of
the cost of goods manufactured.

REQUIRED:
1. Raw materials used from January 01 to April 30, 2016
2. Raw materials destroyed by fire on April 30, 2016
3. Cost of goods manufactured from January 01 to April 30, 2016
4. Total sales from January 01 to April 30, 2016

EXERCISE 7 – INVENTORIES ON CONSIGMENT

You are examining the December 31, 2016 financial statements of NIKE Company, a new client. The
Company was established on January 01, 2015. The Company’s income statements for 2015 and 2016
were presented to you as follows:

NIKE Company
Statements of Income and Expenses
For the years then ended December 31 2016 2015
Sales 1,287,500 1,075,000
Cost of sales 669,500 559,000
Gross profit 618,000 516,000
Selling and administrative expense 403,500 330,000
Net income 214,500 186,000
Your examination disclosed the following:
1. Some sales were made on open account; other sales were made through dealers to whom units
were shipped on a consignment basis. Both sales methods were in effect in 2015 and 2016. In
both years, however, the company treated all shipments as outright sales.
2. The sales price and cost of the units were the same in 2015 and 2016. Each unit had a cost of P130
and was uniformly invoiced at P250 to open account customers and to consignees.
3. During 2016 the amount of cash received from consignees in payment for units sold by them was
P706,500. Consignees remit for the units as soon as they are sold. Confirmations received from
consignees showed that they had a total of 23 unsold units on hand at December 31, 2016.
Consignees were unable to confirm the unsold units on hand at December 31, 2015.
The cost of sales for 2016 was determined by the client as follows:
UNITS
Inventory on hand in warehouse, December 31, 2015 1,510
Purchases 4,454
Available for sale 5,964
Inventory on hand in warehouse, December 31, 2016 814
Shipments to: Open account customers 3,008
Consignee customer 2,142 5,150 @ P130 = P669,500

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 Chapter 5 – Audit of Inventory
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REQUIRED:
1. Compute the total amount of the NIKE Company’s inventory at December 31, 2016
2. Compute the total amount of the NIKE Company’s inventory at December 31, 2015
3. Adjusted sales in 2015
4. Adjusted sales in 2016

EXERCISE 8 – INVENTORY ESTIMATION: GROSS PROFIT METHOD

UNILEVER PHILIPPINES in the past has carried inventories at cost. At the end of the current period, the
inventory valued at 40% of selling price as a matter of convenience. The current financial statements have
been prepared and the inventory sheet destroyed; consequently, you find it impossible to reconstruct the
final inventory at actual cost. The following data are available:

Sales P 400,000
Final inventory (at 40% of selling price) 16,000
Cost of sales 270,000
Net income 14,400
Beginning inventory (at cost) 12,000

Making any appropriate adjustments to the given data, determine the following:
1. Final inventory at cost
2. Total purchases for the current period
3. Corrected cost of sales for the current period
4. Total expenses for the current period
5. Corrected net income for the current period

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 Chapter 5 – Audit of Inventory
APPLIED AUDITING

PROBLEM 1 – INVENTORY COST ALLOCATION

You are the auditor of various manufacturing entities. Your risk assessment procedures for those entities
indicate high risk of material error related to classification and allocation of production costs.
Consequently, you performed recalculation procedures to test the valuation of inventory as reported in
the statement of financial position. The following information was available:

I. An entity incurred fixed production overheads of P900,000 during one-month period in which it
manufactured 200,000 units of production. When operating at normal capacity the entity
manufactures 250,000 units of production per month.

1. The cost that should be allocated to each unit produced during the month is:
a. P3.60
b. P4.50
c. P4.00
d. P2.00
2. The entity shall recognize as expense in the profit or loss an amount equal to
a. P225,000
b. P720,000
c. P180,000
d. P0
II. Assuming the entity manufactured 300,000 units during the month. This level of production is
abnormally high.

3. How much should be allocated as fixed overhead cost to each unit produced during the
month?
a. P3.60
b. P3.00
c. P4.50
d. P4.00
III. An entity manufactures a chemical ‘A’ for use in the agriculture industry. The production process
requires a mixture of base chemicals followed by a maturation process, and from which, a product
‘A’ and a by-product ‘C’ are produced. The total costs of a production run is P100,000.

Each production run produces:

 5,000 liters of product A, sales value = P250,000
 1,000 liters of (by-product) C, sales value = P2,000

4. Assuming the costs to complete and sell the by-product are immaterial. What is the cost per
liter produced of product A?
a. P49.60
b. P19.60
c. P20
d. P19.84

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IV. Assume that instead of the by-product there is another joint product ‘B’ resulting from the
maturation process. Furthermore, the total costs (i.e. including direct costs and the allocation of
overheads) of a production run are P390,000.

Each production run produces:

 5,000 liters of product A, sales value = P250,000
 4,000 liters of product B, sales value = P400,000

The entity allocates the joint process cost to the products produced on the basis of their relative
sales values.

5. The cost per liter produced of product A is:

a. P37.50
b. P35.00
c. P42.00
d. P30.00
6. The cost per liter produced of product B is:
a. P52.50
b. P60.00
c. P48.00
d. P46.15
V. Assume that the maturation process produces products ‘A’ and ‘B’ and by-product ‘C’. the total
cost (i.e. including direct costs and the allocation of overheads) of a production run is P370,000.

Each production run produces:

 5,000 liters of product A, sales value = P250,000
 4,000 liters of product B, sales value = P400,000
 1,000 liters of by-product C, sales value = P6,000

7. The cost per liter of products A is:

a. P28.00
b. P35.00
c. P28.46
d. P35.58
8. The cost per liter of products B is:
a. P44.80
b. P60.00
c. P52.00
d. P56.00
VI. On January 01, 2016, an entity accepted an order for 7,000 custom-made corporate gifts. On
January 03, 2016, the entity purchased raw materials to be consumed in the production process
for P550,000, including P50,000 refundable purchase taxes. The purchase price was funded by
raising a loan of P555,000 (including P5,000 loan-raising fees). The loan is secured by the
inventories. During January 2016, the entity designed the corporate gifts for the customers.

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Design costs included:

 Cost of external designer = P7,000
 Labor = P3,000

During February 2016, the entity’s production team developed the manufacturing technique and
made further modifications necessary to bring the inventories to the conditions specified in the
agreement. The following costs were incurred in the testing phase:
 Materials = P24,000
 Labor = P11,000
 Depreciation of plant used to perform the modifications = P5,000
 Proceeds from sale of the scrapped output = P3,000

During February 2016, the entity incurred the following additional costs in manufacturing the
customized corporate gifts:
 Consumable stores = P55,000
 Labor = P65,000
 Depreciation of plant used to perform the modifications = P15,000

The customized corporate gifts were ready for sale on 1 March 2016. No abnormal wastage
occurred in the development and manufacture of the corporate gifts.

9. What is the cost of inventory?

a. P682,000
b. P735,000
c. P732,000
d. P635,000

PROBLEM 2 – INVENTORY RECONCILIATION (co)

Century Canning Corporation cans two food commodities which it stores at various warehouses. The
company uses perpetual inventory system under which the finished goods inventory is charged with
production and credited for sales at standard cost. The detail of the finished goods inventory is maintained
on punched cards by the tabulating department units and pesos for various warehouses.

The accounting department receives copies of daily production reports and sales invoices. Units are then
extended at standard cost and a summary of the day’s activity is posted to the Finished Goods Inventory
general ledger control account. Next the sales invoices and production reports are sent to the tabulating
department for processing. Every month the control account and detailed tab records are reconciled and
adjustments recorded. The last reconciliation and adjustments were made at November 30, 2016.

Your CPA firm observed the taking of the physical inventory at all locations on December 31, 2016. The
inventory count began at 4:00 pm and was completed at 8:00 pm. The company’s figure for the physical
inventory is P342,400. The general ledger control account balance at December 31 was P384,900, and the
final ‘tab run’ of the inventory punched cards showed a total of P403,300.

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Unit cost data for the company’s two products are as follows:
PRODUCT STD. COST
A P 2.00
B P 3.00
A review of December transitions disclosed the following:
1. Sales invoice no. 1310, Dec. 2, was priced at standard cost for P11,700 but was listed on the
accounting department’s daily summary at P11,200.
2. A production report for P23,900, Dec. 15, was processed twice in error by the tabulating
department.
3. Sales invoice no. 1423, Dec. 9, for 1,200 units of product A, was priced at a standard cost of P1.50
per unit by the accounting department. The tabulating department corrected the error but did
not notify the accounting department of the error.
4. A shipment of 3,400 units of product A was invoiced by the billing department as 3,000 units on
sales invoice no. 1504, Dec. 27. The error was discovered by your review of transactions.
5. On December 27, the Pampanga warehouse notified the tabulating department to remove 2,200
unsalable units of product A from the finished goods inventory, which it did without receiving a
special invoice from the accounting department. The accounting department received a copy of
the Pampanga warehouse notification on December 29 and prepared a special invoice which was
processed in the normal manner. The units were not included in the physical inventory.
6. A report for the production on January 3 of 2,500 units of product B was processed for the Bulacan
plant as of December 31.
7. A shipment of 300 units of product B was made from the Tarlac warehouse to Market-Market
Inc., at 8:30 pm on December 31 as an emergency service. The sales invoice was processed as of
December 31. Century Canning Corporation prefers to treat the transaction as a sale in 2016.
8. The working papers of the auditor observing the physical count at the Bataan warehouse revealed
that 700 units of product B were omitted from Century Canning’s physical count. Century Canning
Corporation concurred that the units were omitted in error.
9. A sales invoice for 600 units of product A shipped from the Zambales warehouse was mislaid and
was not processed until January 5. The units were shipped on December 30.
10. The physical inventory of the Angeles warehouse excluded 350 units of product A marked
“reserved”. Investigation revealed that this merchandise was being stored as a convenience for
Mandaluyong Talipapa Inc., a customer. This merchandise, which has not been recorded as a sale,
is billed as it is shipped.
11. A shipment of 10,000 units of product B was made on December 27 from the Zambales warehouse
to the Bataan warehouse. The shipment arrived on January 6 but had been excluded from the
physical inventories.

REQUIRED:
1. Prepare a reconciliation of balances for PHYSICAL INVENTORY, GENERAL LEDGER CONTROL
ACCOUNT, and TABULATING DEPARTMENT’S DETAIL OF INVENTORY.
2. What is the adjusted balance of inventory?

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