AUDITING AND ASSURANCE – CONCEPTS AND APPLICATIONS 1

AP06: AUDIT OF INVENTORY

PROF. FRANCIS O. MATEOS, CPA

PROBLEM 1
The following are the list of items that may or may not reported as inventory in a company’s
December 31 statement of financial position: Temporary investment in stocks and bonds that will
be resold in the near future, P250,000; goods sold FOB destination that are in transit at
December 31, P20,000; costs identified with units completed but not yet sold, P130,000; goods
held on consignment from another company, P225,000; factory supplies, P10,000; raw materials
on which the company has started production, but which are not completely processed,
P140,000; office supplies, P5,000; materials on hand not yet placed into production, P175,000;
costs incurred to advertise goods held for resale, P10,000; interest cost incurred for inventories
that are routinely manufactured, P20,000; factory labor costs incurred on goods still unsold,
P25,000; freight charges on goods purchased, P40,000; goods sold FOB shipping point that are in
transit December 31, P60,000; goods sold where large returns are predictable, P140,000; goods
sold to another company, for which our company has signed an agreement to repurchase at a
set price that covers all costs related to the inventory, P150,000; goods purchased FOB
destination that are in transit at December 31, P100,000; goods purchased FOB shipping point
that are in transit at December 31, P60,000; goods sold on instalment basis, P50,000; goods out
on consignment at another company’s store, P400,000.

Required: How much of these items would typically be reported as inventory in the statement
of financial position as of December 31?

Problem 2
The accounting staff of Bignay Company submitted an inventory list at December 31, 2020 which
showed a total of P750,000. The following information which may or may not be relevant to the
inventory value submitted, are given below:
a. On December 31, 2020, an order for P3,750 worth of merchandise was placed. This was
included in the year-end inventory although it was received only on January 5, 2021. Seller
shipped the goods FOB destination.
b. Goods valued at P3,000 were received on December 28, 2020 for approval by Bignay Co.
The inventory team included this merchandise in the list but did not place any value on it.
On January 4, 2021, the company informed the supplier by long distance telephone of the
acceptance of the goods and the supplier’s invoice was received on January 7, 2021.
c. Suppliers invoice for P4,500 worth of merchandise dated December 28, 2020 was received
through the mails on December 30, 2020 although the goods arrived only on January 4,
2021. Shipment term is FOB shipping point. This item was included in the December 31,
2020 inventory by the company.
d. A review of the company’s purchase orders shows a commitment to buy P15,000 worth of
merchandise. This was not included in the inventory because the goods were received on
January 3, 2021.
e. The bill of lading and other import documents on a merchandise were delivered by the
bank and the trust receipt accepted by the company on December 26, 2020. Taxes and
duties have been paid on this shipment but the customs broker has not delivered the
merchandise until January 7, 2021. Delivered cost of the shipment totalled P120,000. This
shipment was not included in the inventory in December 2020.
f. Excluded from the inventory were merchandise costing P12,000 because they were
transferred to the delivery department for packaging on December 28 to be shipped on
January 2, 2021.

Required: The correct merchandise inventory at December 31, 2020 of Bignay Company.

Problem 3
The Panda Company’s records as of December 31, 2020 reveal the following balances:
Net Income P 255,000
Net purchases 1,150,000
Net sales 2,525,000
Accounts payable 345,000
Accounts receivable 290,000
Inventory 550,000

AUDITING REVIEW 1
 The company is on a calendar year basis. The following data were found during your audit:
 Merchandise costing P100,000 had been recorded as a purchase but not included as
inventory. Terms of sale are FOB shipping point according to the supplier’s invoice
which had arrived at December 31.
 Your client has an invoice from a supplier, terms FOB shipping point but the goods had
not arrived as yet. However, these materials costing P85,000 had been included in the
inventory count, but no entry had been made for their purchase.
 Goods costing P50,000 and selling for P70,000 had been segregated, but not shipped
at December 31, and were not included in the inventory. A review of the customer’s
purchase order set forth terms as FOB destination. The sale had not been recorded.
 The sale of P75,000 worth of materials and costing P60,000 had been shipped FOB
shipping point on December 31. However, this inventory was found to be included in
the final inventory. The sale was properly recorded in 2020.
 Goods costing P35,000 was out on consignment with Honey Company. Since the
monthly statement from Honey Company listed those materials as on hand, the items
had been excluded from the final inventory and invoiced on December 31 at P40,000.
 Materials costing P125,000 and billed on December 30 at a selling price of P160,000,
had been segregated in the warehouse for shipment to a customer. The materials had
been excluded from inventory as a signed purchase order had been received from
customer. Terms, FOB destination.
 Goods costing P25,000 had been received, included in the inventory and recorded as a
purchase. However, upon your inspection the goods were found to be defective and
would be immediately returned.
 Goods in transit shipped FOB destination by a supplier, in the amount of P50,000, had
been excluded from the inventory, and further testing revealed that the purchase had
been recorded.

Required: Determine the adjusted balances of the following as of December 31, 2020 based
on your audit.
1. Inventory 4. Net purchases
2. Accounts payable 5. Net income
3. Net sales

Problem 4
Danny Factory started operations in 2020. Danny manufactures bath towels. 60% of the
production are “Class A” which sell for P500 per dozen and 40% are “Class B” which sell for P250
per dozen. During 2020, 6,000 dozens were produced at an average cost of P360 per dozen. The
inventory at the end of the year was as follows:
220 dozens “Class A” at P360 P 79,200
300 dozens “Class B” at P360 108,000

Required: Using the relative sales value method, which management considers as a more
equitable basis of cost distribution, answer the following:
1. How much of the total cost should be allocated to “Class A”?
2. How much of the total cost should be allocated to “Class B”?
3. How much is the value of inventory as of December 31, 2020?
4. How much is the cost of sales for the year 2020?
5. How much is the gross profit for the year 2020?

Problem 5
On November 27, 2020, Bunny Airlines entered into a non-cancellable commitment to purchase
3,000 barrels of aviation fuel for P9,000,000 on April 1, 2021. Bunny entered into this purchase
commitment to protect itself against the volatility in the aviation fuel market. By December 31,
2020, the purchase price of aviation fuel had fallen to P2,200 per barrel. However, by April 1,
2021, when Bunny took delivery of the 3,000 barrels, the price of aviation fuel had risen to
P3,100 per barrel.

Required: Based on the above and the result of your audit, answer the following:
1. Loss on purchase commitment on December 31, 2020.
2. Gain on purchase commitment on April 1, 2021.

AUDITING REVIEW 2
Problem 6
The Manggahan Merchandising Company is a leading distributor of kitchen wares. The company
uses the FIFO method of calculating the cost of goods sold. The following information concerning
two of the company’s products is taken from the month of March:

PANS KETTLES
No. of Units Unit Cost No. of Units Unit Cost
March 1, beg. Inventory 10,000 P60 6,000 P40
Purchases:
March 15 14,000 65 9,000 42
March 25 6,000 75
Sales for the month 20,000 10,000
SP: P80 SP: P44

 On March 31, Manggahan’s suppliers reduced their price from the last purchase price by
the following percentages: Pans (25%); Kettles (20%).
 Accordingly, the company agreed to reduce selling prices by 15% on all items beginning
April 1.
 Mangggahan Merchandising Company’s selling costs are calculated at 10% of selling price.
Both products have a normal profit of 30% on sales prices (after selling costs).

Required: Based on the above and the result of your audit, answer the following:
1. Total cost of Pans as of March 31.
2. Total cost of Kettles as of March 31.
3. The inventory at March 31.
4. The loss on inventory write-down for the month of March 31.
5. The cost of sales, before loss on inventory write-down, for the month of March.

Problem 7
In conducting your audit of Mangga Corporation, a company engaged in import and wholesale
business, for the fiscal year ended June 30, 2020, you determined that its internal control system
was good. Accordingly, you observed the physical inventory at an interim date, May 31, 2020
instead as of at June 30, 2020.

 You obtained the following information from the company’s general ledger:
Physical inventory, May 31, 2020 P110,000
Inventory, July 1, 2019 70,000
Purchases for the fiscal year ended June 30, 2020 640,000
Purchases for eleven months ended May 31, 2020 540,000
(before audit adjustments)
Sales for the fiscal year ended June 30, 2020 768,000
Sales for eleven months ended May 31, 2020 672,000
 Your audit disclosed the following additional information:
1. Shipments costing P6,000 were received in May and included in the physical inventory
but recorded as June purchases.
2. Deposit of P2,000 made with vendor and charged to purchases in April 2020. Product
was shipped in July 2020.
3. A shipment in June was damaged through the carelessness of the receiving
department. The shipment was later sold in June at its cost of P8,000.

Required: 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 ratio. Based on the above and the result of your audit, you are
to provide the answer for the following:
1. Gross profit ratio for eleven months ended May 31, 2020.
2. Cost of goods sold during the month of June, 2020 using GP ratio method.
3. Inventory as of June 30, 2020 using the GP ratio method.

Problem 8

AUDITING REVIEW 3
Benguet Store uses the average retail inventory method. The following information is available
for the current year:
Cost Retail
Beginning inventory P550,000 P1,100,000
Purchases 7,900,000 13,150,000
Freight-in 200,000
Purchase returns 300,000 500,000
Purchase allowances 150,000
Departmental transfer in 200,000 400,000
Net markups 300,000
Net markdowns 450,000
Sales 12,350,000
Sales returns 175,000
Sales discounts 100,000
Employee discounts 300,000
Loss from breakage 25,000

Required: Based on the above and the result of your audit, answer the following:
1. Cost ratio using the average retail inventory method.
2. Estimated ending inventory at retail.
3. Estimated ending inventory at cost.
4. Estimated cost of goods sold.
5. If the inventory at retail based on physical count at December 31, 2020 is P850,000, the
estimated inventory shortage is

***END OF DISCUSSION***
***If you get TIRED, learn to REST, not to QUIT***

AUDITING REVIEW 4