Inventory - Valuation

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Question 17a ii

Elounda Co manufactures chemical compounds using a continuous production process. Its year end was 31 July 20X6 and the draft profit before tax is $13·6 million. You are the audit supervisor and the year-end audit is due to commence shortly. The following matters have been brought to your attention.

(ii) Inventory valuation
Your firm attended the year-end inventory count for Elounda Co and ascertained that the process for recording work in progress (WIP) and finished goods was acceptable. Both WIP and finished goods are material to the financial statements and the quantity and stage of completion of all ongoing production was recorded accurately during the count.

During the inventory count, the count supervisor noted that a consignment of finished goods, compound E243, with a value of $720,000, was defective in that the chemical mix was incorrect. The finance director believes that compound E243 can still be sold at a discounted sum of $400,000. (6 marks)

Required:
(a) Describe substantive procedures you should perform to obtain sufficient, appropriate audit evidence in relation to the above three matters.

Note: The mark allocation is shown against each of the three matters above.

Specimen
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Question 18b ii

Vieri Motor Cars Co (Vieri) manufactures a range of motor cars and its year end is 30 June 20X5. You are the audit supervisor of Rossi & Co and are currently preparing the audit programmes for the year-end audit of Vieri. You have had a meeting with your audit manager and he has notified you of the following issues identified during the audit risk assessment process:

Land and buildings
Vieri has a policy of revaluing land and buildings, this is undertaken on a rolling basis over a five-year period. During the year Vieri requested an external independent valuer to revalue a number of properties, including a warehouse purchased in January 20X5. Depreciation is charged on a pro rata basis.

Work in progress
Vieri undertakes continuous production of cars, 24 hours a day, seven days a week. An inventory count is to be undertaken at the year end and Rossi & Co will attend. You are responsible for the audit of work in progress (WIP) and will be part of the team attending the count as well as the final audit. WIP constitutes the partly assembled cars at the year end and this balance is likely to be material. Vieri values WIP according to percentage of completion, and standard costs are then applied to these percentages.

Required:
(b) Describe the substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to:

(ii) The valuation of work in progress. (4 marks)

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Question 6b ii

Jackdaw Motor Cars Co (Jackdaw) manufactures a range of motor cars and its year end is 31 January 2015. You are the audit supervisor of Puffin & Co and are currently preparing the audit programmes for the year-end audit of Jackdaw. You have had a meeting with your audit manager and he has notified you of a number of issues identified during the audit risk assessment process.

Land and buildings
Jackdaw have a policy of revaluing land and buildings, this is undertaken on a rolling basis over a five-year period.

During the year Jackdaw requested an external valuer to revalue a number of properties, including a warehouse purchased in May 2014. Depreciation is charged on a pro rata basis.

Work in progress
Jackdaw undertakes continuous production of cars, 24 hours a day, seven days a week. An inventory count is to be undertaken at the year end and Puffin & Co will attend. You are responsible for the audit of work in progress (WIP) and will be part of the team attending the count as well as the final audit. WIP constitutes the partly assembled cars at the year end and this balance is likely to be material. Jackdaw values WIP according to percentage of completion, and standard costs are then applied to these percentages.

Required:
(b) Describe the substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to:

(ii) The valuation of work in progress. (4 marks)

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Question 1d iii

Minty Cola Co (Minty) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks and its year end is 31 December 2013. You are the audit manager of Parsley & Co and are currently planning the audit of Minty.

You attended the planning meeting with the engagement partner and finance director last week and recorded the minutes from the meeting shown below. You are reviewing these as part of the process of preparing the audit strategy.

Minutes of planning meeting for Minty

Minty’s trading results have been strong this year and the company is forecasting revenue of $85 million, which is an increase from the previous year. The company has invested significantly in the cola and fizzy drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing and replacing a significant amount of the machinery used in the production process.

As the level of production has increased, the company has expanded the number of warehouses it uses to store inventory. It now utilises 15 warehouses; some are owned by Minty and some are rented from third parties. There will be inventory counts taking place at all 15 of these sites at the year end.

A new accounting general ledger has been introduced at the beginning of the year, with the old and new systems being run in parallel for a period of two months.

As a result of the increase in revenue, Minty has recently recruited a new credit controller to chase outstanding receivables. The finance director thinks it is not necessary to continue to maintain an allowance for receivables and so has released the opening allowance of $1•5 million.

In addition, Minty has incurred expenditure of $4•5 million on developing a new brand of fizzy soft drinks. The company started this process in January 2013 and is close to launching their new product into the market place.

The finance director stated that there was a problem in November in the mixing of raw materials within the production process which resulted in a large batch of cola products tasting different. A number of these products were sold; however, due to complaints by customers about the flavour, no further sales of these goods have been made. No adjustment has been made to the valuation of the damaged inventory, which will still be held at cost of $1 million at the year end.

As in previous years, the management of Minty is due to be paid a significant annual bonus based on the value of year-end total assets.

Required:

Describe substantive procedures the audit team should perform to obtain sufficient and appropriate audit evidence in relation to the following three matters:

(iii) The damaged inventory. (3 marks)

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Question 4a

(i) Identify and explain FOUR financial statement assertions relevant to account balances at the year end; and

(ii) For each identified assertion, describe a substantive procedure relevant to the audit of year-end inventory. (8 marks)

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Question 3c

Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has a wide customer base across Europe and Asia. You are the audit manager of Nate & Co and you are planning the audit of Abrahams Co whose financial year end is 31 January.

You attended a planning meeting with the finance director and engagement partner and are now reviewing the meeting notes in order to produce the audit strategy and plan. Revenue for the year is forecast at $25 million.

During the year the company has spent $2•2 million on developing several new products. Some of these are in the early stages of development whilst others are nearing completion. The finance director has confirmed that all projects are likely to be successful and so he is intending to capitalise the full $2•2 million.

Once products have completed the development stage, Abrahams begins manufacturing them. At the year end it is anticipated that there will be significant levels of work in progress. In addition the company uses a standard costing method to value inventory; the standard costs are set when a product is first manufactured and are not usually updated.

In order to fulfil customer orders promptly, Abrahams Co has warehouses for finished goods located across Europe and Asia; approximately one third of these are third party warehouses where Abrahams just rents space.

In September a new accounting package was introduced. This is a bespoke system developed by the information technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too onerous for the accounting team.

Two months after the system changeover the IT manager left the company; a new manager has been recruited but is not due to start work until January.

In order to fund the development of new products, Abrahams has restructured its finance and raised $1 million through issuing shares at a premium and $2•5 million through a long-term loan. There are bank covenants attached to the loan, the main one relating to a minimum level of total assets.

If these covenants are breached then the loan becomes immediately repayable. The company has a policy of revaluing land and buildings, and the finance director has announced that all land and buildings will be revalued as at the year end.

The reporting timetable for audit completion of Abrahams Co is quite short, and the finance director would like to report results even earlier this year.

Required:

Describe substantive procedures you should perform to obtain sufficient appropriate evidence in relation to:

(i) Inventory held at the third party warehouses; and

(ii) Use of standard costs for inventory valuation. (4 marks)

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Question 1d i

Introduction and client background

You are an audit senior in Staple and Co and you are commencing the planning of the audit of -Smoothbrush Paints Co for the year ending 31 August 2010.

Smoothbrush Paints Co is a paint manufacturer and has been trading for over 50 years, it operates from one central site, which includes the production facility, warehouse and administration offices.
Smoothbrush sells all of its goods to large home improvement stores, with 60% being to one large chain store Homewares.

The company has a one year contract to be the sole supplier of paint to Homewares. It secured the contract through significantly reducing prices and offering a four-month credit period, the company’s normal credit period is one month.

Goods in/purchases

In recent years, Smoothbrush has reduced the level of goods directly manufactured and instead started to import paint from South Asia. Approximately 60% is imported and 40% manufactured.

Within the production facility is a large amount of old plant and equipment that is now redundant and has minimal scrap value. Purchase orders for overseas paint are made six months in advance and goods can be in transit for up to two months. Smoothbrush accounts for the inventory when it receives the goods.

To avoid the disruption of a year end inventory count, Smoothbrush has this year introduced a continuous/perpetual inventory counting system. The warehouse has been divided into 12 areas and these are each to be counted once over the year.

The counting team includes a member of the internal audit department and a warehouse staff member. The following procedures have been adopted;

1. The team prints the inventory quantities and descriptions from the system and these records are then compared to the inventory physically present.

2. Any discrepancies in relation to quantities are noted on the inventory sheets, including any items not listed on the sheets but present in the warehouse area.

3. Any damaged or old items are noted and they are removed from the inventory sheets.

4. The sheets are then passed to the fi nance department for adjustments to be made to the records when the count has fi nished.

5. During the counts there will continue to be inventory movements with goods arriving and leaving the warehouse.

At the year end it is proposed that the inventory will be based on the underlying records. Traditionally Smoothbrush has maintained an inventory provision based on 1% of the inventory value, but management feels that as inventory is being reviewed more regularly it no longer needs this provision.

Finance Director

In May 2010 Smoothbrush had a dispute with its finance director (FD) and he immediately left the company. The company has temporarily asked the financial controller to take over the role while they recruit a permanent replacement.

The old FD has notified Smoothbrush that he intends to sue for unfair dismissal. The company is not proposing to make any provision or disclosures for this, as they are confident the claim has no merit.

Required:

Describe THREE substantive procedures the auditor of Smoothbrush Paints Co should perform at the year end in confirming the valuation of inventory; (3 marks)

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Question 1e

Redburn Co, a publisher and producer of books of poetry, has been a client of your fi rm of Chartered Certified Accountants for a number of years. The manager in overall charge of the audit has been discussing the audit plan with the audit team, of which you are a member, prior to commencement of the work.

The audit manager has informed the team, among other things, that there has been a growing interest in poetry generally and that the company has acquired a reputation for publishing poets who are still relatively unknown.

During your audit you determine:

(i) Contracts with the poets state that they are given a royalty of 10% on sales. Free copies of the books are provided to the poets and to some organisations such as copyright libraries and to others, such as reviewers and university lecturers. No royalties are given on these free copies.

(ii) The computerised customer master fi le contains a code indicating whether a despatch is to earn a royalty for the author. This code is shown on the sales invoice and despatch note when they are prepared.

(iii) A computerised royalties fi le is held, all entries therein bearing the invoice number and date.

(iv) The company keeps detailed statistics of sales made, including trends of monthly sales by type of customer, and of colleges where its books are recommended as part of course material, based on reports from sales staff.

(v) Bookshops have the right to return books which are not selling well, but about 10% of these are slightly damaged when returned. The company keeps similar records of returns as it does for sales.

The management of Redburn Co have told you that inventory is correctly valued at the lower of cost and net realisable value. You have already satisfied yourself that cost is correctly determined.

Required:

(i) Define net realisable value; (2 marks)

(ii) State and explain the purpose of FOUR procedures that you should use to ensure that net realisable value of the inventory is at or above cost. (8 marks)

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