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11-1.Substantiation of the figure for inventories is an especially challenging taskbecause of the variety of acceptable methods of valuation. In addition, the varietyof materials found in inventories calls for considerable experience and skill to doan efficient job of identifying and test-counting goods on hand. The possibilitiesof obsolescence and of excessive stocks also create problems. Finally, therelatively large size of inventories and their significance in the determination ofnet income make purposeful misstatement by the client a possibility which theauditors must guard against.11-2.During an audit of a manufacturing company, the auditors review the cost systemfor the following purposes:(1)To determine that costs are properly allocated to current and future periodsand hence that cost figures used in arriving at statement of financial positionand statement of comprehensive income amounts are supported by internalrecords.(2)To obtain assurance that the cost system, as an integral part of the system ofinternal control, provides proper accounting control over costs incurred andrelated inventories.(3)To ascertain, as a service to management, that the cost system is economicaland effectively provides information for reducing or controlling costs and fordetermining the cost and profitability of products, and other related datanecessary for informed managerial decisions.11-3.The auditors make test counts of inventory quantities during their observation ofthe taking of the physical inventory to ascertain that an accurate count is beingmade by the individuals taking the inventory. The extent of test counting will bedetermined by the inventory-taking procedures; for example, the number of theauditors’ test counts would be reduced if there were two teams, one verifying theother, taking the inventory. On the other hand, the auditors’ test counts would beexpended if they found errors in the inventory counts.11-4.The statement is not true. The auditors’ responsibilities with respect to inventoriesinclude not only quantities and pricing, but also the quality or condition of thegoods, the accuracy of extensions, footing, and summaries, and the evaluation ofinternal control. Weakness in internal control may cause large losses fromCHAPTER11SUBSTANTIVE TESTS OF INVENTORIES AND COST OF GOODS SOLD
11-2 Solutions Manual to Accompany Applied Auditing, 2014 Editionexcessive stockpiling, obsolescence, inaccurate cost data, and many other sources,even though the ending inventory is properly counted and priced.11-5.The independent auditors utilize the client’s backlog of unfilled sales orders in thedetermination of net realizable value of finished goods and goods-in-process, andin the determination of losses, if any, on firm sales commitments for which noproduction has yet been undertaken.