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Unformatted text preview: Chapter 12 - Inventories and Cost of Goods Sold CHAPTER 12 Inventories and Cost of Goods Sold Review Questions 12-1 Substantiation of the figure for inventories is an especially challenging task because of the variety of acceptable methods of valuation. In addition, the variety of materials found in inventories calls for considerable experience and skill to do an efficient job of identifying and test-counting goods on hand. The possibilities of obsolescence and of excessive stocks also create problems. Finally, the relatively large size of inventories and their significance in the determination of net income make purposeful misstatement by the client a possibility that the auditors must guard against. 12-2 Issuance of a purchase order requires approval signatures attesting that all established procedures have been observed for (a) determining the need for the item, (b) obtaining the competitive bids, and (c) obtaining approval of the financial aspect of the commitment. Since the issuance of a purchase order commits the company to a liability, the purchasing function is extremely important. 12-3 Internal control over purchasing activities is strengthened by placing exclusive authority for purchases of all kinds in a separate purchasing department, and creating another independent department to handle the receiving function. In addition, the recording of purchase transactions should be assigned to an accounts payable section within the accounting department. In a small concern, departmentalization of operations may not be feasible to this extent, but if internal control is to be achieved, it is necessary as a minimum requirement that the functions of purchasing, receiving, and recording be assigned to different employees not subordinate to one another. 12-4 Adequate internal control of purchase transactions requires the preparation of serially numbered receiving reports by an independent receiving department and the comparison of these reports with vendors' invoices and purchase orders by the accounts payable department prior to approval of the invoice for payment. To ascertain that these procedures are actually being followed, the auditors will make various tests including the examination of receiving reports to see that they are complete, current, legible, and controlled by serial numbers. 6 Chapter 12 - Inventories and Cost of Goods Sold 12-5 During an audit of a manufacturing company, the auditors consider the cost system for the following purposes: (1) To determine that costs are properly allocated to current and future periods and hence that cost figures used in arriving at balance sheet and income statement amounts are supported by internal records. The appropriate allocation of costs to finished goods, work in process, and cost of goods sold is essential to the preparation of financial statements in accordance with generally accepted accounting principles....
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- Spring '09