CHAPTER

SUBSTANTIVE TESTS
OF INVENTORIES AND
COST OF GOODS SOLD

9-1.

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 which the
auditors must guard against.

9-2.

During an audit of a manufacturing company, the auditors review 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.

(2)

To obtain assurance that the cost system, as an integral part of the system of
internal control, provides proper accounting control over costs incurred and
related inventories.

(3)

To ascertain, as a service to management, that the cost system is economical

and effectively provides information for reducing or controlling costs and for
determining the cost and profitability of products, and other related data
necessary for informed managerial decisions.

9-3.

The auditors make test counts of inventory quantities during their observation of
the taking of the physical inventory to ascertain that an accurate count is being
made by the individuals taking the inventory. The extent of test counting will be
determined by the inventory-taking procedures; for example, the number of the
auditors test counts would be reduced if there were two teams, one verifying the
other, taking the inventory. On the other hand, the auditors test counts would be
expended if they found errors in the inventory counts.

9-4.

The statement is not true. The auditors responsibilities with respect to inventories
include not only quantities and pricing, but also the quality or condition of the
goods, the accuracy of extensions, footing, and summaries, and the evaluation of
internal control. Weakness in internal control may cause large losses from

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

excessive stockpiling, obsolescence, inaccurate cost data, and many other sources,
even though the ending inventory is properly counted and priced.

9-5.

The independent auditors utilize the clients backlog of unfilled sales orders in the
determination of net realizable value of finished goods and goods-in-process, and
in the determination of losses, if any, on firm sales commitments for which no
production has yet been undertaken.

9-6.

Beed Company
Since Beed Company obtained all of its merchandise inventory from the president
of the company in a related-party transaction, the auditors must determine the cost
of the merchandise to the president in his operation of a similar business as a
single proprietor. In this related-party transaction, the auditors must look beyond
form--a total cost of P100,000 for the original stock of merchandise--to substance.
Substantively, the merchandise of Beed Company should be priced, on a specific
identification basis if feasible, at its cost from the suppliers of the sole
proprietorship. Any difference between cost as thus determined and amounts
charged by the president to Beed Company represents unamortized discount on
the notes payable. The entire transaction should be fully disclosed in a note to the
financial statements of Beed Company.

9-7.

Jay Company
The following procedures should be undertaken:
(a)

The oral evidence that the motors are on consignment should be

substantiated by a review of the clients records of consigned inventory,
examination of contracts and correspondence with consignors, and
confirmation of consigned stocks by direct communication with consignors.

(b)

The location of the machine in the receiving department, together with the
presence of the REWORK tag, suggests that the machine had been
shipped to a customer but rejected and returned by the customer. The
auditors should examine the receiving report for the machine, the accounts
receivable confirmation from the customer, and records of the clients
quality control department, to ascertain who has title to the machine. If the
customer has title, the machine should not be included in inventory, and a
liability for rework costs should be established. If the client has title, the
customers account should be credited for the sales return and the machine
should be included in the clients inventory at estimated realizable value.

(c)

The Material Inspection and Receiving Report signed by the Navy Source
Inspector, is evidence that title to the machine passed to the Phil. Naval Base
on November 30, 2006. Accordingly, the auditors should ascertain that the
sales value of the machine is included in accounts receivable, and that the

Substantive Tests of Inventories and Cost of Goods Sold

9-3

cost of the machine is not in the perpetual inventory or the physical

inventory.
(d)

9-8.

The location of the storeroom and the dusty condition of the goods suggest
that the items may be obsolete, or at least slow moving. The auditors should
inspect perpetual inventory records for usage of the materials, and should
inquire of production personnel whether the materials are currently useful in
production. The materials may have to be valued at scrap value.

Pancho Manufacturing Corporation

(a) Consignment out.
1. Obtain from the client a complete list of all consignees together with
copies of the consignment contracts.
2. Evaluate the consignment contract provisions relative to the following
areas:
(a) Payment of freight and other handling charges.
(b) Extension of credit.
(c) Rates and computation of commissions to consignees.
(d) Frequency and contents of reports and remittances received from
consignees.
3. Discuss with the client any variations found in the contracts which do not
seem justified by the circumstances.
4. Following review of the consignment contracts, communicate directly
with the consignees to obtain complete information in writing on
merchandise remaining unsold, receivables resulting from sales,
unremitted proceeds, and accrued expenses and commissions, which
should be reconciled with the clients records for the period covered by
the engagement.
5. Determine that merchandise on consignment with consignees is valued
on the same basis as merchandise on hand, and included as part of the
inventory. Ascertain that any arbitrary mark-ons are deducted and that
shipping and related charges for the transfer of merchandise to the
consignees are reflected as part of the inventory.
6. Ascertain that quantities of goods in hands of consignees at the close of
the period under audit appear in the balance sheet and are separately
designated as Merchandise on Consignment.
(b) Finished merchandise in public warehouse pledged as collateral for
outstanding debt.
1. Determine that goods pledged to obtain funds are covered by warehouse
receipts. (The examination of warehouse receipts alone is not a sufficient
verification of goods stored in public warehouses.)
2. Request direct confirmation from the warehouses in which the
merchandise is held.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

3.
4.
5.
6.

9-9.

9-10.

a.

(2)

b.

(3)

e.

(4)

f.

(2)

a.

Principal problems the auditor will face are related by:

b.

9-11.

If available, obtain independent accountants reports on a warehouses

internal controls over custody of stored goods.
Review the clients procedures for acceptance and evaluation of the
performance of warehouses, and review supporting documents.
Review the loan agreements collateralized by warehouse receipts. These
agreements usually provide for certain payments to be made by the
borrower as pledged goods are sold.
Consider observing a physical inventory of goods stored at the public
warehouses.

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

c.

(2)

d.

(2)

1.

Verification of existence of the inventory owned by the company as

against inventory belonging to the customers.

2.

Proper valuation since the perpetual inventory records reflect quantities

only.

Steps that should be undertaken to enable the auditor to render an unqualified

opinion:
1.

Verify postings to the perpetual ledger at the plant office for both stock
owned and stock being held for customers against original cost sheet to
determine amounts debited and credited to the account.

2.

Require that an annual physical inventory taking be done by the client

and arrangements for the presence and observation of the auditor be
done.

3.

Confirm with customers unclaimed merchandise still in the possession of

the client as of the balance sheet date.

Existence or occurrence
Existence or occurrence
Valuation or allocation
Completeness
Completeness
Valuation or allocation
Completeness
Completeness
Existence or occurrence and completeness
Completeness

Substantive Tests of Inventories and Cost of Goods Sold

9-12.

a.

9-5

When the inventory is a material item in the financial statements that the
auditor is examining, observation of the taking of the physical inventory is in
compliance with the auditing standard pertaining to field work that requires
obtaining sufficient competent evidential matter to afford a reasonable basis
for an opinion regarding the financial statements. Observation is a generally
accepting auditing procedure applied in the examination of the physical
inventory.
By observing the taking of the physical inventory, the CPA is seeking to
satisfy himself or herself as to the effectiveness of the methods of inventory
taking and the measure of reliance that can be placed on the client inventory
records and their representations as to inventory quantities. The CPA must
ascertain that the physical inventory actually exists, that the inventory
quantities are being determined by reasonably accurate methods, and that the
inventory is in a salable or usable condition.

b.

The CPA makes test counts of inventory quantities during observation of the
taking of the physical inventory to become satisfied that an accurate count is
being made by the individuals taking the inventory. The extent of test
counting will be determined by the inventory-taking procedures. For
example, the number of test counts would be reduced if there were two teams
taking the inventory, one checking the other. On the other hand, the CPAs
test count would be expanded if errors were found in the inventory counts.
Some test counts are recorded by the CPA for the purpose of subsequent
comparison with the clients compilation of the inventory. The comparison
procedure goes beyond the mere determination that quantities have been
accurately transcribed. In addition, the CPA seeks assurance that the
description and condition of the inventory items are accurate for pricing
purposes and that the quantity information, such as dozen, gross, and cartons,
is proper.

c.

1.

The CPA does not regard the inventory certificate of an outside service
company as a satisfactory substitute for his or her own audit of the
inventory. The service company has merely assumed the clients
function of taking the physical inventory, pricing it, and making the
necessary extensions. To the extent that the service company is
competent, internal control with regard to the inventory has been
strengthened. Nevertheless, as under other strong systems of internal
control, the CPA would investigate the system to become satisfied that it
is operating in a satisfactory manner. The CPAs investigation would
necessarily entail an observation of the taking of the inventory and
testing the pricing and calculation of the inventory.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

2.

The inventory certificate of the outside specialists would have no effect

on the CPAs report. The CPA must be satisfied that the inventory is
fairly stated by observing the taking of the inventory and by testing the
pricing and calculation of the inventory.
However, if the taking of the inventory was not observed and no audit
tests were applied to the computation of the inventory, the CPA would be
compelled to disclaim an opinion on the financial statements as a whole
if the amount of the inventory is material.
If it has been impracticable or impossible for the CPA to observe the
taking of the physical inventory but he or she has been satisfied by the
application of other auditing procedures, the CPA would make no
reference to the matter in the report.

3.

9-13.

The CPA would make no reference to the certificate of the outside

specialists in the report. The outside specialists are serving as adjuncts of
the companys staff of permanent employees and, as such, are in
somewhat the same position as temporary employees. The outside
specialists are not independent in that they are not imbued with thirdparty interests. The CPA is compelled, under certain circumstances, to
mention in the report the reports of other independent auditors, but this
compulsion does not extend to the certificate of outside specialists who
are not independent auditors.

a.

For a client to dispose of the chemical compound in a manner that meets legal
requirements is admirable. However, ethical behavior frequently calls for
individual persons and companies to exhibit behavior that exceeds the
minimum standards set by law. Due to the harm to cattle and the pollution
that has resulted. Remote is involved in a matter that entails ethical issues.

b.

Most auditors are hesitant to serve as judge and jury for clients on ethical
matters. For example, declining to serve this client probably would not cause
any alteration of its behavior. Further, serving the client does not facilitate
any unethical behavior. Further, serving the client does not facilitate any
unethical behavior. Hence, an auditor might choose to discuss the matter with
the board and encourage them to act as responsible citizens.

Substantive Tests of Inventories and Cost of Goods Sold

9-14.

9-7

JC
Requirement (1)
Inventory, as given..........................................................
Deduct (adjustments to cost):
50% markup in (a) [P250,000 (P250,000 1.5)].
60% markup in (b) (P10,000 x 0.60).......................
Exclusion of (c)........................................................
Incorrect amount used in (e) (P2,500 P1,000)......

P271,500
P83,333
6,000
4,000
1,500

Add:
Freight on goods in transit in (d)..............................
Corrected ending inventory......................................

94,833
P176,667
800
P177,467

Requirement (2)
Income Statement
a. Ending inventory overstated (P250,000 P177,467).............
b. Cost of goods sold understated...............................................
c. Gross margin overstated.........................................................
d. Pretax income overstated........................................................
e. Income taxes overstated (P72,533 x 0.40).............................
f. Net income overstated (P72,533 P29,013)..........................

P72,533
72,533
72,533
72,533
29,013
43,520

Balance Sheet:
Current assets, inventory overstated............................................
Current liabilities, income taxes payable overstated....................
Retained earnings overstated........................................................

72,533
29,013
43,520

Requirement (3)
Retained earnings (prior period adjustment)...................
Income taxes payable......................................................
Inventory..................................................................
9-15.

Beginning inventory
Purchases
Cost of goods available for sale
Cost of goods sold (net sales of P51,000 1.50)
Ending inventory before theft
Ending inventory after theft
Inventory lost

43,520
29,013
72,533
P 38,000
19,000
P 57,000
34,000
P 23,000
15,000
P 8,000

9-8
9-16.

Solutions Manual to Accompany Applied Auditing, 2006 Edition

LRT Company
LRT COMPANY
Computation of Value of Inventory Lost
February 16, 2006
Sales
Less: Gross profit (40%)
Cost of goods sold
Finished goods, February 16
Cost of goods available for sale
Less: Finished goods, December 31, 2005
Cost of goods manufactured and completed

P 40,000
16,000
P 24,000
75,000
P 99,000
72,000
P 27,000

Raw materials, December 31, 2005

Raw materials purchases
Raw materials available for production
Raw materials before flood
Raw materials used
Direct labor
Manufacturing overhead cost
Goods in process, December 31, 2005
Cost of production
Less: Cost of goods completed (from above)
Goods in process inventory lost in flood

P 65,000
20,000
P 85,000
70,000
P 15,000
30,000
15,000
80,000
P 140,000
27,000
P 113,000

Total value of inventory

destroyed by flood

9-17.

(P35,000 1/2)

Raw materials lost + Goods in process lost

(P70,000 - P35,000) + P113,000

P148,000

Y Company
a.

Necessary adjustments to clients physical inventory:

Material in Car #AR38162--received in
warehouse on January 2, 2007
Materials stranded en route
(Sales price P19,270/125%)
Total
Less unsalable inventory
Total adjustment

P 8,120
15,416
23,536
1,250*
P22,286

* If freight charges have been included in the clients inventory, the

amount would be P1,600 and the amount of the total adjustment would

Substantive Tests of Inventories and Cost of Goods Sold

b.

be P21,936. Journal entry 6 probably would have a credit to purchases

of P1,600 in this case.
Auditors worksheet adjusting entries:
1.

Purchases
Accounts Payable
To record goods in warehouse but not
invoiced-received on RR 1060.

2.

No entry required. Title to goods had passed.

3.

Accounts receivable
Sales
To record goods as sold which were
loaded on December 31 and not
inventories-SI 968.

4.

No adjustment required.

6.

Claims receivable
Purchases
Freight In
To record claim against carrier for
merchandise damaged in transit.

8.

P 2,183
P 2,183

12,700
12,700

Sales
19,270
Accounts receivable
To reverse out of sales material included
in both sales (SI 966) and in physical
inventory (after adjustment).

5.

7.

9-18.

9-9

19,270

1,600

Inventory
22,286
Cost of goods sold
To adjust accounts for changes in physical
inventory quantities.
Sales
15,773
Accounts receivable
To reverse out of sales invoices #969, #970,
#971. The sales book was held open too long.
This merchandise was in warehouse at time
of physical count and so included therein.

1,250
350

22,286

15,773

Engine Warehouse Supply Company

a.

Cutoff errors will exist for accounts payable whenever the liability for a
purchase is recorded in the wrong period. The following rules should be
followed for recording purchases:
1.

Record as of date received when shipped FOB destination.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

2.

Record as of date shipped when shipped FOB origin.

On this basis, the receiving reports would be evaluated as follows:

Receivin
g Report
No.
679
680
681
682
683
684
685
686

Amoun
t

Date
Shipped

Date
Received

8-29
8-27
8-20
8-27
8-30
8-30
9-06
8-30

8-31
9-01
9-01
9-01
9-02
9-02
9-02
9-02

P 860
1,211
193
4,674
450
106
2,800
686

FOB Point

Should be
Recorded
in August

Was
Recorded
in August

Destination
Origin
Origin
Destination
Destination
Origin
Origin
Destination

Yes
Yes
Yes
No
No
Yes
No
No

Yes
Yes
Yes
Yes
No
No
No
No

The entry to adjust the records as of August 31 for cutoff errors in accounts
payable is as follows:
Dr. Accounts payable
Cr. Purchases

P4,568
P4,568

To adjust accounts payable for cutoff errors in recording inventory purchases:

RR No. 682
RR No. 684
b.

P4,674
( 106)
P4,568

Sales should be recorded as of the date shipped. The following shipping

documents were dated on September 1 and recorded in August:
311
312
313
314

P 56
3,194
635
193
P4,078

The adjusting entry will be:

Dr. Sales
Cr. Accounts receivable
To adjust sales for cutoff errors at August 31.

P4,078
P4,078

Substantive Tests of Inventories and Cost of Goods Sold

c.

1.
2.

9-11

Inventory received near the balance sheet date should be included in

inventory if it is recorded as a purchase and excluded if it is not recorded
as a purchase.
Inventory shipped near the balance sheet date should be excluded from
inventory if it is recorded as a sale and included if it has not been
recorded as a sale.

These principles lead to the following analysis.

Receipt of Goods
1.

Inventory for all receiving reports up to 684 are included in inventory.

2.

Using the analysis in part a, column 6, inventory for all receiving reports
up to 684, except 682 and 683, should be included in accounts payable
and inventory.
Report No.
679
680
681
682*
683*
684
685
686

Amount

Should be Included in
Purchases and Inventory

Was Included
in Inventory

860
1,211
193
4,674
450
106
2,800
686

Yes
Yes
Yes
No
No
Yes
No
No

Yes
Yes
Yes
Yes
Yes
Yes
No
No

* Requires removal from inventory.

3.

Inventory for receiving reports 682 and 683 should therefore be removed
from the physical count:
Amount
682
4,674
683
450
5,124

Shipment of Goods
1.

Inventory for shipping documents 314 to 317 were included in inventory.

All inventory for documents 313 and earlier were excluded.

2.

Sales, after adjustments, were included only for shipments 310 and those
preceding, as shown in the analysis in part b.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

3.

Inventory for shipping documents 311 to 313 should therefore be added

to inventory. The amount of the cost of the inventory cannot be
determined without reference to inventory costs. Presumably, cost will
be less than the sales value shown in part b.
Shipping
Document No.
310
311*
312*
313*
314
315
316
317
318

Included in
Physical
No
No
No
No
Yes
Yes
Yes
Yes
Yes

Recorded as Sale After

Adjustments in Part b
Yes
No
No
No
No
No
No
No
No

* Requires addition to inventory at cost.

Shipping
Document No.
311
312
313
Inventory cost
(70% of selling price)

Selling
Price
P 56
3,194
635
3,885
2,719

Summary
Reduction of inventory due to physical count error
resulting from receipt of goods.
Increase of inventory due to physical count error
resulting from shipment of goods.
Net reduction of inventory required
d.

P5,124.00
2,719.50
P2,404.50

The accuracy about September 1 receipts and shipments of goods could be

verified by reference to bills of lading.

Substantive Tests of Inventories and Cost of Goods Sold

9-19.

9-13

Green Company

Requirement (a)
Green Company
Inventory
12.31.06
Item
A 510
A 520
A 530
A 540
A 550
A 560
A 570

Quantity
720 units
48 units
146 units
86 units
80 units
140 units
910 gross

Total
Add: AJE (1)

Per Audit
Unit Price *
Amount
P 2.64 / doz.
P
218.40
4.70 each
225.60
16.50 each
2,409.00
5.15 each
442.90
8.50 each
680.00
2.00 each
3,360.00
132 gross
120,120.00

Per Client
P 2,592.00
252.60
2,706.00
353.60
7,280.00
280.00
27,360.00

P127,455.90
__________

P 40,824.20
86,631.70

P127,455.90

P127,455.90

* Lower of cost or market

Requirement (b)
Inventory
Cost of sales

86,631.70
86,631.70

9-20.
Requirement (a)

Requirement (b)

1.

Exclude

Title to the goods passed to the client on January 3, 2007

or upon receipt because the term of shipment was FOB
Destination.

2.

Exclude

Goods held on consignment are not owned by the client.

3.

Include

Regular stock item even if segregated but not actually

delivered as of the end of the year is still part of the
clients inventory.

4.

Include

Title to the goods passed to the client on December 31,

2006 or upon shipment because the invoice showed FOB
suppliers warehouse.

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

5.

9-21.

Exclude

Goods fabricated to order for a customer are considered

sold as soon as completed even if not yet delivered.

Isabela Company
ISABELA COMPANY
Worksheet to Correct Selected Accounts
12-31-06

9-22.

Inventory

Accounts Payable

Sales

Initial amounts
Adjustments
Increase (Decrease)
1
2
3
4
5
6
7

P1,250,000

P1,000,000

P9,000,000

P (155,000)
(22,000)
None
210,000
25,000
2,000
(5,300)

P (155,000)
None
None
None
25,000
2,000
(5,300)

None
None
P 40,000
None
None
None
None

Total adjustments

Adjustment amounts

P1,304,700

54,700

P (133,300)

P9,040,000

866,700

40,000

Stockroom W
Stockroom W
Reconciliation of Inventory
Opening
Inventor
y

Receipt
s

Withdrawal
s

Balance per Accounting Department

Add (Deduct) Reconciling Items
1) Receipt of materials
erroneously posted by the
Accounting Department to
Stockroom W.
2) Correction of error in the
Accounting Department.
3) Shortage not recorded in the
Accounting Department.

P 22,600

P28,000

P 26,000

_______

______

90

Balance per Factory Records

P 22,000

P28,480

P 25,490

480
( 600)

Ending
Inventory
P 24,600

480
( 600)
(90)
P 24,990

Substantive Tests of Inventories and Cost of Goods Sold

9-23.

9-15

Pinas Company
Requirement (1)
Audit Adjustments, 12.31.06
1.
2.
3.
4.
5.
6. a.
b.
7.

Retained earnings
Purchases

300

Inventory, January 1, 2006

Retained earnings

700

Accounts receivable
Sales

500

Purchases
Accounts payable

500

Inventory, Dec. 31, 2006 B/S

Inventory, Dec. 31, 2006 I/S

400

300
700
500
500
400

Purchases
Accounts payable

1,200

Inventory, Dec. 31, 2006 B/S

Inventory, Dec. 31, 2006 I/S

1,200

1,200
1,200

Accounts payable
Purchases

800
800

Requirement (2)
Pinas Company
Cost of Sales
2006

Inventory, Jan. 1
Purchases
Total available
Less: Inventory, Dec. 31
Cost of sales

Per
Client
P 3,200
21,100
_______
24,300
4,300
_______
P 20,000

Adjustments
Dr
Cr
P 700 (2)
500 (4)
P 300 (1)
1,200 (6a)
800 (7)

______
P 2,400

Per
Audit
P 3,900
21,700
25,600

400 (5)
1,200 (6b)
5,900
P 2,700
P19,700

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Solutions Manual to Accompany Applied Auditing, 2006 Edition

9-24.

Bers Company
Uncorrected
Amounts

Income statement:
Sales revenue.............................
Cost of goods sold.....................
Gross margin..............................
Expenses....................................
Income.......................................
Balance sheet:
Accounts receivable...................
Inventory....................................
Remaining assets.......................
Accounts payable.......................
Remaining liabilities..................
Share capital, ordinary...............
Retained earnings ....................
Totals......................................
*

P90,000
50,000
40,000
30,000
P10,000
P42,000
20,000
30,000
11,000 *
6,000 *
60,000 *
15,000 *
P
0

Credits.
Retained Earnings is negative after correction.

(a)

(b)

Items for Correction

(c)
(d)

12,000
+ 7,000
7,000

12,000

(e)

+ 6,000

+ 15,000

15,000
8,000

6,000

15,000

7,000

15,000

15,000
+ 8,000

15,000

7,000

12,000
+ 6,000
+ 7,000
7,000

12,000

6,000

Corrected
Amounts
P 63,000
63,000
0
37,000
P(37,000)
P15,000
13,000
30,000
17,000 *
13,000 *
60,000 *
(32,000)
P
0

Substantive Tests of Inventories and Cost of Goods Sold

9-19

9-25.
1.

Jap Co.
P150,000 (P150,000 X .20) = P120,000;
P120,000 (P120,000 X .10) = P108,000, cost of goods purchased

2.

Fred Company
P1,100,000 + P69,000 = P1,169,000. The P69,000 of goods in transit on
which title had passed on December 24 (f.o.b. shipping point) should be
added to 12/31/06 inventory. The P29,000 of goods shipped (f.o.b. shipping
point) on January 3, 2007, should remain part of the 12/31/06 inventory.

3.

B. May Corp.
Because no date was associated with the units issued or sold, the periodic
(rather than perpetual) inventory method must be assumed.
FIFO inventory cost:

1,000 units at P24

1,100 units at 23
Total

P 24,000
25,300
P 49,300

Average cost:

1,500 at P21
2,000 at 22
3,500 at 23
1,000 at 24
8,000

P 31,500
44,000
80,500
24,000
P180,000

Totals

P180,000 8,000 = P22.50

Ending inventory (2,100 X P22.50) is P47,250.
4.

Emmett Lopez Inc.

The inventoriable costs for 2007 are:
Merchandise purchased
Add: Freight-in
Deduct: Purchase returns
Purchase discounts
Inventoriable cost

P909,400
22,000
931,400
P16,500
6,800

23,300
P908,100

Substantive Tests of Inventories and Cost of Goods Sold

9-20

9-26.
(a)

(1)

8/10
Purchases
Accounts Payable

9,000
9,000

8/13
Accounts Payable
Purchase Returns and Allowances

1,200
1,200

8/15
Purchases
Accounts Payable

12,000
12,000
8/25

Purchases
Accounts Payable

15,000
15,000
8/28

Accounts Payable
Cash
(2)

12,000
12,000

Purchasesaddition in cost of goods sold section of income

statement.
Purchase returns and allowancesdeduction from purchases in cost
of goods sold section of the income statement.
Accounts payablecurrent liability in the current liabilities section of
the balance sheet.

(b)

(1)

8/10
Purchases
Accounts Payable (P9,000 X .98)

8,820
8,820

8/13
Accounts Payable
Purchase Returns and Allowances
(P1,200 X .98)

1,176
1,176

8/15
Purchases
Accounts Payable (P12,000 X .99)

11,880
11,880

Substantive Tests of Inventories and Cost of Goods Sold

9-21

8/25
Purchases
Accounts Payable (P15,000 X .98)
8/28
Accounts Payable
Purchase Discounts Lost
Cash
(2)

14,700
11,880
120
12,000

8/31
Purchase Discounts Lost
Accounts Payable
(.02 X [P9,000 P1,200])

(3)

14,700

156
156

Same as part (a) (2) except:

Purchase Discounts Losttreat as financial expense in income
statement.

(c)

9-27.

The second method is better theoretically because it results in the inventory

being carried net of purchase discounts, and purchase discounts not taken
are shown as an expense. The first method is normally used, however, for
practical reasons.

MAR Company
(a)

Purchases
Total Units
April 1 (balance on hand)
April 4
April 11
April 18
April 26
April 30
Total units
Total units sold
Total units (ending inventory)

Sales
Total Units
100
400
300
200
500
200
1,700
1,400
300

April 5
April 12
April 27
April 28
Total units

300
200
800
100
1,400

Assuming costs are not computed for each withdrawal:

(1) First-in, first-out.
Date of Invoice

No. Units

Unit Cost

Total Cost

April 30

200

P5.80

P1,160

9-22

Solutions Manual to Accompany Applied Auditing, 2006 Edition

April 26

100

5.60

560
P1,720

(2) Average cost.

Cost of Part X available.
Date of Invoice

No. Units

Unit Cost

Total Cost

April 1
April 4
April 11
April 18
April 26
April 30
Total Available

100
400
300
200
500
200
1,700

P5.00
5.10
5.30
5.35
5.60
5.80

P 500
2,040
1,590
1,070
2,800
1,160
P9,160

Average cost per unit = P9,160 1,700 = P5.39.

Inventory, April 30 = 300 X P5.39 = P1,617.
(b) Assuming costs are computed for each withdrawal:
(1) First-in, first out.
The inventory would be the same in amount as in part (a), P1,720.
(2) Average cost.

Date
April 1
April 4
April 5
April 11
April 12
April 18
April 26
April 27
April 28
April 30

Purchased
No. of
Unit
units
cost
100
400

P5.00
5.10

300

5.30

200
500

200

Sold
No. of Unit cost
units

300

P5.0800

200

5.2120

800
100

5.4336
5.4336

5.35
5.60

5.80

No. of
units
100
500
200
500
300
500
1,000
200
100
300

Balance
Unit
cost*
P5.0000
5.0800
5.0800
5.2120
5.2120
5.2672
5.4336
5.4336
5.4336
5.6779

Amount
P 500.00
2,540.00
1,016.00
2,606.00
1,563.60
2,633.60
5,433.60
1,086.72
543.36
1,703.36

Substantive Tests of Inventories and Cost of Goods Sold

9-23

Inventory April 30 is P1,703.

*Four decimal places are used to minimize rounding errors.
9-28.

Timmy Turner
Requirement (a)
Merchandise on hand, January 1
Purchases
Less purchase returns and allowances
Net purchases
Freight-in
Total merchandise available for sale
Cost of goods sold*
Ending inventory
Less undamaged goods
Estimated fire loss
*Gross profit =

33 1/3%
100% + 33 1/3%

P38,000
P72,000
2,400
69,600
3,400

73,000
111,000
75,000
36,000
10,900
P 25,100

= 25% of sales.

Cost of goods sold = 75% of sales of P100,000 = P75,000.

Requirement (b)
Cost of goods sold = 66 2/3% of sales of
P100,000 = P66,667
Ending inventory [P111,000 (as computed above)
P66,667]
Less undamaged goods
Estimated fire loss
9-29.

P44,333
10,900
P33,433

Cosmo and Wanda Company

Beginning inventory
Purchases
Purchase returns
Total goods available
Sales
Sales returns
Net sales
Less gross profit (40% X P626,000)
Estimated ending inventory (unadjusted for
damage)

P170,000
390,000
560,000
(30,000)
530,000
P650,000
(24,000)
626,000
(250,400)

375,600
154,400

9-24

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Less goods on handundamaged (at cost)
P21,000 X (1 40%)
Less goods on handdamaged (at net
realizable value)
Fire loss on inventory

(12,600)
(5,300)
P136,500