CHAPTER

9 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
excessive stockpiling, obsolescence, inaccurate cost data, and many other sources,
even though the ending inventory is properly counted and priced.
9-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

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
cost of the machine is not in the perpetual inventory or the physical
inventory.
 Substantive Tests of Inventories and Cost of Goods Sold 9-3
(d) 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.

9-8. 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.
3. If available, obtain independent accountants reports on a warehouses
internal controls over custody of stored goods.
4. Review the clients procedures for acceptance and evaluation of the
performance of warehouses, and review supporting documents.
9-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition

5. 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.
6. Consider observing a physical inventory of goods stored at the public
warehouses.

9-9. a. (2) b. (3) c. (2) d. (2)

e. (4) f. (2)

9-10. a. Principal problems the auditor will face are related by:
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.

b. 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.

9-11. 1. Existence or occurrence

2. Existence or occurrence
3. Valuation or allocation
4. Completeness
5. Completeness
6. Valuation or allocation
7. Completeness
8. Completeness
9. Existence or occurrence and completeness
10. Completeness

9-12. a. 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
 Substantive Tests of Inventories and Cost of Goods Sold 9-5
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.

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.
9-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition

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. 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 third-
party 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.

9-13. 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.

9-14. JC

Requirement (1)

Inventory, as given.......................................................... P271,500

 Substantive Tests of Inventories and Cost of Goods Sold 9-7
Deduct (adjustments to cost):
50% markup in (a) [P250,000 (P250,000 1.5)].. P83,333
60% markup in (b) (P10,000 x 0.60)....................... 6,000
Exclusion of (c)........................................................ 4,000
Incorrect amount used in (e) (P2,500 P1,000)...... 1,500 94,833
P176,667
Add:
Freight on goods in transit in (d).............................. 800
Corrected ending inventory...................................... P177,467

Requirement (2)

Income Statement
a. Ending inventory overstated (P250,000 P177,467)............. P72,533
b. Cost of goods sold understated............................................... 72,533
c. Gross margin overstated......................................................... 72,533
d. Pretax income overstated........................................................ 72,533
e. Income taxes overstated (P72,533 x 0.40)............................. 29,013
f. Net income overstated (P72,533 P29,013).......................... 43,520

Balance Sheet:
Current assets, inventory overstated............................................ 72,533
Current liabilities, income taxes payable overstated.................... 29,013
Retained earnings overstated........................................................ 43,520

Requirement (3)

Retained earnings (prior period adjustment)................... 43,520

Income taxes payable...................................................... 29,013
Inventory.................................................................. 72,533

9-15. Beginning inventory P 38,000

Purchases 19,000
Cost of goods available for sale P 57,000
Cost of goods sold (net sales of P51,000 1.50) 34,000
Ending inventory before theft P 23,000
Ending inventory after theft 15,000
Inventory lost P 8,000

9-16. LRT Company

LRT COMPANY
Computation of Value of Inventory Lost
February 16, 2006
9-8 Solutions Manual to Accompany Applied Auditing, 2006 Edition

Sales P 40,000
Less: Gross profit (40%) 16,000
Cost of goods sold P 24,000
Finished goods, February 16 75,000
Cost of goods available for sale P 99,000
Less: Finished goods, December 31, 2005 72,000
Cost of goods manufactured and completed P 27,000

Raw materials, December 31, 2005 P 65,000

Raw materials purchases 20,000
Raw materials available for production P 85,000
Raw materials before flood 70,000 (P35,000 1/2)
Raw materials used P 15,000
Direct labor 30,000
Manufacturing overhead cost 15,000
Goods in process, December 31, 2005 80,000
Cost of production P 140,000
Less: Cost of goods completed (from above) 27,000
Goods in process inventory lost in flood P 113,000

Total value of inventory = Raw materials lost + Goods in process lost

destroyed by flood
= (P70,000 - P35,000) + P113,000
= P148,000

9-17. Y Company

a. Necessary adjustments to clients physical inventory:

Material in Car #AR38162--received in

warehouse on January 2, 2007 P 8,120
Materials stranded en route
(Sales price P19,270/125%) 15,416
Total 23,536
Less unsalable inventory 1,250*
Total adjustment 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
be P21,936. Journal entry 6 probably would have a credit to purchases
of P1,600 in this case.
b. Auditors worksheet adjusting entries:
1. Purchases P 2,183
Accounts Payable P 2,183
To record goods in warehouse but not
 Substantive Tests of Inventories and Cost of Goods Sold 9-9
invoiced-received on RR 1060.
2. No entry required. Title to goods had passed.
3. Accounts receivable 12,700
Sales 12,700
To record goods as sold which were
loaded on December 31 and not
inventories-SI 968.
4. Sales 19,270
Accounts receivable 19,270
To reverse out of sales material included
in both sales (SI 966) and in physical
inventory (after adjustment).
5. No adjustment required.
6. Claims receivable 1,600
Purchases 1,250
Freight In 350
To record claim against carrier for
merchandise damaged in transit.
7. Inventory 22,286
Cost of goods sold 22,286
To adjust accounts for changes in physical
inventory quantities.
8. Sales 15,773
Accounts receivable 15,773
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.

9-18. 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.
2. Record as of date shipped when shipped FOB origin.

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

Receivin Should be Was

g Report Date Date Recorded Recorded
No. Amoun Shipped Received FOB Point in August in August
9-10 Solutions Manual to Accompany Applied Auditing, 2006 Edition

t
679 P 860 8-29 8-31 Destination Yes Yes
680 1,211 8-27 9-01 Origin Yes Yes
681 193 8-20 9-01 Origin Yes Yes
682 4,674 8-27 9-01 Destination No Yes
683 450 8-30 9-02 Destination No No
684 106 8-30 9-02 Origin Yes No
685 2,800 9-06 9-02 Origin No No
686 686 8-30 9-02 Destination No No

The entry to adjust the records as of August 31 for cutoff errors in accounts
payable is as follows:

Dr. Accounts payable P4,568

Cr. Purchases P4,568

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

RR No. 682 P4,674

RR No. 684 ( 106)
P4,568

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

documents were dated on September 1 and recorded in August:

311 P 56
312 3,194
313 635
314 193
P4,078

The adjusting entry will be:

Dr. Sales P4,078

Cr. Accounts receivable P4,078
To adjust sales for cutoff errors at August 31.

c. 1. 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.
 Substantive Tests of Inventories and Cost of Goods Sold 9-11
2. 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.

Should be Included in Was Included

Report No. Amount Purchases and Inventory in Inventory
679 860 Yes Yes
680 1,211 Yes Yes
681 193 Yes Yes
682* 4,674 No Yes
683* 450 No Yes
684 106 Yes Yes
685 2,800 No No
686 686 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.
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.
9-12 Solutions Manual to Accompany Applied Auditing, 2006 Edition

Shipping Included in Recorded as Sale After

Document No. Physical Adjustments in Part b
310 No Yes
311* No No
312* No No
313* No No
314 Yes No
315 Yes No
316 Yes No
317 Yes No
318 Yes No

* Requires addition to inventory at cost.

Shipping Selling
Document No. Price
311 P 56
312 3,194
313 635
Inventory cost 3,885
(70% of selling price) 2,719

Summary
Reduction of inventory due to physical count error
resulting from receipt of goods. P5,124.00
Increase of inventory due to physical count error
resulting from shipment of goods. 2,719.50
Net reduction of inventory required P2,404.50

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

verified by reference to bills of lading.

9-19. Green Company

Requirement (a)
 Substantive Tests of Inventories and Cost of Goods Sold 9-13
Green Company
Inventory
12.31.06

Per Audit
Item Quantity Unit Price * Amount Per Client
A 510 720 units P 2.64 / doz. P 218.40 P 2,592.00
A 520 48 units 4.70 each 225.60 252.60
A 530 146 units 16.50 each 2,409.00 2,706.00
A 540 86 units 5.15 each 442.90 353.60
A 550 80 units 8.50 each 680.00 7,280.00
A 560 140 units 2.00 each 3,360.00 280.00
A 570 910 gross 132 gross 120,120.00 27,360.00
Total P127,455.90 P 40,824.20
Add: AJE (1) __________ 86,631.70
P127,455.90 P127,455.90

* Lower of cost or market

Requirement (b)

Inventory 86,631.70
Cost of sales 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.
5. Exclude Goods fabricated to order for a customer are considered
sold as soon as completed even if not yet delivered.

9-21. Isabela Company

ISABELA COMPANY
9-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition

Worksheet to Correct Selected Accounts

12-31-06

Inventory Accounts Payable Sales

Initial amounts P1,250,000 P1,000,000 P9,000,000
Adjustments
Increase (Decrease)
1 P (155,000) P (155,000) None
2 (22,000) None None
3 None None P 40,000
4 210,000 None None
5 25,000 25,000 None
6 2,000 2,000 None
7 (5,300) (5,300) None
Total adjustments P 54,700 P (133,300) P 40,000
Adjustment amounts P1,304,700 P 866,700 P9,040,000

9-22. Stockroom W

Stockroom W
Reconciliation of Inventory

Opening Ending
Inventor Receipt Withdrawal Inventory
y s s
Balance per Accounting Department P 22,600 P28,000 P 26,000 P 24,600
Add (Deduct) Reconciling Items
1) Receipt of materials
erroneously posted by the
Accounting Department to
Stockroom W. 480 480
2) Correction of error in the
Accounting Department. ( 600) ( 600)
3) Shortage not recorded in the
Accounting Department. _______ ______ 90 (90)
Balance per Factory Records P 22,000 P28,480 P 25,490 P 24,990

9-23. Pinas Company

 Substantive Tests of Inventories and Cost of Goods Sold 9-15
Requirement (1)

Audit Adjustments, 12.31.06

1. Retained earnings 300

Purchases 300
2. Inventory, January 1, 2006 700
Retained earnings 700
3. Accounts receivable 500
Sales 500
4. Purchases 500
Accounts payable 500
5. Inventory, Dec. 31, 2006 B/S 400
Inventory, Dec. 31, 2006 I/S 400
6. a. Purchases 1,200
Accounts payable 1,200
b. Inventory, Dec. 31, 2006 B/S 1,200
Inventory, Dec. 31, 2006 I/S 1,200
7. Accounts payable 800
Purchases 800

Requirement (2)

Pinas Company
Cost of Sales
2006

Per Adjustments Per

Client Dr Cr Audit
Inventory, Jan. 1 P 3,200 P 700 (2) P 3,900
Purchases 21,100 500 (4) P 300 (1)
_______ 1,200 (6a) 800 (7) 21,700
Total available 24,300 25,600
Less: Inventory, Dec. 31 4,300 400 (5)
_______ ______ 1,200 (6b) 5,900
Cost of sales P 20,000 P 2,400 P 2,700 P19,700
9-16 Solutions Manual to Accompany Applied Auditing, 2006 Edition

9-24. Bers Company

Uncorrected Items for Correction Corrected

Amounts (a) (b) (c) (d) (e) Amounts
Income statement:
Sales revenue............................. P90,000 12,000 15,000 P 63,000
Cost of goods sold..................... 50,000 + 6,000 + 15,000 8,000 63,000
Gross margin.............................. 40,000 0
Expenses.................................... 30,000 + 7,000 37,000
Income....................................... P10,000 7,000 12,000 6,000 15,000 7,000 P(37,000)
Balance sheet:
Accounts receivable................... P42,000 12,000 15,000 P15,000
Inventory.................................... 20,000 15,000 + 8,000 13,000
Remaining assets....................... 30,000 30,000
Accounts payable....................... 11,000 * + 6,000 17,000 *
Remaining liabilities.................. 6,000 * + 7,000 13,000 *
Share capital, ordinary............... 60,000 * 60,000 *
Retained earnings .................... 15,000 * 7,000 12,000 6,000 15,000 7,000 (32,000)
Totals...................................... P 0 P 0

* Credits.

Retained Earnings is negative after correction.

 Substantive Tests of Inventories and Cost of Goods Sold 9-17
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 P 24,000

1,100 units at 23 25,300
Total P 49,300

Average cost: 1,500 at P21 P 31,500

2,000 at 22 44,000
3,500 at 23 80,500
1,000 at 24 24,000
Totals 8,000 P180,000

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 P909,400

Add: Freight-in 22,000
931,400
Deduct: Purchase returns P16,500
Purchase discounts 6,800 23,300
Inventoriable cost P908,100
 Substantive Tests of Inventories and Cost of Goods Sold 9-18

9-26.

(a) (1) 8/10

Purchases 9,000
Accounts Payable 9,000

8/13
Accounts Payable 1,200
Purchase Returns and Allowances 1,200

8/15
Purchases 12,000
Accounts Payable 12,000

8/25
Purchases 15,000
Accounts Payable 15,000

8/28
Accounts Payable 12,000
Cash 12,000

(2) 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 8,820
Accounts Payable (P9,000 X .98) 8,820

8/13
Accounts Payable 1,176
Purchase Returns and Allowances 1,176
(P1,200 X .98)

8/15
Purchases 11,880
Accounts Payable (P12,000 X .99) 11,880
 Substantive Tests of Inventories and Cost of Goods Sold 9-19
8/25
Purchases 14,700
Accounts Payable (P15,000 X .98) 14,700
8/28
Accounts Payable 11,880
Purchase Discounts Lost 120
Cash 12,000

(2) 8/31
Purchase Discounts Lost 156
Accounts Payable
(.02 X [P9,000 P1,200]) 156

(3) Same as part (a) (2) except:

Purchase Discounts Losttreat as financial expense in income
statement.

(c) 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.

9-27. MAR Company

(a) Purchases Sales

Total Units Total Units
April 1 (balance on hand) 100 April 5 300
April 4 400 April 12 200
April 11 300 April 27 800
April 18 200 April 28 100
April 26 500 Total units 1,400
April 30 200
Total units 1,700
Total units sold 1,400
Total units (ending inventory) 300

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
April 26 100 5.60 560
9-20 Solutions Manual to Accompany Applied Auditing, 2006 Edition

P1,720

(2) Average cost.

Cost of Part X available.

Date of Invoice No. Units Unit Cost Total Cost

April 1 100 P5.00 P 500
April 4 400 5.10 2,040
April 11 300 5.30 1,590
April 18 200 5.35 1,070
April 26 500 5.60 2,800
April 30 200 5.80 1,160
Total Available 1,700 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.

Purchased Sold Balance

No. of Unit No. of Unit cost No. of Unit
Date units cost units units cost* Amount
April 1 100 P5.00 100 P5.0000 P 500.00
April 4 400 5.10 500 5.0800 2,540.00
April 5 300 P5.0800 200 5.0800 1,016.00
April 11 300 5.30 500 5.2120 2,606.00
April 12 200 5.2120 300 5.2120 1,563.60
April 18 200 5.35 500 5.2672 2,633.60
April 26 500 5.60 1,000 5.4336 5,433.60
April 27 800 5.4336 200 5.4336 1,086.72
April 28 100 5.4336 100 5.4336 543.36
April 30 200 5.80 300 5.6779 1,703.36
 Substantive Tests of Inventories and Cost of Goods Sold 9-21
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 P38,000
Purchases P72,000
Less purchase returns and allowances 2,400
Net purchases 69,600
Freight-in 3,400 73,000
Total merchandise available for sale 111,000
Cost of goods sold* 75,000
Ending inventory 36,000
Less undamaged goods 10,900
Estimated fire loss P 25,100

33 1/3%
*Gross profit = = 25% of sales.
100% + 33 1/3%
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] P44,333
Less undamaged goods 10,900
Estimated fire loss P33,433

9-29. Cosmo and Wanda Company

Beginning inventory P170,000

Purchases 390,000
560,000
Purchase returns (30,000)
Total goods available 530,000
Sales P650,000
Sales returns (24,000)
Net sales 626,000
Less gross profit (40% X P626,000) (250,400) 375,600
Estimated ending inventory (unadjusted for
damage) 154,400
9-22 Solutions Manual to Accompany Applied Auditing, 2006 Edition

Less goods on handundamaged (at cost)

P21,000 X (1 40%) (12,600)
Less goods on handdamaged (at net
realizable value) (5,300)
Fire loss on inventory P136,500