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ADM 1340 Chapter Notes - Chapter 6: Perpetual Inventory, Consignor, Consignee

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School
University of Ottawa
Department
Administration
Course
ADM 1340
Professor
Darlene Himik

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Document Summary

Need to consider ownership of goods when taking inventory. Goods in transit at the end of the period make the determination of ownership more complicated: determine who has legal title to goods in transit, include in inventory if company has legal title. Apply freight/shipping concepts from chapter 5: fob shipping point versus fob destination. Ownership of consigned goods remains with the owner (the consignor), not the holder of the goods (the consignee) Goods taken home on approval by a customer are still owned by the company. Specific identification: tracks actual physical flow of goods, can only be used when actual costs of each inventory item can be determined. Assumes that the first item purchased is the first item sold. Inventory is recorded at most recent (current) cost. Cost of goods sold is recorded at the oldest inventory cost. Ending inventory and cost of goods sold under fifo is the same for perpetual and periodic inventory systems: average.

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Related Questions

Travis Company has just completed a physical inventory count at year-end, December 31 of the current year. Only the items on the shelves, in storage, and in the receiving area were counted and costed on a FIFO basis. The inventory amounted to $66,500. During the audit, the independent CPA developed the following additional information: Goods costing $910 were being used by a customer on a trial basis and were excluded from the inventory count at December 31 of the current year. Goods in transit on December 31 of the current year, from a supplier, with terms FOB destination (explained in the “Required” section), cost $1,400. Because these goods had not yet arrived, they were excluded from the physical inventory count. On December 31 of the current year, goods in transit to customers, with terms FOB shipping point, amounted to $1,800 (expected delivery date January 10 of next year). Because the goods had been shipped, they were excluded from the physical inventory count. On December 28 of the current year, a customer purchased goods for cash amounting to $3,050 and left them “for pickup on January 3 of next year.” Travis Company had paid $1,720 for the goods and, because they were on hand, included the latter amount in the physical inventory count. On the date of the inventory count, the company received notice from a supplier that goods ordered earlier at a cost of $4,000 had been delivered to the transportation company on December 27 of the current year; the terms were FOB shipping point. Because the shipment had not arrived by December 31 of the current year, it was excluded from the physical inventory count. On December 31 current year, the company shipped $1,700 worth of goods to a customer, FOB destination. The goods are expected to arrive at their destination no earlier than January 8 of next year. Because the goods were not on hand, they were not included in the physical inventory count. One of the items sold by the company has such a low volume that management planned to drop it last year. To induce Travis Company to continue carrying the item, the manufacturer-supplier provided the item on a “consignment basis.” This means that the manufacturer-supplier retains ownership of the item, and Travis Company (the consignee) has no responsibility to pay for the items until they are sold to a customer. Each month, Travis Company sends a report to the manufacturer on the number sold and remits cash for the cost. At the end of December of the current year, Travis Company had seven of these items on hand; therefore, they were included in the physical inventory count at $780 each. Required: Assume that Travis’s accounting policy requires including in inventory all goods for which it has title. Note that the point where title (ownership) changes hands is determined by the shipping terms in the sales contract. When goods are shipped “FOB shipping point,” title changes hands at shipment and the buyer normally pays for shipping. When they are shipped “FOB destination,” title changes hands on delivery, and the seller normally pays for shipping. Begin with the $66,500 inventory amount and compute the correct amount for the ending inventory. (Deductible amounts should be entered with a minus sign. If no adjustment is necessary, enter a 0 in the cell.)

QUESTION 2: UNDERSTANDING THE INTERNAL CONTROL PROCESS, ASSESSING CONTROL RISK AND INVENTORY MANAGEMENT SYSTEM OF RUSSELL LTD.

Russell Ltd carries four types raw-chemicals under both product Line A and product Line B as shown in the table below. The company uses perpetual inventory system and adopts FIFO (first in and first out) method to estimate the inventory cost. Inventory level is managed and monitored by APEX, an inventory management system. There are two central warehouses. One is located in Auckland, New Zealand and the other is in Adelaide, Australia. The warehouses dispatch clothes to all retailing stores within the country. In addition, the Australia warehouse dispatches stock to stores in Indonesia. On the balance date, the two central warehouses hold 20% of total inventory and all retailing stores hold 80% of total inventory.

Location | Number of stores

Auckland 5

Wellington 4

Christchurch 3

Perth 6

Adelaide 6

Total 24

INVENTORY AT YEAR END RETAIL STORES

Nature of the range | Label | Value $000

Product Line A Chemicals-P2P 173000

Chemical-T2P 100000

Product Line B Chemicals-Paints 89000

Chemicals-cosmetics 100000

Total Closing balance of inventory 462000

APEX - INVENTORY MANAGEMENT SYSTEM

APEX, the company’s inventory management system has a central server. It records information on inventory item code, item description, cost price per item, selling price per item, and the available quantities. It also tracks the available quantities of inventory in each warehouse and store. Reorder point was not set up in APEX. Instead, the order quantities are based on anticipated sales level. Since some raw materials sell quicker than others, Russell has a policy of providing 30% discounts for inventories (raw materials) that have been on the shop floor for more than 4 weeks and 50% discount after 7 weeks. New inventory normally arrives in the store every 4 weeks. The discounts are automatically applied to the inventories based on their arrival dates in the stores, by using a Sales Register System – SALENET.

SALENET – THE SALES REGISTER SYSTEM

SALENET links to APEX (the company’s inventory management system); and the terminals for the sales system are located in each store. SALENET records cash and credit card sales, calculate discounts, sales tax and produces Daily Sales Report (DSR) for each store. The DSR records all raw types of raw materials under both product lines and quantities sold on that day, and the sales and cost prices of those raw materials. The SALENET system automatically updates inventory levels in APEX at midnight daily, after which it also exports information on the DSR to the general accounting system (a separate software) for the recording of sales.

SUPPLIERS

In Russell Ltd, inventory (raw materials) code, description, and quantities ordered are assigned with a pre-numbered Purchase Order (PO). The Malaysian suppliers source the different inputs-raw materials used for producing chemicals from their local markets. The payment arrangement agreed between Russell and the Malaysian suppliers is as follows: (1) 40% of total costs as a deposit at the time when the completed negotiation and the PO are sent to the suppliers. (2) Once the raw materials are ready and shipped, Russell has 30 days to pay the remaining balance 60%. The suppliers provide a Bill of Lading as proof that the garments are shipped, its ownership transfers to Russell at the time of shipment. When the inventory are shipped (Russell receives a copy of the Bill of Lading via email), the accounting department records a journal entry to recognise both inventory-in-transit and account payable, but the actual inventory level in APEX is not updated until the inventory arrived at the warehouse.

RECEIVING INVENTORY

The shipment of raw-inputs arrives at the central warehouses. The barcodes and the quantities of inventory items shipped are printed on the outside of the cartons. A Packing Slip is attached to each shipment. Each barcode printed on the carton contains information on the inventory item code and raw materials description. For each shipment that arrives, the warehouse assistant prints off the relevant pre-numbered PO. The warehouse assistant using a scanning device reads each barcode printed on the outside the cartons and compares it with the information on the PO. When the information agrees, the warehouse assistant ticks and signs the PO. He then logs into the APEX system to click on the “received” box on the PO filed in the system, after which the APEX system updates the inventory levels and also prints out a Receiving Report (RR). At this point, APEX also sends a copy of Receiving Report to the accounting department regarding the arrival of the inventory. The accounting department then initiates a journal entry to reverse inventory-in-transit and to increase inventory. The warehouse assistant is authorised to alter the quantities received in APEX to reflect the actual received quantities when there is a discrepancy in the information between the PO and the barcodes printed on the cartons. The Receiving Report and supplier’s Packing Slip are filed in the warehouse. The signed PO and a copy of Receiving Report are handed to the inventory manager for inventory distribution.

DISTRIBUTING INVENTORY TO RETAIL STORES

The inventory (chemicals) manager is responsible for distributing inventory to the retail stores. The inventory distribution is usually based on the size and turnover of the retail store. When the new inventories arrive, the inventory manager uses APEX to allocate inventory to each retail store. APEX generates and prints a pre-numbered Distribution Report which displays the inventory item code, item description and quantities and the location of the store. Two copies of the Distribution Report go to the warehouse for packing and then shipping via an external carrier. The warehouse files one copy of the Distribution Report and the other copy goes with the inventory to a retail store. When the inventories arrive at the retail store, the shop manager logs into the APEX system. She identifies the relevant shipment by checking its reference number on the Distribution Report and then confirms receipt of the inventories by clicking the “arrived in store” box, after which the shop manager and/or assistants unpack the inventory. Russell carried out an annual inventory count on the 30 June 2016 at 6pm local time. During the inventory counts, the stores were shut. Each store manager has access to APEX. They can read and print out inventory reports, but they cannot edit the inventory levels in APEX. For the inventory counts, the store manager prints out a list of inventories held in the store, which shows the item code, description and quantities. Two staff members and the manager count the stock and write down the numbers counted next to each inventory item on the list. They take note of any differences. At end of the inventory count, the store manager prepares an Inventory level Report which notes the differences using SALENET. SALENET adjusts the inventory level in APEX at midnight to reflect the results from the inventory count. A copy of the Inventory Count Report from each individual store are sent to the accounting department, at where all reports are aggregated based on item codes. The accounting department then adjust the inventory level accordingly in the accounting system.

QUESTION 2: UNDERSTANDING THE INTERNAL CONTROL PROCESS, ASSESSING CONTROL RISK, AUDIT PROCEDURE FOR INVENTORIES

Identify four control weaknesses in the inventory system of Russell Ltd. Explain how each weakness may affect the financial statements and identify the audit procedures to address the control weakness. [15 marks]

a. You are required to present your answers according to this format:

Identify a control weakness :

How the weakness may affect financial statements:

Audit procedures to address the control weakness:

b. Identify three control strengths in the inventory system of Russell Ltd and explain why each control is a strength. For each control strength, identify audit procedures to test the effectiveness of control. Use the format to present your answers. [5 marks] You are required to present your answers according to this format:

Identify a control strength:

Why it is a strength :

Audit Procedures to test the control:

c. Assuming the control risk is medium, explain substantive audit procedures for verifying inventory at year end. The substantive procedures should address the following assertions, and explanation should be given for the procedures. [25 marks] You are required to present your answers according to this format:

Assertions | Audit procedures | Details and rationale of each procedure |

Existence & Occurrence

Completeness

Accuracy & Valuation

QUESTION 2: UNDERSTANDING THE INTERNAL CONTROL PROCESS, ASSESSING CONTROL RISK AND INVENTORY MANAGEMENT SYSTEM OF RUSSELL LTD.

Russell Ltd carries four types raw-chemicals under both product Line A and product Line B as shown in the table below. The company uses perpetual inventory system and adopts FIFO (first in and first out) method to estimate the inventory cost. Inventory level is managed and monitored by APEX, an inventory management system.

There are two central warehouses. One is located in Auckland, New Zealand and the other is in Adelaide, Australia. The warehouses dispatch clothes to all retailing stores within the country. In addition, the Australia warehouse dispatches stock to stores in Indonesia. On the balance date, the two central warehouses hold 20% of total inventory and all retailing stores hold 80% of total inventory.

Location

Number of stores

Auckland

5

Wellington

4

Christchurch,

3

Perth

6

Adelaide

6

Total

24

INVENTORY AT YEAR END RETAIL STORES

Nature of the range

Label

Value $000

Product Line A

Chemicals-P2P

173000

Chemical-T2P

100000

Product Line B

Chemicals-Paints

89000

Chemicals-cosmetics

100000

Total Closing balance of inventory

462000

APEX - INVENTORY MANAGEMENT SYSTEM

APEX, the company’s inventory management system has a central server. It records information on inventory item code, item description, cost price per item, selling price per item, and the available quantities. It also tracks the available quantities of inventory in each warehouse and store. Reorder point was not set up in APEX. Instead, the order quantities are based on anticipated sales level.

Since some raw materials sell quicker than others, Russell has a policy of providing 30% discounts for inventories (raw materials) that have been on the shop floor for more than 4 weeks and 50% discount after 7 weeks. New inventory normally arrives in the store every 4 weeks. The discounts are automatically applied to the inventories based on their arrival dates in the stores, by using a Sales Register System – SALENET.

SALENET – THE SALES REGISTER SYSTEM

SALENET links to APEX (the company’s inventory management system); and the terminals for the sales system are located in each store. SALENET records cash and credit card sales, calculate discounts, sales tax and produces Daily Sales Report (DSR) for each store. The DSR records all raw types of raw materials under both product lines and quantities sold on that day, and the sales and cost prices of those raw materials. The SALENET system automatically updates inventory levels in APEX at midnight daily, after which it also exports information on the DSR to the general accounting system (a separate software) for the recording of sales.

SUPPLIERS

In Russell Ltd, inventory (raw materials) code, description, and quantities ordered are assigned with a pre-numbered Purchase Order (PO). The Malaysian suppliers source the different inputs-raw materials used for producing chemicals from their local markets. The payment arrangement agreed between Russell and the Malaysian suppliers is as follows: (1) 40% of total costs as a deposit at the time when the completed negotiation and the PO are sent to the suppliers. (2) Once the raw materials are ready and shipped, Russell has 30 days to pay the remaining balance 60%. The suppliers provide a Bill of Lading as proof that the garments are shipped, its ownership transfers to Russell at the time of shipment. When the inventory are shipped (Russell receives a copy of the Bill of Lading via email), the accounting department records a journal entry to recognise both inventory-in-transit and account payable, but the actual inventory level in APEX is not updated until the inventory arrived at the warehouse.

RECEIVING INVENTORY

The shipment of raw-inputs arrives at the central warehouses. The barcodes and the quantities of inventory items shipped are printed on the outside of the cartons. A Packing Slip is attached to each shipment. Each barcode printed on the carton contains information on the inventory item code and raw materials description.

For each shipment that arrives, the warehouse assistant prints off the relevant pre-numbered PO. The warehouse assistant using a scanning device reads each barcode printed on the outside the cartons and compares it with the information on the PO. When the information agrees, the warehouse assistant ticks and signs the PO. He then logs into the APEX system to click on the “received” box on the PO filed in the system, after which the APEX system updates the inventory levels and also prints out a Receiving Report (RR). At this point, APEX also sends a copy of Receiving Report to the accounting department regarding the arrival of the inventory. The accounting department then initiates a journal entry to reverse inventory-in-transit and to increase inventory. The warehouse assistant is authorised to alter the quantities received in APEX to reflect the actual received quantities when there is a discrepancy in the information between the PO and the barcodes printed on the cartons. The Receiving Report and supplier’s Packing Slip are filed in the warehouse. The signed PO and a copy of Receiving Report are handed to the inventory manager for inventory distribution.

DISTRIBUTING INVENTORY TO RETAIL STORES

The inventory (chemicals) manager is responsible for distributing inventory to the retail stores. The inventory distribution is usually based on the size and turnover of the retail store. When the new inventories arrive, the inventory manager uses APEX to allocate inventory to each retail store. APEX generates and prints a pre-numbered Distribution Report which displays the inventory item code, item description and quantities and the location of the store. Two copies of the Distribution Report go to the warehouse for packing and then shipping via an external carrier. The warehouse files one copy of the Distribution Report and the other copy goes with the inventory to a retail store. When the inventories arrive at the retail store, the shop manager logs into the APEX system. She identifies the relevant shipment by checking its reference number on the Distribution Report and then confirms receipt of the inventories by clicking the “arrived in store” box, after which the shop manager and/or assistants unpack the inventory.

Russell carried out an annual inventory count on the 30 June 2016 at 6pm local time. During the inventory counts, the stores were shut. Each store manager has access to APEX. They can read and print out inventory reports, but they cannot edit the inventory levels in APEX. For the inventory counts, the store manager prints out a list of inventories held in the store, which shows the item code, description and quantities. Two staff members and the manager count the stock and write down the numbers counted next to each inventory item on the list. They take note of any differences. At end of the inventory count, the store manager prepares an Inventory level Report which notes the differences using SALENET. SALENET adjusts the inventory level in APEX at midnight to reflect the results from the inventory count. A copy of the Inventory Count Report from each individual store are sent to the accounting department, at where all reports are aggregated based on item codes. The accounting department then adjust the inventory level accordingly in the accounting system.

QUESTION 2: UNDERSTANDING THE INTERNAL CONTROL PROCESS, ASSESSING CONTROL RISK, AUDIT PROCEDURE FOR INVENTORIES

Identify three control strengths in the inventory system of Russell Ltd and explain why each control is a strength. For each control strength, identify audit procedures to test the effectiveness of control. Use the format to present your answers.

You are required to present your answers according to this format:

Identify a control strength

Why it is a strength

Audit Procedures to test the control