Your audit client. Household Appliances, Inc., operates a retail store in the center of town. Lacking sufficient storage space. Household keeps undisplayed inventory in a public warehouse outside of town. The warehouse receives inventory from suppliers and, on request from your client by a shipping advice or telephone call, delivers merchandise to customers or to the retail outlet. The accounts are maintained at the retail store by a bookkeeper. Each month the warehouse sends to the bookkeeper a quantity report indicating opening balance, receipts, deliveries, and ending balance. The bookkeeper compares book quantities on hand at month end with the warehouse report and adjusts the books to agree with the report. No physical counts of the merchandise at the warehouse were made by your client during the year. You are now preparing for your audit of the current year's financial statements. Last year you issued an unqualified opinion.

Required:

1. Design audit procedures for observing the physical inventory of Household Appliances, Inc.:

a. At the retail outlet, and

b. At the warehouse.

2. As part of your tests, would you verify inventory quantities at the warehouse by:

a. A warehouse confirmation? Why?

b. Test counts of inventory at the warehouse? Why?

3. Since the bookkeeper adjusts the books to quantities shown on the warehouse report each month, what significance would you attach to the year end adjustments if they were substantial? Discuss.

4. Assume you are unable to satisfy yourself as to the inventory. Could you issue an unqualified opinion? Why?