1. Nolan Manufacturing Company retains you on April 1 to perform an audit for the fiscal year ending June 30. During the month of May, you make extensive studies of internal control over inventories.

All goods purchased pass through a receiving department under the direction of the chief purchasing agent. The duties of the receiving department are to unpack, count, and inspect the goods. The quantity received is compared with the quantity shown on the receiving department's copy of the purchase order. If there is no discrepancy, the purchase order is stamped “OK—Receiving Dept.” and forwarded to the accounts payable section of the accounting department. Any discrepancies in quantity or variations from specifications are called to the attention of the buyer by returning the purchase order to him with an explanation of the circumstances. No records are maintained in the receiving department, and no reports originate there.

As soon as goods have been inspected and counted in the receiving department, they are sent to the factory production area and stored alongside the machines in which they are to be processed. Finished goods are moved from the assembly line to a storeroom in the custody of a stock clerk, who maintains a perpetual inventory record in terms of physical units but not in dollars.

What weaknesses, if any, do you see in the internal control over inventories?

2. The following are typical questions that might appear on an internal control questionnaire for inventory:

Are written procedures prepared by the client for the taking of the physical inventory?

Do the client's inventory-taking procedures include a requirement to identify damaged inventory items?

Does the client maintain perpetual inventory records?

3. The following are typical questions that might appear on an internal control questionnaire relating to plant and equipment:

Has a dollar minimum been established for expenditures to be capitalized?

Are subsidiary ledgers for plant and equipment regularly reconciled with general ledger controlling accounts?

Describe the manner in which each of the above procedures might be tested.