Thermox Inc. manufactures heating elements and devices. One of its main raw material components is steel tubing. During the current year, Thermox’s new raw material buyer began purchasing steel tubing from a U.S. supplier. The buyer found this supplier’s prices to be considerably lower than the previous Canadian suppliers.
Thermox’s cost accounting department uses standard manufacturing costs to determine its inventory cost and cost of goods sold. In her audit of the reasonability of the standard costs, the audit senior is vouching the raw materials components list to supplier invoices and supporting documents. She notes several steel tubing purchases in March that were invoiced in U.S. dollars (a U.S. dollar at this time was worth about $1.25 Canadian).
However, the U.S. dollar amount, not the Canadian dollar amount, is used in the standard costing formula. Steel tubing comprises 70% of Thermox’s standard manufacturing cost. The audit senior extends her vouching and discovers that all steel tubing purchases from March to the December year-end were from the same U.S. supplier and were invoiced in U.S. dollars.
The audit senior then examines the U.S. supplier’s monthly statements of account and discovers that Thermox’s accounts payable department has been paying the U.S. steel tubing invoices in Canadian dollars. Thus Thermox has been short-paying the U.S. supplier by about 25%. Because of this related error, no significant cost variances appeared for raw materials, which would have alerted Thermox management to the problem.

Required:
a. What impact will this error have on Thermox’s year-end inventory balance and its cost of sales if standard costs are used and no variances are adjusted? What impact will this error have on accounts payable? State any assumptions you make.
b. What records will the audit senior need to examine and what tests and analyses will she need to perform to assess the magnitude of the error in inventory, cost of goods sold, and accounts payable?
c. What control deficiency would allow this type of error to occur, and what kind of control procedure(s) could be implemented to prevent this type of error?