Question

When testing a company's cost accounting system, the auditor uses procedures that are primarily designed to determine that?

1) Quantities on hand have been computed based on acceptable cost accounting techniques that reasonably approximate actual quantities on hand
2) Physical inventory counts agree substantially with book inventories
3) Costs have been properly assigned to finished goods, work-in-process, and cost of goods sold
4) The system is in accordance with generally accepted accounting principles and is functioning as planned

Answer 1

In auditing a company's cost accounting system, procedures aim to confirm proper cost allocation to goods and adherence to GAAP, exemplified by a firm's calculation of accounting profit from revenues and expenses.

Step-by-step explanation:

When testing a company's cost accounting system, an auditor uses procedures that are primarily designed to ensure that costs have been properly assigned to finished goods, work-in-process, and cost of goods sold. The objectives of such an audit can include verifying that the system is consistent with generally accepted accounting principles (GAAP), ensuring that it functions as expected, and substantiating that the reported inventory balances reflect actual quantities on hand.

To illustrate, consider the scenario where a firm had sales revenue of $1 million last year while incurring expenses of $600,000 on labor, $150,000 on capital, and $200,000 on materials. The firm's accounting profit would be calculated by subtracting these costs from the sales revenue, yielding a profit of $50,000.

Understanding the relationship between production and costs, the factor prices for each production input, and examining factors such as total cost, fixed cost, variable cost, marginal cost, and average cost are integral to evaluating a firm's cost structure and profitability. Such analyses allow businesses to make informed decisions and adapt strategies for maximizing profit.