2.9.19 Flashcards
Which of the following events occurring after the issuance of the auditor’s report most likely would cause the auditor to make further inquiries about the previously issued financial statements?
New information regarding significant unrecorded transactions from the year under audit is discovered.
Subsequent events occur between the date of the financial statements and the date of the auditor’s report. Subsequently discovered facts become known to the auditor after the date of the auditor’s report. Had they been known to the auditor at that date, they might have caused the auditor to revise the auditor’s report. The auditor is not required to perform any audit procedures regarding the financial statements after the date of the auditor’s report. However, if a subsequently discovered fact (e.g., unrecorded transactions) becomes known to the auditor, the auditor should (1) discuss the matter with management and, if appropriate, those charged with governance and (2) determine whether the financial statements need revision and, if so, inquire how management intends to address the matter. The auditor has still more responsibilities when the discovery is made after the report release date, especially if unrevised statements have been made available to third parties.
Tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management’s assertion of
Cutoff.
The cutoff assertion is that transactions and events have been recorded in the correct accounting period. It is tested by examining recorded sales for several days before and after the balance sheet date and comparing them with sales invoices and shipping documents. The auditor may detect the recording of a sale in a period other than that in which title passed.
Payroll Data Co. (PDC) processes payroll transactions for a retailer. Cook, CPA, is engaged to issue a report on PDC’s internal controls implemented as of a specific date. These controls are relevant to the retailer’s internal control, so Cook’s report may be useful in providing the retailer’s independent auditor with information necessary to plan a financial statement audit. Cook’s report should
Contain a disclaimer of opinion on the operating effectiveness of PDC’s controls.
Service auditors may report (1) on the fairness of management’s description of the controls and whether the controls have been implemented and are suitably designed (type 1 report) or (2) additionally on operating effectiveness (type 2 report). The type 1 report should include a disclaimer of opinion related to operating effectiveness of the controls.
The AICPA has issued additional guidance on service auditor reports. The term System and Organization Controls (SOC) report is used in this guidance. The reports obtained by the user auditor in an audit are called SOC 1 reports (type 1 or type 2). Service auditors also may prepare SOC 2 and SOC 3 reports to provide assurance on more than internal controls over financial reporting (e.g., security, availability, processing integrity, confidentiality, or privacy). SOC 2 reports are to be used by those identified in the report, and SOC 3 reports may be used by any user.```
Which of the following most likely should be included as part of an auditor’s tests of controls?
Inspection.
The auditor should perform other procedures in combination with inquiry to obtain evidence about the operating effectiveness of controls. Thus, inquiry by itself is not sufficient. Accordingly, inquiry combined with inspection, recalculation, or reperformance may be preferable to inquiry and observation. An observation is relevant only at a moment in time (AU-C 330). Inspection is an examination of internal or external records or documents in any medium. Inspection also includes physical examination of an asset (AU-C 500).
The current file of an auditor’s audit documentation most likely would include a copy of the
Bank reconciliation.
The current file of an auditor’s audit documentation includes all working papers applicable to the current year under audit. A bank reconciliation supports a specific amount on the audited year’s financial statements. Thus, it belongs in the current file.
Vouching selected items from the payroll journal to employee time cards that have been approved by supervisory personnel provides evidence that
Employees worked the number of hours for which their pay was computed.
Effective internal control segregates the authorization, timekeeping, and payroll preparation functions. Preparation should be based on a list of authorized employees and pay rates originating in the human resources department and time records forwarded from the timekeeping department. By vouching entries from the payroll journal to approved employee time cards, the auditor can obtain evidence that the employees worked the number of hours for which their pay was computed.
Two assertions for which confirmation of accounts receivable balances provides primary evidence are
Rights and obligations and existence.
An external confirmation is audit evidence obtained as a direct, written response from a third party (the confirming party). External confirmation of accounts receivable is required unless (1) the overall account balance is not material; (2) the procedure would be ineffective; or (3) the assessed RMM at the assertion level is low, and other planned substantive procedures address the assessed risk. External confirmations are frequently relevant to assertions about account balances. Assertions about account balances at period end include (1) existence, (2) rights and obligations, (3) completeness, and (4) valuation and allocation. Assertions about existence address whether assets, liabilities, or equity interests of the entity exist. Assertions about rights and obligations address whether (1) the entity holds or controls the rights to assets, and (2) liabilities are the obligations of the entity. Thus, external confirmation provides relevant evidence that receivables exist and that the client has the right of collection. The valuation and allocation assertion states whether items have been included in the financial statements at appropriate amounts, and any valuation or allocation adjustments are recorded appropriately. However, external confirmation provides less relevant evidence for the valuation of gross accounts receivable balances than for the valuation of the related allowance accounts. The completeness assertion states whether all items that should be recorded are recorded, for example, all receivables. Unrecorded receivables are usually not discovered by confirmation. Thus, confirmation provides less relevant evidence about the valuation assertion and the completeness assertion than about the existence and rights and obligations assertions.
An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal. The purpose of this substantive audit procedure most likely was to
Determine that purchases were properly recorded.
The auditor tests the completeness assertion for accounting records by tracing supporting documents to the entries in the records.
Which of the following statements extracted from entity’s legal counsel’s letter regarding litigation, claims, and assessments most likely would cause the auditor to request clarification?
“I believe that the plaintiff will have problems establishing any liability.”
The letter of inquiry requests, among other things, that legal counsel evaluate the likelihood of unfavorable outcomes of pending or threatened litigation, claims, and assessments. It also requests that legal counsel estimate, if possible, the amount or range of potential loss (AU-C 501). Thus, the auditor is concerned about the amount of the expected settlement as well as the likelihood of the outcome. However, the statement that the plaintiff will have problems establishing any liability is unclear. For example, a plaintiff may have problems yet still prevail.
An auditor will usually trace the details of the test counts made during the observation of the physical inventory taking to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are
Included in the final inventory schedule.
Tracing the details of test counts to the final inventory schedule assures the auditor that items in the observed physical inventory are included in the inventory records. The auditor should compare the inventory tag sequence numbers in the final inventory schedule to those in the records of his or her test counts made during the client’s physical inventory.
When outside firms of nonaccountants specializing in the taking of physical inventories are used to count, list, price, and subsequently compute the total dollar amount of inventory on hand at the date of the physical count, the auditor will ordinarily
Make or observe some physical counts of the inventory, recompute certain inventory calculations, and test certain inventory transactions.
The taking of inventory by an outside firm of nonaccountants (use of a management’s specialist) does not substitute for the auditor’s own observation or performance of some test counts. The auditor may, as a result, be able to reduce the extent of his or her procedures but only after an evaluation of the work of management’s specialist. For example, the auditor may (1) examine its program, (2) observe its procedures and controls, (3) make or observe some physical counts, (4) recompute calculations, and (5) apply tests to post-count transactions.
An auditor is least likely to test controls that provide for
Classification of revenue and expense transactions by product line.
The auditor is primarily concerned with the fairness of external financial reporting and therefore with controls relevant to a financial statement audit. (S)he is less likely to test controls over records used solely for internal management purposes than those used to prepare financial statements for external distribution. Assertions about the presentation of transactions by product line are not typically made. Thus, the auditor is unlikely to expend significant audit effort in testing such classifications.
As the acceptable level of detection risk increases for a given audit risk, an auditor may change the
Timing of substantive procedures from year end to an interim date.
For a given audit risk, the acceptable detection risk (the auditor’s risk) is inversely related to the assessed RMMs (the entity’s risks) at the assertion level. Detection risk is the risk that audit procedures will not detect a material misstatement. It relates to the nature, timing, and extent of procedures performed to reduce audit risk to an acceptably low level. Thus, it depends on the effectiveness of audit procedures and their application by the auditor (AU-C 330). For example, as the acceptable level of detection risk for a given audit risk increases, the audit effort devoted to substantive procedures may be reduced. The auditor may change the nature, timing, or extent of substantive procedures, for example, by changing the timing to an interim date.
In a retail cash sales environment, which of the following controls is often absent?
Separation of functions.
In the usual retail cash sales situation, the sales clerk authorizes and records the transactions and takes custody of assets. However, management ordinarily employs other compensating controls to minimize the effects of the failure to separate functions. The cash receipts function is closely supervised, cash registers provide limited access to assets, and an internal recording function maintains control over cash receipts.
A large retail enterprise has established a policy that requires the paymaster to deliver all unclaimed payroll checks to the internal audit department at the end of each payroll distribution day. This policy was most likely adopted to
Detect any fictitious employee who may have been placed on the payroll.
A follow-up of unclaimed checks may result in identification of fictitious or terminated employees, thus eliminating an employee’s opportunity to claim a paycheck belonging to a terminated employee. The unclaimed checks should then be turned over to a custodian so the internal audit function does not assume operating responsibilities.
