A4 Audit Evidence PT 4

Question 1

Give four examples of management bias under PCAOB standards.

Answer 1

1. Selective correction of misstatement brought to management attention during the audit
2. The identification by mngmnt of additional AJE that offset misstatements accumulated by the auditor
3. Bias in the selection and application of acctg principles
4. Bias in acctg estimates

Question 2

Describe the required characteristics of the engagement quality reviewer.

Answer 2

The engagement quality reviewer must be a partner who is not otherwise associated with the engagement and who is competent, independent, objective, and acts with integrity.

Question 3

When does a significant engagement deficiency exist?

Four situations

Answer 3

1. The engagement team failed to obtain sufficient appropriate evidence.
2. The engagement team reached an inappropriate overall conclusion.
3. The engagement team is not appropriate for the circumstances.
4. The firm is not independent of the client.

Question 4

What are five types of financial ration?

Answer 4

1. Liquidity ratios: measures s-t ability to pay obligations.
2. Activity ratios: measures effective use of assets.
3. Profitability ratios: measures items of interest to investors.
4. Coverage ratios: measure security for LT creditors/investors.
5. Investor ratios - Measure security for long-term creditors / investors

Question 5

What are Five limitations of using financial ratios?

Answer 5

Although ratios are useful they have the following limitations:

1. Few industry benchmarks exist for comparison.
2. Dissimilar business units make analysis difficult.
3. Mngmnt may manipulate financial data and ratio.
4. Inflation can reduce comparability of BS items.
5. The choice or change in acctg principle can affect ratios and reduce comparability.

Question 6

1. current ratio,

2. Quick (Acid-Test) Ratio

Answer 6

1. Current Ratio = CA / CL
2. Quick Ratio = (Cash & cash equivalent + mkt securities + net receivables) / CL
3. Cash Ratio = Cash and Cash equivalents + Marketable Securities divided by Current Liabilities

Question 7

1. AR T-O

2. Inventory T-O

Answer 7

1. AR T-O = Net Credit Sales / Avg A/R
2. Inv T-O = COGS / Average Inventory

Note that dividing 365 by the turnover provides a measure of turnover in days.

Question 8

1. Net Profit Margins

2. Return on Total Assets

Answer 8

1. NPM = NI / NS

2. Return on Total Assets = NI / Average Total Assets

Question 9

1. EPS

2. Price / Earnings Ratio

Answer 9

1. EPS = (NI - Preferred Div) / Weighted Average Number of Common Shares Outstanding
2. P/E Ratio = Market Price Per Share / Dilute Earnings Per Share

Question 10

1. Debt / Equity Ratio
2. Debt Ratio
3. Times Interest Earned

Answer 10

1. Debt / Equity = Total Liab / Common SH Equity
2. Debt Ratio = TL / TA
3. TIE = Earnings before Interest and Taxes / Interest