Audit Evidence-Concepts

Question 1

What is an important consideration when deciding the nature of tests to use in a financial statement audit?

Answer 1

Audit procedures should be responsive to the auditor’s assessment of the risks of material misstatement. The specific procedures that are appropriate in the circumstances is a matter of professional judgment.

Question 2

What kind of audit procedure is this?

An auditor interviews and observes appropriate personnel to determine segregation of duties

Answer 2

This is a test of controls. The auditor is verifying that segregation of duties exists and is operating effectively

Question 3

Before applying principal substantive tests to an entity’s accounts receivable at an interim date, an auditor should

Answer 3

The auditor would consider the difficulty in controlling the incremental audit risk, i.e., the risk that material misstatements will not be detected due to the early testing at interim. This difficulty would be impacted by the effectiveness of internal controls, the presence of rapidly changing business conditions or circumstances, and the availability of relevant information.

Question 4

Samples to test internal control structure procedures are intended to provide a basis for an auditor to conclude whether

Answer 4

Tests of controls are intended to enable the auditor to ascertain whether the controls are operating effectively.

Question 5

Which of the following procedures would an auditor most likely perform to test controls relating to management’s assertion about the completeness of cash receipts for cash sales at a retail outlet?

Answer 5

The cardinal rule regarding cash receipts is to ensure that they are recorded. By requiring employees to record all sales in the cash register and to give customers the cash register tape evidencing the sale, companies can ensure that all cash sales are recorded (the completeness of cash receipts for cash sales.) The auditor can test controls by observing employees’ use of cash registers and tapes. . If cash has been recorded and then is subsequently stolen, the problem becomes existence, rather than completeness. (Recorded cash that has been stolen no longer exists.)

Question 6

An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?

Answer 6

The auditor should consider whether the assessments of the risks of material misstatement at the relevant assertion level in engagement planning are appropriate in light of the auditor’s substantive procedures.

Question 7

Which of the following procedures would an auditor most likely perform during an audit engagement’s overall review stage in formulating an opinion on an entity’s financial statements?

Answer 7

During the overall review stage, the auditor assesses the conclusions reached and the evaluation of the overall financial statement presentation. As part of that evaluation, he/she would consider whether the results of the audit procedures performed affect the risk of material misstatement due to fraud. The overall review would include considering the adequacy of the evidence gathered in response to unusual or unexpected balances and whether such balances reflected a misstatement due to fraud.

Question 8

The term judgmental misstatement would best apply to

Answer 8

The definition of judgmental misstatements includes unreasonable accounting estimates (as well as the selection of inappropriate accounting policies).

Question 9

For all (non-trivial) factual misstatements identified by the auditor, the auditor should

Answer 9

The auditor should request management to correct (non-trivial) identified factual misstatements.

Question 10

Each of the following might be considered as a type of factual misstatement, EXCEPT

Answer 10

Differences between management and the auditor in making judgments about accounting estimates are included in the definition of judgmental misstatements and would not normally be included among known misstatements.

Question 11

An auditor is not required to document

Answer 11

The auditor should not divulge to management the specific levels of materiality used or the materiality levels allocated to individual elements of the financial statements. So obtaining such agreement would not be appropriate.

Question 12

An auditor’s documentation should

Answer 12

The audit documentation must show that the accounting records have been agreed to or reconciled with the financial statements.

Question 13

An auditor’s documentation serves mainly to

Answer 13

Audit documentation serves mainly to provide the principal support for the opinion rendered in the auditor’s report. It also aids the auditor in the conduct and supervision of the audit.

Question 14

Although the quantity and content of audit documentation vary with each particular engagement, an auditor’s permanent files most likely include

Answer 14

A permanent file contains information that is referred to for more than one audit period. Therefore, an auditor’s permanent files most likely would include analyses of capital stock and other owners’ equity accounts.

Question 15

Which of the following factors most likely would affect an auditor’s judgment about the quantity, type, and content of the auditor’s documentation?

Answer 15

Which of the following factors most likely would affect an auditor’s judgment about the quantity, type, and content of the auditor’s documentation?

Question 16

Which of the following is not required documentation in an audit, in accordance with generally accepted auditing standards?

Answer 16

A flowchart depicting the segregation of duties and authorization of transactions is one of several methods that may be employed to document the auditor’s understanding of the internal control system. Its use, however, is not required.

Question 17

An audit supervisor reviewed the work performed by the staff to determine if the audit was adequately performed. The supervisor accomplished this primarily by reviewing which of the following?
 A.   Checklists. 
 B.   Audit documentation. 
 C.   Analytical procedures. 
 D.   Financial statements.

Answer 17

The work performed by the staff is recorded in the audit documentation. The supervisor would review the audit documentation to ensure that the evidence collected adequately supports the audit judgments reached. It would also ensure that GAAS were properly followed.

Question 18

An auditor ordinarily uses a working trial balance resembling the financial statements without footnotes, but containing columns for
 A.   Reclassification and adjustments. 
 B.   Reconciliations and tickmarks. 
 C.   Accruals and deferrals. 
 D.   Expense and revenue summaries.

Answer 18

The working trial balance is very similar to the worksheet. It begins with the balances per the client’s trial balance, provides columns for audit adjustments and reclassifications, and ends up with the audited balances per the financial statements.
Reconciliations and tickmarks would appear in the supporting audit documentation, not necessarily in the working trial balance.

Question 19

Which of the following factors would least likely affect the quantity and content of an auditor’s documentation?
A. The condition of the client’s records.
B. The assessed level of control risk.
C. The nature of the auditor’s report.
D. The content of the representation letter.

Answer 19

The quantity and content of an auditor’s documentation would least likely be affected by the content of the representation letter. The representation letter is prepared at the end of the audit to document management’s responses to audit inquiries as well as key management assertions.

Question 20

Which of the following pairs of accounts would an auditor most likely analyze on the same audit documentation?
A. Notes receivable and interest income.
B. Accrued interest receivable and accrued interest payable.
C. Notes payable and notes receivable.
D. Interest income and interest expense.

Answer 20

Notes receivable and interest income would most likely be analyzed on the same working paper as they are directly related to each other. Interest income is earned on notes receivable and is a function of the interest rate and the principal balances on the notes

Question 21

The permanent file of an auditor’s documentation generally would not include
A. Bond indenture agreements.
B. Lease agreements.
C. Working trial balance.
D. Flowchart of internal control structure.

Answer 21

The working trial balance would NOT appear in the permanent file. It is normally included in the current year audit documentation.

Question 22

The current file of an auditor’s documentation most likely would include a copy of the
A. Bank reconciliation.
B. Pension plan contract.
C. Articles of incorporation.
D. Flowchart of the internal control procedures.

Answer 22

The current file of an auditor’s documentation includes items relevant to the current year audit. The bank reconciliation that reflects the support for the cash balance in the current year financial statements would be included in the current file.

Question 23

Using microcomputers in auditing may affect the methods used to review the work of staff assistants because
A. The audit field work standards for supervision may differ.
B. Documenting the supervisory review may require the assistance of consulting services personnel.
C. Supervisory personnel may not have an understanding of the capabilities and limitations of microcomputers.
D. Working paper documentation

Answer 23

The use of microcomputers impacts the manner in which audit documentation is completed and displayed. If a spreadsheet program is used to create the documentation, it may not contain readily observable details of calculations because the formulas will be hidden in the cells.

Question 24

Which of the following statements ordinarily is correct concerning the content of audit documentation?
A. Whenever possible, the auditor’s staff, not the entity’s employees, should prepare schedules and analyses.
B. It is preferable to have negative figures indicated in red figures instead of parentheses to emphasize amounts being subtracted.
C. It is appropriate to use calculator tapes with names or explanations on the tapes, rather than writing separate lists into the audit documentation.
D. The analysis of asset accounts and their related expense or income accounts should not appear on the same working paper.

Answer 24

The auditing procedures documented, and the audit documentation itself, should be both efficient and effective. This means that it would be appropriate to use calculator tapes with names or explanations on the tapes, rather than writing separate lists into the documentation, as long as the nature of the work performed and the conclusions reached were clearly evident. Rewriting the lists would take additional time without necessarily offering more persuasive evidence

Question 25

The permanent (continuing) file of an auditor's documentation would most likely include copies of the
 A.   Lead schedules. 
 B.   Attorney's letters. 
 C.   Bank statements. 
 D.   Debt agreements.

Answer 25

The permanent file contains information which is required for multiple periods. Items commonly included in the permanent file include debt agreements, articles of incorporation, the corporate charter, etc.

Question 26

Which of the following is required documentation in an audit, in accordance with generally accepted auditing standards?
A. A flowchart or narrative of the accounting system describing the recording and classification of transactions for financial reporting.
B. An audit program setting forth in detail the procedures necessary to accomplish the engagement’s objectives.
C. A letter signed by the client acknowledging responsibility for preparing requested audit scheduled by specific due dates.
D. An internal control questionnaire identifying policies and procedures that assure specific objectives will be achieved.

Answer 26

GAAS require that a written audit program be prepared that details the audit procedures considered necessary to achieve the objectives of the audit.

Question 27

In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?
A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.
B. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.
C. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.
D. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

Answer 27

The use of negative accounts receivable confirmations requires:

1) a low risk of material misstatement;
2) a large number of small balances; and
3) an expected very low exception rate;
4) no reason to believe that the recipients of the confirmations would not review them properly. Having a small number of accounts in dispute and an accounts receivable balance arising from sales to many customers with small balances meets two of the fourthree criteria and would be more likely to justify the use of negative confirmations.

Question 28

The negative request form of accounts receivable confirmation is useful particularly when the

Answer 28

In order to use the negative form of accounts receivable confirmation, the following conditions must be met:

1) the risk of material misstatement;
2) a large number of small balances is involved;
3) an expected very low exception rate; and
4) the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration.

Question 29

Under which of the following circumstances would the use of the blank form of confirmations of accounts receivable most likely be preferable to positive confirmations?

Answer 29

Using the blank form of confirmation of accounts receivable provides greater assurance that the recipient of the confirmation has verified that the information is correct. It is more likely to be used when the auditor is concerned that recipients will not devote proper attention to the confirmations.

Question 30

The confirmation of customers’ accounts receivable rarely provides reliable evidence about the completeness assertion because

Answer 30

Confirmations of accounts receivable provide strong evidence for the existence assertion and some evidence for the valuation (accuracy) assertion. They rarely provide evidence about the completeness assertion because customers are typically happy to confirm an amount that is less than the amount they actually owe. They are, therefore, not terribly inclined to report understatement errors on their accounts.

Question 31

The blank form of accounts receivable confirmations may be less efficient than the positive form because

Answer 31

AICPA Professional Standards indicate that using blank confirmation requests may provide a greater degree of assurance about the information confirmed because of the need to fill in the amount. However, blank forms might also result in lower response rates because additional effort is required of the recipients. When lower response rates occur, the auditor may have to perform more alternative procedures making the confirmation effort less efficient.

Question 32

To reduce the risks associated with accepting fax responses to requests for confirmations of accounts receivable, an auditor most likely would
A. Examine the shipping documents that provide evidence for the existence assertion.
B. Verify the sources and contents of the faxes in telephone calls to the senders.
C. Consider the faxes to be nonresponses and evaluate them as unadjusted differences.
D. Inspect the faxes for forgeries or alterations and consider them to be acceptable if none are noted.

Answer 32

To ensure that a fax is valid, the auditor would need to perform other procedures that would aid in verifying the authenticity of the fax. Telephoning the sender would provide additional evidence that the fax was authentic.

Question 33

Which of the following statements is correct concerning the use of negative confirmation requests?

Answer 33

When negative confirmations are used, the respondent is asked to return the request only if there is a problem or error in the balance. Thus, it is assumed that the balances are correct unless the confirmation is returned. Unreturned negative confirmation requests, therefore, are considered to be evidence. This evidence is implied, it is not explicit.

Question 34

Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?
A. When the assessed level of control risk over the sale is low.
B. When the assessed level of detection risk over the sale is high.
C. When the combined assessed level of inherent and control risk over the sale is moderate.
D. When the combined assessed level of inherent and control risk over the sale is high.

Answer 34

The auditor would be more likely to confirm certain relevant contract terms as the risk of material misstatement increases. In this case, the risk of material misstatement is said to be “high,” which is consistent with the need to perform additional procedures to address revenue-recognition issues.

Question 35

Which of the following procedures most likely would assist an auditor in determining whether management has identified all accounting estimates that could be material to the financial statements?
A. Inquire about the existence of related party transactions.
B. Determine whether accounting estimates deviate from historical patterns.
C. Confirm inventories at locations outside the entity.
D. Review the lawyer’s letter for information about litigation.

Answer 35

If the auditor is concerned about identifying all material accounting estimates, the auditor is seeking to discover unrecorded estimates. The auditor is most likely to review the lawyer’s letter for information about litigation. Litigation losses is an area that commonly requires estimates and one in which estimates could be material to the financial statements.
It is also an area that falls outside of the normal financial reporting process and, thus, is more likely to be missed.

Question 36

Which of the following statements is correct regarding accounting estimates?

A.
The auditor’s objective is to evaluate whether accounting estimates are reasonable in the circumstances.

B.
Accounting estimates should be used when data concerning past events can be accumulated in a timely, cost-effective manner.

C.
An important accounting estimate is management’s listing of accounts receivable greater than 90 days past due.

D.
Accounting estimates should not be used when the outcome of future events related to the estimated item is unknown

Answer 36

AICPA Professional Standards indicate that the auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the applicable financial reporting framework.

Question 37

In evaluating an entity’s accounting estimates, one of an auditor’s objectives is to determine whether the estimates are
A. Not subject to bias.
B. Consistent with industry guidelines.
C. Based on objective assumptions.
D. Reasonable in the circumstances

Answer 37

The auditor must evaluate the reasonableness of the accounting estimates made by management. Because of their nature, such estimates are subject to bias, even when the estimation process involves the use of relevant and reliable data and competent personnel.

Question 38

In evaluating the reasonableness of an accounting estimate, an auditor most likely would concentrate on key factors and assumptions that are

Answer 38

In evaluating the reasonableness of an accounting estimate, an auditor concentrates on key factors and assumptions that are: 1.significant to the accounting estimate;

2. sensitive to variations;
3. deviations from historical patterns; and
4. subjective and susceptible to misstatement and bias

Question 39

In evaluating the reasonableness of an entity’s accounting estimates, an auditor normally would be concerned about assumptions that are

Answer 39

This question focuses on something that would be a “concern” to the auditor about an accounting estimate. To the extent that the estimate is potentially biased (e.g., perhaps management has a lot of latitude in determining the resulting estimate), the auditor would be concerned about the reasonableness of that estimate.

Question 40

Which procedures would an auditor ordinarily perform first in evaluating management’s accounting estimates for reasonableness?

Answer 40

In evaluating management’s accounting estimates for reasonableness, the auditor must first obtain an understanding of how management developed the estimate. While this approach is cited in the Standards, common sense should also tell you that you must first understand how the estimate was created.

Question 41

The auditor’s responsibility to communicate with those charged with governance about fair value measurements and disclosure issues is best described by the following statement:

Answer 41

The auditor will consider whether or not the nature of significant assumptions used in fair value measurements, the degree of subjectivity involved in the development of the assumptions, and the relative materiality of the items being measured at fair value need to be communicated to those charged with governance.

Question 42

When there are no observable market prices, the auditor is not obligated to consider whether

Answer 42

The decision to engage a specialist is an auditor judgment, not a management decision.

Question 43

Which of the following statements describing the auditor’s responsibilities when evaluating an entity’s fair value measurements and disclosures is incorrect?

Answer 43

This is not an accurate characterization of the auditor’s responsibilities. The decision to engage a specialist is a matter of professional judgment. The auditor may have the necessary skill and knowledge to audit fair values or may decide to use a specialist.

Question 44

When auditing material for fair value measurements and disclosures, the auditors substantive audit procedures might include all of the following, except for
A. Developing independent estimates to compare to management’s estimates.
B. Performing tests of control to evaluate the effectiveness of controls affecting the fair value measurements.
C. Reviewing subsequent events and transactions to evaluate the reasonableness of the fair value measurements.
D. Performing tests of the valuation model, including significant assumptions, and the underlying data.

Answer 44

Tests of control are not “substantive” audit procedures

Question 45

The auditing procedure that provides the best indicator of “fair value” is
A. Evaluating management’s significant assumptions and the valuation model used by management and testing the underlying data used by management.
B. Developing independent fair value estimates to compare to the entity’s recorded estimates.
C. Reviewing subsequent events and transactions for corroborating information and outcomes.
D. Examining published price quotations in an active market.

Answer 45

In describing certain assets and liabilities, the Standards indicate that .the existence of published price quotations in an active and open market is the best evidence of fair value.

Question 46

Which of the following statements, extracted from a client’s lawyer’s letter concerning litigation, claims, and assessments, would be most likely to cause the auditor to request clarification?

A. 	 "We believe that the possible liability to the company is nominal in amount."

B. 	 "We believe that the action can be settled for less than the damages claimed."

C. 	 "We believe that the plaintiff's case against the company is without merit."

D. 	 "We believe that the company will be able to defend this action successfully."

Answer 46

This comment is extremely vague and clarification would be required. What exactly would this mean? In litigation, settlements are always less than the damages claimed!

Question 47

Which of the following is an audit procedure that an auditor would most likely perform concerning litigation, claims, and assessments?
A. Request that the client’s lawyer evaluate whether the client’s pending litigation, claims, and assessments indicate a going concern problem.
B. Examine the legal documents in the client’s lawyer’s possession concerning litigation, claims, and assessments to which the lawyer has devoted substantive attention.
C. Discuss with management the policies and procedures it has adopted for evaluating and accounting for litigation, claims, and assessments.
D. Confirm directly with the client’s lawyer that all litigation, claims, and assessments have been recorded or disclosed in the financial statements.

Answer 47

This is the only correct answer. The auditor would discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.

Question 48

Which of the following procedures would be most likely to assist an auditor in identifying litigation, claims, and assessments?

A. 	 Inspect checks included with the client's cut-off bank statement.

B. 	 Obtain a letter of representations from the client's underwriter of securities.

C. 	 Apply ratio analysis on the current-year's liability accounts.

D. 	 Read the file of correspondence from taxing authorities.

Answer 48

A taxing authority could impose an assessment on an entity related to tax matters. The auditor might then identify the existence of such an assessment by reviewing correspondence between the entity and the taxing authority.

Question 49

The refusal of a client’s attorney to provide information requested in an inquiry letter generally is considered
A. Grounds for an adverse opinion.
B. A limitation on the scope of the audit.
C. Reason to withdraw from the engagement.
D. Equivalent to a significant deficiency.

Answer 49

The refusal of a client’s attorney to provide information requested in an inquiry letter is considered a limitation on the scope of the audit. It would result in a disclaimer or a qualified opinion.

Question 50

The primary source of information to be reported about litigation, claims, and assessments is the
	A. 	Client's lawyer.
	B. 	Court records.
	C. 	Client's management.
	D. 	Independent auditor.

Answer 50

Management is the primary source of information about litigation, claims, and assessments. The information provided by management is corroborated by the client’s lawyer.

Question 51

In auditing contingent liabilities, which of the following procedures would an auditor be most likely to perform?
A.
Confirm the details of outstanding purchase orders.

B. 	 Apply analytical procedures to accounts payable.

C. 	 Read the minutes of the board of directors' meetings.

D. 	 Perform tests of controls on the cash disbursement activities.

Answer 51

Issues that are significant to the entity (for example, litigation issues that result in contingent liabilities) normally rise to the level of discussion by those charged with governance. The auditor routinely reads the minutes of these meetings to identify issues that have financial reporting implications, including issues related to contingent liabilities.

Question 52

Which of the following is not an audit procedure that the independent auditor would perform concerning litigation, claims, and assessments?
A. Obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed.
B. Confirm directly with the client’s lawyer that all claims have been recorded in the financial statements.
C. Inquire about and discuss with management the policies and procedures adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.
D. Obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.

Answer 52

The auditor would NOT confirm with the attorney that ALL claims have been recorded in the financial statements. All claims do not require recording and the attorney would not have knowledge of what had been recorded in the financial statements.

Question 53

The scope of an audit is not restricted when an attorney’s response to an auditor, as a result of a client’s letter of audit inquiry, limits the response to
A. Matters to which the attorney has given substantive attention in the form of legal representation.
B. An evaluation of the likelihood of an unfavorable outcome of the matters disclosed by the entity.
C. The attorney’s opinion of the entity’s historical experience in recent similar litigation.
D. The probable outcome of asserted claims and pending or threatened litigation.

Answer 53

A lawyer may appropriately limit the response to matters to which the lawyer has given substantive attention in the form of legal consultation or representation.

Question 54

The primary reason an auditor requests letters of inquiry be sent to a client’s attorneys is to provide the auditor with
A. The probable outcome of asserted claims and pending or threatened litigation.
B. Corroboration of the information furnished by management about litigation, claims, and assessments.
C. The attorneys’ opinions of the client’s historical experiences in recent similar litigation.
D. A description and evaluation of litigation, claims, and assessments that existed at the balance sheet date.

Answer 54

An attorney’s letter is primarily intended to provide the auditor with corroboration of the information furnished by management about litigation, claims, and assessments.

Question 55

A lawyer’s response to an auditor’s inquiry concerning litigation, claims, and assessments may be limited to matters that are considered individually or collectively material to the client’s financial statements. Which parties should reach an understanding on the limits of materiality for this purpose?
A. The auditor and the client’s management.
B. The client’s audit committee and the lawyer.
C. The client’s management and the lawyer.
D. The lawyer and the auditor.

Answer 55

The client and the auditor should reach an understanding about materiality. This understanding is then communicated to the attorney who will limit his/her response accordingly.

Question 56

What is an auditor’s primary method to corroborate information on litigation, claims, and assessments?

A. Examining legal invoices sent by the client’s attorney.
B. Verifying attorney-client privilege through interviews.
C. Reviewing the response from the client’s lawyer to a letter of audit inquiry.
D. Reviewing the written representation letter obtained from management.

Answer 56

The auditor will often seek to obtain an attorney’s letter, as that provides some of the primary evidence supporting litigation, claims, and assessments. Note that the question indicates that the auditor is corroborating information. The auditor first obtains the information from the client. That information is then corroborated by the information obtained from the attorney.