Audit Evidence - Specific Audit Areas

Question 1

When is the detailed testing of payroll (or other expense accounts) typically performed?

Answer 1

Usually performed only when the auditor ‘s analytical procedures suggest that there is a risk of material misstatement relating to payroll (or other expense accounts).

Question 2

Identify an audit procedure that addresses the existence assertion for stockholder’s equity.

Answer 2

If the entity has an external registrar, confirm the outstanding shares of stock.

Question 3

Give an example of an analytical procedure to evaluate interest payable at year-end.

Answer 3

The auditor might estimate the accrued interest for the time period involved, based on the interest rate (and payment dates) specified in the underlying debt agreements.

Question 4

Give an example of an analytical procedure to evaluate dividends payable at year-end.

Answer 4

The auditor might estimate the dividends payable, in view of the declared dividends/share (per the minutes of board meetings) times the number of shares outstanding at year-end.

Question 5

Identify an audit procedure that addresses the rights and obligations assertion for accounts payable.

Answer 5

Inquire of management about any transactions with related parties that result in obligations.

Question 6

Give an example of an analytical procedure to evaluate wages and salaries payable at year-end.

Answer 6

The auditor might estimate the wages and salaries payable based on the number of days to be accrued relative to the payroll for a normal pay period.

Question 7

Describe how the auditor might address the completeness assertion for fixed assets.

Answer 7

Review repairs and maintenance expense accounts to see if any transactions should have been capitalized instead of expensed.

Question 8

What is meant by the term “derivative?”

Answer 8

A derivative is a financial instrument or other contract whose value is derived (hence, the name derivative) from its relationship to something else known as the underlying. The underlying can be another financial instrument, a physical commodity, currency, etc.

Question 9

What is meant by the term “hedge?”

Answer 9

A hedge is a defensive strategy designed to protect against the risk of adverse price or interest rate movements to achieve a state of balance.

Question 10

What is usually considered to be the best evidence of fair value for a financial instrument that is measured at fair value?

Answer 10

Quoted market prices obtained from financial publications, national exchanges, or NASDAQ.

Question 11

What else should the auditor do if estimates of fair value for financial instruments are obtained from third-party sources (such as broker-dealers)?

Answer 11

The auditor should obtain an understanding of the methods they used.

Question 12

What is the auditor’s basic responsibility if estimates of fair value for financial instruments are based on management’s valuation model?

Answer 12

The auditor should obtain sufficient appropriate audit evidence about the fair value based on that model.

Question 13

What audit procedures might an auditor perform to evaluate an investment in securities that is based on cost?

Answer 13

The auditor might inspect the documentation of the purchase price, confirm the existence of the security with the appropriate outside parties, and test the amortization of any premium or discount.

Question 14

What audit procedures might an auditor perform to evaluate an investment in securities that is based on the investee’s financial results?

Answer 14

The auditor would normally read the audited financial statements of the investee.

Question 15

Describe how the auditor might address the existence assertion of for inventory in the entity’s possession.

Answer 15

Participate in the client’s count of inventory and perform test counts of selected inventory tags to verify the accuracy of the entity’s counts. (Select a sample of items on the entity’s inventory listing and agree them to the auditor’s test counts.)

Question 16

How might the auditor address the rights and obligations assertion for inventory?

Answer 16

Inquire of management about any inventory held on consignment or pledged as collateral. The auditor might also read the entity’s debt agreements for any discussion of collateral, such as inventory.

Question 17

What is meant by the term “lapping” related to accounts receivable?

Answer 17

An attempt to cover up a theft of receipts, where a clerk might apply a different customer’s payment to a prior customer’s account (whose payment was stolen) to conceal the theft.

Question 18

Describe how the auditor performs the “cutoff test” for sales.

Answer 18

Examine the last few transactions before year-end and the first few after year-end. Agree the entries on the sales journal to the shipping documents (existence); and agree the shipping documents to the sales journal (completeness).

Question 19

What is the main audit procedure that addresses the completeness assertion for accounts receivable?

Answer 19

Perform cutoff test of sales to verify that sales transactions are recorded in the proper period. Sales transactions may be recorded prematurely, violating the existence assertion, or recorded belatedly, which violates the completeness assertion.

Question 20

What is meant by the term “cutoff bank statement?”

Answer 20

Short period bank statement obtained directly from the bank (normally for a 10-day period) useful in verifying the deposits in transit and providing some (usually partial) evidence about outstanding checks on a bank reconciliation.

Question 21

What is the schedule of interbank transfers used for?

Answer 21

It is used to verify that transfers between the entity’s bank accounts are recorded properly (and to detect kiting, which overstates the cash balance).

Question 22

What is meant by the term “kiting?”

Answer 22

An overstatement of the true cash balance at year-end caused by recording the receipt, while failing to record the disbursement, associated with a transfer between the entity’s cash accounts.

Question 23

What does the “proof of cash” compare?

Answer 23

Compares the beginning balance per the bank plus deposits minus checks clearing the bank versus the beginning balance per the books plus receipts minus disbursements according to the books.

Question 24

List the 5 assertions related to income-statement items (that is, for transactions and events during the period).

Answer 24

1. Accuracy
2. Occurrence
3. Completeness
4. Cutoff
5. Classification

Question 25

Identify an audit procedure that addresses the valuation assertion for stockholder’s equity.

Answer 25

• Review the cash receipts journal and the cash disbursements journal for any changes related to the stock accounts.
• Compare the subsidiary ledger related to the stock accounts to the general ledger balance.
• Verify the par value on the stock certificate or the stated value in the minutes of meetings of those charged with governance.

Question 26

Identify an audit procedure that addresses the completeness assertion for stockholder’s equity.

Answer 26

• Read the minutes of meetings of those charged with governance for authorization of any stock-related transactions that should have been recorded.
• Verify that all certificate numbers are accounted for.

Question 27

Identify a few audit procedures that address the rights and obligations assertion for stockholder’s equity.

Answer 27

• Review minutes of meetings of those charged with governance for authorization of stock-related transactions.
• Review the entity’s compliance with contracts for employee stock plans.
• Inquire of management about any restrictions applicable to retained earnings.

Question 28

Give an example of an audit procedure for completeness of Long-term Liabilities.

Answer 28

• Verify due dates for payments in the loan agreements
• Trace cash disbursements from the accounting records to the bank statement
• Examine canceled notes if paid in full.

Question 29

Identify a few audit procedures that address the existence assertion for long-term liabilities.

Answer 29

• Obtain copies of new loan agreements for the audit documentation.
• Verify authorization of new debt in minutes of meetings of those charged with governance.
• Trace the proceeds received from the accounting records to the bank statement.

Question 30

Identify a few audit procedures that address the valuation assertion for long-term liabilities.

Answer 30

1. Trace related cash receipts (for increases) and disbursements (for decreases) from the accounting records to the bank statement for any debt activities.
2. Examine underlying loan documents for issuance of new debt and scheduled payments.
3. Recalculate the amortization of any discount or premium involved.

Question 31

Identify an audit procedure that addresses the rights and obligations assertion for long-term liabilities.

Answer 31

• Review loan documents for any restrictive debt covenants to be disclosed.
• Review the loan documents (or inquire of management) to identify the current portion of long-term debt to be reclassified as a current liability.

Question 32

Identify a few audit procedures to address the existence assertion for accounts payable.

Answer 32

• Compare the general ledger control account to the supporting detailed listing of payables.
• Agree selected items to vendors’ invoices
• May choose to confirm payables (but usually do not, since completeness is typically a greater concern than existence with respect to liability accounts).

Question 33

Identify a few audit procedures that address the existence assertion for fixed assets.

Answer 33

• Verify that detailed (subsidiary) listing supports general ledger account
• Examine underlying documents to evaluate any additions
• Trace proceeds from any disposals (retirements) to cash receipts journal and to bank statement.

Question 34

Describe the basic steps that comprise the auditor’s search for unrecorded liabilities.

Answer 34

• Review cash disbursements after year-end and examine underlying documents to identify liabilities of the period under audit.
• Examine unpaid invoices (and receiving documents) at the time of the test.
• Inquire of management as to the completeness of liabilities (document that in the management representations letter).

Question 35

Describe how the auditor might address the valuation assertion for fixed assets.

Answer 35

• Review calculations for depreciation expense
• Inquire of management as to whether any assets have become impaired.

Question 36

Identify 2 audit procedures that address the rights and obligations assertion for fixed assets.

Answer 36

• Inquire about any fixed assets pledged as collateral for debts
• Read the entity’s debt agreements for any discussion of collateral, such as fixed assets.

Question 37

What considerations might be helpful to the auditor in determining whether a decline in fair value for a financial instrument is other than temporary?

Answer 37

1. How much (and how long) the fair value is below the carrying value.
2. Whether the financial condition of the issuer has deteriorated.
3. Whether a rating agency has downgraded the security.
4. Whether dividends have been reduced or eliminated (or interest payments not made).
5. Whether the entity recorded losses on the security after the period-end.

Question 38

Describe how the auditor might address the completeness assertion for inventory.

Answer 38

1. Test sales cut-off (regarding cost of goods sold, decreases to inventory)
2. Test purchases cut-off (regarding purchases of inventory).

Question 39

Identify a few audit procedures that might address the valuation assertion for inventory.

Answer 39

• Perform price tests (to evaluate the appropriateness of the inventory’s cost/unit - e.g., agree unit costs to a recent supplier’s invoice).
• Test the extensions (quantity times cost/unit) and foot the total.
• Perform lower of cost or market analysis. Might calculate the inventory turnover ratio to identify slow-moving inventory.

Question 40

Identify 2 audit procedures that address the rights and obligations assertion for accounts receivable.

Answer 40

• Inquire about receivables pledged as collateral.
• Read the debt agreements for any discussion of collateral.

Question 41

Identify several audit procedures that address the valuation assertion for accounts receivable.

Answer 41

• Review the aged trial balance (and test its accuracy).
• Inquire about individually large, delinquent items.
• Estimate uncollectible accounts based on time outstanding (that is, based on each category of age).
• Review receiving documents after year-end for sales returns.

Question 42

Describe the basic steps associated with the auditor’s participation in an entity’s physical count of inventory.

Answer 42

• Review and evaluate the entity’s written counting procedures.
• Perform test counts for selected count tags to compare to client counts.
• Determine that all inventory tags are properly accounted for
• Be alert for and inquire about any obsolete or damaged items.

Question 43

Identify several audit procedures that address the existence assertion for accounts receivable.

Answer 43

• Verify subsidiary ledger agrees with the general ledger control account
• Confirm individually material accounts and selected others.
• Investigate exceptions (disputed balances) from confirmations
• Complete alternate procedures for nonresponses to positive confirmations.

Question 44

List some typical audit procedures applicable to cash accounts.

Answer 44

• Review and test the entity’s bank reconciliations;
• Prepare and test a schedule of interbank transfers if there are multiple bank accounts with transfers among them;
• Prepare proof of cash if fraud is suspected;
• May count petty cash, but usually do not due to its immateriality;
• Inquire about minimum balance requirements on bank accounts.

Question 45

What is the purpose of a bank confirmation?

Answer 45

• It verifies the existence and ownership of bank accounts; and
• It also provides evidence about the completeness and terms of notes payable with bank.

Question 46

Identify several substantive procedures usually performed in every audit area.

Answer 46

• Agree financial statement elements, or trial balance from which financial statement elements are derived, to underlying accounting records (general ledger);
• Scan the entity’s journals and ledgers for any “unusual” items;
• Make inquiries of management and other personnel; document inquiries and management’s responses in the management representations letter; and
• Perform specific analytical procedures - consider historical trends and events within the industry.

Question 47

Identify the 4 assertions for account balances at the end of the period.

Answer 47

1. Existence
2. Completeness
3. Rights and obligations
4. Valuation and allocation