CH3 Performing Flashcards
An auditor’s tests of controls for completeness for the revenue cycle usually include determining whether:
A.
each receivable is collected subsequent to the year-end.
B.
an invoice is prepared for each shipping document.
C.
each invoice is supported by a customer purchase order.
D.
each credit memo is properly approved.
B. an invoice is prepared for each shipping document.
The completeness assertion deals with whether or not all of the transactions and events that should have been recorded have been recorded. If an order was shipped, were the corresponding revenue and receivable recorded? In order to determine that the control is in place, the auditor would make sure that an invoice has been prepared for each shipping document.
Determining whether each receivable is collected subsequent to the year-end would provide evidence about the valuation of the accounts receivable balance. This procedure would be a substantive test, not a test of controls.
Ensuring that each invoice is supported by a purchase order may help the auditor determine if the sale is from a valid customer, but the revenue still would not be recorded until the order has been shipped.
Examining the approval of credit memos would assist the auditor with testing the controls over the existence of sales returns.
If the auditor identifies a significant risk related to fraud involving improper revenue recognition, the auditor may perform all of the following except:
A.
confirm contract terms with customers.
B.
perform substantive analytical procedures relating to revenue.
C.
observe shipment of goods.
D.
observe inventory at year-end as agreed upon in the planning stages of the audit.
D. observe inventory at year-end as agreed upon in the planning stages of the audit.
Examples of responses to the auditor’s assessment of the risks of material misstatement due to fraudulent financial reporting are as follows:
Revenue Recognition
Performing substantive analytical procedures relating to revenue using disaggregated data; for example, comparing revenue reported by month and by product line or business segment during the current reporting period with comparable prior periods or with revenue related to cash collections…
Confirming with customers certain relevant contract terms and the absence of side agreements because the appropriate accounting often is influenced by such terms or agreements and basis for rebates or the period to which they relate are often poorly documented (for example, acceptance criteria, delivery and payment terms, the absence of future or continuing vendor obligations, the right to return the product, guaranteed resale amounts, and cancellation or refund provisions often are relevant in such circumstances)
Inquiring of the entity’s sales and marketing personnel or in-house legal counsel regarding sales or shipments near the end of the period and their knowledge of any unusual terms or conditions associated with these transactions
Being physically present at one or more locations at period end to observe goods being shipped or being readied for shipment (or returns awaiting processing) and performing other appropriate sales and inventory cutoff procedures
For those situations for which revenue transactions are electronically initiated, processed, and recorded, testing controls to determine whether they provide assurance that recorded revenue transactions occurred and are properly recorded
Observing inventory should be done on a surprise, unannounced basis.
The use of the ratio estimation sampling technique is most effective when:
A.
the calculated audit amounts are approximately proportional to the client’s book amounts.
B.
a relatively small number of differences exist in the population.
C.
estimating populations whose records consist of quantities but not book values.
D.
large overstatement differences and large understatement differences exist in the population.
A.
the calculated audit amounts are approximately proportional to the client’s book amounts.
The use of the ratio estimation sampling technique is most effective when the calculated audit amounts are approximately proportional to the client’s book amounts. Ratio estimation takes the ratio of the mean of the sample audit values to the mean of the sample book values and applies it to the total book value. This would provide a valid statement about the total population if the calculated audit amounts are approximately proportional to the client’s book amounts.
An auditor uses the knowledge provided by the understanding of internal control and the final assessed level of control risk primarily to determine the nature, timing, and extent of the:
A.
attribute tests.
B.
compliance tests.
C.
tests of controls.
D.
substantive tests.
D. substantive tests.
The auditor should design and perform further audit procedures whose nature, timing, and extent are based on, and are responsive to, the assessed risks of material misstatement at the relevant assertion level.
When auditing inventories, an auditor would least likely verify that:
A.
the financial statement presentation of inventories is appropriate.
B.
damaged goods and obsolete items have been properly accounted for.
C.
all inventory owned by the client is on hand at the time of the count.
D.
the client has used proper inventory pricing.
C. all inventory owned by the client is on hand at the time of the count.
The auditor is required to design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure.
The five assertions consist of existence/occurrence, completeness, rights/obligations, valuation/allocation, and presentation/disclosure.
The answer choices “the financial statement presentation of inventories is appropriate,” “damaged goods and obsolete items have been properly accounted for,” and “the client has used proper inventory pricing” are relevant to the presentation/disclosure assertion. “All inventory owned by the client is on hand at the time of the count” is relevant to the valuation assertion—are defective items included in the inventory value?
Whereas all inventory owned by the client does not have to be on hand at the time of the count, inventories could be held on consignment or in public warehouses, where confirmation procedures might be more appropriate.
Which of the following is the primary reason that many auditors hesitate to use embedded audit modules?
A.
Embedded audit modules cannot be protected from computer viruses.
B.
Auditors are required to monitor embedded audit modules continuously to obtain valid results.
C.
Embedded audit modules can easily be modified through management tampering.
D.
Auditors are required to be involved in the system design of the application to be monitored.
D. Auditors are required to be involved in the system design of the application to be monitored.
An embedded audit module is a section of program code that is included in the client’s application program in order to collect audit data for the auditor. For example, at the auditor’s direction, an electronic file may be created of all sales transactions that are for more than $100. This monitors the client’s computer/software system as transactions are actually being processed.
It can be hard to install an embedded audit module after an application program is operational and already in use. It is usually easier and more efficient to install the embedded audit module during system design.
Since auditors are required to be involved in the system design of the application to be monitored, it is difficult to monitor exceptions. There are other approaches the auditor may use to audit the system.
Which of the following is not a major reason for maintaining an audit trail for a computer system?
A.
Deterrent to fraud
B.
Monitoring purposes
C.
Analytical purposes
D.
Query answering
C. Analytical purposes
An audit trail in a computer system, as in a manual system, assists in discovering fraud and therefore acts as a deterrent to perpetration of such acts.
Other major reasons for an audit trail include:
monitoring the system and the data produced, and
answering queries by tracking a specific transaction through the accounting records or tracing a transaction back to the original source and observing how it is processed through the system.
Analytical purposes are not a major factor for maintaining an audit trail in a computer system. Analytical review can be performed by retrieving recorded data stored in the computer system or on hard copy.
In auditing computer-based systems, the integrated test facility:
A.
allows the auditor to assemble test transactions and run them through the computer system to test the integrity of controls on a sample database.
B.
is a set of specialized software routines designed to perform specialized audit tests and store audit evidence.
C.
is a concurrent audit technique where a special set of dummy master files is established and test transactions are entered to test the programs using the dummy files during regular processing runs.
D.
uses a set of software routines that are embedded in the computer system which detect and flag transactions that may be indicative of fraud.
C.
is a concurrent audit technique where a special set of dummy master files is established and test transactions are entered to test the programs using the dummy files during regular processing runs.
An integrated test facility involves the use of a set of transactions belonging to a dummy entity. These transactions have a predetermined result against which the computer processing will be compared. These transactions are run during the regular processing of data and often without the computer operator’s knowledge.
A company’s management provided its auditors with information concerning litigation, claims, and assessments. Which of the following is the auditor’s primary means of corroborating management’s information?
A.
Inquiring of company’s outside counsel
B.
Meeting with the company’s audit committee
C.
Meeting with the company’s chairman of the board
D.
Inquiring of the company’s in-house counsel
A.
Inquiring of company’s outside counsel
Management provides a description and evaluation of litigation, claims, and assessments (LCA) that existed at the balance sheet date and during the period from the balance sheet date to the date the information is furnished. An auditor ordinarily does not possess legal skills and, therefore, cannot make legal judgments regarding the information obtained from management and from the inspection of documents (such as minutes of meetings, contracts, loan agreements, and confirmations from banks).
Accordingly, the auditor should request that management prepare a letter of inquiry that is sent by the auditor to those lawyers with whom management consulted concerning LCAs; this is the auditor’s primary means of corroboration of the information furnished by management concerning LCA.
In evaluating controls over cash disbursements, an auditor most likely would determine that the control risk is lower when the person who signs checks also:
A.
reviews the monthly bank reconciliation.
B.
returns the checks to accounts payable.
C.
is denied access to the supporting documents.
D.
is responsible for mailing the checks.
D.
is responsible for mailing the checks.
To prevent a check from being misdirected, the person who signs checks should also mail the checks. This prevents someone from intercepting and misdirecting a check made either to a fictitious payee/addressee or to a real payee but for a fictitious amount or purpose. In testing controls over cash disbursements, an auditor most likely would determine that the person who signs checks is also responsible for mailing the checks. This arrangement represents appropriate segregation of duties.
If the objective of an auditor’s test of details is to detect a possible understatement of sales, the auditor most likely would trace transactions from the:
A.
sales invoices to the shipping documents.
B.
cash receipts journal to the sales journal.
C.
shipping documents to the sales invoices.
D.
sales journal to the cash receipts journal.
C.
shipping documents to the sales invoices.
If the auditor were concerned about a possible understatement of sales, she would be looking for additional, unrecorded invoices. If the auditor is confident that the shipping documents represent a complete population of all sales shipped, then she would start with the shipping document and trace back to the sales invoices. Any missing sales invoice would represent an understatement of sales.
Which of the following would be a consideration in planning an auditor’s sample for a test of controls?
A.
Preliminary judgments about materiality levels
B.
The auditor’s allowable risk of assessing control risk is too high.
C.
The level of detection for the account
D.
The auditor’s allowable risk of assessing control risk is too low.
D.
The auditor’s allowable risk of assessing control risk is too low.
When determining a sample size for a test of controls, the auditor should consider the tolerable rate of deviation from the controls (expressed in %), the likely rate of deviations (expressed in %), and the allowable risk of assessing control risk too low (the reliability level).
During the performance of an audit, the auditor has encountered several misstatements that could affect the financial statements. Because the auditor set the maximum amount of misstatements allowed at less than the materiality level the auditor did not have to make any adjustments to the financial statements. The level established for misstatements is an example of:
A.
materiality.
B.
analytical procedures.
C.
performance materiality.
D.
control risk assessment.
C.
performance materiality.
AU-C 320.09 states that performance materiality is “the amount or amounts set by the auditor at less than materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.”
In auditing an entity’s computerized payroll transactions, an auditor would be least likely to use test data to test controls concerning:
A.
overpayment of employees for hours not worked.
B.
control and distribution of unclaimed checks.
C.
withholding of taxes and Social Security contributions.
D.
missing employee identification numbers.
B.
control and distribution of unclaimed checks.
Test data is introduced into the client’s computer system and processed with the client’s software in order to determine if specified controls are operating effectively. When using test data, the auditor is looking for controls that are built into the system, not controls that operate outside of the computer. Thus, the auditor would not be testing controls concerning control over and distribution of unclaimed paychecks.
An analysis of which of the following accounts would best aid in verifying that all fixed assets have been capitalized?
A.
Cash
B.
Depreciation expense
C.
Property tax expense
D.
Repairs and maintenance
D.
Repairs and maintenance
An entity is most likely to mistakenly record a major repair that extends the life of a fixed asset in the repairs and maintenance expense account. The auditor would examine the population of expenses posted in this account to determine if any capital purchases have been incorrectly recorded. Examination of the other accounts listed would not aid in this audit objective.
“There are no violations or possible violations of laws or regulations whose effects should be considered for disclosure in the financial statements or as a basis for recording a loss contingency.”
The foregoing passage is most likely from:
A.
a client engagement letter.
B.
a report on compliance with laws and regulations.
C.
a management representation letter.
D.
an attestation report on an internal control.
C. a management representation letter.
This statement should appear in the client’s management representation letter to the auditor. Keep in mind the difference between management representations and auditor attestations (opinions or reports). It is the responsibility of management to give the assurance that there are no undisclosed violations (i.e., noncompliance with laws and regulations). The audit is not designed to guarantee that all violations will be found; the auditor’s knowledge is limited to that acquired through the audit. Thus, the auditor and the user must rely on management representations.
The client engagement letter is the contract between the auditor and client outlining the scope and other details of the engagement. No representations of the sort quoted in the question are made in the engagement letter.
Even a report on compliance with laws and regulations does not state such representations. An auditor can only give negative assurance on compliance with laws and regulations under government auditing standards: “nothing came to our attention to cause us to believe…”
In an attestation report on an internal control, the auditor attests that “the entity maintained effective internal control over financial reporting” or that “management’s assertion (about the effectiveness of the entity’s internal control) is fairly stated…”
Which of the following statements is correct concerning statistical sampling in tests of controls?
A.
As the population size increases, the sample size should increase proportionately.
B.
Deviations from specific internal control procedures at a given rate ordinarily result in misstatements at a lower rate.
C.
There is an inverse relationship between the expected population deviation rate and the sample size.
D.
In determining tolerable rate, an auditor considers detection risk and the sample size.
B. Deviations from specific internal control procedures at a given rate ordinarily result in misstatements at a lower rate.
Two types of sampling risk that affect performing tests of controls are:
The risk of assessing control risk too low
The risk of assessing control risk too high
If the auditor assesses control risk too high, which would occur if there are deviations from an internal control procedure in the sample, additional substantive procedures would normally be applied and oftentimes results in the true operating effectiveness of the control at a lower rate.
In testing plant and equipment balances, an auditor may inspect new additions listed on the analysis of plant and equipment. This procedure is designed to obtain evidence concerning management’s assertions of:
I. presentation and disclosure.
II. existence or occurrence.
A.
Both I and II
B.
I only
C.
II only
D.
Neither I nor II
C.
II only
Assertions are claims in the financial statements made by management. The existence assertion for an asset such as property, plant, and equipment involves determining whether the asset actually exists on a given date. By personally inspecting additions to property, plant, and equipment, the auditor satisfies the existence assertion. The “presentation and disclosure” assertion involves judging whether an asset is properly classified in the financial statements. Visually inspecting an asset does not sufficiently determine whether the financial statements are properly prepared.
An auditor discovered that a client’s accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that:
A.
obsolete inventory has not yet been reduced to fair market value.
B.
there was an improper cutoff of sales at the end of the year.
C.
an unusually large receivable was written off near the end of the year.
D.
the aging of accounts receivable was improperly performed in both years.
B. there was an improper cutoff of sales at the end of the year.
The accounts receivable turnover ratio is:
Net Credit Sales/ Average Receivables
If the divisor (average receivables) of this ratio increases without a change in the net credit sales, the ratio would be lower. This situation would occur if the company did not properly cut off sales at the end of the year and recorded more in accounts receivable than should have been recorded.
The reduction of the value of obsolete inventory has nothing to do with the accounts receivable turnover ratio.
If the company had written off an unusually large receivable near the end of the year, the average receivables would decrease, and the ratio would be higher.
The aging of receivables would not change the average receivables calculation.
To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is:
A.
supported by a vendor’s invoice.
B.
stamped “paid” by the check signer.
C.
prenumbered and accounted for.
D.
approved for authorized purchases.
B.
stamped “paid” by the check signer.
To verify that a voucher is submitted and paid only once, a system must be in place that cancels the voucher. Canceling prevents a voucher from being accepted as valid for payment again. Stamping a voucher paid is a form of canceling. If a sample of paid vouchers is examined to verify each are stamped “paid” and stamped only once, this provides assurance that each voucher is submitted and paid only once.
The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the:
A.
evidence to be gathered to provide a sufficient basis for the auditor’s opinion.
B.
procedures to be undertaken to discover litigation, claims, and assessments.
C.
pending legal matters to be included in the inquiry of the client’s attorney.
D.
timing of inventory observation procedures to be performed.
D.
timing of inventory observation procedures to be performed.
The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the timing of inventory observation procedures to be performed. This is a timing and scheduling issue appropriate to the planning stage. What constitutes sufficient evidence; procedures to be undertaken to discover litigation, claims, and assessments; and what pending legal matters should be included in the inquiry of the client’s attorney are less likely to be issues discussed and agreed upon with the client.
An auditor analyzes repairs and maintenance accounts primarily to obtain evidence in support of the audit assertion that all:
A.
noncapitalizable expenditures for repairs and maintenance have been recorded in the proper period.
B.
expenditures for property and equipment have been recorded in the proper period.
C.
noncapitalizable expenditures for repairs and maintenance have been properly charged to expense.
D.
expenditures for property and equipment have not been charged to expense.
D. expenditures for property and equipment have not been charged to expense.
The trick to this question is the population that is being examined. Property and equipment expenditures for asset acquisition or enhancement or for extension of the life of an asset should be capitalized, not expensed, to value assets and expenses properly. By analyzing amounts recorded as repairs and maintenance (the population specified in the question), the auditor verifies that expenditures for property and equipment have not been incorrectly charged to expense.
The other primary audit concern regarding property and equipment—that noncapitalizable expenditures for repairs and maintenance have been properly charged to expense—is verified by examining a different population. Specifically, the auditor should examine the property and equipment accounts to ensure that expenses were not capitalized.
The auditor would also review both noncapitalizable expenses and the expenditures for property and equipment recorded in the asset accounts to verify all amounts are recorded in the proper period, but this is not a primary audit concern.
On August 13, a CPA completed fieldwork on an engagement to audit financial statements for the year ended June 30. On August 27, an event came to the CPA’s attention that should be disclosed in the notes to the financial statements. The event was properly disclosed by the entity, but the CPA decided not to dual date the auditor’s report and dated the report August 27. Under these circumstances, the CPA was taking responsibility for:
A.
all subsequent events that occurred through August 27.
B.
only the specific subsequent event disclosed by the entity.
C.
all subsequent events that occurred through August 13 and the specific subsequent event disclosed by the entity.
D.
only the subsequent events that occurred through August 13.
A.
all subsequent events that occurred through August 27.
Should the auditor choose to date the report August 27, her responsibility extends to the date of the report. She is responsible for all subsequent events that occurred through August 27, and all necessary auditing procedures should be extended to that date.
An alternate choice is for the auditor to date the report as of the end of the fieldwork (August 13) and date the note about the subsequent event as of the date of disclosure (August 27). This is called dual dating. In this case, the auditor’s responsibility for events subsequent to the original report date is limited to the note dated August 27.
Which of the following procedures is considered a test of controls?
A.
An auditor reviews the entity’s check register for unrecorded liabilities.
B.
An auditor evaluates whether a general journal entry was recorded at the proper amount.
C.
An auditor interviews and observes appropriate personnel to determine segregation of duties.
D.
An auditor reviews the audit workpapers to ensure proper sign-off.
C. An auditor interviews and observes appropriate personnel to determine segregation of duties.
Procedures directed toward evaluating the effectiveness of the design of a control are concerned with whether that control is suitably designed to prevent or detect material misstatements in specific financial statement assertions. According to AU-C 330.A28, “Inquiry alone is not sufficient to test the operating effectiveness of controls. Accordingly, other audit procedures are performed in combination with inquiry. In this regard, inquiry combined with inspection, recalculation, or reperformance may provide more assurance than inquiry and observation because an observation is pertinent only at the point in time at which it was made.”
In establishing the existence and ownership of a long-term investment in the form of publicly traded stock, an auditor should inspect the securities or:
A.
correspond with the investee company to verify the number of shares owned.
B.
inspect the audited financial statements of the investee company.
C.
confirm the number of shares owned that are held by an independent custodian.
D.
determine that the investment is carried at market.
C. confirm the number of shares owned that are held by an independent custodian.
The key to this type of question is to match the correct procedure to the assertion specified in the question (since all answer choices could be appropriate procedures).
To establish the existence and ownership (two different assertions) of a long-term investment in the form of publicly traded stock, an auditor should inspect the stock certificates or confirm the number of shares owned that are held by an independent custodian. (The procedures should answer the questions, “Does this recorded investment really exist?” and “Did the purchase of this stock really occur?”) Confirmation is usually necessary when securities are on deposit, pledged, or in safekeeping. However, confirmation correspondence is sent to the custodian with physical possession of the securities, not to the investee company.
The audited financial statements of the investee company might be inspected to provide evidence concerning valuation of investments carried under the equity method. Further evidence concerning the valuation assertion is provided by determining that the investment is carried at market price (rather than lower of cost or market) per FASB ASC 320-10.
Which of the following strategies would a CPA most likely consider in auditing an entity that processes most of its financial data only in electronic form, such as a paperless system?
A.
Continual monitoring and analysis of transaction processing with an embedded audit module
B.
Increased reliance on internal control activities that emphasize the segregation of duties
C.
Verification of encrypted digital certificates used to monitor the authorization of transactions
D.
Extensive testing of firewall boundaries that restrict the recording of outside network traffic
A.
Continual monitoring and analysis of transaction processing with an embedded audit module
The audit of an entity that processes most of its financial data only in electronic form may require continual monitoring throughout the year, including testing of controls and analysis of transaction processing at the time it occurs. Such testing may only be effectively accomplished through the use of auditing software embedded in the program. While the other strategies are important in testing aspects of the internal control system, the testing of such attributes as completeness, authorization, and accuracy in a paperless system can only be achieved at the time the transaction takes place.
In performing tests concerning the granting of stock options, an auditor should:
A.
confirm the transaction with the Secretary of State in the state of incorporation.
B.
verify the existence of option holders in the entity’s payroll records or stock ledgers.
C.
determine that sufficient treasury stock is available to cover any new stock issued.
D.
trace the authorization for the transaction to a vote of the board of directors.
D. trace the authorization for the transaction to a vote of the board of directors.
Stock options are granted by an entity as additional compensation to key employees. The primary audit concern is that the options were properly authorized. Thus, the auditor should trace the authorization for the transaction to a vote of the board of directors.
It is not necessary for an entity to register the issuance of additional shares of stock with the Secretary of State once the shares have been authorized; even if it were, this is a legal concern, not an audit concern. Since only the right to acquire stock has been given, the entity’s payroll records or stock ledgers would not record the options. Additional treasury stock could be acquired or new shares of stock could be issued upon the exercise of stock options. It is not necessary that the entity have sufficient treasury stock on hand to cover the exercise of all the options.
To satisfy the valuation assertion when auditing an investment accounted for by the equity method, an auditor most likely would:
A.
inspect the stock certificates evidencing the investment.
B.
examine the audited financial statements of the investee company.
C.
review the broker’s advice or canceled check for the investment’s acquisition.
D.
obtain market quotations from financial newspapers or periodicals.
B. examine the audited financial statements of the investee company.
The key to this type of question is to match the correct procedure to the assertion specified in the question (since all answer choices could be appropriate procedures).
To establish the valuation of an investment accounted for by the equity method is an assertion about an account balance at the period-end. The valuation assertion states that all assets, liabilities, and equity interests are included in the financial statements at appropriate amounts. The audited financial statements of the investee company might be inspected to provide evidence concerning valuation of investments carried under the equity method. Further evidence concerning the valuation assertion is provided by determining that the investment is carried at market price (rather than lower of cost or market) per FASB ASC 320-10.
The definition of the equity method is the investor records the investment at acquisition cost (fair market value on the date of acquisition) and adjusts the carrying amount (increase/decrease) to recognize the investor’s share of the earnings/losses of the investee (whether distributed to the investor or not). The adjustment is also recognized as a determinant of net income of the investor in proportion to the investor’s ownership in the investee. Both are eliminated in consolidated financial statements. Dividends received from the investee reduce the carrying amount of the investment.
Thus, obtaining market quotations, while perhaps meeting the valuation assertion for other investments, would not be the most likely procedure the auditor takes for an equity method investment.
To determine whether accounts payable are complete, an auditor performs a test to verify that all merchandise received is recorded. The population of documents for this test consists of all:
A.
vendors’ invoices.
B.
purchase orders.
C.
receiving reports.
D.
canceled checks.
C. receiving reports.
Remember that when analyzing the effect of an audit test, you are asking, “Was this sample unit subjected to this accounting function?” And, to verify that all merchandise received was recorded, you are asking, “Was all merchandise received recorded in the accounts payable account and in the inventory account?” Receiving reports are the sampling units that show what merchandise was received.
Providing more supervision during an audit of a nonissuer in response to assessed risks of material misstatement at the financial statement level is an example of:
A.
a substantive response.
B.
further audit procedures.
C.
tests of controls.
D.
an overall response.
D. an overall response.
The auditor’s overall responses to address the assessed risks of material misstatement at the financial statement level may include the following:
Emphasizing to the audit team the need to maintain professional skepticism in gathering and evaluating audit evidence
Assigning more experienced staff or those with specialized skills such as specialists
Providing more supervision
Incorporating additional elements of unpredictability in the selection of further audit procedures to be performed
Substantive responses, further audit procedures, and test of controls are specific responses, not an overall response.
Which of the following courses of action is the most appropriate if an auditor concludes that there is a high risk of material misstatement?
A.
Use smaller, rather than larger, sample sizes
B.
Perform substantive tests as of an interim date
C.
Select more effective substantive tests
D.
Increase of tests of controls
C.
Select more effective substantive tests
If an auditor concludes that there is a high risk of material misstatement, the auditor may expand substantive testing or select more effective substantive tests. Using smaller sample sizes, performing substantive tests at an interim date, and increasing tests of controls are not examples of expanding substantive testing or selecting more effective substantive tests.
Which of the following parties should request inquiry of a client’s lawyer?
A.
The auditor
B.
The stockholders
C.
Client management
D.
The auditor’s attorney
C.
Client management
Client management addresses the attorney and requests that information regarding litigation, claims, and assessments (LCA), which management has already disclosed, be confirmed directly with the auditor. Due to the confidential nature of the communications between a client and an attorney, the client must give permission for the attorney to discuss any matters with the auditor. This letter is a means of obtaining corroborating evidence regarding contingencies which may be facing the client.
In performing tests of controls over authorization of cash disbursements, which of the following statistical sampling methods would be most appropriate?
A.
Variable
B.
Stratified
C.
Ratio
D.
Attribute
D. Attribute
Attribute sampling is used to estimate the rate of occurrence of a specific attribute in a population. Two common types of attribute sampling are testing correct account distributions and adequate supporting documentation. Account distributions would include cash disbursements.
Attribute sampling is used primarily for tests of controls, whereas variable sampling is most used as a substantive test.
Variable sampling is used when the auditor wants to reach a conclusion about a population in terms of dollar amount.
Stratified sampling is dividing the population into relatively homogeneous groups (layers). It is a sample selection strategy that increases the efficiency and coverage of dollar amounts in audit sampling and is used when the population is highly variable (high standard deviation).
Which of the following statements is correct regarding a management representation letter?
A.
A representation letter can be used in place of specific, previously identified audit procedures.
B.
A representation letter encompasses a different set of assertions than those inherent in the financial statements.
C.
The date of the representation letter should typically be the same as the audit report.
D.
The representations made apply until the date of a client’s financial statements.
C. The date of the representation letter should typically be the same as the audit report.
A management representation letter should include the following (not inclusive):
Acknowledgement of management’s responsibility for the design, implementation, and maintenance of internal controls
Identification of noncompliance with laws and regulations
Appropriate accounting for and disclosure of related party transactions
The written representation should have the same date as the auditor’s report.
A representation letter does not replace audit procedures, it cannot contain a different set of assertions than those inherent in the financial statements, and the representations do not end at the financial statement date.
To obtain audit evidence about control risk, an auditor selects tests from a variety of techniques including:
A.
inquiry.
B.
analytical procedures.
C.
calculation.
D.
confirmation.
A. inquiry.
Audit evidence about control risk is obtained by performing tests of controls that evaluate the effectiveness of specific controls. Methods of determining the effectiveness of the design and operation of a control include inquiry, inspection, observation, and reperformance.
Analytical procedures, calculations by the auditor, and the confirmation process are substantive tests. Analytical procedures are used throughout the audit, in planning, substantive testing, and the final review of the financial statements. Confirmation provides highly reliable evidence, since evidence is obtained from external, independent third parties.
An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods:
A.
can more easily convert the sample into a dual-purpose test useful for substantive testing.
B.
eliminate the need to use judgment in determining appropriate sample sizes.
C.
afford greater assurance than a nonstatistical sample of equal size.
D.
provide an objective basis for quantitatively evaluating sample risk.
D.
provide an objective basis for quantitatively evaluating sample risk.
Sampling risk arises from the possibility that when a test of controls or a substantive test is restricted to a sample of balances or transactions, the auditor’s conclusions about the account balance or class of transactions may be different from the conclusions he or she would reach if the test were applied in the same way to all items in the account balance or class of transactions. Statistical sampling allows the auditor to calculate this risk quantitatively. Statistical sampling also enables the auditor to make objective statements about the population on the basis of the sample. Statistical sampling does not eliminate professional judgment.
Which of the following strategies most likely could improve the response rate of the confirmation of accounts receivable?
A.
Including a list of items or invoices that constitute the account balance
B.
Restricting the selection of accounts to be confirmed to those customers with relatively large balances
C.
Requesting customers to respond to the confirmation requests directly to the auditor by fax or e-mail
D.
Notifying the recipients that second requests will be mailed if they fail to respond in a timely manner
A. Including a list of items or invoices that constitute the account balance
Confirmations that allow debtors to respond with a minimum amount of work on their part are more likely to have a higher response rate than those requiring the debtor to spend a significant amount of time and effort. For example, a confirmation listing the items or invoices contains more information than a confirmation that simply lists the account balance. In this situation, it is relatively simple for the debtor to review the balance and determine if it is correct.
Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the operating effectiveness of an internal control activity?
A.
Inquiry of client personnel
B.
Inspection of documents and reports
C.
Observation of client personnel
D.
Preparation of system flowcharts
D.
Preparation of system flowcharts
The evaluation of the operating effectiveness of an internal control is concerned with how the control was applied (whether manual or automated), the consistency with which it was applied, and by whom it was applied. Inspection of documents and reports, and observation and inquiry of client personnel would assist with evaluating operating effectiveness.
Preparation of system flowcharts, however, assists the auditor with understanding the design of the internal control, not the operating effectiveness. Flowcharts would provide the least assurance about the operating effectiveness of an internal control.
An entity’s income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. The auditor most likely could have detected this by:
A.
tracing a sample of journal entries to the general ledger.
B.
evaluating the effectiveness of internal control.
C.
investigating the reconciliations between controlling accounts and subsidiary records.
D.
performing analytical procedures designed to disclose differences from expectations.
D. performing analytical procedures designed to disclose differences from expectations.
The recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts may indicate a deliberate attempt to misstate earnings. Income statement accounts are more likely (than balance sheet accounts) to provide reliable relationships from which the auditor may develop expectations. Since analytical procedures involve the comparison of recorded amounts (or ratios developed therefrom) to such expectations, the auditor is most likely to detect a misstatement of this type by performing analytical procedures designed to disclose differences from expectations. Such differences are the first condition which would arouse the auditor’s professional skepticism that a misstatement may exist.
Tracing a sample of journal entries to the general ledger would merely ensure that the selected entries are properly posted, and there is no guarantee that the selection would include the unusual entries.
Evaluating the effectiveness of internal controls may not detect misstatements caused by the circumvention or management override of the evaluated internal controls.
Investigating the reconciliations between the controlling accounts and the subsidiary records would detect this particular type of fraud only if significant unreconciled differences are found which the client has not appropriately investigated and corrected on a timely basis.
An auditor discovers that an account balance believed not to be materially misstated based on an audit sample was materially misstated based on the total population of the account balance. This is an example of which of the following sampling types of risks?
A.
Incorrect rejection
B.
Incorrect acceptance
C.
Assessing control risk too low
D.
Assessing control risk too high
B.
Incorrect acceptance
The risk of incorrect acceptance is the chance that the statistical evidence might support fair statement of a materially misstated book value. In this instance, the auditor believed that the account balance was not materially misstated based on the sample when it actually was materially misstated based on the total population of the account balance.
The risk of incorrect rejection is the chance that the statistical evidence might fail to support fair statement of a correct book value.
An auditor of a nonissuer should design tests of details to ensure that sufficient appropriate audit evidence supports which of the following?
A.
The planned level of control risk
B.
Management’s assertions that internal controls exist and are operating efficiently
C.
The effectiveness of internal controls
D.
The planned level of assurance at the relevant assertion level
D. The planned level of assurance at the relevant assertion level
In a review engagement or compilation engagement, the accountant should accumulate evidence to obtain the relevant assertion level. The other answer choices are incorrect because in a review engagement or compilation engagement, the accountant does not contemplate obtaining an understanding of the entity’s internal control.
To support financial statement assertions, an auditor develops specific audit objectives. The auditor then designs substantive tests to satisfy or accomplish each objective. Which of the following audit procedures would primarily respond to the audit objective for property and equipment that the entity has legal right to property and equipment acquired during the year?
A.
Review the provision for depreciation expense and determine that depreciable lives and methods used in the current year are consistent with those used in the prior year
B.
Examine deeds and title insurance certificates
C.
Determine that property and equipment are adequately insured
D.
Physically examine all major property and equipment additions
B. The audit procedure, “Examine deeds and title insurance certificates,” is used to satisfy the audit objective that the entity has legal right to property and equipment acquired during the year (which supports the assertion about rights). It provides independent external evidence (the most competent type) that the investments exist and that the entity holds the legal title, i.e., owns the assets.
An auditor’s principal objective in analyzing repairs and maintenance expense accounts is to:
A.
determine that all obsolete plant and equipment assets were written off before the year-end.
B.
verify that all recorded plant and equipment assets actually exist.
C.
discover expenditures that were expensed but should have been capitalized.
D.
identify plant and equipment assets that cannot be repaired and should be written off.
C. discover expenditures that were expensed but should have been capitalized.
Ask the question, “What would the auditor be looking for in the population of repair and maintenance expenses?” The auditor would be looking for the incorrect recording of an expenditure that should have been capitalized.
The other answer choices involve the population of entries in the plant and equipment asset accounts.
To determine which assets should be written off and that they have been written off before year-end, the auditor would refer to an asset listing, make inquiries of management regarding asset dispositions, possibly tour the plant, and then examine the plant and equipment account detail in the general ledger to make sure that the account reflects the results of the audit procedures.
To verify that all recorded plant and equipment assets actually exist, the auditor would examine the plant and equipment asset accounts and then trace these entries to physical assets on the plant floor.
Which of the following statements ordinarily is included among the written management representations obtained by the auditor?
A.
Management has made available to you all financial records and related data.
B.
Management acknowledges responsibility for noncompliance with laws and regulations by employees.
C.
Sufficient appropriate audit evidence has been made available to permit the issuance of an unmodified opinion.
D.
Management acknowledges that there are no material weaknesses in the internal control system.
A. Management has made available to you all financial records and related data.
A written management representation that management has made available all financial records and related data should be obtained by the auditor. The responsibility for noncompliance with laws and regulations by employees is not assumed by management. Sufficient appropriate audit evidence is obtained by the auditor in order to issue an opinion on the client’s financial statements. The auditor reports any material weaknesses noted in internal control.
Which of the following is true regarding significant deficiencies?
A.
Auditors must search for them.
B.
Auditors must communicate them to the audit committee.
C.
They must be included in the financial statements.
D.
They must be disclosed in footnotes.
B. Auditors must communicate them to the audit committee.
The auditor has no responsibility to search for significant deficiencies. However, during the course of an audit, the auditor may become aware of deficiencies in internal control. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. If these deficiencies are important enough to merit attention by those charged with governance, they are significant deficiencies.
These matters should be communicated to management and those charged with governance (this group would include the audit committee). They are not included in the financial statements, and they are not disclosed in the footnotes.
Which of the following types of evidence would an auditor most likely examine to determine whether control activities are operating as designed?
A.
Gross margin information regarding the client’s industry
B.
Confirmations of receivables verifying account balances
C.
Client records documenting the use of EDP programs
D.
Anticipated results documented in budgets or forecasts
C. Client records documenting the use of EDP programs
For an auditor to determine whether control activities are operating as designed, the auditor would need to examine records documenting the use of those internal controls. Gross margin information and comparisons to budgets or forecasts may show the auditor the relative health of the organization or may highlight areas of concern, but they will do nothing to tell the auditor whether or not control activities are operating as designed. Confirmation of receivables verifying account balances may or may not tell an auditor whether control activities are effective. Of all the possible responses provided, only the examination of client records documenting the use of EDP programs is an example of examining records that could provide the auditor information to determine if control activities are operating as designed.
On December 30, 20X1, Vida Co. had cash of $200,000, a current ratio of 1.5:1 and a quick ratio of 0.5:1. On December 31, 20X1, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?
A.
Increased current ratio and decreased quick ratio
B.
Increased current ratio and no effect on quick ratio
C.
Decreased current ratio and increased quick ratio
D.
Decreased current ratio and no effect on quick ratio
A. Increased current ratio and decreased quick ratio
Note that cash is included in the numerator and accounts payable is in the denominator of both ratios:
Current ratio = Current assets / Current liabilities
Quick ratio = Quick assets / Current liabilities
In the case of the current ratio, assume that the 1.5:1 ratio represents $150 of current assets to $100 of current liabilities. If $50 of cash is used to pay off $50 of current liabilities the current ratio is increased to 2:1 (i.e., $100 of current assets to $50 of current liabilities). This would occur in any situation in which the ratio was greater than 1:1. If a ratio is less than 1:1, the opposite would hold true. In Vida Co.’s case the quick ratio would decrease.
To which of the following matters would materiality limits not apply in obtaining written representations?
A.
The availability of minutes of stockholders’ and directors’ meetings
B.
Losses from purchase commitments at prices in excess of market value
C.
The disclosure of compensating balance arrangements involving related parties
D.
Reductions of obsolete inventory to net realizable value
A.
The availability of minutes of stockholders’ and directors’ meetings
The availability of minutes is the only answer choice that is not related to financial statements. Thus, materiality limits would not apply to the availability of minutes. Materiality would only apply for representations that are financial statement–related.
An auditor observes the mailing of monthly statements to a client’s customers and reviews evidence of follow-up on errors reported by the customers. This test of controls most likely is performed to support management’s financial statement assertion of:
A.
presentation and disclosure.
B.
existence.
Incorrect C.
both presentation and disclosure and existence.
D.
neither presentation and disclosure nor existence.
B. existence.
Assertions tested by the auditor for classes of transactions and events for the period under audit:
Occurrence—Transactions and events that have been recorded have occurred and pertain to the entity.
Completeness—All transactions and events that should have been recorded have been recorded.
Accuracy—Amounts and other data relating to recorded transactions and events have been recorded appropriately.
Cutoff—Transactions and events have been recorded in the correct accounting period.
Classification—Transactions and events have been recorded in the proper accounts.
Assertions tested by the auditor for account balances at period end:
Existence—Assets, liabilities, and equity interests exist.
Rights and obligations—The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
Completeness—All assets, liabilities, and equity interests that should have been recorded have been recorded.
Valuation and allocation—Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.
If an auditor observes the mailing of monthly statements to customers and reviews evidence of follow-up errors, the auditor can determine if customer balances exist at the balance sheet date based on this evidence. The auditor can also determine that the billing transactions recorded in the sales and accounts receivable accounts occurred.
The question did not ask about whether the amounts were appropriately presented and clearly expressed (which would be an assertion associated with presentation and disclosure).
If interim substantive procedures for an account identified no exceptions, which of the following would the auditor not perform on that account at year-end?
A.
Tests of details for the entire year under audit
B.
Tests of details of activity during the period since the interim testing date
C.
Reconciliation of year-end balances to interim balances
D.
Substantive analytical procedures of the period since the interim testing date
A. Tests of details for the entire year under audit
The auditor does not need to perform tests of details for the entire year under audit. If no exceptions are identified during interim substantive procedures, the auditor should cover the remaining period by implementing substantive procedures along with tests of controls for the intervening period or, if the auditor determines that it is sufficient, only substantive procedures.
When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor will most likely increase the:
A.
level of detection risk.
B.
extent of tests of controls.
C.
level of inherent risk.
D.
extent of tests of details.
D. extent of tests of details.
Overall audit risk (AR) is a combination of inherent risk (IR), control risk (CR) (IR and CR together are the risk of material misstatement (RMM)), and detection risk (DR). The equation is:
AR = IR × CR × DR, or AR = RMM × DR
If control risk is high, this means that the auditor must have a low detection risk in order to keep the audit risk at a low level. In order to lower detection risk, the auditor would perform more tests of details (substantive procedures). In other words, the auditor would increase the extent of tests of details.
An auditor most likely would extend substantive tests of payroll when:
A.
payroll is extensively audited by the state government.
B.
payroll expense is substantially higher than in the prior year.
C.
overpayments are discovered in performing tests of details.
D.
employees complain to management about too much overtime.
C.
overpayments are discovered in performing tests of details.
Substantive tests of payroll should be extended when overpayments are discovered in performing tests of details. Since the auditor has substantial doubts concerning the validity of payroll transactions, he should obtain additional audit evidence to remove this doubt. When payroll is extensively audited by the state government, the auditor may consider a higher acceptable level of detection risk (i.e., fewer substantive tests). The fact that payroll expense is substantially higher than in the prior year and that employees complain about too much overtime does not necessarily result in material misstatements of payroll expense.
In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the:
A.
completeness of recorded investment income.
B.
classification between current and noncurrent portfolios.
C.
valuation of marketable equity securities.
D.
existence of unrealized gains or losses in the portfolio.
A. completeness of recorded investment income.
Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts, as income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time.
Only using long-term investments to ascertain the reasonableness of investment income relates to an income statement account.
An auditor may decide to perform only substantive procedures for specific assertions because the auditor believes:
A.
control policies and procedures are unlikely to pertain to the assertions.
B.
the entity’s control environment, monitoring, and control activities are interrelated.
C.
sufficient audit evidence to support the assertions is likely to be available.
D.
more emphasis on tests of controls than substantive tests is warranted.
A. control policies and procedures are unlikely to pertain to the assertions.
In developing an audit approach and detailed procedures, auditors should assess inherent risk in relation to financial statement assertions, about material account balances and classes of transactions, taking account of factors relevant both to the entity as a whole and to the specific assertions.
In a case in which assertions pertain to policy or procedure, the auditor may choose to perform substantive tests and procedures.
In an environment that is highly automated, an auditor determines that it is not possible to reduce detection risk solely by substantive tests of transactions. Under these circumstances, the auditor most likely would:
A.
perform tests of controls to support a lower level of assessed control risk.
B.
increase the sample size to reduce sampling risk and detection risk.
C.
adjust the materiality level and consider the effect on inherent risk.
D.
apply analytical procedures and consider the effect on control risk.
A. perform tests of controls to support a lower level of assessed control risk.
“The auditor should design and perform tests of controls to obtain sufficient appropriate audit evidence about the operating effectiveness of relevant controls if…substantive procedures alone cannot provide sufficient appropriate audit evidence at the relevant assertion level.” (AU-C 330.08)
Increasing the sample size in the substantive procedure (when substantive tests are not appropriate for the assertion), adjusting the materiality level, or applying analytical procedures (which are also substantive procedures) would not assist with lowering the overall audit risk.
In testing for unrecorded retirements of equipment, an auditor most likely would:
A.
select items of equipment from the accounting records and then locate them during the plant tour.
B.
compare depreciation journal entries with similar prior-year entries in search of fully depreciated equipment.
C.
inspect items of equipment observed during the plant tour and then trace them to the equipment subsidiary ledger.
D.
scan the general journal for unusual equipment additions and excessive debits to repairs and maintenance expense.
A.
select items of equipment from the accounting records and then locate them during the plant tour.
By selecting items of equipment from the accounting records and then locating them during the plant tour, unrecorded retirements are detected. This is an example of a “downstream” test, beginning with the entity’s books and agreeing them to supporting evidence. An “upstream test” (observing equipment and tracing it to the equipment subsidiary ledger) would detect unrecorded assets. Analytical procedures, such as reviewing depreciation journal entries, unusual equipment additions, and excessive debits to repairs and maintenance expense, are indirect methods that do not necessarily detect unrecorded retirements of equipment.
Which of the following statements concerning material weaknesses and significant deficiencies is correct?
A.
An auditor should identify and communicate material weaknesses separately from significant deficiencies.
B.
All material weaknesses are significant deficiencies.
C.
An auditor should immediately report material weaknesses and significant deficiencies discovered during an audit.
D.
All significant deficiencies are material weaknesses.
B. All material weaknesses are significant deficiencies.
A deficiency exists when the design or operation of one or more of the internal control components does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis.
A material weakness is a deficiency, or a combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.
A significant deficiency is a deficiency in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.
All material weaknesses are significant deficiencies; they merit attention by those charged with governance due to their severity and their potential effect on the financial statements.
Determining if a significant deficiency is also a material weakness requires professional judgment.
An auditor is required to report material weaknesses and significant deficiencies to those charged with governance. “Although the auditor is required…to make the communications…no later than 60 days following the report release date, the communication is best made by the report release date because receipt of such communication may be an important factor in enabling those charged with governance to discharge their oversight responsibilities” (AU-C 265.A16). If communication is vital due to the relative significance of the issues and the urgency for corrective follow-up action, the auditor can communicate the matters during the audit. They do not need to be communicated in writing during the audit, but significant deficiencies and material weaknesses should ultimately be included in a written communication even if they were remediated during the audit (AU-C 265.A17).
The two types of deficiencies do not have to be reported separately.
An auditor usually tests the reasonableness of dividend income from investments in publicly held companies by computing the amounts that should have been received by referring to:
A.
dividend record books produced by investment advisory services.
B.
stock indentures published by corporate transfer agents.
C.
stock ledgers maintained by independent registrars.
D.
annual audited financial statements issued by the investee companies.
A. dividend record books produced by investment advisory services.
If the entity has multiple investments in publicly held companies, they have usually invested through a broker or other investment service. The investment service could easily confirm dividends paid to the entity.
Stock ledgers published by transfer agents would not have dividend information on file, only the record of stockholders’ names and outstanding and issued shares of stock.
An indenture is a formal contract between an issuer and the holder and would not have dividend information.
Annual audited financial statements would not provide dividend information on individual investments.
What is the most likely source of the following statement?
“Although we have not conducted a comprehensive, detailed search of our records, no other deposit or loan accounts have come to our attention except as noted below.”
A.
Management representation letter
B.
Standard financial institution confirmation request
C.
Auditor’s communication with the audit committee
D.
Auditor’s report
B.
Standard financial institution confirmation request
A standard financial institution confirmation request would contain a statement addressed to the auditor concerning the results of a search for the existence of deposit or loan accounts.
In evaluating the reasonableness of an accounting estimate, an auditor most likely would concentrate on key factors and assumptions that are:
A.
consistent with prior periods.
B.
similar to industry guidelines.
C.
objective and not susceptible to bias.
D.
deviations from historical patterns.
D.
deviations from historical patterns.
In evaluating the reasonableness of an accounting estimate, the auditor focuses on the key factors and assumptions that are deviations from historical patterns. Also of concern to the auditor are key factors and assumptions that are significant, sensitive to variations, and subjective and susceptible to misstatement and bias. Estimates are more likely to be reasonable if they are consistent with prior periods, similar to industry guidelines, and objective and not susceptible to bias.
In addition to evaluating the frequency of deviations in tests of controls, an auditor should also consider certain qualitative aspects of the deviations. The auditor most likely would give broader consideration to the implications of a deviation if it were:
A.
the only deviation discovered in the sample.
B.
identical to a deviation discovered during the prior year’s audit.
C.
caused by an employee’s misunderstanding of instructions.
D.
initially concealed by a forged document.
D. initially concealed by a forged document.
In addition to the evaluation of the frequency and amounts of monetary misstatements, consideration should be given to the qualitative aspects of errors. These include the nature and cause of misstatements, such as whether there are differences in principles or in application, whether there are errors or fraud, or whether the misstatements are due to misunderstanding of instructions or to carelessness. If the deviation is the only one discovered in the sample, less consideration would be given concerning its implication. If a deviation seems to be part of a pattern, more consideration may be given. However, a single deviation that is simply identical to a single deviation discovered during the prior year’s audit may be very easily explained. An error caused by an employee’s misunderstanding would not cause broader consideration to be given. A deviation initially concealed by a forged document would cause the most alarm with an auditor and, consequently, would broaden the consideration given to the implications of such a deviation.
When control risk is assessed as low for assertions related to payroll, substantive tests of payroll balances most likely would be limited to applying analytical procedures and:
A.
observing the distribution of paychecks.
B.
footing and crossfooting the payroll register.
C.
inspecting payroll tax returns.
D.
reviewing payroll accruals for reasonableness.
D.
reviewing payroll accruals for reasonableness.
in assertions related to payroll, if accounting controls are satisfactory, substantive tests of payroll balances may be limited to applying analytical procedures and testing some transaction details for payroll, such as recalculating payroll accruals to verify that the amounts used in the analytical procedures have reasonable assurance of validity. When control risk is assessed as low, it means the accounting controls have been evaluated as satisfactory and operating as described.
Which of the following would not be considered an analytical procedure?
A.
Estimating payroll expense by multiplying the number of employees by the average hourly wage rate and the total hours worked
B.
Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics
C.
Computing accounts receivable turnover by dividing credit sales by the average net receivables
D.
Developing the expected current-year sales based on the sales trend of the prior five years
B.
Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics
Analytical procedures evaluate significant ratios, operating statistics, and trends in financial data. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristic is a use of tests of details, not analytical procedures.
Which of the following procedures should an auditor generally perform regarding subsequent events?
A.
Compare the latest available interim financial statements with the financial statements being audited
B.
Send second requests to the client’s customers who failed to respond to initial accounts receivable confirmation requests
C.
Communicate material weaknesses in the internal control to the client’s audit committee
D.
Review the cutoff bank statements for several months after the year-end
A. Compare the latest available interim financial statements with the financial statements being audited
AU-C 560.03 states that AU-C 560 addresses “auditor’s responsibilities relating to subsequent events occurring between the date of the financial statements and the date of the auditor’s report that require adjustment of, or disclosure in, the financial statements. It also addresses the auditor’s responsibilities relating to subsequently discovered facts that become known to the auditor after the date of the auditor’s report.”
As part of the audit procedures regarding subsequent events, AU-C 560.10 notes that the auditor should read and compare the latest available interim financial statements with the financial statements being audited.
The other three answer choices do not test the period after year-end.
Which of the following would be considered an analytical procedure?
A.
Testing purchasing, shipping, and receiving cutoff activities
B.
Comparing inventory balances to recent sales activities
C.
Projecting the deviation rate of a statistical sample to the population
D.
Reconciling physical counts to perpetual records and general ledger balances
B. Comparing inventory balances to recent sales activities
Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data. A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Analytical procedures involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor.
Examples of sources of information for developing expectations include:
comparable information for prior periods,
anticipated results (e.g., budgets or forecasts including extrapolations from interim or annual data),
relationships among elements of financial information within the period,
similar industry information (e.g., gross margin information), and
relationships of financial information with relevant nonfinancial information.
Testing purchasing, shipping, and receiving cutoff activities; projecting the deviation rate of a statistical sample to the population; and reconciling physical counts to perpetual records and general ledger balances are not examples of analytical procedures because they do not involve comparisons of recorded amounts to expectations developed by the auditor.
What type of analytical procedure would an auditor most likely use in developing relationships among balance sheet accounts when reviewing the financial statements of a nonpublic entity (nonissuer)?
A.
Trend analysis
B.
Regression analysis
C.
Ratio analysis
D.
Risk analysis
C.
Ratio analysis
By definition, a ratio is the relationship between two or more things. Therefore, the analysis to develop relationships among balance sheet accounts would be ratio analysis.
In confirming a client’s accounts receivable in prior years, an auditor discovered many differences between recorded account balances and confirmation replies. These differences were resolved and were not misstatements. In defining the sampling unit for the current year’s audit, the auditor most likely would choose:
A.
customers with credit balances.
B.
small account balances.
C.
individual overdue balances.
D.
individual invoices.
D.
individual invoices.
An attribute must be carefully defined before an auditor begins attribute sampling execution. Defining an attribute is difficult and is a matter of professional judgment. In the prior years the auditor chose the attribute of accounts receivable balances and discovered many differences between recorded account balances and confirmation replies. These differences were resolved and were not misstatements; the auditor’s professional judgment indicates that a different attribute, such as individual invoices, rather than accounts receivable balances, should be chosen to avoid the resolved differences experienced in the prior years’ audits.
To support financial statement assertions, an auditor develops specific audit objectives. The auditor then designs substantive tests to satisfy or accomplish each objective. Which of the following audit procedures would primarily respond to the audit objective for accounts receivable that accounts receivable are properly described and presented in the financial statements?
A.
Analyze the relationship of accounts receivable and sales and compare it with relationships for preceding periods.
B.
Review the aged trial balance for significant past due accounts.
C.
Review loan agreements for indications of whether accounts receivable have been factored or pledged.
D.
Review the accounts receivable trial balance for amounts due from officers and employees.
D.
Review the accounts receivable trial balance for amounts due from officers and employees.
The audit procedure, “Review the accounts receivable trial balance for amounts due from officers and employees,” is used to satisfy the audit objective that accounts receivable are properly described and presented in the financial statements (which supports the assertion about presentation) because it provides evidence about transactions with related parties, which must be separately disclosed.
When an auditor tests the internal controls of a computerized accounting system, which of the following is true of the test data approach?
A.
Test data is coded to a dummy subsidiary so they can be extracted from the system under actual operating conditions.
B.
Test data programs need not be tailor-made by the auditor for each client’s computer applications.
C.
Test data programs usually consist of all possible valid and invalid conditions regarding compliance with internal controls.
D.
Test data is processed with the client’s computer and the results are compared with the auditor’s predetermined results.
D. Test data is processed with the client’s computer and the results are compared with the auditor’s predetermined results.
The test data approach (sometimes called the test deck approach) is a way to audit “through the computer.” Test data is introduced into the client’s computer system using the same program to operate the application being tested. The output is compared to the auditor’s predetermined results. The test data approach does not involve a separate program.
An integrated test facility introduces a fictitious entity (such as a dummy subsidiary) with real entries in the master files of the client’s computer system. The auditor then compares the processing of data through the fictitious entity with what should be there in order to test that the data processing is reliable. Like the test data (or test deck) approach, an integrated test facility uses the client’s system.
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 board 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
D.
The lawyer and the auditor
Legal counsel’s response may be limited to matters that are considered individually or collectively material to the financial statements, provided the entity and auditor have reached an understanding on the meaning and limits of materiality for purposes of this letter and management has communicated such understanding to the legal counsel.
In performing a count of negotiable securities, an auditor records the details of the count on a security count worksheet. What other information is usually included on this worksheet?
A.
An acknowledgment by a client representative that the securities were returned intact
B.
An analysis of realized gains and losses from the sale of securities during the year
C.
An evaluation of the client’s internal control concerning physical access to the securities
D.
A description of the client’s procedures that prevent the negotiation of securities by just one person
A.
An acknowledgment by a client representative that the securities were returned intact
When performing a count of negotiable securities, an auditor records information to support management’s assertion regarding their value. In addition, the auditor uses a client representative to support that the securities were returned intact by the auditor.
