Chapter 12 -- Evidence -- The Purchases, Inventory, Payroll, and Other Cycles Flashcards
Section 12.1: Substantive Testing of Accounts Payable and Purchases
When should an auditor do to confirm accounts payable?
- Documentary evidence is lacking
- Individual creditors have relatively large balances
- The client has made a major purchase from the creditor regardless of the size of the balance
- Unusual transactions are involved
- The account is secured
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is the primary audit procedure to determine whether accounts payable is measured properly?
Vouching accounts payable to supporting documentation
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is one way for an auditor to determine whether all merchandise for which the client was billed was received?
Review the vendor invoices and trace these them to the related receiving reports to confirm:
* Items purchased
* The amounts due
* The payment terms
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is the auditor’s primary concern regarding procurement of liabilities?
- That accounts payable are not materially understated on the balance sheet
- The auditor should guard against management’s tendency both to inflate earnings and to exaggerate the financial strength of the firm through understatement of liabilities and expenses or overstatement of assets and revenues.
- The auditor’s primary focus will be on the completeness assertion
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is most important for an auditor who is auditing a public warehouse?
- Inspection of receiving and issuing procedures in order to disclose for unrecorded liabilities
- Shipping orders and receiving reports that are not reflected in the records suggest that transactions are not being properly recorded.
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is the best procedure for an auditor to test whether any checks have been issued without vouchers, purchase orders, and receiving reports?
- Trace cancelled checks to the related supporting documentation
- The checks should not have been written before the dates on the receiving reports.
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What documentation does the auditor use to verify that the recieved merchandise has been recorded?
The auditor should review the receiving report since an accounts payable record should be included in the report.
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is the appropriate population that an auditor should use when sending accounts payable confirmations?
The auditor should send confirmations to the vendors that have done previous business with the entity, regardless if there is a balance due.
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What steps should an auditor do when testing for unrecorded liabilities?
- Examining cash disbursements made after the balance sheet date and comparing them with the accounts payable trial balance
- Sending confirmations to vendors with small and zero balances
- Reconciling payable balances with vendors’ documentation
- Vouch a sample of cash disbursements recorded just after year end to receiving reports and vendor invoices
- Trace subsequent payments to recorded payables is a primary procedure to match payments (checks issued) after year end with the related payables
Section 12.1: Substantive Testing of Accounts Payable and Purchases
What is the purpose of an auditor reviewing the renewal of a note payable shortly after the balance sheet date?
- To test for the classification assertion
- The auditor should determine that the renewal had essentially the same terms and conditions as the recorded debt at year end
- A significant change may affect the classification of notes payable (e.g., as current or noncurrent).
Section 12.1: Substantive Testing of Accounts Payable and Purchases
Why are audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable?
Because accrued liabilities usually pertain to services that were paid for in the current year, but continue to the next reporting year, where as accounts payable report completed transactions.
Section 12.2: Substantive Testing of Inventory
What is the auditor most interested in examining when verifying debits to perpetual inventory records?
Vendor invoices to confirm:
* The items purchased
* The amount due
* The payment terms
* Document inventory cost when compared with purchase orders and receiving reports
Section 12.2: Substantive Testing of Inventory
What does an auditor test for the presentation assertion of inventory?
- Aggregation or disaggregation of balances
- Clarity of their descriptions
- Relevance and understandability of financial statement disclosures to test the presentation assertion.
- Confirmation of pledged inventory
- Inquire of management about consigned goods
- Inquire of management about major purchase commitments
- Inquire of management about pledging of inventory
- Inquire of management about other significant transactions or events.
Section 12.2: Substantive Testing of Inventory
How can an auditor determine if there isn’t a distinction between consigned goods and regular sales?
If there are large debits to accounts receivables and small periodic credits.
Section 12.2: Substantive Testing of Inventory
What is included in the safeguarding of inventory?
Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical count.
Section 12.2: Substantive Testing of Inventory
How does the auditor verify the accuracy, valuation and allocation assertion for inventory?
Make inquiries of production and sales personnel regarding obsolete and slow-moving inventory
Section 12.2: Substantive Testing of Inventory
How does the auditor verify the completeness assertion for inventory?
- Tracing a sample of tags to the physical inventory listing to ensure that the tagged items are included in the listing
- Tracing the details of test counts to the final inventory schedule
Section 12.2: Substantive Testing of Inventory
What is the process if statistical sampling methods are used instead of taking physical inventory?
- The auditor should become satisfied by performing alternative audit procedures.
- Attending a year-end inventory count is obviously impractical when the entity measures its inventory using statistical methods.
- The auditor is required to attend and observe at least some counts and should evaluate whether the methods applied and results are appropriate.
Section 12.2: Substantive Testing of Inventory
How does the auditor verify the existence assertion for inventory?
- Send confirmations to vendors
- Tracing from the schedule to the inventory tags and ultimately to the auditor’s count sheet.
- Items listed in the inventory listing schedule to inventory tags and the auditor’s recorded count sheets.
Section 12.2: Substantive Testing of Inventory
What is the most reliable procedure for an auditor to use to test the existence of a client’s inventory at an outside location?
- Observing physical counts (This is the most reliable as it provide direct personal knowledge)
- Confirming inventories at outside locations
- Testing transactions between a preliminary physical inventory date and the balance sheet date.
Section 12.2: Substantive Testing of Inventory
What is the most appropriate for testing the completeness assertion for inventory?
- Performing cutoff procedures for shipping and receiving
- The terms, FOB shipping point versus FOB destination, should be evaluated to assure that the goods were recorded in the proper period.
Section 12.2: Substantive Testing of Inventory
What areas should an auditor consider when testing the completeness assertion at the end of the year?
- Vertical Analysis
- Non-financial information (i.e. volume of goods)
- The inventory turnover ratio
Section 12.3: Substantive Testing of Property, Plant, and Equipment
What is the most convincing evidence an auditor can obtain in verifying the amount of goodwill?
Fair values received from independent appraisals
Section 12.3: Substantive Testing of Property, Plant, and Equipment
How does an auditor test for the existence assertion for PPE?
Select equipment recorded in the accounting records and locate them on the floor.
Section 12.3: Substantive Testing of Property, Plant, and Equipment
How does an auditor test for the completeness assertion for PPE?
Trace the serial numbers on equipment to a nonissuer’s sub-ledger.
Section 12.3: Substantive Testing of Property, Plant, and Equipment
How does an auditor test for the Allocation, valuation and accuracy assertion for PPE?
- Particular components of the financial statements are included at appropriate amounts
- Allocation adjustments are appropriately recorded
- Disclosures are appropriately measured and described.
Section 12.3: Substantive Testing of Property, Plant, and Equipment
What does an auditor do when few property and equipment transactions occur during the year?
- Perform extensive tests of current year property and equipment transactions
- The auditor also may not rely on controls after obtaining an understanding of internal control
Section 12.3: Substantive Testing of Property, Plant, and Equipment
What ways can an auditor learn of retirements of equipment?
- Review of depreciation
- Analysis of debits to the accumulated depreciation account
- Review if insurancy policy riders
Section 12.3: Substantive Testing of Property, Plant, and Equipment
Why does an auditor analyzes repairs and maintenance accounts?
To obtain evidence that expenditures for property and equipment that should be capitalized are not charged to expense.
Section 12.3: Substantive Testing of Property, Plant, and Equipment
What situations would cause debits to the accumulated depreciation account?
- Equipment that was sold or disposed of
- The life of an asset has been lengthened
Section 12.3: Substantive Testing of Property, Plant, and Equipment
How does an auditor test for the presentaion assertion of equipment when it is classified as a finance lease?
The auditor will evaluate the propriety of the interest rate used in discounting the future lease payments.
Section 12.4: Substantive Testing of Investments
What provides the best form of audit evidence pertaining to the annual measurement of the investment when an investor did not select the fair value option?
The audited financial statements of the investee
Section 12.4: Substantive Testing of Investments
What should an auditor do when an entity holds an asset of another entity as security for an outstanding debt?
- The auditor should examine the collateral and estimate its fair value to determine the reasonableness of the arrangement.
- The auditor may refer to published data such as current market quotations to determine the value of securities.
Section 12.4: Substantive Testing of Investments
How does an auditor test for existence and rights and obligations assertions for publicly traded stock?
- Inspection
- External confirmation by the issuer, custodian, or counterparty;
- External confirmation of unsettled transactions by the broker-dealer
- Reading partnership or similar agreements.
- Brokers, banks, agents, or others holding securities for the client should be requested by the client to respond directly in writing to the auditor’s confirmation requests.
Section 12.4: Substantive Testing of Investments
How does an auditor test for the completeness assertion for investments?
Using analytical procedures to estimate the total investment income.
Section 12.4: Substantive Testing of Investments
What procedures would an auditor perform on an audit of a prepaid insurance account?
The prepayments are:
* Properly valued according to the applicable reporting framework
* Apply to future periods
* Are expected to be realized (to provide future benefits)
* Are accurately classified.
Section 12.4: Substantive Testing of Investments
When an auditor is performing analytical procedures on an equity method investment, what would cause the expected return on an equity method investment to be lower?
- An error in recording amortization of the excess of the investor’s cost over the investment’s underlying carrying amount.
- The transaction to record the amortization is a recurring entry that, if miscalculated, could result in a lower return than expected
Section 12.4: Substantive Testing of Investments
In a manufacturing company, how does an auditor test for the existence assertion?
- Confirm with the broker-dealer
- Inspect and count stocks and bonds
- Vouching all changes during the year to the broker-dealer’s advices and statements
Section 12.5: Substantive Testing of Noncurrent Debt
What steps does an auditor perform when auditing non-current debt?
- Analyze the interest expense recorded for th period with the outstanding debt
- The auditor verifies the amount of outstanding liabilities
- If interest expense is excessive in relation to noncurrent debt, unrecorded interest-bearing obligations may be outstanding
Section 12.5: Substantive Testing of Noncurrent Debt
What steps does an auditor perform when auditing notes payable?
- Multiply the average outstanding loan balance by the interest rate and Compare the result to the interest expense recorded
- The debt-to-equity ratio, which equals total liabilities divided by total equity, also can be calculated and compared with previous periods
Section 12.5: Substantive Testing of Noncurrent Debt
What is the bond trustee?
- The bond trustee is an outside, independent agent responsible for maintaining subsidiary ledgers and paying dividends
- They often keeps the sinking-fund accounts
- The auditor should verify bond sinking-fund transactions with this trustee
Section 12.5: Substantive Testing of Noncurrent Debt
What should an auditor do when auditing a current issue of bonds payable?
The auditor therefore should determine that the client has obtained the opinion of a lawyer on the legality of the bond issue, which includes:
* Determine that all noncurrent debt has been recorded and constitutes bona fide liabilities
* Verify that federal and state laws relevant to financial reporting have been complied with
* Determine that premium, discount, interest payable, and interest expense are accurately recorded
* Monitor compliance with debt contracts
* Review proper presentation and disclosure in the financial statements.
Section 12.6: Substantive Testing of Equity
What date is the auditor concerned with for establishing that dividends are paid to client corporation shareholders who hold stock?
The record date
Section 12.6: Substantive Testing of Equity
What is an auditor’s primary concern when examining the shareholders’ equity section of a client’s balance sheet?
- That all capital stock transactions are properly authorized
- All entries in the capital stock account should be traced to the minutes of the board of directors’ meetings
- The articles of incorporation, by-laws, and minutes of shareholders’ meetings should also be reviewed
Section 12.6: Substantive Testing of Equity
What is included in an audit of owners’ equity?
- Determining that dividend declarations have been in compliance with debt agreements
- Tracing the authorization of the dividend from the directors’ minutes
- Determining that the declared dividend amount was closed into retained earnings
Section 12.6: Substantive Testing of Equity
How does an auditor test for the existence assertion for treasury stock?
Auditors can inspect their clients’ stock certificates to ensure that all recorded treasury stock actually exists and is in the possession of the company
Section 12.6: Substantive Testing of Equity
How does an auditor test for the valuation assertion for treasury stock?
- The auditor should test closing entries to determine whether net income has been closed to retained earnings
- This assures that net income was properly closed to retained earnings will help an auditor determine whether retained earnings is valued correctly
Section 12.7: Substantive Testing of Payroll
In testing for the completness and cut-off assertions when the RMM is assessed as low, what substantive tests of payroll balances would an auditor most likely perform?
- Apply analytical procedures
- Recalculate payroll accruals
- Compare payroll costs with entity standards or budgets
Section 12.7: Substantive Testing of Payroll
How does an auditor test for the existence assertion for costs and expenses?
- Compare the current year’s expense with that of the prior year’s is an analytical procedure
- The objective of analytical procedures is to identify such things as the existence of unusual transactions and events, and amounts, ratios, and trends that might indicate matters that have financial statement and audit planning ramifications
Section 12.7: Substantive Testing of Payroll
When would an auditor most likely would perform substantive tests of details on payroll transactions and balances?
- When analytical procedures indicate unusual fluctuations in recurring payroll entries
- An auditor should first inquire of management about the fluctuations.
- If management does not give a valid reason, then the auditor performs additional procedures to investigate the differences are necessary
Section 12.7: Substantive Testing of Payroll
What steps does an auditor perform to check the accuracy of hours worked?
- Compare clock cards with shop job time tickets
- The job tickets, which contain the total hours worked on each job, should not vary significantly from the employee time cards used to compute payroll
Section 12.7: Substantive Testing of Payroll
Why would auditor should consider observing a client’s distribution of regular payroll checks?
- Separation of payroll duties is not effective enough to reduce control risk
- The observation should establish whether payment is made only to bona fide employees
Section 12.7: Substantive Testing of Payroll
What procedures in an audit most effectively tests that benefit payments to plan participants are paid in accordance with a nonissuer’s defined benefit pension plan plan document?
- Recalculating benefits for selected participants based on the plan provisions using relevant service and salary history to support the recorded benefits paid to the participants
- Inquiries of management about pension benefit agreements
- Comparison of general ledger and financial statement balances
- Recalculation of pension costs
