Chapter 13 - Substantive Procedures Flashcards
1
Q
In my SOFP what are my assertions that I will use for substantive test?
A
CCPERV
Completeness
Classification
Presentation
Existence
Rights and obligations
Valuation
2
Q
What are examples of tangible non-current assets?
A
Land, buildings, plant, vehicles, fittings, and equipment.
3
Q
What assertion is at risk if a company does not actually own an asset?
How can I check this?
A
Rights and obligations.
Sample from Asset register to ownership documents ie title deeds
4
Q
Which assertion is related to assets that do not exist or have been sold?
How do we test for this?
A
Existence.
We take the NCA register then go look for the NCA. We don’t look for assets then tick it off the list as we are are testing to see if it exists going the other way test completeness.
Sample from asset register to physical asset
5
Q
What is a potential misstatement risk for assets omitted from financial records?
How can I check for this?
A
Completeness.
We find the assets then tick it off the NCA register, we want to ensure the register is
Sample of physical asset to asset register complete.
6
Q
How could assets be misstated in terms of valuation?
How can I check for this?
A
By under or overvaluing them, due to incorrect revaluation policies or inappropriate depreciation charges.
Sample from asset register to purchase invoice, enquire about any further costs incurred in purchase of asset
7
Q
What is the assertion we are testing for when looking at if an assets has been incorrectly presented in the financial statements?
A
Presentation and disclosure.
Review F/S ensure minimum disclosures meet (IAS16) ie Depreciation rates
8
Q
What are some sources of information for verifying tangible non-current assets?
A
What are some sources of information for verifying tangible non-current assets?
A: Non-current asset register, purchase (additions) and sales invoices (disposals), registration documents (rights+obligations), third-party valuations, physical inspection, and depreciation records (valuation).
9
Q
What are examples of intangible non-current assets?
A
Licences, development costs, and purchased brands.
10
Q
What assertion is at risk if expenses are capitalised as non-current assets inappropriately?
A
Existence.
11
Q
What are some ways intangible assets might be misstated in valuation?
A
By inflating costs, not amortising appropriately, or not conducting impairment reviews.
12
Q
What sources of information are used to verify intangible non-current assets?
A
Accounting standards, purchase invoices (purchased intangibles), client calculations and schedules (R&D), and specialist valuations.
13
Q
When can we capitalised on R&D?
A
R&D = Research and development
Do not capitalise until we can market it then it becomes a NCA
14
Q
Which three of the following might an auditor vouch when testing the rights and obligations of a company in respect of a vehicle?
A A purchase invoice
B A registration document
C A hire-purchase agreement
D An asset register
A
A A purchase invoice
B A registration document
C A hire-purchase agreement
15
Q
What is the journal entry for inventory?
A
DR Closing Inventory
CR COS
16
Q
What assertion is at risk when inventory that does not exist is included in the financial statements?
A
Existence.
17
Q
What assertion is at risk when not all inventory that exists is included in the financial statements?
A
Completeness.
18
Q
When inventory is included in the financial statements at full value despite being obsolete or damaged, what assertion is at risk?
A
Valuation.
19
Q
What assertion is at risk when inventory is included at the wrong value due to cost miscalculation or low net realisable value?
A
Valuation.
20
Q
What assertion is at risk if inventory that belongs to third parties is included in the financial statements?
A
Rights and obligations.
21
Q
If inventory that has been sold is still included in the financial statements, which assertions are at risk?
A
Cut-off and rights and obligations.
22
Q
Name three key sources of evidence used for inventory assurance.
A
The company’s controls over inventory counting.
The auditors’ attendance at the annual inventory count.
Confirmations with third parties holding inventory on behalf of the entity.
23
Q
What records might auditors examine for work-in-progress inventory?
A
Work-in-progress records for inventory.
24
Q
Why might auditors review post-year-end sales orders?
A
To confirm inventory valuation and cut-off.
25
What is the purpose of attending an inventory count?
To confirm the existence of inventory by observing controls during the company’s annual count.
26
What three aspects are critical for inventory count observation?
Organisation of the count, counting process, and recording of inventory.
27
What role do senior staff play in inventory count organisation?
They supervise the count, including senior staff not normally involved in inventory.
28
How is damaged or slow-moving inventory identified during a count?
Through specific observation for damaged, obsolete, third-party, or returnable inventory.
29
What is a systematic counting process?
Ensuring all inventory is counted with teams of two counters for independent verification
30
Why are two counters often used during inventory counts?
To improve accuracy and ensure independent verification.
31
Why is serial numbering of inventory sheets important?
To ensure control and return of all sheets, preventing loss or error.
32
What should inventory sheets be completed in, and why?
Ink, to ensure permanent records.
33
What is the purpose of reconciling inventory records with physical counts?
To identify and correct any discrepancies.
34
What stages of inventory production should be recorded during a count?
Quantity, condition, and stage of production for work-in-progress.
35
List 4 examples of when NRV is likely to be less than cost.
1. Item is obsolete
2. Item is damaged = should be recorded at recoverable amount
3. Item has a lot of competitors
4. Making a loss on trying to get it ready to sell
5. Operating as a loss leader = sell certain products at a loss on the assumption people will buy other items
6. Recession
36
If we are looking to test existence of inventory where do I look?
Sheet to floor
Existence test, looking for overstatement
Attend the inventory count
Inspect a sample of items from the inventory sheets and trace to the physical item
37
If we are looking to test completeness of inventory where do I look?
Floor to sheet
Completeness test, looking for understatement
Sample physical inventory and trace to the inventory count sheets
38
Which one of the following procedures should be undertaken to confirm the existence of inventory?
A Attendance at inventory count
B Follow up of inventory count sheets to final inventory sheets
C Trace items of inventory to purchase invoices
D Cast the final inventory sheets
A Attendance at inventory count
39
If we are looking to test rights and obligations for inventory what should I do? (2)
Enquire about consignment stock and inspect 3rd party confirmations
Inspect purchase invoices for ownership
40
If we are looking to test valuation for inventory what should I do? (2)
Valuation
Inspect purchase invoices for costs
Where client has WIP inspect labour, overheads and material costs
41
What is the journal entry for TR?
DR TR
CR Sales/Income
or
CR TR
DR Irrecoverable debt exp
42
What are the major risks of misstatement in receivables?
1. Debts being uncollectable (Valuation).
2. Debts being contested by customers (Existence, Rights, and Obligations).
43
How can I test for completeness in my trade receivables? (3)
3rd party confirmation of a sample of nil balances
Analytical procedures
GDN dates prior to y/e
44
How can I test for existence in my trade receivables? (3)
3rd party confirmation of a sample of old balances
Analytical procedures
Payments received post y/e
45
How can I test for rights and obligations in my trade receivables? (2)
3rd party confirmation – confirms balance is owed (but not that it will be paid!)
Inspect a sample of sales invoices
46
How can I test for valuation in my trade receivables? (2)
Recalculate TR schedule to see if casts and balance agrees to F/S
Inspect all confirmations for discrepancies
47
What are the key sources of audit evidence for receivables? (3)
Which is the best/most persuasive method?
Receivables ledger information.
Confirmations from customers. = BEST
Cash payments received after the year-end.
48
What is the purpose of customer confirmations? (2)
To provide relevant and reliable audit evidence that:
Customers exist.
Customers owe bona fide amounts to the company (Existence, Rights, and Obligations).
49
What are the two types of confirmation methods? (2)
Positive confirmation: Customers are requested to give the balance or confirm the valuation of the balance shown.
Negative confirmation: Customers reply only if they disagree with the balance.
50
Why is positive confirmation considered more reliable than negative confirmation? (2)
Lack of response in negative confirmation may indicate:
The customer did not receive the request.
The customer ignored the request.
51
When should negative confirmation be used? (5)
Assessed risk of material misstatement is low.
Relevant controls are operating effectively.
A large number of small balances is involved.
Errors are not expected.
No reason to believe customers will disregard the request.
52
Which classes of accounts require special attention for confirmations?
Material, risky accounts. = NEW CUSTOMER/CUSTOMER IN DIFFICULTY
Old unpaid accounts. = AGED DRS/AGED RECEIVABLES
Accounts written off during the period.
Accounts with credit balances. = RETURNS, THE BALANCE IS NOW TP
Accounts settled by round sum payments.
Accounts with nil balances. = ANY ERROR
53
What alternative procedures can verify existence/rights and obligations?
Check receipt of cash after the date.
Examine the account to validate specific invoices.
Test controls over credit notes and bad debt write-offs.
54
How are bad debts tested for valuation?
Review cash received after the date to assess the collectability of debts.
55
Assurance providers will have to carry out further work in relation to those receivables who: (2)
Disagree with the balance stated (positive and negative confirmation)
Do not respond (positive confirmation only)
56
What is the treatment for differences arising from invoices or cash in transit?
Normal timing differences (e.g., invoices or cash in transit) generally do not require adjustment.
Disputed amounts or errors by the client may indicate that further substantive work is necessary to determine whether material adjustments are required.
57
Which one of the following procedures should be undertaken to confirm the rights and obligations of TR?
A Review of cash received after date
B Tests of controls over ordering
C Receivables external confirmation
D Recalculation of specific allowance for doubtful debts
C Receivables external confirmation
58
What are the risks of misstatement related to bank balances in financial statements? (3) What are the assertions? (3)
Not all bank balances owned by the client being disclosed.
Assertion: Rights and obligations/completeness
Reconciliation differences between bank balance and cash book balance being misstated.
Assertion: Valuation
Material cash floats being omitted or misstated.
Assertion: Completeness/existence
59
What assertion does this relate to - Not all bank balances owned by the client being disclosed.
Assertion: Rights and obligations/completeness
60
What assertion does this relate to - Reconciliation differences between bank balance and cash book balance being misstated.
Assertion: Valuation
61
What assertion does this relate to - Material cash floats being omitted or misstated.
Assertion: Completeness/existence
62
What are the objectives of tests on bank balances? (4)
To prove assertions about the bank balances:
Completeness
Existence
Rights and obligations
Valuation
63
What are the key sources of information used to test bank balances? (4)
Cash book
Confirmation from the bank
Bank statements
Bank reconciliation carried out by the client
64
What is direct confirmation with a bank, and what does it test?
Direct confirmation tests:
Completeness
Existence
Rights and obligations
Valuation
It involves obtaining third-party confirmations from the client’s bank and reconciling these with accounting records.
65
What are the procedural requirements for direct confirmation with banks? (4)
1. Banks require explicit written authority from the client to disclose the requested information.
2. The request must reference the client’s letter of authority and its date.
3. The request should reach the branch manager at least two weeks in advance of the client’s year-end.
4. The bank confirmation must be sent directly from the bank to the assurance provider.
66
What is the purpose of bank reconciliation in auditing?
To ensure there is no window dressing or manipulation of accounts to overstate liquidity.
67
What are examples of window dressing and how are they audited? 2
Keeping the cash book open to take credit for remittances received after the year-end:
Impact: Enhances cash balance and reduces receivables.
Audit: Examine paying-in slips to ensure amounts were actually paid into the bank on or before the balance sheet date.
Recording cheques paid during the review period that were not despatched until after year-end:
Impact: Decreases cash balance and reduces payables.
Audit: Check whether the cheques cleared within a reasonable time in the new period.
68
Why is it important to monitor remittances and cheque clearances during bank reconciliation?
To detect any misstatements or manipulations that artificially enhance the liquidity or financial position of the company.
69
What is an outstanding lodgement? (2)
Receipts with
- cash not been banked
- cash not been cleared
70
What is an unpresented cheque? (2)
- check sent but not yet banked by supplier
71
Which one of the following will be confirmed by obtaining a bank letter from a specific bank?
A That the bank balance stated on the bank reconciliation is correct.
B That the unpresented cheques listed on the bank reconciliation were sent out pre year-end.
C That the company possesses only the bank accounts it declares.
D That the cash floats of the company are fairly stated.
A That the bank balance stated on the bank reconciliation is correct.
72
What are the main risks of misstatement for trade payables? (3)
Understating liabilities in the financial statements (Completeness).
Incorrect cut-off between goods received and liability recording (Rights and obligations).
Declaring non-existent liabilities (rare) (Existence, rights, and obligations).
73
What assertion does this misstatement relate to - Understating liabilities in the financial statements
(Completeness).
74
What assertion does this misstatement relate to - Incorrect cut-off between goods received and liability recording
(Rights and obligations).
75
What assertion does this misstatement relate to - Declaring non-existent liabilities (rare)
(Existence, rights, and obligations).
76
What are the audit procedures for testing the Completeness assertion in trade payables? (3)
- Trace low, nil, and negative balances to supplier statements or confirmations.
- Perform analytical procedures.
- Inspect Goods Received Notes (GRN) around the year-end to confirm appropriate inclusion of invoices.
77
What are the audit procedures for testing the Existence assertion in trade payables? (1)
Inspect a sample of balances to supplier statements.
78
What are the audit procedures for testing the Rights and Obligations assertion in trade payables? (2)
Inspect purchase invoices that make up a sample of balances in the payables ledger.
Agree balances to third-party confirmation.
79
What are the key points for Valuation assertion testing in trade payables?
The same procedures as for completeness, existence, and rights/obligations may be used.
80
What are the main sources of evidence for payables testing?
Payables ledger records.
Confirmations from suppliers.
81
What is the most critical test when auditing trade payables?
Comparing supplier statements with the payables ledger balances to identify any understatements.
82
Why is it essential to test low, nil, or negative balances in trade payables?
Errors of understatement can occur equally in payables with low, nil, or negative balances as with high balances.
83
What should be considered when auditing other payables and accrued expenses?
Focus on understatement risks and try to obtain third-party evidence for the balances.
84
TRUE OR FALSE
Supplier statements are a strong source of evidence as they are third party evidence; however, as the assurance provider receives them through the medium of the client, the assurance provider must treat supplier statements with professional scepticism.
TRUE
Assurance providers must always behave with professional scepticism, not assuming that documents such as supplier statements have been tampered with, but bearing in mind that it is a possibility if indications arise supporting that suggestion.
85
TRUE OR FALSE
Payables may be tested by cash payments after date as these give an indication that debts were owed and the value of those debts has not been understated.
FALSE
Cash payments after date do not prove that the balance is not understated, as the client may control the payments it makes and conceal correspondence from suppliers requesting full payment.
Testing is not sufficient as I could say I owe x amount and pay x but I actually owe x+20. I can't verify the we need a supplier statement therefore false.
86
What are the primary risks of misstatement related to long-term liabilities? (3)
1. Not all long-term liabilities are disclosed.
2. Interest payable is not calculated correctly or included in the correct period.
3. Disclosure is incorrect.
87
How is completeness tested for long-term liabilities? (2) What is a risk of misstatement? (1)
Analytical procedures to prior year
Inspect board minutes
Not all long-term liabilities are disclosed.
88
How is existence tested for long-term liabilities? (1)
Obtain and inspect confirmation from banks to gain assurance of existence of NCL
89
How is rights and obligations tested for long-term liabilities? (1) What is a risk of misstatement? (1)
Rights and obligations
That interest payable has not been calculated correctly and included in the correct accounting period
90
How is valuation tested for long-term liabilities? (1)
Recalculate – agreeing B/fwd to prior year and movements to any 3rd party documentation
91
How is Presentation and disclosure tested for long-term liabilities? (2) What is a risk of misstatement? (1)
Inspect classification, Current Liability vs Long Term Liability
Appropriate written disclosures ie securities
That disclosure is incorrect
92
In my SOPL what are my assertions that I will use for substantive test?
CCCOAP
Completeness
Classification
Cut-off
Occurence
Accuracy
Presentation
Existence
Rights and obligations
Valuation
93
In my SOPL when reviewing revenue
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
REVENUE = SALES = INCOME
A. O/S
B. Analytical procedures, seasonal, yearly comparisons, enquiry if unusual
Analytical procedures, predictable relationships with other items in the financial statements, notably receivables,
C. Inspect sample of individual transactions to sales invoices to ensure existence
94
In my SOPL when reviewing purchases
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
PURCHASES = EXPENSES
A. U/S
B. Analytical procedures due to the strong relationships that purchases has with other items in financial statements, notably inventory and payables.
C. Inspect a sample of transactions, invoices, tracing them through the system to ensure completeness.
95
In my SOPL when reviewing payroll costs
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
A. U/S - TYPE OF EXP
B. Analytical procedures are often carried out on payroll costs as there are strong relationships between numbers of staff, pay rates and overall costs and also tax/NI rates and pay.
Inspect a sample of payroll records, ensuring that time worked has been correctly included (to clock- cards), employees exist (personnel records) and are being paid at the correct rate (contracts/personnel records)
Recalculate a sample of payroll employees to ensure correctly calculated
Inspect a sample of payments to the employees and tax authorities by verifying to bank statements.
C. ACCURACY
96
In my SOPL when reviewing interest paid
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
A. U/S EXP
B. Inspecting bank statements or confirmations from other lenders to ensure interest correctly paid or received
C. ACCURACY
97
In my SOPL when reviewing interest received
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
A. O/S INCOME
B. Inspecting bank statements or confirmations from other lenders to ensure interest correctly paid or received
C. ACCURACY
98
In my SOPL when reviewing expenses
a. what should I look out for over or under statement?
b. how should I test for this?
c. what assertion am I looking out for?
A. U/S EXP
B. Analytical procedures, by looking at year on year comparisons and enquiring if anything spotted is unusual
Inspect specific transactions to purchase invoices.
C. ACCURACY
99
Which one of the following assertions is the assurance provider least concerned with when testing a non-current asset balance?
A Existence
B Rights and obligations
C Completeness
D Cut-off
D Cut-off
Cut-off is a financial statement assertion that affects classes of transactions, not account balances.
100
Which two of the following constitute the best quality evidence concerning the net realisable value of inventory?
A Company’s controls over inventory counting
B Post year-end sales invoices
C Post year-end sales orders
D Post year-end sales price list
B Post year-end sales invoices
C Post year-end sales orders
Post year-end sales invoices and orders. The controls over counting relate to existence, not valuation. A post year-end sales price list gives evidence of management intention in relation to inventory, but not evidence of the price that customers are genuinely prepared to pay (in the way that invoices and orders do). SAMPLE EXAM
101
Which one of the following procedures is most appropriate to confirm the valuation of trade receivables?
A Review of the receivables ledger
B Direct confirmations with customers
C Review of cash paid after date
D Review of sales invoices
C Review of cash paid after date
Direct confirmations with customers are not appropriate for determining valuation as they only provide confirmation of the existence and rights and obligations of the year-end trade receivables balance, whereas the receivables ledger and sales invoices are part of the client’s own records and as such may not be as reliable as reviewing actual cash amounts received.
102
8 Which three of the following are reasons why the auditors might seek direct confirmation of balances due from suppliers?
A To obtain third-party evidence
B The auditors suspect that the client is deliberately understating payables
C The internal controls relating to purchases are weak
D Supplier statements are unavailable
8 Correct answer(s):
B The auditors suspect that the client is deliberately understating payables
C The internal controls relating to purchases are weak
D Supplier statements are unavailable
Although a payables circularisation does provide third-party evidence, it is unnecessary on those grounds alone, because supplier statements provide third-party evidence as well. Therefore, a payables circularisation will only be needed where there is some problem, such as those described in the final three options.
103
9 Which two of the following are reasons why sales are often verified by testing the internal controls in place over sales?
A There are usually too many individual transactions to test them individually.
B Sales constitute a high volume of similar transactions which are suitable for controls testing.
C Controls over sales in a company are often strong.
D Because there are so many individual transactions, there is a significant risk that sales are misstated.
B Sales constitute a high volume of similar transactions which are suitable for controls testing.
C Controls over sales in a company are often strong.
“Sales constitute a high volume of similar transactions which are suitable for controls testing” is correct – that sales constitute a high volume of similar transactions and are hence suitable to controls testing. Regarding “Controls over sales in a company are often strong”, where controls are expected to be strong, ISA (UK) 330 requires that the auditors test them so this is also correct. “There are usually too many individual transactions to test them individually” cannot be used as a reason for testing internal controls over sales. However many transactions there are, if controls appear to be deficient, then those transactions will need to be subjected to tests of detail. “Because there are so many individual transactions, there is a significant risk that sales are misstated” is incorrect as where there is a high risk of misstatement, substantive procedures should be used.
104
10 Which three of the following relationships/ratios are reasons why analytical procedures can give strong evidence in relation to the accuracy of purchases?
A Operating margin
B Purchases and payables
C Purchases and inventories
D Gross margin
B Purchases and payables
C Purchases and inventories
D Gross margin
Applying analytical procedures to the operating margin which contains the effect of all expenses, not just purchases, will not provide direct evidence as to the accuracy of purchases.
105
11 The results of substantive tests on trade payables at Fulham Ltd are set out below. The materiality threshold set for these tests was £17,000.
For each of the following results, select the action which should be taken by the audit senior.
Three goods inwards records dated before the year end relating to goods worth £16,000 were traced to purchase invoices which have been included in the subsequent year and not provided for this year.
A Draw conclusion
B Refer to senior colleague
C Extend sample
In a sample of 20 supplier statement reconciliations, statements were unavailable for 10 suppliers. Statements were available for seven of these 10 suppliers in the previous year.
D Draw conclusion
E Refer to senior colleague
F Extend sample
Correct answer(s):
C Extend sample
For the misstatement in cut-off, the sample should be extended to measure the full extent of the cut- off misstatement.
Correct answer(s):
E Refer to senior colleague
Missing supplier statements (which should make the auditor suspicious) should be referred to a senior colleague, so that this is investigated and alternative procedures designed if necessary.
106
12 The auditor of Barnett plc carried out an external confirmation of receivables at the year end to confirm the accuracy of total trade receivables in the statement of financial position at that date. Two of the replies to the confirmations disagreed with the balance.
For each of these two disagreements, select whether the disagreement would or would not be considered a misstatement for the purposes of evaluating the accuracy of total trade receivables in the statement of financial position at the year end.
Watford Ltd disagreed with the balance because they had made a payment two days before the year end. The auditor has confirmed that the cheque cleared the bank two days after the year end.
A Misstatement
B Not misstatement
Radlet Ltd disagreed with the balance because their records did not contain invoice number SI 00492. This invoice and associated goods were despatched by Barnett plc on the last day of the year. The auditor has verified that the despatch record and cut-off with inventory are correct.
C Misstatement
D Not misstatement
B Not misstatement
D Not misstatement
Both disagreements are due to timing differences and hence do not constitute misstatements in the accuracy of total trade receivables.
107
13 Hayley, an audit junior, has carried out the following tests to verify the valuation of inventory in the financial statements of Cobham plc.
In each case, select whether the test proves the assertion of valuation or not. Attending the inventory count and carrying out sample counts on a number of items
A Proves valuation
B Does not prove valuation
Comparing cost on a number of inventory items to sales invoices subsequent to the year end C Proves valuation
D Does not prove valuation
B Does not prove valuation
C Proves valuation
The first statement represents a test of control over inventory counting procedures and therefore the completeness or existence of the quantity of inventory. It is not a test of valuation. Checking inventory items against sales invoices tests for net realisable value (NRV) and hence valuation of the inventory.
108
14 Lisa has obtained a list of items which make up the cash and cash equivalents balance (£3,556) in the financial statements of Baker Ltd. Materiality has been set at £4,000.
For each item, select whether or not Lisa should test the item.
Current account balance (overdrawn) £5,600
A Test
B Not test
Petty cash float £750
C Test
D Not test
Special directors’ cash account £1,294
E Test
F Not test
Correct answer(s): A Test
The current account balance should be tested as it is over the materiality threshold. Correct answer(s):
D Not test
The petty cash float is not material and hence need not be tested.
Correct answer(s): E Test
SAMPLE EXAM
The special directors’ cash account should be tested whatever its monetary value. Strict materiality thresholds do not apply to directors’ emoluments which need to be disclosed whatever their amount. In any case the auditor needs to ascertain what this balance represents.
109
16 The auditor of Mondays Ltd is performing a test to ensure that there are no omissions from the non- current asset register.
In respect of which one of the following assertions will this procedure provide audit evidence?
A Cut-off
B Accuracy, valuation and allocation
C Completeness
D Existence
E Classification
C Completeness
Testing for omissions is the same as testing for completeness (ie, saying that nothing has been omitted from the register means the same as saying the register is complete).
110
17 Which two of the following procedures would provide evidence of rights and obligations of motor vehicles?
A Vouching a sample of motor vehicles in the asset register to registration documents
B Physical inspection of motor vehicles
C Review of purchase invoices for motor vehicles acquired in the period
D Confirmation that calculations on the non-current asset schedule are correct in respect of motor vehicles
A Vouching a sample of motor vehicles in the asset register to registration documents C Review of purchase invoices for motor vehicles acquired in the period
Physical inspection and confirmation of calculations provide evidence of existence and valuation respectively as opposed to rights and obligations.
The rights and obligations assertion means that the entity holds or controls the rights to assets. Although registration documents show registered keeper, not owner, the keeper is likely to have control of the asset. Purchase invoices give evidence of ownership (which gives control).
111
20 The following describes a number of features of the inventory count instructions of Sydney Ltd. For each feature, select whether it represents a strength or a deficiency.
The inventory count is performed by warehouse staff and supervised by the warehouse manager. A Strength
B Deficiency
Inventory sheets are completed in pencil.
C Strength
D Deficiency
There are two teams of counters, one counting and one checking.
E Strength
F Deficiency
Correct answer(s): B Deficiency
Correct answer(s): D Deficiency Correct answer(s): E Strength
The inventory count should involve personnel who are independent of the warehouse staff. Count sheets should be completed in pen so that there is a permanent record. By having two teams of counters involved in the inventory count, there is a check within the inventory counting process that the count is being carried out correctly.
112
21 For each of the following statements concerning perpetual inventory counts, select whether they are true or false.
Adequate inventory records must be kept up to date.
A True
B False
All inventory lines must be counted at least once per month.
C True
D False
Material differences between book inventory and actual inventory must be investigated and corrected.
E True
F False
Correct answer(s):
A True
Correct answer(s):
D False
All inventory lines must be counted at least once per year, not once per month. Correct answer(s):
E True
113
22 Management should compare cost and net realisable value for each item of inventory.
Which three of the following circumstances could result in net realisable value being lower than cost?
A An increase in the cost of raw materials which cannot be passed on to the customer
B An increase in selling price
C Errors in production
D An increase in production overheads
E Trade discounts from suppliers
Correct answer(s):
A An increase in the cost of raw materials which cannot be passed on to the customer
C Errors in production
D An increase in production overheads
An increase in selling price increases net realisable value. Trade discounts from suppliers reduce cost.
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23 Direct confirmation of trade receivables provides evidence in respect of which two of the following assertions?
A Existence
B Accuracy, valuation and allocation
C Rights and obligations
D Completeness
E Occurrence
A Existence
C Rights and obligations
Accuracy, valuation and allocation is not supported as we have no evidence that these receivables intend to pay. Completeness is not supported as it is the list of receivables provided by the client that is subject to direct confirmation (ie, the test is for existence and ownership (= rights and obligations) from that list). Occurrence is a financial statement assertion that affects classes of transactions and not account balances.
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24 Which one of the following is the most reliable evidence of the valuation of trade receivables?
A A comparison of current year-end total with previous year
B Analysis of after-date receipts
C Checking a sample of customers on the customer list against the receivables ledger accounts
D Reconstruction of receivables balance by tracing individual amounts invoiced to despatch records
B Analysis of after-date receipts
Whereas the procedures described in A and D are helpful with respect to the valuation assertion, subsequent receipt of cash confirms absolutely that the balance was recoverable at the year end. Checking that customers on the customer list have receivables ledger accounts is a test of
completeness, not valuation.
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25 Two types of procedures used in gathering evidence are tests of controls and substantive procedures.
For each of the following examples, select the type of procedure illustrated. Examining the instructions issued for a year-end physical inventory count
A Test of control
B Substantive procedure
Observing despatch procedures
C Test of control
D Substantive procedure
Comparing this year’s sales figures to those of previous years
E Test of control
F Substantive procedure
Correct answer(s):
A Test of control
The instructions are likely to lead to an accurate count.
Correct answer(s):
C Test of control
Despatch procedures are being properly followed.
Correct answer(s):
F Substantive procedure
SAMPLE EXAM
Remembering that substantive procedures include analytical procedures, which is what this describes.
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26 The following are examples of tests which an assurance firm might use at the gathering evidence stage of an assignment.
For each example, select the type of procedure which that test illustrates. Adding the list of year-end receivables
A Confirmation
B Recalculation
C Reperformance
Using computer-assisted audit techniques (CAATs) to check the ageing of the year-end list of aged receivables
D Confirmation
E Recalculation
F Reperformance
Correct answer(s): B Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records, therefore casting the list of year-end receivables is a recalculation procedure.
Correct answer(s): F Reperformance
Reperformance is the auditor’s independent execution of procedures or controls which were originally performed as part of the entity’s internal control, therefore using CAATs to check the ageing of the year-end list of aged receivables is a reperformance of that ageing analysis, which is itself a control over the recoverability of receivables.
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28 Which one of the following financial statement assertions will be supported by a sample check on the numerical sequence of despatch records and invoices?
A Cut-off
B Occurrence
C Completeness
D Accuracy, valuation and allocation
C Completeness
A sequence check will highlight missing documents which may indicate unrecorded transactions – ie, test the completeness of sales.
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29 Which one of the following procedures should be undertaken to confirm the existence of cash at bank?
A Inspecting the bank reconciliation statement prepared by the client
B Agreeing the figures on the bank reconciliation to the cash at bank nominal ledger account
C Obtaining direct confirmation of the bank balance from the client’s bank
D Reperforming the additions on the bank reconciliation
C Obtaining direct confirmation of the bank balance from the client’s bank
Obtaining direct confirmation of the bank balance from the client’s bank will confirm the existence of the cash at bank with a third party (ie, the bank).
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30 The auditor of Raindrop Ltd carried out a direct confirmation at the year end to confirm the accuracy of total trade receivables in the statement of financial position at that date. Two of the replies to the circularisation disagreed with the balance.
For each of these two disagreements, select whether the disagreement would be considered a misstatement for the purpose of evaluating the accuracy of total trade receivables.
Jones LLP disagreed with the balance because their records indicated that the amount had been paid a few days before the year end. The auditor’s enquiries revealed that the cheque was cleared shortly after the year end.
A Misstatement
B Not a misstatement
Sunny plc disagreed with the balance because its records indicated that it had paid the balance two weeks before the year end. The auditor’s enquiries revealed that the amount had been received and credited to another customer’s account before the year end.
C Misstatement
D Not a misstatement
Correct answer(s):
B Not a misstatement
This disagreement stems from a timing difference and, as such, does not indicate a misstatement in the receivables balance.
Correct answer(s):
D Not a misstatement
This disagreement stems from a mis-posting which does not affect the total receivables balance in the financial statements.
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31 The external auditor of Aaron Ltd has set materiality thresholds such that items under £40,000 are not generally considered material.
For each of the following items in Aaron Ltd’s financial statements select whether the auditor would usually test it for overstatement or for understatement, or whether the item would not be tested at all.
£1,000 due from Harriett, a director of Aaron Ltd
A Overstatement
B Understatement
C Not test
Sundry income £35,000
D Overstatement
E Understatement
F Not test
A Overstatement
The amount is an asset so we test primarily for overstatement. The amount owed is considered irrespective of the materiality threshold due to the nature of the item (director loan).
F Not test
The amount is below the materiality threshold. The likelihood of material fraud or misstatement within the balance is very low.
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32 Gamma Ltd has a head office and several branches. The head office operates a continuous inventory counting system. The system ensures that all items are counted at least twice a year and checked against inventory records.
During the interim audit, an examination of the counts undertaken by head office staff showed that differences between inventory records and the physical count frequently arise. Usually, actual inventory levels at branches are found to be higher than book inventory.
Which one of the following explains this difference? A Unrecorded write-offs of scrapped inventory
B Unrecorded purchase returns
C Unrecorded branch requisitions
D Unrecorded branch returns
C Unrecorded branch requisitions
Actual inventory levels at branches are higher than book inventory – ie, there must be unrecorded goods inwards. Only unrecorded branch requisitions (goods coming in from head office) would explain this. All the others would lean to book inventory higher than actual inventory.
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33 The results of substantive audit tests at Errata plc are set out below. The materiality threshold set for these tests was £1,000.
For each of the following results, select the action which should be taken by the audit senior. No misstatements found
A Draw conclusion
B Refer to senior colleague
C Extend sample
An arithmetical misstatement of £5,000 found
D Draw conclusion
E Refer to senior colleague
F Extend sample
A misstatement of £10 found, sanctioned by the finance director
G Draw conclusion
H Refer to senior colleague
I Extend sample
Correct answer(s):
A Draw conclusion
No misstatements are found; therefore, the appropriate action would be to draw a conclusion.
Correct answer(s):
F Extend sample
An arithmetic misstatement of £5,000 found would be above the materiality threshold and so the auditor should extend their sample.
Correct answer(s):
H Refer to senior colleague
A misstatement of £10 found, sanctioned by the finance director (FD) should lead to the auditor to refer the matter to a senior colleague due to the FD’s sanctioning.
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Which two of the following statements identify an appropriate source of information for audit work directed towards the stated risk associated with tangible non-current assets?
A Purchase invoices for assets purchased within the year may contain evidence in relation to the risk of omission of assets owned by the company.
B Physical inspection of the assets themselves by the auditor may generate evidence in relation to the risk of the company not actually owning the assets.
C Valuations carried out by third-party valuers may contain evidence in relation to the risk of the assets being incorrectly presented in the financial statements.
D Sales invoices for assets sold within the year may contain evidence in relation to the risk of the company not actually owning the assets.
A Purchase invoices for assets purchased within the year may contain evidence in relation to the risk of omission of assets owned by the company.
D Sales invoices for assets sold within the year may contain evidence in relation to the risk of the company not actually owning the assets.
Purchase invoices for assets purchased within the year may contain evidence in relation to the risk of omission of assets owned by the company.
Physical inspection of the assets themselves by the auditor would not generate evidence in relation to the risk of the company not actually owning the assets. The mere existence of the physical assets does not tell us that the company has the rights and obligations that relate to them.
Valuations carried out by third-party valuers would not generate evidence in relation to the risk of the assets being incorrectly presented in the financial statements. Although the assets may be valued correctly, this does not necessarily mean that they have been presented in line with IFRS Accounting Standards.
Sales invoices for assets sold within the year may contain evidence in relation to the risk of the company not actually owning the assets. This helps address the risk that the assets do not exist.
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36 Assurance providers obtain evidence using procedures, as set out in ISA (UK) 500, Audit Evidence. For each of the following statements, select whether they are most likely to be true or false.
A major risk of misstatement of the receivables balance in the financial statements is of debts not being complete.
A True
B False
The principal risk of misstatement of long-term liabilities in the financial statements is of non-existent liabilities being declared.
C True
D False
A major risk of misstatement of the inventory balance in the financial statements is of inventory being included in the financial statements at full value when it is obsolete or damaged.
E True
F False
Correct answer(s): B False
Completeness of debts receivable is not usually considered a major risk (ie, understatement of assets) – the opposite is usually the case ie, existence is a major risk.
Correct answer(s): D False
Although existence of long-term liabilities is indeed a risk, it is not the principal risk.
Correct answer(s):
E True
Incorrect valuation of inventory – particularly obsolete or damaged inventory – is a major risk of misstatement.
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38 For each of the following statements concerning the audit of inventory, select whether they are true or false.
When determining the cost of inventory, the costs of bringing the inventory to its present location and condition should be included.
A True B False
LO 3f
The use of inventory count sheets, which include inventory quantities based on the inventory records as at the close of business the previous day, is a deficiency in internal control.
C True D False
Correct answer(s): A True
Inventory cost includes the costs of bringing the inventory to its present location and condition, in line with IAS 2, Inventory.
Correct answer(s): C True
This is a deficiency because the inclusion of the inventory quantity on the count sheets may deter the inventory counters from performing the count accurately because they already have a suggested quantity for each inventory item. Similarly, the count sheets may not be up to date
