Chapter 14

Question 1

A common form of segmenting is called the_______ , which divides classes of transactions and account balances that are closely related into segments.

Answer 1

cycles approach

Question 2

There are five classes of transactions in the sales and collection cycle:

Answer 2

1. Sales (cash and sales on account)
2. Cash receipts
3. Sales returns and allowances
4. Write-off of uncollectible accounts
5. Estimate of bad debt expense

Question 3

Auditing Standards Requirements: Auditors should use external confirmations for accounts receivable unless: (3)

Answer 3

1. The overall accounts receivable balance is immaterial.
2. The auditor considers confirmations ineffective evidence because response rates will likely be inadequate or unreliable.
3. The auditor’s assessed level of the risk of material misstatement is low and other evidence can be accumulated to provide sufficient evidence.

Question 4

Types of Confirmations (3)

Answer 4

1. Positive Confirmation
2. Negative Confirmation:
3. Negative Confirmation:

Question 5

Positive Confirmation:

Answer 5

A communication addressed to the debtor requesting the recipient to confirm directly whether the balance as stated is correct or incorrect. Figure 16-5 is an example of a positive confirmation request.

Question 6

Negative Confirmation:

Answer 6

A communication addressed to the debtor, but requests a response only when the debtor disagrees with the stated amount. Figure 16-6 is an example of a negative confirmation

Question 7

Observations regarding confirmations:

Answer 7

a. Observations regarding confirmations: Positive confirmations are more reliable, but negative confirmations are less costly.
b. Negative confirmations are acceptable as the sole substantive audit procedure only when all of the following circumstances are present: a. The auditor has assessed the risk of material misstatement as low.
b. The population of items is made up of a large number of small, homogenous account balances.
c. The auditor expects a low exception rate.
d. The auditor reasonably believes that recipients of negative confirmation requests will give the requests adequate consideration.
c. The most reliable evidence from confirmations is obtained when they are sent as close to the balance sheet date as possible.
d. Sample size is based on the following factors: performance materiality, inherent risk, control risk, achieved detection risk from other substantive tests, and type of confirmation. Some type of stratification is desirable with most confirmations.

Question 8

There are three classes of transactions in the acquisition and payment cycle:

Answer 8

1. Acquisitions of goods and services
2. Cash disbursements
3. Purchase returns and allowances and purchase discounts

Question 9

Auditing this cycle is often the most complex and time-consuming part of the audit for these reasons:

Answer 9

• Inventory is often the largest account on the balance sheet
• Inventory is often in different locations, making physical control and counting difficult
• Diverse inventory items such as jewels, chemicals, and electronic parts are often difficult for auditors to observe and value.
• Valuation is also difficult when estimation of inventory obsolescence is necessary and when manufacturing costs must be allocated to inventory.
• There are several acceptable inventory valuation methods.

Six functions make up the inventory and warehousing cycle:• Process Purchase orders, Receive RM, Store RM, Process goods, Store FG, Ship FG

Question 10

Inventory Observation Requirements for the Auditor:

Answer 10

1.Be present at the time the client counts its inventory.
2.Observe the client’s counting procedures.
3.Make inquiries of client personnel about their counting procedures.
4.Make their own independent tests of the physical count.
Auditors have been required to perform physical observation tests of inventory since a major fraud involving recording of nonexistent inventory in 1938. Regardless of inventory method, the client must make a periodic physical count of inventory. The count may be done at or near the balance sheet date or at an interim date.

Question 11

Audit Decisions: The auditor must make some decisions regarding the observation of the physical inventory count:

Answer 11

1.Timing—The auditor must decide whether the physical count can be taken before year-end.2.Sample Size—The number of items to count is difficult because the auditor should concentrate on observing the client’s procedures.3.Selection of Items—When auditors observe the client counting inventory, they should be careful to:a.Observe the counting of the most significant items.b.Inquire about items that are likely obsolete or damaged.c.Discuss with management the reasons for excluding any material items.