EXAM 2 Flashcards
A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being equal, which of the following would lead to a larger sample size?
Smaller amount of tolerable misstatement
Which of the following sample planning factors would influence the sample size for a substantive test of details for a specific account?
Expected misstatement = yes, tolerable misstatement = yes
The risk of incorrect acceptance relates to the
Effectiveness of the audit
Which of the following statements concerning monetary-unit sampling is correct?
The auditor controls the risk of incorrect acceptance by specifying the desired confidence level for the sampling plan
How would increases in tolerable misstatement and assessed level of control risk affect the sample size in a substantive test of details?
Increase in Tolerable Misstatement = Decrease in Sample Size
Increase in assessed level of control risk = Increase sample size
For the control activities to be effective, employees maintaining the accounts receivable subsidiary ledger should not also approve
Write-offs of customer accounts
Which of the following controls is most likely to help ensure that all credit revenue transactions of an entity are recorded?
The billing department supervisor matches prenumbered shipping documents with entries in the sales journal
Which of the following internal controls would be most likely to deter the lapping of collections from customers?
Segregation of duties between receiving cash and posting the accounts receivable ledger
Smith Corporation has numerous customers. A customer file is kept on a disk. Each customer file contains a name, an address, a credit limit, and an account balance. The auditor wishes to test this file to determine whether credit limits are exceeded. The best procedure for the auditor to follow would be to
Develop a program to compare credit limits with account balances and print out the details of any account with a balance exceeding its credit limit
Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor?
Understanding the sales journal
If accounts receivable turnover (credit sales/receivables) was 7.1 times in 2011 compared to only 5.6 times in 2012, it is possible that there were
Fictitious sales in 2012
If the number of days’ sales in accounts receivable (365 days/receivables turnover) decreases significantly, which of the following assertions for accounts receivable most likely is violated?
Completeness
Which of the following is most likely to be detected by an auditor’s review of a client’s sales cutoff?
Unrecorded sales for the year
Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because
The auditor cannot infer that all nonrespondents have verified their account information
The negative request form of accounts receivable confirmation is useful particularly when
The assessed level of control risk relating to receivables is = low, the number of small balances is = high, consideration by the recipient is = likely
An auditor should perform alterative procedures to substantiate the existence of accounts receivable when
No reply to a positive confirmation request is received
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support management’s financial statement of assertion of
Valuation and allocation
Ensure that the entity has legal title to accounts receivable (rights and obligations)
Review of bank confirmations and loan agreements.
Determine that recorded accounts receivable include all amounts owed to the client (completeness)
Select a sample of shipping documents, match them with related sales invoices, and determine that they have been included in the sales journal and accounts receivable subsidiary ledger.
Verify that all accounts receivable are recorded in the correct period (cutoff)
Select a sample of shipping documents for a few days before and after year-end.
Ensure that the allowance for uncollectible accounts is properly stated (valuation and allocation)
Review of aging of accounts receivable with the credit manager.
Confirm that recorded accounts receivable are valid (existence)
Confirmation of accounts receivable.
In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase order, requisition, and receiving report are verified. The next step in the system is
Entering of the voucher into the voucher register
When goods are received, the receiving clerk should match the goods with
The vendor shipping document and the purchase order
Internal control is strengthened when the quantity of merchandise ordered is omitted from the copy of the purchase order sent to the
Receiving department
Which of the following control activities is not usually performed in the accounts payable department?
Accounting for unused prenumbered purchase orders and receiving reports
In a properly designed purchasing process, the same employee most likely would match vendors’ invoices with receiving reports and also
Recompute the calculations on vendors’ invoices
For effective internal control purposes, which of the following individuals should be responsible for mailing signed checks?
Treasurer
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
Receiving reports
Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
Review of cash disbursements recorded subsequent to the balance sheet date to determine whether the related payable apply to the prior period.
Purchase cutoff procedures should be designed to test whether all inventory
Purchased and received before the end of the year was recorded
Which of the following procedures is least likely to be performed before the balance sheet date?
Search for unrecorded liabilities
When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely would be
Vendors with whom the entity has previously done business
During the year being audited, the Matthews Corporation changed from a system of recording time worked on clock cards to an IT payroll system in which employees record time in and out with magnetic cards. The IT system automatically updates all payroll records. Because of this change
Without paper clock cards, part of the audit trail is altered
Which of the following procedures would most likely be considered a weakness in an entity’s internal controls over payroll?
The employee who distributes payroll checks returns unclaimed payroll checks to payroll department
In meeting the control objective of safeguarding of assets, which department should be responsible for the following?
Distribution of paychecks and custody of unclaimed paychecks = treasurer
For an appropriate segregation of duties, journalizing and posting summary payroll transactions should be assigned to
General accounting
The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the
Authorization of transactions from the custody-related assets
An auditor who is testing IT controls in a payroll system would most likely use test data that contain conditions such as
Time cards with invalid job numbers
It would be appropriate for the payroll department to be responsible for which of the following functions?
Preparation of periodic governmental reports as to employees’ earnings and withholding taxes
Which of the following audit tests would most likely be used to test the occurrence assertion for payroll transactions?
Trace a sample of payroll checks to the approved time sheet summary and the master employee list to verify validity
Effective control activities over the payroll function may include
Verification of agreement of job time cards with employee clock card hours by a payroll department employee.
An auditor is most likely to perform substantive tests of details on payroll transactions and balances when
Substantive analytical procedures indicate unusual fluctuations in recurring payroll entries
The objectives of internal control for an inventory management process are to provide assurance that transactions are properly authorized and recorded and that
Custody of work in process and finished goods is properly manufactured
Which of the following control activities would be most likely to assist in reducing the control risk related to the occurrence of inventory transactions?
Inventory manager does not have ability to record inventory transactions
Which of the following would most likely be an internal control activity designed to detect errors and fraud concerning the custody of inventory?
Independent comparisons of finished goods records with counts of goods on hand
Independent internal verification of inventory (i.e. proper segregation of duties) occurs when employees who
Compare records of goods on hand with physical quantities do not maintain the records or have custody of the inventory
An auditor’s tests of controls over the issuance of raw materials to production would most likely include
Examination of materials requisitions and reperformance of client controls designed to process and record issuances
Which of the following internal control activities is most likely to address the completeness assertion for inventory?
Receiving reports are prenumbered and periodically reconciled
A client maintains perpetual inventory records in both quantities and dollars. If the level of control risk were set at high, an auditor would probably
Request that the client schedule the physical inventory count at the end of the year
After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items
Represented by inventory tags are included in the listing
When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that
All goods owned at year-end are included in the inventory balance
Inquiries of warehouse personnel concerning possibly obsolete or slow-moving inventory items provide assurance about management’s assertion of
Valuation
Periodic or cycle counts of selected inventory items are made at various times during the year rather than via a single inventory count at year-end. Which of the following is necessary if the auditor plans to observe inventory at interim dates?
Perpetual inventory records are maintained
An auditor would probably be least interested in which of the following fields in an electronic perpetual inventory file?
Economic re-order quantity
Which of the following audit procedures would probably provide the most reliable evidence concerning the entity’s assertion of rights and obligations related to inventory?
During physical observation of inventory verify that “bill-and-hold” inventory is segregated and not included in the ending inventory count.
We are sorry but we cannot answer your request for confirmation of our account as the Detroit Tigers Company uses an accounts payable voucher system.
No error
The balance of $1,050 was paid on December 23, 2012
Error
The balance of $7,750 was paid on January 5, 2013
No error
The balance noted above has been paid
Maybe error
We do not owe you anything at December 31, 2012, as the goods represented by your invoice dated December 30, 2012, number 1852, in the amount of $11,550, were received on January 5, 2013, on FOB destination terms
Error
An advance payment of $2,500 made by us in November 2012 should cover the two invoices totaling $1,350 shown on the statement attached
Error
We never received these goods
Maybe error
We are contesting the propriety of the $12,525 charge. We think the charge is excessive.
Maybe error
Amount okay. As the goods have been shipped to us on consignment, we will remit payment upon selling the goods
Error
The $10,000 you show as a receivable from us is a deposit you made to us under a lease. The deposit will be applied against the rent due to us during 2015, the last year of your lease.
Error
Your credit memo dated December 5, 2012, in the amount of $440 cancels the balance above
Error
Separation of duties
authorizing, recording, custody
Remediation
The process of correcting…
Steps in a monetary-unit sampling application
planning -> performance -> evaluation
Revenue cycle
customer purchase order -> credit approval -> shipping -> sales invoice -> customer monthly statements -> cash
Lapping
Prevent by having segregation of duties by depositing checks is separate from recording A/R
Aging of A/R -> determine estimated bad debts
Valuation
Sending out confirmations of A/R
Existence
Positive Confirmation
- Shipping documents
2. Cash payments
Negative Confirmation
- Small dollar amounts
- Good internal controls
- Expect that customers will give it due consideration
Improper Revenue Recognition
- sales to ficticious customers
- channel stuffing - inflates sales by shipping a lot of goods to distributor
- sell to customers with poor credit ratings
- cut-offs (ex - sales in January being recorded in the previous fiscal year
- record sales but did not ship sales
- pricing errors
EDGAR
Electronic Data Gathering, Analysis, and Retrieval System
Risk of purchasing process
accounts payable - understated
–focuses on completeness
Monetary Misstatements (Substantive tests)
- Vouchers - supporting documents
- Recompute the math
- Trace vouchers to purchase journal
- Has the vender change?
Major concern of payroll
overpayments and unauthorized payments
Segregation of duties
Separation of hiring personnel and distribution of checks
Human resources (personnel)
approving pay rates and deductions
Treasurer
distribution of paychecks + custody of unclaimed checks
General accounting is responsible for…
journalizing and posting summary payroll transactions
ESSAY – what an auditor should do during the observation of physical count of inventory?
- ensure that no production is scheduled during the count
- ensure that there is no movement of goods during the count
- make sure the count teams are following the inventory count instructions
- perform test counts and record a sample of counts in the work papers
- observe the condition of obsolete and slow moving inventories
- inquire about goods held on consignment
- obtain tag control information for testing the client’s inventory compilation
- ensure that inventory tags are issued sequentially to individual departments
- obtain cutoff information
Inventory work
during the audit planning, the auditors will determine with the client the timing of inventory observation
Weak Controls
schedule inventory counts at the end of the year
Strong Controls (control risk is low)
schedule the inventory count at an interim date (ex - November - perpetual inventory records)
Occurrence/Existence
does the recorded inventory actually exist? -> go from client list to count items on the floor
Completeness
auditor counts something from the floor, then trace it back to the client list
Valuation
slow moving items -> increase in the days outstanding in inventory ratio -> obsolete
- has the client used the proper pricing?
- is the financial statement presentation appropriate?
- has damaged goods been properly counted for?
If inventories are HIGHER than records…
purchases are not being recorded
If inventories are LOWER than accounting records…
sales are not being recorded
Cash and cash equivalents
“all unrestricted highly liquid investments”
maturity date of 3 months or less
kiting
transfering money from one bank to another and recording the transactions improperly (done at year end)
Investment analytical procedures
recompute interest, dividends earned, market securities
Case Study
- Larry Gray has to sign confidentiality contracts to not tell anyone
- not allowed to visit during the work week
- warehouse only has carpets
- viewed contracts that were only a single sheet of paper
- no construction permits
- said it was in National City and then moved it to San Diego
- only allowed to talk to 3 people -> question integrity
- Larry -> there is a need for auditor to understand the industry
- is the amount for contract reasonable? (normal is less than $3 mil, he got $8 mil)
- everything was photocopy (easily altered)
- huge expenditures at the end in short amount of time
An auditor ordinarily sends a standard confirmation request to all banks with which the client has done business during the year under audit, regardless of the year-end balance. One purpose of this procedure is to
Seek information about loans from the banks
The primary evidence regarding year-end bank balances is documented in the
Standard bank confirmations
Which of the following controls would most effectively ensure that the proper custody of assets in the investing process is maintained?
The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safe-deposit box by independent personnel
An auditor testing long-term investments would ordinarily use substantive analytical procedures to ascertain the reasonableness of the
Completeness of recorded investment income
To establish the existence and rights of a long-term investment in the common stock of a publicly traded company, an auditor ordinarily performs a security count or
Confirms the number of shares owned that are held by an independent custodian
Which of the following is likely to be the most effective audit procedure for verifying dividends earned on investments in publicly traded equity securities?
Reconcile recorded earnings with the dividend earnings reported in the investment broker statement
An auditor would most likely verify the interest earned on bond investments by
Recomputing the interest earned on the basis of face amount, interest rate, and period held
The audit firm’s valuation specialist would likely be brought in to assist in the audit of fair value measurements at an entity when the following is present:
Significant uncertainty exists in key inputs to the entity’s valuation models
