Auditing Chapter 4

The auditor should consider certain factors in assessing the efficiency and effectiveness of analytical procedures as compared to tests of details. In determining whether and to what extent analytical procedures should be used, which of the following should the auditor consider? a. Interrelationships of financial information. b. Nonfinancial information that may affect financial information. c. The nature of the assertion tested. d. Explanations provided by the client.

)c. The nature of the assertion tested. (AICPA Professional Standards (specifically, AU-C 520.A8) list 4 factors that determine the effectiveness and efficiency of analytical procedures used for substantive purposes: (1) the nature of the assertion, (2) the plausibility and predictability of the relationship, (3) the availability and reliability of the data used to develop the expectation, and (4) the precision of the expectation.)

For all audits of financial statements made in accordance with generally accepted auditing standards, the use of analytical procedures is required to some extent [in the planning stage, as a substantive test, in the review stage] a. Yes, No, Yes b. No, Yes, No c. No, Yes, Yes d. Yes, No, No

a. Yes, No, Yes (Analytical procedures are required in planning and in the overall review. They may be used, but are not required, as substantive tests.)

Which of the following results of analytical procedures would most likely indicate possible unrecorded liabilities? a. Current ratio of 2:1 as compared to 5:1 for the prior period. b. Ratio of accounts payable to total current liabilities of 4:1, compared to 6:1 for the prior period. c. Accounts payable turnover of 5, compared to 10 for the prior period. d. Accounts payable balance increase greater than 10% over the prior period.

b. Ratio of accounts payable to total current liabilities of 4:1, compared to 6:1 for the prior period. (This ratio is A/P divided by total current liabilities. A decrease in this ratio (from 6:1 to 4:1) could be caused by an omission of current liabilities (other than A/P) resulting in the appearance that A/P is a larger proportion of total current liabilities than it should be.)

An auditor's decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the a. Availability of data aggregated at a high level. b. Relative effectiveness and efficiency of the tests. c. Timing of tests performed after the balance sheet date. d. Auditor's familiarity with industry trends.

b. Relative effectiveness and efficiency of the tests. (Evidence may be gathered by means of analytical tests (performed as substantive tests), tests of transactions, and tests of details of balances. The decision as to which means to employ is based on the auditor's judgment of the expected effectiveness and efficiency of the available procedures.)

Which of the following events most likely indicates the existence of related parties? a. Borrowing a large sum of money at a variable rate of interest. b. Selling real estate at a price that differs significantly from its market value. c. Making a loan with scheduled terms for repayment of the funds. d. Discussing merger terms with a company that is a major competitor.

b. Selling real estate at a price that differs significantly from its market value. (Selling real estate at a price that is significantly different from its market value would be indicative of a related party transaction. If real estate is held for any length of time, its market value, and, thus, its selling price, would most likely differ significantly from its book value.)

Which of the following comparisons would an auditor most likely make in evaluating an entity's costs and expenses? a. The current year's accounts receivable with the prior year's accounts receivable b. The current year's payroll expense with the prior year's payroll expense c. The budgeted current year's sales with the prior year's sales d. The budgeted current year's warranty expense with the current year's contingent liabilities

b. The current year's payroll expense with the prior year's payroll expense (The auditor evaluates an entity's costs and expenses to try to detect any material misstatements present. The best comparison would be current-year and prior-year payroll expense as they are likely to be related to each other. Thus, prior-year expense can be used to predict likely current-year expense. If the numbers are materially different, it could indicate the existence of a material misstatement.)

Which of the following statements is correct concerning analytical procedures used in planning an audit engagement? a. They often replace the tests of controls that are performed to assess control risk. b. They usually use financial and nonfinancial data aggregated at a high level. c. They usually involve the comparison of assertions developed by management to ratios calculated by an auditor. d. They are often used to develop an auditor's preliminary judgment about materiality.

b. They usually use financial and nonfinancial data aggregated at a high level. (Analytical procedures used in planning often use data aggregated at a high level.)

What is the primary purpose of reviewing conflict-of-interest statements signed by members of management? a. To obtain an understanding of business processes. b. To identify transactions with related parties. c. To assess control risk. d. To consider limitations of internal control.

b. To identify transactions with related parties. (Reviewing conflict-of-interest statements signed by management would provide the auditor with information about potential relationships with related parties that might warrant additional disclosure in the financial statements.)

An auditor who performed analytical procedures that compared current-year financial information to the comparable prior period noted a significant increase in net income. Given this result, which of the following expectations of recorded amounts would be unreasonable? a. A decrease in costs of goods sold as a percentage of sales. b. A decrease in accounts payable. c. A decrease in retained earnings. d. A decrease in notes payable.

c. A decrease in retained earnings. (Incorrect. If there is a fixed cost component to inventory (for example, in a manufacturing environment), an increase in production to meet increased sales may result in a decrease in cost of goods sold as a percentage of sales.)

Which of the following is an analytical procedure that an auditor most likely would perform when planning an audit? a. Confirming a sample of accounts payable b. Scanning payroll files for terminated employees c. Comparing current-year balances to budgeted balances d. Recalculating interest expense based on notes payable balances

c. Comparing current-year balances to budgeted balances (In planning the audit engagement, an auditor likely would compare current-year balances with budgeted balances that would be useful in developing expectations.)

Which of the following activities is an analytical procedure an auditor would perform in the final overall review stage of an audit to ensure that the financial statements are free from material misstatement? a. Reading the minutes of the board of directors' meetings for the year under audit b. Obtaining a letter concerning potential liabilities from the client's attorney c. Comparing the current year's financial statements with those of the prior year d. Ensuring that a representation letter signed by management is in the file

c. Comparing the current year's financial statements with those of the prior year (Comparing the current and prior year's financial statements is a legitimate analytical procedure performed both in planning and as a final review.)

After identifying related party transactions, an auditor most likely would a. Substantiate that the transactions were consummated on terms equivalent to those prevailing in arms-length transactions. b. Discuss the implications of the transactions with third parties, such as the entity's attorneys and bankers. c. Determine whether the transactions were approved by the board of directors or other appropriate officials. d. Ascertain whether the transactions would have occurred if the parties had not been related.

c. Determine whether the transactions were approved by the board of directors or other appropriate officials. (The auditor's primary concern with regard to related party transactions is disclosure. After identifying related party transactions, the auditor should examine the transactions in order to determine the purpose, nature, and extent of the transactions and their effects on the financial statements. In that process, the auditor would look to see if the transactions were properly authorized by the board of directors.)

When auditing related party transactions, an auditor places primary emphasis on a. Confirming the existence of the related parties. b. Verifying the valuation of the related party transactions. c. Evaluating the disclosure of the related party transactions. d. Ascertaining the rights and obligations of the related parties.

c. Evaluating the disclosure of the related party transactions. (When auditing related party transactions, the auditor is primarily concerned with the adequacy of disclosure.)

After determining that a related party transaction has, in fact, occurred, an auditor should a. Add a separate paragraph to the auditor's standard report to explain the transaction. b. Perform analytical procedures to verify whether similar transactions occurred, but were not recorded. c. Obtain an understanding of the business purpose of the transaction. d. Substantiate that the transaction was consummated on terms equivalent to an arm's-length transaction.

c. Obtain an understanding of the business purpose of the transaction. (After determining that a related party transaction has occurred, the auditor should obtain an understanding of the business purpose of the transaction. The auditor should apply the procedures considered necessary to determine the purpose, nature, and extent of the related party transactions and their effects on the financial statements.)

Which of the following procedures would an auditor most likely use to identify unusual year-end transactions? a. Obtaining a client representation letter. b. Obtaining a legal inquiry letter. c. Performing analytical procedures. d. Testing arithmetic accuracy of the accounting records.

c. Performing analytical procedures. (Analytical procedures are defined as follows (AU-C 520.04): "Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data. Analytical procedures also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount." Accordingly, analytical procedures would be useful in identifying unusual year-end transactions.)

Which of the following would not be considered an analytical procedure? a. Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages b. Developing the current year's expected net sales based on the sales trend of similar entities within the same industry c. Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics d. Estimating the current year's expected expenses based on the prior year's expenses and the current year's budget

c. Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics (Evaluating the characteristics of a population by means of applying statistical sampling techniques, specifically projecting a deviation or error rate, is likely to be performed as part of "test of controls," not an analytical procedure.)

Which of the following is an analytical procedure that an auditor most likely would perform during the final review stage of an audit? a. Comparing each individual expense account balance with the relevant budgeted amounts and investigating any significant variations b. Testing the effectiveness of internal control procedures that appear to be suitably designed to prevent or detect material misstatements c. Reading the financial statements and considering whether there are any unusual or unexpected balances that were not previously identified d. Calculating each individual expense account balance as a percentage of total entity expenses and comparing the results with industry averages

c. Reading the financial statements and considering whether there are any unusual or unexpected balances that were not previously identified (AICPA Professional Standards indicate that the overall review might include reading the financial statements and considering whether the evidence gathered is adequate to address identified unusual or unexpected balances as well as unusual or unexpected balances or relationships that were not previously identified.)

Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive tests? a. Relationships involving balance sheet accounts b. Transactions subject to management discretion c. Relationships involving income statement accounts d. Data subject to audit testing in the prior year

c. Relationships involving income statement accounts (Relationships involving income statement accounts tend to be more predictable for analytical review purposes because the income statement accounts represent transactions occurring over a period of time.)

Which of the following auditing procedures would be most likely to assist an auditor in identifying related party transactions? a. Inspecting correspondence with lawyers for evidence of unreported contingent liabilities. b. Vouching accounting records for recurring transactions recorded just after the balance sheet date. c. Reviewing confirmations of loans receivable and payable for indications of guarantees. d. Performing analytical procedures to seek indications of possible financial difficulties.

c. Reviewing confirmations of loans receivable and payable for indications of guarantees. (Reviewing confirmation of loans receivable and payable for indications of guarantees is one of the auditing procedures that will assist the auditor in identifying related party transactions.)

Analytical procedures used in planning an audit should focus on identifying a. Material weaknesses in the internal control structure. b. The predictability of financial data from individual transactions. c. The various assertions that are embodied in the financial statements. d. Areas that may represent specific risks relevant to the audit.

d. Areas that may represent specific risks relevant to the audit. (Analytical procedures utilize historical data and relationships to predict expected balances. Analytical procedures enable the auditor to gain an understanding of the client's business and raise questions when current balances differ from expected balances. In this manner, the auditor is able to identify specific areas of risk that will need to be addressed during the audit.)

A primary objective of analytical procedures used in the final review stage of an audit is to a. Identify account balances that represent specific risks relevant to the audit. b. Gather evidence from tests of details to corroborate financial statement assertions. c. Detect fraud that may cause the financial statements to be misstated. d. Assist the auditor in evaluating the overall financial statement presentation.

d. Assist the auditor in evaluating the overall financial statement presentation. (Analytical procedures used in the overall review stage of an audit are intended to assist the auditor in assessing the conclusions reached and in evaluating the overall financial statement presentation.)

In auditing related-party transactions, an auditor ordinarily places primary emphasis on a. The probability that related-party transactions will recur. b. Confirming the existence of the related parties. c. Verifying the valuation of the related-party transactions. d. The adequacy of the disclosure of the related-party transactions.

d. The adequacy of the disclosure of the related-party transactions. (GAAP focuses on providing full disclosure of related-party issues, so the auditor places primary emphasis on evaluating the adequacy of disclosure of such transactions.)

Which of the following most likely would cause an auditor to consider whether a client's financial statements contain material misstatements? a. Management did not disclose to the auditor that it consulted with other accountants about significant accounting matters. b. The chief financial officer will not sign the management representation letter until the last day of the auditor's fieldwork. c. Audit trails of computer-generated transactions exist only for a short time. d. The results of an analytical procedure disclose unexpected differences.

d. The results of an analytical procedure disclose unexpected differences. (Analytical procedures are a category of "substantive" audit procedures, and unexpected differences relative to the auditor's expectations may direct the auditor's attention to the possibility of a material misstatement.)