Topic 9 - Multiple Choice

If the auditor becomes aware that her client's primary goal is to reduce reported sales and income in the current year to avoid paying income taxes, which of the following management assertions would become more important to test? a. Completeness b. Occurrence

Answer: Completeness Assertions vary in importance based on the nature of the account and on client-specific characteristics and objectives. In a setting where a client has an incentive to minimize sales and income, the auditor should be increasingly concerned about the *Completeness* assertion (i.e., making sure the client has recorded all of the sales that happened during the period). The Occurrence assertion is generally more concerning in a traditional environment where a client seeks to maximize reported sales and income.

Generally speaking, which of the following management assertions would an auditor be most concerned about when auditing the series of transactions that make up the Legal Expense account balance at year-end? a. occurrence b. completeness

Answer: Completeness Generally speaking, auditors are more concerned about Completeness than Existence or Occurrence for liability and expense account balances and their underlying transactions. In other words, since companies usually have an incentive to reduce expenses and liabilities, auditors are usually more concerned that a client may not have completely recorded all of its liabilities or expenses on the financial statements.

If the auditor wants to test a "three-way match" to confirm that cash disbursements were made for authorized purchases and in the appropriate amounts, the three documents the auditor would match are the Purchase Order, the Receiving Report, and the Packing Slip. a. true b. false

Answer: False False. A "three-way match" for expenditures would include the Purchase Order, Receiving Report, and *Vendor Invoice*. The Packing Slip is a document generated by the vendor that accompanies the goods in transit and informs the receiving employees what they should expect to find in the package.

In order to ensure compliance with GAAP, every company's specific timing, procedures, and documentation for recording revenue will be the same. a. true b. false

Answer: False False. Although the basic process of (1) receiving an order, (2) fulfilling it, (3) billing the customer, and (4) collecting cash are at the core of the Revenue Cycle for all organizations, the specific timing, procedures, and documentation for revenue recognition may vary significantly between industries and among different companies within a particular industry.

Generally speaking, auditors are more concerned about Existence or Occurrence assertions than the Completeness assertion for liability and expense account balances and their underlying transactions. a. true b. false

Answer: False False. Generally speaking, auditors are more concerned about *Completeness* than Existence or Occurrence for liability and expense account balances and their underlying transactions. In other words, since companies usually have an incentive to reduce expenses and liabilities, auditors are usually more concerned that a client may not have completely recorded all of its liabilities or expenses on the financial statements.

The Expenditure Cycle includes transactions pertaining to acquiring and repaying capital to fund a company's growth and operations. a. true b. false

Answer: False False. The Expenditure Cycle includes transactions pertaining to purchasing and paying for goods or services needed by the organization. The definition provided describes the Financing Cycle.

The Expenditure Cycle Includes transactions pertaining to selling goods or services and collecting payment from customers. a. true b. false

Answer: False False. The Expenditure Cycle includes transactions pertaining to purchasing and paying for goods or services needed by the organization. The definition provided is for the Revenue Cycle.

Which of the following accounts would likely be considered as part of an audit plan of the Expenditure Cycle for a client? a. Cost of Goods Sold b. Prepaid Expenses c. Accounts Payable d. Inventory e. Cash

Answer: Inventory; Cost of Goods Sold; Prepaid Expenses; Accounts Payable; Cash Each of the listed accounts is likely to be included in an audit plan of a client's Expenditure Cycle.

In order to ensure that a company doesn't issue payment for fictitious vendor invoices (i.e., invoices received from vendors who did not actually provide goods or services), which two documents should be matched and verified to each Vendor Invoice prior to making a payment (a.k.a., a three-way match)? a. Check b. Receiving Report c. Purchase Order d. Packing Slip e. Bill of Lading

Answer: Purchase Order; Receiving Report A "three-way match" in the expenditure cycle consists of verifying information from an authorized Purchase Order, the related Receiving Report, and the associated Vendor Invoice. Requiring a match of relevant information from all three documents helps prevent the disbursement of funds for unauthorized purchases or for orders that were not received.

Accounts in the Expenditure Cycle have an elevated risk of misstatement due to fraud. a. true b. false

Answer: True This statement is true, the inventory account in particular is a common area for financial statement fraud.

The Revenue Cycle consists of activities involved in a company's activities designed to generate income by providing goods and services to its customers. a. true b. false

Answer: True This statement is true.

For most audit engagements, auditing standards require that the auditor perform a third-party confirmation of Accounts Receivable balances. a. true b. false

Answer: True True. Except in certain situations (e.g., Accounts Receivable balances are immaterial), auditing standards indicate that auditors are expected to use third-party confirmations to test the Existence assertion of Accounts Receivable balances.

The Expenditure Cycle consists of transactions involved with the acquisition of goods and materials (i.e., raw materials, inventory, supplies, equipment) or services used in the operation of a business. a. true b. false

Answer: True This statement is true.

If the auditor wants to test a "three-way match" to confirm that cash disbursements were made for authorized purchases and in the appropriate amounts, the three documents the auditor would match are the Purchase Order, the Receiving Report, and the Vendor Invoice. a. true b. false

Answer: True True. A "three-way match" for expenditures would include the Purchase Order, Receiving Report, and Vendor Invoice.

The Inventory account is generally considered to be part of the Expenditure Cycle. a. true b. false

Answer: True True. The Inventory account is generally considered as part of the Expenditure Cycle.

If an auditor is concerned that a client has not sufficiently written down obsolete inventory, which management assertion is the auditor questioning? a. Existence b. Rights and Obligations c. Valuation d. Completeness e. Accuracy

Answer: Valuation Periodic write-downs of items in the Inventory account (e.g., for obsolescence or damage) are often the result of a subjective, market-based determination by the client. This subjective judgment regarding the appropriate value of the inventory is part of the *Valuation* assertion. Key word subjective

Which of the following accounts are generally considered part of the revenue cycle? (Check all that apply.) a. Cash b. Inventory c. Accounts Receivable d. Sales

Answer: a. Cash; d. Sales; c. Accounts Receivable The inventory account is not typically viewed as part of the revenue cycle. It is generally included in the expenditure cycle.

Generally speaking, which of the following management assertions would an auditor be more concerned about when auditing the Accounts Payable account balance at year-end? a. Completeness b. Existence

Answer: a. Completeness Generally speaking, auditors are more concerned about Completeness than Existence or Occurrence for liability and expense account balances and their underlying transactions. In other words, since companies usually have an incentive to reduce expenses and liabilities, auditors are usually more concerned that a client may not have completely recorded all of its liabilities or expenses on the financial statements.

A common fraud scheme involving the Inventory account is for a company to overstate the quantity of inventory in stock at the end of an accounting period. With respect to this particular fraud risk, which of the following management assertions would the auditor be most concerned with? a. Existence b. Cutoff c. Completeness d. Classification e. Occurrence

Answer: a. Existence (hint: inventory is an asset account) The inflation of inventory occurs when a company claims to have more inventory in stock than it actually has. The relevant management assertion is the *Existence* assertion (i.e., the inventory recorded on the client's records actually exists). The Occurrence assertion is similar to Existence, but Occurrence deals with specific transactions rather than on an entire account balance. cutoff is a throw off answer: cutoff is not relevant here, because we are not testing, the period, we are testing the quantity of inventory.

Which account is generally NOT considered a part of the revenue cycle? a. Accounts Receivable b. Inventory c. Sales d. Cash

Answer: b. Inventory The inventory account is not typically viewed as part of the revenue cycle. It is generally included in the expenditure cycle.

Which of the following is NOT one of the primary concerns the auditor may have in the audit of the revenue cycle? a. Sales might be recorded in the wrong accounting period b. Inventory might be overstated due to fictitious inventory c. Receivables may be overstated from failure to write off uncollectible receivables d. Cash may be overstated due to fictitious cash being reported

Answer: b. Inventory might be overstated due to fictitious inventory Inventory might be overstated due to fictitious inventory is a concern the auditor might have in auditing the expenditure cycle, not the revenue cycle.

Which of the following management assertions would the auditor generally be more concerned about when seeking to obtain evidence regarding sales transactions in the Revenue Cycle? a. completeness b. occurence

Answer: b. Occurrence Because companies generally have an incentive to report as much revenue as possible, it's more likely that a company would record additional sales that weren't completed than to fail to record sales that really happened. Thus, the auditor would generally be more concerned with the *Occurrence* assertion (i.e., each recorded sale actually occurred) rather than the *Completeness* assertion (i.e., the client recorded each sales transaction that occurred).

If a company were to inappropriately capitalize a routine expense (e.g., debiting a capital asset account instead of the appropriate expense account), the effect of this misstatement would be to ____________ assets, ______________ expenses, and __________ Net Income. a. overstate; overstate; overstate b. overstate; understate; overstate c. overstate; understate; understate d. understate; overstate; understate e. understate; understate; understate

Answer: b. overstate; understate; overstate When a company capitalizes a transaction (i.e., debits an asset account) that should be expensed, the effect is to overstate assets, understate expenses, and overstate Net Income. Because of these effects, the inappropriate capitalization of expenses is a common fraud scheme conducted in the Expenditure Cycle.

Which of the following management assertions related to the year-end Cash account balance are auditors most likely to focus on? a. Cutoff b. Completeness c. Existence d. Occurrence

Answer: c. Existence The auditor's principal concern with the year-end Cash balance is that the amount, as reported by the client, actually *exists* (e.g., in a bank account) and is not overstated somehow. The Cutoff and Occurrence assertions focus on individual transactions rather than an account balance, so they are not as practical for the Cash account balance. Because companies usually have no incentive to hide their cash from financial statement users (i.e., fail to record all of their cash), the Completeness assertion is generally not a significant concern for auditors.

Which of the following activities is not generally considered part of the Expenditure Cycle? a. Paying vendors for goods received b. Receiving goods from vendors c. Ordering goods from vendors d. Delivering goods to customers

Answer: d. Delivering goods to customers Delivering goods to customers is part of the Revenue Cycle, not the Expenditure Cycle.

Which of the following documents would be generated first during activities in the Expenditure Cycle? a. Receiving Report b. Vendor Invoice c. Check d. Purchase Order

Answer: d. Purchase Order The Purchase Order is used to initiate a purchase of goods or services. Each of the other listed documents would be generated in subsequent Expenditure Cycle activities.

If the auditor is concerned that a client has not exercised sound judgment in determining an appropriate model to accrue the Allowance for Doubtful Accounts balance at the end of the period, what management assertion is in question? a. existence b. accuracy c. cutoff d. valuation

Answer: d. Valuation When the auditor examines a client's estimate for an account balance, the assertion being questioned is whether the client properly valued the account (i.e., *Valuation*). The client typically values an estimated account (like the Allowance for Doubtful Accounts) by using a mathematical model with appropriate assumptions (e.g., historical default rate on Accounts Receivable balances), reliable and relevant information (e.g., macroeconomic trends, industry benchmarks for default rates), and other inputs that the client feels will produce an appropriate forecast of the ultimate outcome - or value - of the account. The Accuracy assertion focuses more on the mathematical correctness of a model (i.e., do spreadsheet formulas do what they're designed to), but not on the subjective or judgmental inputs that management decides to include or exclude from the model.

Which of the following activities is NOT one of the FASB's required revenue recognition activities? a. Identify a contract with a customer b. Identify the performance obligations in the contract c. Determine the transaction price d. Allocate the transaction price to the performance obligations e. Complete the performance obligations and record the associated revenue f. Collect cash from the customer

Answer: f. Collect cash from the customer Although the ultimate goal of generating a sale is to collect cash from a customer, the act of collecting the cash is not required in order to recognize revenue. In other words, a company can recognize revenue for a sale on account (i.e., recording an Account Receivable balance) once the company has fulfilled its obligations related to the sale. When cash is ultimately received from the customer, the Account Receivable balance is removed and replaced with Cash.

The Revenue Cycle consists of a set of activities designed to acquire goods and services for use in the organization's operations. a. true b. false

False. The Revenue Cycle consists of activities involved in a company's activities designed to generate income by providing goods and services to its customers. The definition provided describes the Expenditure Cycle.

Create a multiple choice problem for each of these like: What you could do is all of the following are examples of fictitious revenue transactions recorded except? Look at table 9.1 for the others.

The auditor is concerned that the client may fail to write off uncollectible account balances. Which control activity would most effectivley address this risk? a. Prior to estimating Bad Debts, the Controller reviews the accuracy of the estimate from the prior year and, considering any changes to credit policies or customer situations, determines whether a different method or percentage should be used in the current period. *(The estimates of allowance for doubtful accounts and bad debt expense are inadequate)* b. The controller receives and reviews the Accounts Receivable Aging Schedule on a bi-weekly basis, noting balances that are more than 90 days old and determines, using notes in the accounting information system, whether a balance should be written off. *(failure to Write-off UN-collectible account balances)* c. Computerized access controls prohibit unauthorized users from generating invoices and recording revenue in the accounting information system. (*Fictitious revenue transactions are recorded*) d. All revenue transactions must be documented by retaining a copy of the purchase order (or sales order), shipping documents, invoice, and evidence of payment. (*Also fictitious revenue transactions are recorded*)

The auditor is concerned with the following risk: *The client inappropriately capitalizes periodic expenses (e.g., maintenance).* Which of the following controls would most likely help mitigate this risk? a. Use chart of accounts b. Perform substantive analytical procedures to identify unexpected differences in liability or expense accounts c. Use bar codes or RFID technology to identify inventory items d. Require three-way match (i.e., purchase order, receiving report, vendor invoice) prior to approving cash disbursements

a. Use of chart of accounts

The term reliance approach refers to an auditor relying on his or her substantive tests of account balances or transactions when determining whether the financial statements are free of material misstatement. a. true b. false

a. false Reliance approach: an approach auditing a client's financial statements in which the auditor plans to rely on *internal controls* for a portion of his or her audit evidence. Substantive approach: An approach to auditing a client's financial statements in which the auditor does not plan to rely on internal controls, but rather chooses to rely *exclusively on substantive audit procedures* for audit evidence.

Internal controls implemented by the client for the purpose of mitigating identified risks of material misstatement are commonly referred to as Control Activities. a. true b. false

a. true

Which two characteristics of internal control are evaluated by the auditor when determining whether or not the controls can be relied upon for audit evidence? a. Structuredness b. Design c. Implementation d. Appearance

b. and c.

Which of the following best describes the process the auditor uses when assessing the risk of material misstatement. a. Consider the remaining risk of material misstatement, assess risks of material misstatement, consider control activities meant to mitigate the risks of material misstatement b. Consider control activities meant to mitigate the risks of material misstatement, assess risks of material misstatement, consider the remaining risk of material misstatement c. Assess risks of material misstatement, consider control activities meant to mitigate the risks of material misstatement, consider the remaining risk of material misstatement

c. Assess risks of material misstatement, consider control activities meant to mitigate the risks of material misstatement, consider the remaining risk of material misstatement

The following control activity was most likely implemented by a client in order to address which of the risks identified below? Control Activity: Use independent market data to monitor fair value of inventory items a. Inflated inventory counts b. Recording of fictitious expenses and liabilities c. Failure to write down obsolete inventory to the lower of cost or market d. Failing to record Accounts Payable and other current liabilities

c. Failure to write down obsolete inventory to the lower of cost or market.

The auditor is concerned that the client may fail to write off uncollectible account balances. Which control activity would most effectivley address this risk? a. All revenue transactions must be documented by retaining a copy of the purchase order (or sales order), shipping documents, invoice, and evidence of payment. b. Prior to estimating Bad Debts, the Controller reviews the accuracy of the estimate from the prior year and, considering any changes to credit policies or customer situations, determines whether a different method or percentage should be used in the current period. c. The controller receives and reviews the Accounts Receivable Aging Schedule on a bi-weekly basis, noting balances that are more than 90 days old and determines, using notes in the accounting information system, whether a balance should be written off. d. Computerized access controls prohibit unauthorized users from generating invoices and recording revenue in the accounting information system.

c. The controller receives and reviews the Accounts Receivable Aging Schedule on a bi-weekly basis, noting balances that are more than 90 days old and determines, using notes in the accounting information system, whether a balance should be written off.

The following control activity was most likely implemented by a client in order to address which of the identified risks below? Control Activity: Computerized access controls prohibit unauthorized users from generating invoices and recording revenue in the accounting information system. a. Failure to write off uncollectible account balances b. Fictitious cash balances are reported c. Failure to record sales returns or sales discounts d. Fictitious revenue transactions are recorded

d. Fictitious revenue transactions are recorded