Auditing and Attestation 9-12

The inclusion of any obsolete or damaged goods. When observing a client's physical inventories, the auditor always should be alert to the inclusion of any obsolete or damaged goods. The auditor should be alert for empty boxes, empty squares, and inventory defects.

As part of the process of observing a client's physical inventories, an auditor should be alert to

True. 1.As risk decreases, the auditor may modify substantive tests by changing their nature from more effective to less effective (and less costly) tests. 2.The auditor requires less evidence to form an opinion, with lower risk.

As the combined assessed level of the risk of material misstatement decreases, the auditor may modify substantive tests by changing their nature from more effective to less effective (and less costly) tests.

Search for unrecorded cash receipts. GAAS do not specifically require a search for unrecorded cash receipts. Given a low assessed RMM, the auditor might decide to reduce the audit effort devoted to substantive tests of assertions about cash and omit the procedure.

Assuming a low assessed risk of material misstatement, which of the following audit procedures would be least likely to be performed?

Obtain additional evidence regarding the valuation of inventory. If the audit evidence is not sufficient and appropriate, the auditor should perform other procedures, such as tests of details or analytical procedures.

At the conclusion of an audit, an auditor is reviewing the audit evidence obtained. With regard to the valuation of inventory, the auditor concludes that the evidence obtained is not sufficient to support management's assertions. Which of the following actions is the auditor most likely to take?

False. Audit documentation is the property of the auditor.

Audit documentation is the property of the client.

True. 1.Permanent files are schedules, documents, and records with continuing audit significance for a specific client. These may include the articles of incorporation, bylaws, contracts (including debt agreements), schedules of ongoing importance (e.g., plant, property, and equipment), the organization chart, and internal control analyses. 2.Current files include schedules and analyses that relate to the current year under audit. For example, results of substantive tests such as confirmations and inventory observation and test counts are kept in the current files.

Audit documentation is typically classified into permanent and current files.

True. Audit documentation serves mainly to provide the principal support for the auditor's report and aid in the conduct and supervision of the audit.

Audit documentation provides the principal record of the work and the conclusions reached and should be designed to meet the circumstances of a particular engagement.

Designed to meet the circumstances of the particular engagement. Audit documentation should be designed to meet the circumstances of a particular engagement. Audit documentation should provide (1) a sufficient and appropriate record of the basis for the auditor's report and (2) evidence that the audit was planned and performed in accordance with GAAS (AU-C 230).

Audit documentation that records the procedures used by the auditor to gather evidence should be

Prenumbered purchase order forms. When documentation, such as purchase order forms, is prepared solely by client personnel, its persuasiveness will be less than that prepared by the auditor or an independent party. Ordinarily, the most reliable documentation is created outside the entity and has never been within the client's control.

Audit evidence can come in different forms with different degrees of persuasiveness. Which of the following is the least persuasive type of evidence?

a) One of the cashiers has been engaged in lapping.

1. An auditor confirms a representative number of A/R and investigates respondents exceptions and comments. By this procedure the auditor would be most likely to learn which of the following?

d) Strong, and the individuals receiving the confirmation requests are likely to give them adequate consideration.

10. When there are a large number of relatively small account balances, negative confirmation of A/R is feasible if I/C is

b) Verify that accounts payable were properly authorized.

11. An examination of the A/P account is ordinarily not designed to

b) Quality

12. When title to merchandise in transit has passed to the audit client, the auditor engaged in the performance of a purchase cutoff will encounter the greatest difficulty in gaining assurance with respect to the

d) There is likely to be other reliable external evidence available to support the balances.

13. Auditor confirmation of A/P balances may not be necessary because

b) Compare purchase invoice terms with disbursement records and checks.

14. Which of the following would detect an understatement of a purchase discount?

b) Review subsequent bank statements and canceled checks received directly from the bank.

15. Which of the following is one of the better auditing techniques that might be used by an auditor to detect kiting?

d) All goods owned at year-end are included in the inventory balance.

17. When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that

b) Checks dated prior to year-end to the outstanding checks listed on the year-end bank reconciliation. reconciliation.

18. On receiving the bank cutoff statement, the auditor should trace

c) Seeks information about indebtedness to the bank.

19. An auditor ordinarily should send 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, because this procedure

a) Examine shipping documents.

2. Customers having substantial year-end past due balances fail to reply after second request forms have been mailed directly to them. Which of the following is the most appropriate audit procedure?

b) Examine a sample of cash disbursements in the period subsequent to year-end.

20. Which of the following is the best audit procedure for determining the existence of unrecorded liabilities at year-end?

a) Computerized records of perpetual inventory are maintained.

21. Instead of taking a physical count on the balance sheet date, the client may take physical counts prior to the year-end if internal controls are adequate and

b) Represented by inventory tags are included in the listing.

22. 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

d) Vendors invoices.

23. In verifying debits to perpetual inventory records of a non-manufacturing company, the auditor would investigate the

d) Review of perpetual inv. records.

24. An auditor would be most likely to learn of slow-moving inventory through

c) Purchases.

25. A client's physical count of inventories was higher than the inventory quantities per the perpetual records. This situation could be the results of the failure to record

d) All employees worked the number of hours used to compute their pay.

26. A common audit procedure in the audit of payroll transactions involves tracing selected items from the payroll journal to employee time cards that have been approved by supervisory personnel. This procedure is designed to provide evidence in support of the audit proposition that

a) Multiplication of the applicable rate by the individual gross taxable earnings.

27. A bookkeeper perpetrated a theft by preparing erroneous W-2 forms. The bookkeeper's FICA withheld was overstated by $500.00 and the FICA withheld from all other employees was understated. Which of the following is an audit procedure which would detect such a fraud?

d) Examination of personnel department records.

28. In testing the payroll of a large company, the auditor wants to establish that the individuals included in a sample actually were employees of the company during the period under review. What will be the best source to determine this?

d) Names on the company payroll are those of bona fide employees presently on the job.

29. A surprise observation by an auditor of a client's regular distribution of payroll checks is primarily designed to satisfy the auditor that

d) Analyze transactions occurring within a few days before and after year-end.

3. To determine that sales transactions have been recorded in the proper accounting period, the auditor performs a cut-off review. Which of the following best describes the overall approach used when performing a cut-off review?

a) Observation should be limited to one or more selected departments.

30. An auditor decides that it is important and necessary to observe a client's distribution of payroll checks on a particular audit. The client organization is so large that the auditor cannot conveniently observe the distribution of the entire payroll. In these circumstances, which of the following is most acceptable to the auditor?

a) All inventory owned by the clients is on hand at the time of the count.

31. In an audit of inventories, an auditor would least likely verify that

c) Lien on the plant equipment.

32. When auditing prepaid insurance, an auditor discovers that the original insurance policy on plant equipment is not available for inspection. The policy's absence most likely indicates the possibility of a(an)

d) Request the client to schedule the physical inventory count at the end of the year.

33. A client maintains perpetual inventory records in both quantities and dollars. If the assessed level of control risk is high, an auditor would probably

c) Cash balances were overstated because of kiting.

34. An auditor should trace bank transfers for the last part of the audit period and first part of the subsequent period to detect whether

b) Perpetual inventory records are maintained.

35. Periodic or cycle counts of selected inventory times are made at various times during the year rather than single inventory count at year end. Which of the following is necessary if the auditor plans to observe inventories at interim dates?

c) Overpayments are discovered in performing tests of details.

36. An auditor most likely would extend substantive tests of payroll when

b) Standard.

4. The confirmation of the client's trade accounts receivable is a means of obtaining evidential matter and is specifically considered to be generally accepted auditing

d) The sales journal was held open after year-end.

5. Approximately 95% of returned accounts receivable confirmations indicated that the customer owed a smaller balance than the amount confirmed. This might be explained by the fact that

a) To verify cash deposited during the year.

6. Which of the following is not a principal objective of the auditor in the examination of revenues?

a) Compare shipping documents with sales records.

7. Which of the following procedures would ordinarily be expected to best reveal unrecorded sales at the balance sheet date?

d) Fictitious sales in 1980.

8. If accounts receivable turned over 7.1 times in 1979 as compared to only 5.6 times in 1980, it is possible that there were

d) Investigating responses to accounts receivable confirmations.

9. Lapping would most likely be detected by

Meter department records to the billing (sales) register. The best direction of testing is to proceed from the meter department records, which indicate those customers who have received service, to the billing (sales) register. Comparing services rendered with billings is the best way to detect omitted billings.

A CPA auditing an electric utility wishes to determine whether all customers are being billed. The CPA's best direction of test is from the

False. Cash receipts after the balance sheet date provide the best evidence of collectibility.

Cash receipts after the balance sheet date provide the least evidence of collectibility.

12/10 12/19 12/12 Goods shipped on 12/10 would have been properly recorded as a sale on 12/19, a date within the same accounting period. Moreover, the credit to inventory on 12/12 preceded the physical count on 12/15. No adjustment is necessary.

A CPA is engaged in the annual audit of a calendar year client. The client took a complete physical inventory under the CPA's observation on December 15 and adjusted its inventory account and detailed perpetual inventory records to agree with the physical inventory. The client considers a sale to be made in the period that goods are shipped. Listed below are four items taken from the CPA's sales cutoff test worksheet. Which item does not require an adjusting entry on the client's books? Shipped; Recorded as Sale; Credited to Inventory

True. The auditor should determine that the balance contains all transactions for the period. This is typically the major detection risk for the auditor in testing payables.

Completeness is typically the major detection risk for the auditor in testing payables.

False. 1.A confirmation is requested by (i.e., signed by) the client, but it should be sent by the CPA to any bank with which the client has had business during the period. 2.The form confirms the account name, account number, interest rate, and balance for deposits. 3.The form should be returned directly to the CPA.

A bank confirmation is requested by the CPA, but it should be sent by the client.

True. 1.The auditor should inspect or prepare bank reconciliations for each account. 2.The balances for the bank and the books should be equal after adjustment for deposits in transit, outstanding checks, bank charges, etc.

A bank reconciliation verifies the agreement of the bank statements obtained directly from the institution and the amount of cash reported in the financial statements.

Accounts payable are not materially understated. The auditor is primarily concerned that accounts payable are not materially understated on the balance sheet, i.e., that accounts payable are recorded at the proper amounts. This is important because current liabilities are significant in evaluating an entity's short-term solvency. Also, understatement of accounts payable understates expenses. The auditor should guard against management's tendency both to inflate earnings and to exaggerate the financial strength of the firm through understatement of liabilities and expenses or overstatement of assets and revenues.

A client's procurement system ends with the assumption of a liability and the eventual payment of the liability. Which of the following best describes the auditor's primary concern with respect to liabilities resulting from the procurement system?

Trace the cash received from the issuance to the accounting records. The auditor's best course of action is to trace the cash received from the issuance of the bonds into the accounting records to gather evidence that the transaction was recorded in the proper amounts in the appropriate accounts.

A company issued bonds for cash during the year under audit. To ascertain that this transaction was properly recorded, the auditor's best course of action is to

True. 1.The client should request that the bank send the cutoff statement directly to the auditor. 2.The cutoff bank statement should be used to test reconciling items on the year-end bank reconciliation, e.g., deposits in transit and outstanding checks. 3.The auditor searches for checks written before year-end but not listed as outstanding on the bank reconciliation. These checks are often evidence of a fraud termed kiting, which results from an improper recording of a bank transfer.

A cutoff bank statement should be requested directly from the bank for the period 7 to 10 days after year-end.

False. 1.A working trial balance is ordinarily used to record the year-end ledger balances prior to audit. Reclassifications and adjustments are accumulated on the trial balance to reflect the final audited balances. 2.Lead schedules are summaries of detailed schedules. For example, a cash lead schedule may summarize findings recorded on the cash in bank, petty cash, and count of cash on hand detail schedules.

A lead schedule balance is ordinarily used to record the year-end ledger balances prior to audit.

True. 1.Neural networks are another form of artificial intelligence. 2.An expert system imitates a human expert and relies on many programmed rules, while a neural network has a generalized learning capacity. It learns by experience.

A neural network learns from its mistakes in that it changes its knowledge database when informed of the accuracy of its decisions.

Confirmation. The auditor should confirm or investigate inventories held in public warehouses. Confirmation is efficient because of its low cost. The auditor ordinarily obtains confirmation of the existence of inventories by direct communication with the custodian. When a significant portion of current or total assets is held in a public warehouse, the auditor should consider testing the client's procedures by (1) evaluating the warehouser, (2) obtaining an independent accountant's report on the warehouser's internal control, (3) visiting the warehouse and observing physical counts, and (4) investigating the use of warehouse receipts (e.g., whether they are being used for collateral). The auditor should confirm with lenders the details of any pledged receipts.

A portion of a client's inventory is in public warehouses. Evidence of the existence of this merchandise can most efficiently be acquired through which of the following methods?

Focuses on entity-level controls and then significant amounts. The top down approach to evaluating internal control begins at the financial statement level by understanding overall risks, focusing on entity-level controls, and then working down to significant accounts. Examples of entity-level controls are controls (1) related to the control environment, (2) over management override, (3) to monitor results of operations, (4) over the period-end financial reporting process, and (5) to monitor other controls.

A practitioner is conducting an integrated examination of internal control with the audit of a nonissuer's financial statements. In applying the top-down approach, the auditor first

Access information stored on computer files while having a limited understanding of the client's hardware and software features. These packages permit the auditor to audit through the computer; e.g., to extract, compare, analyze, and summarize data; and to generate output for use in the audit. Although generalized audit software requires the auditor to provide certain specifications about the client's records, computer equipment, and file formats, a detailed knowledge of the client's system may be unnecessary because the audit package is designed to be used in many environments.

A primary advantage of using generalized audit software packages to audit the financial statements of a client that uses a computer system is that the auditor may

True. Checks should be issued only for payables recorded at year end or for payables credited since year end. Any checks that cannot be matched are likely indications of unrecorded liabilities.

A primary test to trace subsequent payments to recorded payables is to match the payments (checks) issued after year end with the related payables.

True. 1.When control risk is high (when control activities for the transaction process are not effective), a proof of cash may be prepared. 2.It provides direct evidence that both the beginning and ending balances as well as deposit and disbursement transactions recorded by the bank reconcile with transactions recorded in the accounting records for a period of time, typically a month.

A proof of cash provides direct evidence regarding the beginning and ending cash balances.

Perform tests several times during the year, rather than only at year end. Accounting records and other evidence may be available only in electronic form. For example, if EDI is used, purchase, shipping, billing, cash receipt, and cash payment transactions often occur by exchange of electronic messages instead of source documents. In an image processing system, documents are scanned and converted into electronic form for storage purposes, and the source documents may not be retained. Thus, electronic evidence may exist at a given moment in time, but it may not be retrievable after a specified period if files are changed and no backups exist. Consequently, the auditor should consider the time during which information is available to determine the nature, timing, and extent of substantive tests and tests of controls. For example, the auditor may change the timing of audit tests by performing them several times during the year instead of only at year end.

A retail entity uses electronic data interchange (EDI) in executing and recording most of its purchase transactions. The entity's auditor recognizes that the documentation of the transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would

True. 1.Test to determine that a sale and receivable were recorded when title passed to the customer, which often occurs when goods are shipped (i.e., when terms are FOB shipping point). 2.Shipping documents are traced to the accounting records for several days prior to and after year end to determine proper recognition in the appropriate period of the sale and receivable. This test detects inflated sales.

A sales cutoff test should be applied to assure that transactions are reported in the proper period.

False. A communication of internal control related matters, e.g., significant deficiencies and/or material weaknesses, should state that the purpose of the audit is to report on the financial statements, not to provide assurance on internal control.

A written communication on internal control related matters identified in an audit should state that a purpose of the financial statement audit is to provide assurance on internal control.

The report of an auditor's specialist regarding the valuation of a collection of paintings held as an investment provides greater assurance than the auditor's physical observation of the paintings. Appropriate audit evidence is relevant and reliable. Evidence is usually more reliable when it (1) is obtained from independent sources; (2) is generated internally under effective internal control; (3) is obtained directly by the auditor; (4) is in documentary form, whether paper, electronic, or another medium; and (5) consists of original documents. Preference for the report of an auditor's specialist over the auditor's physical observation of works of art is acceptable because the auditor is not expected to have such expertise. Physical observation provides evidence of the existence of assets but often does not verify their value, ownership, cost, or condition. Consequently, the generalization in favor of the auditor's direct knowledge is overcome in this case.

AU-C 500 describes five generalizations about the reliability of evidence. The situations given below indicate the relative degrees of assurance provided by two types of evidence obtained in different situations. Which describes an exception to one of the generalizations?

Rights and obligations and existence. Confirmation by means of direct (independent) communication with debtors is the generally accepted auditing procedure for accounts receivable. Properly designed requests may address any assertion in the financial statements, but they are most likely to be effective for the existence and rights and obligations assertions. Thus, confirmation provides evidence that (1) receivables are valid, (2) the client has ownership of the accounts and the right of collection, and (3) the debtor has the obligation to pay.

AU-C 505, External Confirmations, defines external confirmation as "a direct written response to the auditor from a third party (the confirming party), either in paper form or by electronic or other medium." The assertions for which confirmation of accounts receivable balances provides primary evidence are

False. According to the PCAOB's AS No.3, audit documentation must be retained for at least 7 years from the report release date.

According to the PCAOB's AS No.3, audit documentation must be retained for at least 10 years from the report release date.

False. Accounting records alone cannot be considered sufficient support for financial statements. 2.The auditor tests the accounting records by examining other supporting information using analysis, retracing, vouching, recalculation, and reconciliation.

Accounting records alone can be considered sufficient support for financial statements.

Confirmations of accounts receivable. Other information includes minutes of meetings; confirmations; and information obtained from inquiry, observation, and inspection. It includes information developed by or available to the auditor that permits valid reasoning (AU-C 500).

Accounting records alone do not provide sufficient appropriate evidence on which to base an opinion on the financial statements. Thus, the auditor should obtain other information. Which of the following is other information in this context?

True. Accounts receivable are the entity's claims against customers that have arisen from the sale of goods or services in the normal course of business and from a financial institution's loans.

Accounts receivable are the entity's claims against customers that have arisen from the sale of goods or services.

Represented by inventory tags are included in the listing. The auditor should observe the counting process, determine that proper procedures are followed, and make selected test counts. Because the auditor does not make a complete count, not every misstatement will be detected, but (s)he should be able to determine that no large block of inventory has been omitted. Having accounted for a sequence of inventory tags, the auditor should trace a sample of the tags to the physical inventory sheets. The purpose is to test the completeness assertion that all inventory listed on a tag is reflected in the inventory listing.

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

False. Manufactured goods should be costed to include direct materials, direct labor, and an allocation of overhead. The overhead allocation rate should be tested for reasonableness.

Allocation of fixed manufacturing costs to inventory during production should be avoided.

False. Accounts receivable should be presented as a current asset, minus the allowance for uncollectible accounts.

Allowance for uncollectible accounts should be added to accounts receivable and presented as a current asset.

True. The auditor ordinarily tests the documentation that supports the return to determine whether proper authorization exists and the credit to the customer's account was supported by a receiving report representing the return of goods.

Although the auditor should test all assertions, if the risk of material misstatement is low, the primary tests for sales returns and allowances will concern the occurrence and existence assertions.

Analyses of capital stock and other owners' equity accounts. The permanent section of audit documentation usually contains copies of important client documents. They may include (1) the articles of incorporation, stock options, contracts, and bylaws; (2) the engagement letter, the contract between the auditor and the client; (3) analyses from previous audits of accounts of special importance to the auditor, such as noncurrent debt, PP&E, and equity; and (4) information concerning internal control, e.g., flowcharts, organization charts, and questionnaires.

Although the quantity and content of audit documentation vary with each engagement, an auditor's permanent files most likely include

True. The inventory turnover ratio for individual inventory items is calculated because excessive inventory results in small turnover ratios and provides evidence of potentially obsolete items.

An applicable analytical procedure is to calculate the inventory turnover ratio for individual inventory items.

Valuation and allocation. Inventory should properly include the costs of direct labor, direct materials, and manufacturing overhead. Thus, to be properly measured, an appropriate amount of manufacturing overhead should be charged to inventory. Costs of an idle plant should not be included in manufacturing overhead.

An auditor concluded that no excessive costs for an idle plant were charged to inventory. This conclusion most likely related to the auditor's objective to obtain evidence about the relevant assertions regarding inventory, including presentation and disclosure and

One of the cashiers has been covering a personal embezzlement by lapping. Lapping is the theft of a cash payment from one customer concealed by crediting that customer's account when a second customer makes a payment. When lapping exists at the balance sheet date, the confirmation of customer balances will probably detect the fraud because the customers' and entity's records of lapped accounts will differ.

An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents' exceptions and comments. By this procedure, the auditor would be most likely to learn of which of the following?

There was an improper cutoff of sales at the end of the year. The receivables turnover equals net credit sales divided by average receivables. An improper sales cutoff could result in recognition of next-year sales in the current year. The effect of adding the amount of these presumably uncollected receivables to the numerator and denominator is to decrease a ratio that exceeds 1.0.

An auditor discovered that a client's accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that

The same. AS No. 5 indicates that the auditor should use the same materiality considerations in the audit of internal control over financial reporting that (s)he would use in planning the audit of annual financial statements.

An auditor is auditing internal control in conjunction with the audit of financial statements for an issuer. The auditor is considering the appropriate materiality level for planning the audit of internal control. Relative to the materiality level for the audit of the financial statements materiality levels for the audit of internal control are

Shipping document file. Matching shipping documents to sales invoices will indicate whether the shipping documents generated the preparation of a sales invoice.

An auditor is determining whether internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices. The auditor most likely would select a sample of transactions from the population represented by the

Material to the financial statements. Confirmation of accounts receivable is a generally accepted auditing procedure. The auditor should confirm accounts receivable unless (1) they are immaterial, (2) confirmation would be ineffective, or (3) the RMM based on other procedures is judged to be sufficiently low.

An auditor is required to confirm accounts receivable if the accounts receivable balances are

An increase of $8. The client should increase income by $8,000. The March 29 shipment (which resulted in a $4,000 gain) should have been recorded in April because the company records sales 3 days after shipment. Because the selling price of this shipment was greater than its cost, the effect of the error was to overstate income for March by the $4,000 difference. The April 2 shipment (which resulted in a $12,000 loss) was erroneously recorded in March. Because its selling price was less than cost, the effect of the error was to understate income for March by the $12,000 loss. The net effect of these adjustments is that income for the period ended March 31 should be increased by $8,000.

An auditor is reviewing a sales cutoff as of March 31. All sales are shipped FOB destination, and the company records sales 3 days after shipment. The auditor notes the following items: (Amounts in Thousands) Date Month Selling Shipped Recorded Price Cost March 28 March $192 $200 March 29 March 44 40 March 30 April 77 81 April 2 March 208 220 April 5 April 92 84 If the client records the required adjustments, the net effect on income in thousands of dollars for the period ended March 31 is

Valuation and allocation. Assertions about valuation and allocation address whether (1) assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and (2) resulting adjustments are properly recorded. An examination of inventory turnover pertains to identifying slow-moving, excess, defective, and obsolete items included in inventories. This audit procedure tests the valuation and allocation assertion.

An auditor most likely would analyze inventory turnover rates to obtain evidence concerning relevant assertions about

Classification and understandability. Assertions about presentation and disclosure address whether particular components of the financial statements are properly classified, described, and disclosed. Determining that the pledge or assignment of inventories is appropriately disclosed is an audit objective related to the classification and understandability assertion.

An auditor most likely would inspect loan agreements under which an entity's inventories are pledged to support management's financial statement assertion of

Valuation and allocation. The valuation and allocation assertion is directed towards whether inventory is recorded at lower of cost or market. The discovery of slow-moving, excess, defective, or obsolete inventory suggests that the cost of inventory be written down to market.

An auditor most likely would make inquiries of production and sales personnel concerning possible obsolete or slow-moving inventory to support the relevant assertion about

Seek information about other deposit and loan amounts that come to the attention of the institution in the process of completing the confirmation. The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used to confirm specifically listed deposit and loan balances. Nevertheless, the standard confirmation form contains this language: "Although we do not request or expect you to conduct a comprehensive, detailed search of your records, if, during the process of completing this confirmation, additional information about other deposit and loan accounts we may have with you comes to your attention, please include such information below."

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. A purpose of this procedure is to

Reclassifications and adjustments. A working trial balance is ordinarily used to record the year-end ledger balances prior to audit in the audit documentation. Reclassifications and adjustments are accumulated on the trial balance to reflect the final audited balances.

An auditor ordinarily uses a working trial balance resembling the financial statements without notes, but containing columns for

Vendors' invoices. Vendors' invoices are the billing documents received by the client. They describe the items purchased, the amounts due, and the payment terms. The auditor should trace these invoices to the related receiving reports.

An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this test consists of all

An opening balance in a subsidiary ledger account was improperly carried forward from the previous accounting period. By reconciling the accounts receivable ledger to the general ledger control account, transfer misstatements will be identified.

An auditor reconciles the total of the accounts receivable subsidiary ledger to the general ledger control account, as of October 31. By this procedure, the auditor would be most likely to learn of which of the following?

Completeness. Tracing the details of test counts to the final inventory schedule assures the auditor that items in the observed physical inventory are included in the inventory records. The auditor should compare the inventory tag sequence numbers in the final inventory schedule with those in the records of his/her test counts made during the client's physical inventory.

An auditor selected items for test counts while observing a client's physical inventory. The auditor then traced the test counts to the client's inventory listing. This procedure most likely obtained evidence concerning the relevant assertion about

Cash balances were overstated because of kiting. Kiting is the recording of a deposit from an interbank transfer in the current period while failing to record the related disbursement until the next period. It is a fraud that exploits the lag (float period) between the deposit of a check in one account and the time it clears the bank on which it is drawn. To detect kiting, the auditor should examine a schedule of bank transfers for a period covering a few days before and after the balance sheet date. For the procedure to be effective, however, the auditor should be assured that all transfers have been identified.

An auditor should test bank transfers for the last part of the audit period and first part of the subsequent period to detect whether

Cash disbursements. The best procedure to test whether any checks have been issued without supporting vouchers, purchase orders, and receiving reports is to select an appropriate sample of canceled checks (cash disbursements) and trace them to the related supporting documentation.

An auditor suspects that certain client employees are ordering merchandise for themselves over the Internet without recording the purchase or receipt of the merchandise. When vendors' invoices arrive, one of the employees approves the invoices for payment. After the invoices are paid, the employee destroys the invoices and the related vouchers. In gathering evidence regarding the fraud, the auditor most likely would select items for testing from the file of all

Determine that purchases were properly recorded. The auditor tests the completeness assertion for accounting records by tracing supporting documents to the entries in the records.

An auditor traced a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal. The purpose of this substantive audit procedure most likely was to

Most of the returned positive confirmation requests indicate that the debtor owes a smaller balance than the amount being confirmed. When the majority of the returned positive confirmation requests indicate smaller balances at year end than those in the client's records, the client may have held open the sales journal after year end. Thus, the client debited customers' accounts for the period under audit rather than for the subsequent period. The effect is to overstate sales and receivables.

An auditor who has confirmed accounts receivable may discover that the sales journal was held open past year end if

Included in the final inventory schedule. Tracing the details of test counts to the final inventory schedule assures the auditor that items in the observed physical inventory are included in the inventory records. The auditor should compare the inventory tag sequence numbers in the final inventory schedule to those in the records of his/her test counts made during the client's physical inventory.

An auditor will usually trace the details of the test counts made during the observation of the physical inventory taking to a final inventory schedule. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are

Review of perpetual inventory records. To identify slow-moving inventory, the auditor should review perpetual inventory records. In a perpetual system, receipts and issuances of goods are recorded as the transactions occur, both as to quantities and prices. By comparing the dates of receipt and issuance, the auditor is able to readily identify slow-moving and possibly obsolete inventory.

An auditor would be most likely to learn of slow-moving inventory through

The maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated. An auditor is responsible for determining the levels of materiality appropriate in the audit of a client's financial statements. Only the general nature of materiality need by discussed.

An auditor would least likely initiate a discussion with a client's audit committee concerning

Assess risk. The auditor is required to obtain an understanding of the entity and its environment, including its internal control, and to assess the risk of material misstatement to plan the audit. This assessment is a matter of professional judgment that cannot be accomplished with a computer.

An auditor would least likely use computer software to

The client opened a second retail outlet in the current year, and its credit sales approximately equaled those of the older, established outlet. Typically, an increase in accounts receivable usually indicates that a company is either increasing sales or making its credit terms less stringent. If a company is making its credit terms less stringent, then it should have a corresponding increase in the allowance for doubtful accounts because it is more likely that customers will default on payments. Because the allowance for doubtful account percentage remained the same, a reasonable explanation is that sales increased.

An auditor's analytical procedures performed during the overall review stage indicated that the client's accounts receivable had doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor?

Classification and understandability. Events such as the renewal of the note payable do not require adjustment of the financial statements but may require disclosure. Accordingly, the auditor should determine that the renewal had essentially the same terms and conditions as the recorded debt at year end. A significant change may affect the classification of notes payable (e.g., as current or noncurrent), the understandability of the statements, and the required disclosures.

An auditor's purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain evidence concerning relevant assertions about

Board of directors. In many organizations, governance is provided by the board of directors (and its related audit committee). However, the communication may be made to individuals at an equivalent level of authority and responsibility if the organization does not have a board.

An auditor's written communication of internal control related matters identified in an audit would be addressed to "those charged with governance," which would include the

Scanning the general journal for unusual entries. The general journal is a book of original entry used for transactions not suitable for recording in the special journals (sales, purchases, cash receipts, cash disbursements). Entries involving unusual combinations of accounts are more likely to appear in the general journal than in one of the special journals, which are designed to record large numbers of similar items. For example, credit sales (debit accounts receivable, credit sales) are entered in the sales journal.

An entity's financial statements were misstated over a period of years because large amounts of revenue were recorded in journal entries that involved debits and credits to an illogical combination of accounts. The auditor could most likely have been alerted to this fraud by

Canceled checks. The best procedure is to test whether any checks have been issued without vouchers, purchase orders, and receiving reports. An appropriate sample of canceled checks should be traced to the related supporting documentation. The checks should not have been written before the dates on the receiving reports.

An entity's internal control requires that an approved voucher, a prenumbered purchase order, and a prenumbered receiving report accompany every check request. To determine whether checks are being issued for unauthorized expenditures, an auditor most likely would select items for testing from the population of all

The form was mailed by the controller. The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used for specific deposits and loans. A confirmation is signed (requested) by the client, but it should be sent by the auditor. Thus, the auditor should control confirmation requests and responses. Control means direct communication between the intended recipient and the auditor to minimize possible bias of the results because of interception and alteration of the requests or responses.

An independent auditor asked a client's internal auditor to assist in preparing a standard financial institution confirmation request for a payroll account that had been closed during the year under audit. After the internal auditor prepared the form, the controller signed it and mailed it to the bank. What was the major flaw in this procedure?

Select and examine canceled checks and ascertain that the related vouchers are dated no later than the checks. Payment vouchers bearing the required approvals should be supported by a properly authorized purchase requisition, a purchase order executing the transaction, a receiving report indicating all goods ordered have been received in good condition, and a vendor invoice confirming the amount owed. To determine that check requests are valid, the appropriate audit procedure is therefore to compare checks and the related vouchers. The direction of testing should be from a sample of checks to the approved vouchers. If the date of a voucher is later than the date of the related check, the inference is that a check was issued without proper support.

An internal control narrative indicates that an approved voucher is required to support every check request for payment of merchandise. Which of the following procedures provides the greatest assurance that this control is operating effectively?

Properly designed and operated effectively. According to PCAOB's AS No. 5, the report states the auditor's opinion on whether the entity maintained, in all material respects, effective internal control over financial reporting as of the specified date based on the control criteria.

An issuer subject to the Securities Exchange Act of 1934 is required to include in its annual report an auditor's opinion on whether internal control over financial reporting was

True. Analytical procedures use sources of data (e.g., prior experience, budgets prepared by management at the beginning of the period, nonfinancial data, industry information, and interrelationships) to develop expectations to compare with management's presentations.

Analytical procedures are used to test various management assertions.

The client opened a second retail outlet during the current year, and its credit sales approximately equaled the older outlet. Opening a second outlet with about the same credit sales as the first explains the receivables effects. Given no change in credit policy, the characteristics of the customers served, or economic conditions, the ratio of doubtful accounts should not change.

Analytical procedures performed during an audit indicate that accounts receivable doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations would satisfy the auditor?

True. 1.Appropriateness is the measure of the quality of evidence that relates to relevance and reliability. Generalizations suggest that evidence is more reliable when it is a.Obtained from knowledgeable independent sources outside the entity b.Generated under effective internal controls c.Obtained directly by the auditor d.In documentary form (either paper or electronic) e.Represented by original documents (rather than photocopies)

Appropriate evidence, regardless of its form, must be both reliable and relevant.

False. Appropriateness is the measure of the quality of evidence. It is the relevance and reliability of evidence. Evidence is generally more reliable when it is 1.Obtained from knowledgeable independent sources outside the entity 2.Generated under effective internal controls 3.Obtained directly by the auditor 4.In documentary form (in any medium) 5.Represented by original documents (rather than photocopies)

Appropriateness is the measure of the quantity of evidence.

True. AI attempts to mimic human thinking activities.

Artificial intelligence (AI) is computer software designed to perceive, reason, and understand.

Description of the scope and nature of Drake's procedures. The report expressing an opinion on the description of controls implemented and their design (type 1 report) includes (1) a title that includes the word independent; (2) an addressee; (3) indentification of management's description of the system; (4) a reference to management's assertion and a statement of management's responsibility for the controls; (5) a statement that the service auditor's responsibility is to express an opinion on the fairness of management's description of the system and the suitability of the design of the controls in meeting the objectives; (6) a statement that the report was conducted in accordance with the AICPA attestation standards; (7) a statement that the service auditor did not test the effectiveness of the controls; (8) statements about the scope of the service auditor's procedures; (9) a statement about the inherent limitations of controls; (10) an opinion on whether, in all material respects, management's description of a system is fairly stated and whether the controls are suitably designed; (11) a statement restricting the use of the report to management of the service organization and user entities; (12) the date of the report; and (13) the name, city, and state of the service auditor.

Computer Services Company (CSC) processes payroll transactions for schools. Drake, CPA, is engaged to report on CSC's controls implemented as of a specific date. These controls are relevant to the schools' internal control, so Drake's report will be useful in providing the schools' independent auditors with information necessary to plan their audits. Drake's report expressing an opinion on CSC's controls implemented as of a specific date should contain a(n)

True. If the client held open the sales journal after year end and improperly recorded sales and receivables for the period under audit, responses to confirmations would indicate that the amounts owed as of year end are smaller than the recorded amounts.

Confirmation may detect an improper cutoff.

True. 1.Confirmation at year end provides greater assurance than at an interim date. 2.The auditor will confirm accounts receivable unless a.Receivables are immaterial b.Confirmation would be ineffective c.Risk of misstatement based on other procedures is judged sufficiently low 3.An auditor who has not confirmed accounts receivable should document how (s)he overcame this presumption.

Confirmation of accounts receivable is a generally accepted auditing procedure.

True. 1.Confirmation of accounts receivable is a generally accepted auditing procedure. The presumption is that the auditor will confirm accounts receivable unless one of the following is true: a.They are immaterial. b.Confirmation would be ineffective. c.The combined assessed level of inherent and control risk is low, and that level, together with the evidence expected to be obtained from analytical procedures or other substantive tests of details, is sufficient to reduce audit risk to an acceptably low level.

Confirmation of accounts receivable is a generally accepted auditing procedure.

False. 1.Effectiveness of confirmations depends on whether the auditor selects items from an appropriate population, for example, from a list of vendors when accounts payable are confirmed. 2.However, some confirmations are not designed to elicit evidence on completeness; e.g., the Standard Form to Confirm Account Balance Information with Financial Institutions does not provide assurance about information not listed on the form.

Confirmation requests cannot be designed to provide evidence for the completeness assertion.

False. 1.Confirming receivables may detect lapping because the balances will differ even after the auditor reconciles the timing differences. 2.Lapping is the theft of a cash payment from one customer concealed by crediting that customer's account when a second customer makes a payment.

Confirming receivables will not detect lapping because the customer's payment record and the company's receipt record will be different.

Send positive confirmation requests. The presumption that the auditor will request confirmation of receivables cannot be overcome unless (1) the receivables are not material, (2) external confirmation requests are unlikely to be effective, (3) the assessed risks of material misstatement are low, and (4) other planned substantive procedures apply to the assessed risks. None of these conditions apply. Thus, the auditor should confirm the receivables. However, negative confirmation requests are not used unless the assessed risks of material misstatement are low. Because the municipality's internal control is ineffective, the auditor should send positive confirmation requests.

Cooper, CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is ineffective. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely

True. During the count, the auditor should 1.Control all cash and negotiable securities to protect against substitution. 2.Determine that all received checks are payable to the client. 3.Determine that all received checks are endorsed "For Deposit Only into Account Number XXXX."

Counting cash on hand tests the existence assertion.

False. Management may be motivated to delay recording of liabilities to improve the current ratio. Unrecorded accounts payable must be paid, and financial statements that fail to report all liabilities at year end are misstated.

Delayed recording of liabilities is an acceptable method of ratio management.

Search for significant deficiencies in the operation of internal control. The auditor should obtain an understanding of the entity and its environment, including its internal control, and assess risks of material misstatement. The limited purpose of this consideration does not include the search for significant deficiencies or material weaknesses.

During consideration of internal control in a financial statement audit, an auditor is not obligated to

Adverse opinion of internal control. Material weaknesses are significant control deficiencies that result in more than a remote chance that a material misstatement will result in the financial statements. A material weakness requires the auditor to express an adverse opinion on the effectiveness of internal control.

During the audit of internal controls integrated with the audit of the financial statements, the auditor discovered a material weakness in internal control. The auditor most likely will express a(n)

There were significant changes in the application of significant accounting policies. The auditor should determine that those charged with governance are informed about the initial selection of and changes in significant accounting policies or their application. Moreover, the auditor should discuss the quality of the auditee's accounting principles as applied in its financial reports (AU-C 260).

During the planning phase of an audit, an auditor is identifying matters for communication to those charged with governance. The auditor most likely would ask management whether

Verify that the amount was received. Responses to confirmation requests that involve significant differences are investigated by the auditor. Others are delegated to client employees with a request that explanations be given to the auditor. Such differences often arise because of recent cash payments. In that event, the auditor should trace remittances to verify that stated amounts were received.

During the process of confirming receivables as of December 31, Year 1, a positive confirmation was returned indicating the "balance owed as of December 31 was paid on January 9, Year 2." The auditor would most likely

Difficulty and cost involved in testing a particular item. The costs and benefits of obtaining evidence should have a rational relationship. However, the difficulty, time, or cost required to perform a procedure is not in itself a valid reason for its omission if no alternative is available. Such matters also do not justify being satisfied with audit evidence that is less than persuasive (AU-C 500).

Each of the following might, by itself, form a valid basis for an auditor to decide to omit a procedure except for the

True. Audit evidence is all information used by the auditor in arriving at the conclusion on which the audit opinion is based.

Evidence supporting the financial statements consists of accounting records and all other information available to the auditor.

Deposits in transit of the applicable bank reconciliation. The tick marks indicate transfers recorded by the depository banks in January that were recorded in the books in December. Accordingly, these transactions were deposits in transit at December 31 and should have been included in the appropriate bank reconciliations.

Fact Pattern: Miles Company Bank Transfer Schedule December 31 Date Date Disbursed Deposited Accounts Per Per Check Number From To Amount Books Bank Books Bank 2020 1st Natl. Suburban $32,000 12/31 1/5 þ 12/31 1/3Ø 2021 1st Natl. Capital 21,000 12/31 1/4 þ 12/31 1/3Ø 3217 2nd State Suburban 6,700 1/3 1/5 1/3 1/6 0659 Midtown Suburban 5,500 12/30 1/5 þ 12/30 1/3Ø The tick mark Ø most likely indicates that the amount was traced to the

1. An outstanding check is written on the disbursing bank in the current period, but does not clear the bank until the subsequent period. Transfer (1) does not reflect an outstanding check because the disbursement was recorded in the books on 12/30 and by the bank on 12/31.

Fact Pattern: Listed below are four of a client's interbank cash transfers, indicated by the numbers 1, 2, 3, and 4, for late December and early in the following January. Your answer choice for each question should be selected from this list. Bank Account One Bank Account Two Disbursing Date Receiving Date (Month/Day) (Month/Day) Per Per Per Per Bank Books Bank Books 1. 12/31 12/30 12/31 12/30 2. 1/2 12/30 12/31 12/31 3. 1/3 12/31 1/2 1/2 4. 1/3 12/31 1/2 12/31 Which of the cash transfers would not appear as an outstanding check on the December 31 bank reconciliation?

#202 and #404. Kiting is the recording of a deposit from an interbank transfer in the current period while failing to record the related disbursement until the next period. It is a fraud that exploits the lag (float period) between the deposit of a check in one account and the time it clears the bank on which it is drawn. Checks #202 and #404 may indicate kiting. They were recorded as receipts on the books in the current period. However, they were recorded as disbursements on the books in the next year.

Fact Pattern: The following was taken from the bank transfer schedule prepared during the audit of Fox Co.'s financial statements for the year ended December 31, Year 1. Assume all checks are dated and issued on December 30, Year 1. Bank Accounts Disbursement Date Receipt Date Check Per Per Per Per No. From To Books Bank Books Bank 101 National Federal Dec. 30 Jan. 4 Dec. 30 Jan. 3 202 County State Jan. 3 Jan. 2 Dec. 30 Dec. 31 303 Federal American Dec. 31 Jan. 3 Jan. 2 Jan. 2 404 State Republic Jan. 2 Jan. 2 Dec. 31 Jan. 2 Which of the following checks might indicate kiting?

Determine whether management's report is complete and properly presented. According to PCAOB AS No. 5, the auditor must express (or disclaim) an opinion on the effectiveness of internal control. Furthermore, if the auditor determines that elements of management's annual report on internal control over financial reporting are incomplete or improperly presented, the auditor should modify his/her report to describe the reasons for this determination.

Firms subject to the reporting requirements of the Securities Exchange Act of 1934 are required by the Foreign Corrupt Practices Act of 1977 to maintain satisfactory internal control. Moreover, the Sarbanes-Oxley Act of 2002 requires that annual reports include (1) a statement of management's responsibility for establishing and maintaining adequate internal control and procedures for financial reporting, and (2) management's assessment of their effectiveness. The role of the registered auditor relative to the assessment made by management is to

Determine whether management's report is complete and properly presented. According to PCAOB AS No. 5, the auditor must express (or disclaim) an opinion on the effectiveness of internal control. Moreover, if the auditor determines that elements of management's annual report on internal control over financial reporting are incomplete or improperly presented, the auditor should modify his/her report to describe the reasons for this determination.

Firms subject to the reporting requirements of the Securities Exchange Act of 1934 are required by the Foreign Corrupt Practices Act of 1977 to maintain satisfactory internal control. Moreover, the Sarbanes-Oxley Act of 2002 requires that annual reports include (1) a statement of management's responsibility for establishing and maintaining adequate internal control and procedures for financial reporting, and (2) management's assessment of their effectiveness. The role of the registered auditor relative to the assessment made by management is to

False. For the auditor to satisfactorily complete an audit of internal control over financial reporting, management must accept responsibility for the effectiveness of internal control.

For the auditor to satisfactorily complete an audit of internal control over financial reporting, the auditor must accept responsibility for the effectiveness of internal control.

Yes Yes Generalized audit software is useful for both tests of controls and substantive procedures. It can be used to perform audit tasks such as (1) sampling and selecting items; (2) testing extensions, footings, and calculations; (3) examining records; (4) summarizing and sorting data; and (5) performing analytical procedures.

Generalized audit software is useful for Tests of Controls Substantive Procedures

True. 1.Generalized audit software is software that is written to interface with many different client systems. 2.It can be used to test the effectiveness of controls as well as to perform analytical procedures and tests of details.

Generalized audit software is useful for both tests of controls and substantive tests.

False. Goods shipped FOB destination should be recorded in the period received. Receiving documents are traced to the accounting records by the auditor for several days prior to and after year end to determine proper recognition of inventory and accounts payable. Goods shipped FOB shipping point should be recorded in the period of shipment to the client.

Goods shipped by a vendor to the client FOB destination on the last day of the year should be recorded in the period of shipment by the client.

True. 1.The auditor might decide to attempt to confirm the receivables previously written off. 2.If the write-offs were legitimate, most requests will be marked Return to Sender because the debtors will probably not be in business.

If controls over the write-off of bad debts are weak, the auditor will perform specific substantive tests to control for the risks.

False. When the auditor has not received replies to positive confirmation requests, (s)he should apply alternative procedures to the nonresponses to reduce audit risk to an acceptably low level.

If the auditor does not receive a reply to positive confirmation requests, the auditor should assume that the client is involved in fraud and withdraw from the engagement.

False. If the auditor has substantial doubt about any assertion of material significance, (s)he must refrain from forming an opinion until (s)he has obtained sufficient appropriate evidence to remove the doubt, express a qualified opinion, or disclaim an opinion.

If the auditor has substantial doubt about any assertion of material significance, (s)he may still form and express an unmodified opinion.

Allowance for doubtful accounts. During a recession, receivables may increase because collections have slowed. Whenever collections of receivables have slowed, the auditor should determine the effects on the allowance for doubtful accounts. (S)he should therefore expand tests of collectibility, e.g., with a review of collections subsequent to the balance sheet date and investigation of credit ratings.

If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts?

False. If the entity uses the perpetual inventory method, counts may be made at interim dates if records are well kept.

If the entity uses the periodic inventory method, counts may be made at interim dates if records are well kept.

Accounting records with the source documents. Overstatements of sales likely result from entries with no supporting documentation. The proper direction of testing is to sample entries in the sales account and vouch them to the shipping documents. The source documents represent the valid sales.

If the objective of a test of details is to detect overstatements of sales, the auditor should compare transactions in the

Shipping documents to the sales invoices. If a shipment occurred, matching shipping documents to recorded sales would disclose the understatement if no recorded sale could be found.

If the objective of an auditor's test of details is to detect a possible understatement of sales, the auditor most likely would trace transactions from the

Purchases. In a perpetual system, purchases are debited directly to inventory at the time of the transaction rather than to a purchases account. A sale requires an immediate credit to inventory. Thus, failure to record a purchase would understate inventory.

If the perpetual inventory records show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded

False. The user auditor should not refer to the service auditor's report as a basis, in part, for his/her own opinion because the service auditor was not responsible for examining any portion of the user organization's statements.

If the service auditor has a good reputation, the user auditor may refer to the service auditor's report as a basis for the opinion.

Yes Yes The matters to be discussed with those charged with governance include the quality of the accounting principles used by management. Management is normally a participant in the discussion. Matters covered may include the auditor's views on the entity's significant accounting practices, e.g., policies, estimates, and disclosures. Furthermore, in any audit engagement, the auditor and those charged with governance should discuss any major issues discussed with management in connection with the initial or recurring retention of the auditors, for example, issues concerning the application of accounting principles and auditing standards.

In an audit engagement, should an auditor communicate the following matters to those charged with governance? Auditor's Judgments About the Quality of The Client's Accounting Principles; Issues Discussed with Management Prior to the Auditor's Retention

Yes Yes The matters to be discussed with those charged with governance include the quality of the accounting principles used by management. Management is normally a participant in the discussion. Matters covered may include the auditor's views on the entity's significant accounting practices, e.g., policies, estimates, and disclosures. Furthermore, in any audit engagement, the auditor and those charged with governance should discuss any major issues discussed with management in connection with the initial or recurring retention of the auditors, for example, issues concerning the application of accounting principles and auditing standards.

In an audit engagement, should an auditor communicate the following matters to those charged with governance? Auditors' Judgments Issues Discussed About the Quality of with Management the Client's Prior to the Accounting Principles Auditor's Retention

Both material weaknesses and significant deficiencies. The auditor should communicate, in writing, to management and to those charged with governance all material weaknesses and significant deficiencies indentified during the audit. The written communication should be made prior to the report release date. The auditor also should communicate to management, in writing, all lesser deficiencies in internal control and inform those charged with governance when such a communication has been made.

In an examination of internal control over financial reporting, which deficiencies in control should be communicated in writing to those charged with governance?

False. The auditor begins at the financial statement level by understanding overall risks. (S)he then focuses on entity-level controls and works down to significant accounts and disclosures and their relevant assertions. Examples of entity-level controls are controls 1.Related to the control environment 2.Over management override 3.To monitor results of operations 4.Over the period-end financial reporting process 5.To monitor other controls

In assessing controls for an audit of internal control, the auditor begins at the transaction level and performs a bottom up approach.

Individual invoices. The sampling unit is an individual item included in a population. It may be a physical thing or a monetary unit. When testing accounts receivable, it is important to determine that the transactions have been recorded appropriately. Thus, the auditor should compare the transactions recorded in accounts receivable with the individual invoices.

In confirming a client's accounts receivable in prior years, an auditor discovered many differences between recorded account balances and confirmation replies. These differences were resolved and were not misstatements. In defining the sampling unit for the current year's audit, the auditor most likely would choose

A client-prepared statement of account showing the details of the customer's account balance. A confirmation request should contain management's authorization to the confirming party to respond. Also, an external confirmation should be requested by the client because the receiving party has no relationship with the client's auditor. In confirming the customer's account balance, display of the details of the balance will likely help the customer in reconciling the amount and may increase response rates. The auditor, however, will send the request directly to the customer, who will be requested to send the response directly to the auditor.

In confirming accounts receivable, an auditor decided to confirm customers' account balances rather than individual invoices. Which of the following most likely will be included with the client's confirmation letter?

General ledger information, such as account numbers, prior-year account balances, and current-year unadjusted information. Lead schedules are summaries of detailed schedules. To create these summaries, general ledger information is needed. A lead schedule contains the detailed accounts from the general ledger making up the line item total. For example, a cash lead schedule may summarize findings recorded on the cash in bank, petty cash, and count-of-cash-on-hand detail schedules.

In creating lead schedules for an audit engagement, a CPA often uses automated audit documentation software. What client information is needed to begin this process?

Original source documents. Determining whether transactions have been recorded is a test of the completeness assertion. Thus, beginning with the original source documents and tracing the transactions to the appropriate accounting records determines whether they were recorded.

In determining whether transactions have been recorded, the direction of the audit testing should begin from the

Valuation and allocation. Assertions about valuation and allocation concern whether financial statement components have been included at appropriate amounts in accordance with the applicable financial reporting framework. For example, management asserts that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Aging the receivables is a procedure for assessing the reasonableness of the allowance.

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 assertion of

Send confirmations to customers. Confirmations to customers are substantive procedures used to test the existence assertion. They are not useful in obtaining an understanding of controls.

In obtaining an understanding of an issuer's internal control, an auditor does all the following except

Sales. In auditing the sales or revenue account, tests of controls are particularly appropriate, provided the auditor believes that the risks of material misstatement at the relevant assertion level can be assessed at a low level. Because of the large volume of transactions, examining all items will seldom be cost-effective.

In the audit of which of the following general ledger accounts will tests of controls be particularly appropriate?

Request confirmation of a sample of the inactive accounts. When the risk of material misstatement at the relevant assertion level is at an acceptably low level, the auditor will confirm only a sample of receivables. The sample should include inactive or past due accounts. If such accounts are to be regarded as assets, acknowledgment of the debts must be obtained. Confirming inactive accounts may also detect lapping or establish what amounts are in dispute.

In the confirmation of accounts receivable, the auditor would most likely

Invoices. Vendor invoices, which state the items purchased, the amount due, and the payment terms, document inventory cost when compared with purchase orders and receiving reports.

In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor would be most interested in examining the purchase

False. Inherent risk is high for cash, so most audit procedures are directed toward existence.

Inherent risk for the existence assertion is low for cash.

Valuation. The audit objective of identifying slow-moving, excess, defective, and obsolete items pertains to the valuation or allocation assertion. Among the audit procedures that may help achieve this audit objective are (1) examining an analysis of inventory turnover, (2) reviewing industry experience and trends, (3) analytically comparing the relationship of inventory and sales volume, (4) observing the count of the physical inventory, and (5) inquiring about possible excess or obsolete items.

Inquiries of warehouse personnel concerning possible obsolete or slow-moving inventory items provide assurance about management's assertion of

False. Inventory consists only of the goods held for resale by the client.

Inventory consists of all short-term assets held by the client.

True. U.S. GAAP indicates that a departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as its cost. This is generally accomplished by stating such goods at a lower level commonly designated as market.

Inventory is recorded at lower of cost or market.

False. Adequate disclosures concerning inventory valuation, cost flow assumptions, and significant transactions such as pledging of inventory are often required in notes to the financial statements.

Inventory seldom requires disclosure of issues in the notes to the financial statements.

Lake may not refer to Cope under the circumstances above. The service auditor was not responsible for examining any portion of the user entity's financial statements. Hence, the user auditor should not refer to the service auditor's report as a basis in part for his/her own opinion on those financial statements (AU-C 402).

Lake, CPA, is auditing the financial statements of Gill Co. Gill uses EDP Service Center, Inc. to process its payroll transactions. EDP's financial statements are audited by Cope, CPA, who recently issues a report on EDP's internal control. Lake is considering Cope's report on EDP's internal control in assessing control risk on the Gill engagement. What is Lake's responsibility concerning making reference to Cope as a basis, in part, for Lake's own opinion?

The auditor may accept the engagement if management provides a statement that the identified material weakness no longer exists. PCAOB AS No.4 applies to engagements solely to report on whether a previously reported material continues to exist. Such an engagement is voluntary and may be performed as of any reasonable date selected by management. To perform such an engagement, the auditor should receive a written report from management that the identified material weakness no longer exists as of the date specified. The auditor then applies appropriate procedures to assess whether remediation has been accomplished.

Management of an issuer subject to SEC requirements requests the auditor to report on whether a previously reported material weakness in internal control continues to exist. The request comes 3 months after the annual audited financial statements and report on internal control were released

False. 1.The auditor should control the requests. 2.Control means direct communication between the intended recipient and the auditor to minimize possible bias because of interception and alteration of the requests or responses.

Management should control confirmation requests and responses during the performance of procedures.

The issuance of the stock and reduction in convertible debt. Information about noncash financing and investing activities must be reported in related disclosures but not on the face of the statement of cash flows. Exclusion of such transactions from the statement avoids complicating it and emphasizes the entity's cash receipts and payments. The issuance of stock and the reduction of convertible debt should therefore be disclosed in a related but separate schedule. All financing (and investing) activities during the period should be reported, including those that do not directly affect cash.

Many of the Granada Corporation's convertible bondholders have converted their bonds into stock during the year under audit. The independent auditor should review the Granada Corporation's statement of cash flows and related disclosures to ascertain that they show

False. Positive confirmation may ask the respondent to state whether (s)he agrees with the information given or request that the recipient fill in an account balance (termed a blank form) or provide other information.

Negative confirmation requests a reply regardless of whether the respondent agrees with the information stated.

True. The auditor should observe and make test counts but is not responsible for taking inventory.

Observation of inventories is a generally accepted auditing procedure.

True. The auditor must observe and make test counts even if inventory is taken by independent specialists (i.e., businesses that perform inventory counts as their service).

Observations should encompass all significant inventory locations.

Examining paid checks returned with the bank statement of the next accounting period after year end. Because the check used to make the bank transfer is not recorded in the current period, the check is not listed as outstanding on the reconciliation of the bank account on which it was drawn. The auditor detects kiting by comparing paid checks, returned in the next period and dated prior to year end, with the checks listed as outstanding on the related bank reconciliation. In other words, the auditor searches for checks that should have been listed as outstanding but were not.

On the last day of the fiscal year, the cash disbursements clerk drew a company check on bank A and deposited the check in the company account bank B to cover a previous theft of cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by

Expand tests of collectibility. Whenever collections of receivables have slowed, the auditor should determine the effects on the allowance for doubtful accounts. (S)he should therefore expand tests of collectibility, e.g., with a review of collections subsequent to the balance sheet date and investigation of credit ratings. The verification of the allowance for doubtful accounts ensures that receivables are fairly presented at their net realizable value in the balance sheet and that bad debt expense is fairly stated in the income statement.

Once a CPA has determined that accounts receivable have increased because of slow collections in a tight money environment, the CPA is likely to

False. 1.Negative confirmations request the recipient to respond only if (s)he disagrees with the information stated. 2.Negative forms are used to reduce audit risk to an acceptable level when the combined assessed level of inherent and control risk is low, a large number of small balances is involved, a very low exception rate is expected, and the auditor has no reason to believe that the recipients are unlikely to give them consideration. 3.The auditor should consider performing other substantive procedures to supplement the use of negative confirmation.

Positive confirmations request the recipient to respond only if (s)he disagrees with the information stated.

False. 1.Preparing a schedule of interbank transfers can help detect errors in transfers but may not be effective in the detection of kiting because the disbursement has not been recorded. 2.For this procedure to be effective, the auditor should be assured that all transfers have been identified.

Preparing a schedule of interbank transfers from the cash disbursement records assures detection of kiting.

False. Accounts payable should be presented as a current liability on the balance sheet. Purchases should be used in the determination of cost of sales for the income statement.

Proper presentation of purchases and accounts payable require their inclusion on the balance sheet.

Purchased and whose title has passed before year end was recorded. Evaluations of purchase transactions at year end are performed to test the cutoff assertion about inventories. Tests are performed to obtain evidence that all goods owned by the client at the balance sheet date are included in inventory and that the related liability is recorded. Legal title to goods in transit is determined by whether the shipping terms are FOB shipping point or destination.

Purchase cutoff procedures should be designed to test whether all inventory

False. Cutoff tests should provide evidence that the inventory owned by the entity at year end was actually reflected in inventory and accounts payable. The calculation of amounts and ratios and their comparison with expectations can identify unusual findings indicative of misstatements.

Purchase cutoff procedures would focus on a sample of transactions occurring throughout the year.

False. Restricted cash (e.g., sinking funds and compensating balances) is reported in the noncurrent asset section of the balance sheet.

Restricted cash is reported in the current asset section of the balance sheet.

False. The risk is relatively low that management would present liabilities of others; thus, the procedures testing rights and obligations associated with accounts payable are not as consequential as those for other assertions.

Rights and obligations associated with accounts payable is an area of high risk for auditors.

False. 1.In most cases, risks related to ownership (rights) are low and few specific tests are applied. 2.However, confirmation procedures discussed with respect to the existence assertion provide evidence for this assertion. 3.Inquiries of management are also appropriate.

Risks related to ownership of cash are high.

True. 1.The auditor should read note disclosures to determine that accounting policies are disclosed (e.g., accounts receivable should be presented at net realizable value). 2.Pledges of accounts receivable should be disclosed. 3.Any significant sales or receivables transactions with related parties should also be disclosed.

Significant sales with related parties and pledges of accounts receivable should be disclosed.

False. When the nature of the client or industry suggests the possibility of consignment transactions (e.g., the client has held or shipped consigned goods in the past), the auditor should review the client's correspondence, evaluate sales and receivables records, and consider the results of vouching purchases to detect unrecognized consignment activity.

Since inventory is measured by what is on hand, an auditor may ignore the industry or client practices for consigned goods.

Large debits to accounts receivable and small periodic credits. A consignment is a shipment of inventory by the owner to a sales agent (the consignee), who sells the goods and then pays the consignor. Goods on consignment are owned by the consignor. If the entity does not distinguish between consignments and sales, large debits to accounts receivable and small periodic credits suggest that large quantities have been consigned, and smaller quantities have been sold. Typically, consignment payments are remitted periodically as the consignee makes sales. Failing to distinguish sales and consignments overstates net income and understates inventory.

Some firms that dispose of only a small part of their total output by consignment shipments fail to make any distinction between consignment shipments and regular sales. Which of the following would suggest to the auditor that the client's goods have been shipped on consignment?

False. Generalized audit software can be used to perform audit tasks such as sampling and selecting items (e.g., confirmations); testing extensions, footings, and calculations; examining records (e.g., accounts receivable for amounts in excess of credit limits); summarizing and sorting data; performing analytical procedures, such as comparing inventory records with transaction details; and file access and file reorganization.

Statistical sampling is beyond the capability of most generalized audit software; customized audit software is usually required for this operation.

True. Substantive tests are used to detect material misstatements at the assertion level and include: 1.Tests of details of transactions, account balances, and disclosures, and 2.Substantive analytical procedures.

Substantive tests used to detect material misstatements include tests of details of transactions, account balances, and disclosures as well as substantive analytical procedures.

False. Sufficiency is the measure of the quantity of evidence. The greater the risk of material misstatement, the more evidence required.

Sufficiency is the measure of the quality of audit evidence.

True. Sufficiency of audit evidence is the measure of the quantity of evidence. 1.The greater the RMM, the more evidence required. 2.The higher the quality of evidence, the less evidence required.

Sufficiency of audit evidence is the measure of the quantity of evidence.

True. Purchases obviously result in ending inventory, but because inventory is a significant item on the balance sheet, a separate audit plan is typically developed for the account.

Testing assertions about accounts payable provides evidence concerning the assertions about purchases and ultimately cost of goods sold.

False. Testing assertions about accounts receivable results in evidence relevant to the assertions about sales revenues and vice versa.

Testing assertions about accounts receivable provides little or no evidence relevant to the assertions about sales revenues.

Cutoff. The cutoff assertion is that transactions and events have been recorded in the correct accounting period. It is tested by examining recorded sales for several days before and after the balance sheet date and comparing them with sales invoices and shipping documents. The auditor may detect the recording of a sale in a period other than that in which title passed.

Tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management's assertion of

Cutoff. The cutoff assertion is that transactions and events have been recorded in the proper period. To determine that all goods for which title has passed to the client at year end are recorded in inventory and accounts payable, a purchases cutoff test is appropriate.

Tests designed to detect purchases made before the end of the year that have been recorded in the subsequent year most likely would provide assurance about the relevant assertion regarding

The company is more aggressively collecting customer accounts. The accounts receivable turnover ratio equals net credit sales divided by average accounts receivable. Thus, the ratio increases if the entity more effectively collects accounts while holding other factors, such as credit policy, constant.

The accounts receivable turnover ratio increased significantly over a two-year period. This trend could indicate that

Need not test the service organization's internal control if the user entity has effective controls related to service organization processing. The significance of controls at the service organization depends on the degree of interaction between its activities and those of the user entity. The degree of interaction is the extent to which the user entity can, and chooses to, implement effective controls over service organization processing. In these circumstances, the user auditor may be able to obtain an understanding from the user entity of the service organization's services that suffices to assess the RMMs. Accordingly, the user auditor need not obtain a type 1 or type 2 report.

The activities of the user entity and the service organization have a high degree of interaction. The user auditor

Sale in the current period. Goods on hand and counted in the year-end inventory also should not have been recorded as sold during the current audit period. If they were sold, they could not have been owned by the client at year end. The auditor should perform cutoff tests to assure the proper recording of year-end inventory. These tests include comparison of the records of sales and purchases for several days before and after the balance sheet date with duplicate sales invoices and shipping records. Items purchased and items not yet sold should be in inventory. Items sold or not yet purchased should not be in inventory.

The audit of year-end physical inventories should include steps to verify that the client's purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year end was not recorded as a

Accrued liabilities usually pertain to services of a continuing nature whereas accounts payable are the result of completed transactions. The procedures differ because the balances result from different transactional processes. Liabilities are accrued for such continuing transactions as rent, salaries, and interest. Accounts payable are short-term obligations arising from the purchase of goods and services in the ordinary course of business.

The audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable because

False. The auditor should ensure that the client obtains a valid count.

The auditor must not influence the client in any way during the planning for the physical count of inventory.

True. The auditor ordinarily obtains confirmation by direct communication with the custodian. When a significant portion of current or total assets is held in a public warehouse, the auditor should consider testing the client's procedures by evaluating the warehouseman, obtaining an independent accountant's report on the warehouseman's internal control, visiting the warehouse and observing physical counts, and investigating the use of warehouse receipts (e.g., whether they are being used for collateral). The auditor should confirm with lenders the details of any pledged receipts.

The auditor should confirm or investigate client inventories held in public warehouses.

True. 1.The communication is expected to be two-way. If the communication is oral, it should be documented by memoranda or notations in the audit documentation. The auditor may want to review any minutes prepared by those charged with governance to determine that they are consistent with the auditor's understanding of the communication. If the auditor's communication is written, it should state that it is intended solely for those charged with governance, and, if appropriate, management. 2.The auditor should communicate with those charged with governance on a sufficiently timely basis to enable those charged with governance to take appropriate action. 3.GAAS does not preclude communications about other matters or with others in the organization.

The auditor should ensure that those charged with governance receive additional information about the audit that may assist in the oversight process.

True. The auditor should also inquire of management about consigned goods, major purchase commitments, pledging of inventory, and other significant transactions or events. A management representation letter that includes assertions relating to inventory and cost of sales should also be obtained.

The auditor should inspect the financial statements to determine that accounts are properly reflected and notes adequately informative.

True. Performing tests of the count should include Observing employees following the plan Assuring that all items are tagged Observing employees making counts and recording amounts on tags Determining that tags and inventory summary sheets are controlled Making test counts, comparing test counts with amounts recorded on the tags and summary sheets, and reconciling amounts with records Being alert for empty boxes, empty squares (i.e., boxes stacked to suggest the block of boxes is solid when the middle does not contain boxes), and inventory defects (e.g., damaged or dirty items) Establishing a cutoff by documenting the last receiving report and shipping document

The auditor should perform test counts of inventory regardless of methods employed.

True. The auditor should search the unpaid voucher suspense files for unmatched documents to determine whether relevant documents have been lost, misplaced, or misfiled.

The auditor should search the unpaid voucher suspense files for unmatched documents to determine whether relevant documents have been lost, misplaced, or misfiled.

True. The auditor should use appropriate sources of data (e.g., prior experience, budgets prepared by management at the beginning of the period, nonfinancial information, industry data, and interrelationships) to form expectations with which to compare management's presentations.

The auditor should use appropriate sources of data (e.g., prior experience, budgets prepared by management at the beginning of the period, nonfinancial information, industry data, and interrelationships) to form expectations with which to compare management's presentations.

False. 1.The auditor's audit objectives do not change based on the method of processing information (i.e., manually or electronically). 2.The methods of applying audit procedures to gather evidence, however, may be influenced by the data processing method. The more computerized an accounting system, the more the auditor must use information technology-assisted audit techniques to obtain evidence.

The auditor's audit objectives change based on the method of processing information (i.e., manually or electronically).

Bank reconciliations. A bank reconciliation verifies the agreement of the bank statements obtained directly from the institution and the amount of cash reported in the financial statements. These amounts should be equal after adjustment for deposits in transit, outstanding checks, bank charges, etc. Thus, a bank reconciliation documents direct (primary) evidence of the year-end bank balance.

The best evidence regarding year-end bank balances is documented in the

More nonresponses to the requests are likely to occur. A positive confirmation request asks for a reply in all cases. It may ask the confirming parties to state whether they agree with the information given or to provide information. Thus, positive confirmation requests obtain evidence only when responses are received. Blank confirmation requests are used to reduce the risk that recipients will respond without verifying the information. They omit the amount or other information to be confirmed and ask the confirming parties to fill in the information. The disadvantage is a lower response rate because of the additional effort required.

The blank form of accounts receivable confirmations may be inefficient because

True. The calculation of amounts and ratios and their comparison with expectations can identify unusual findings indicative of misstatements. Industry averages for the client's industry can be compared with the client's ratio.

The calculation of amounts and ratios and their comparison with expectations can identify unusual findings indicative of misstatements.

Search for significant deficiencies in the operation of internal control. The auditor should obtain an understanding of the entity and its environment, including its internal control, and assess the risks of material misstatement. The limited purpose of this consideration does not include the search for significant deficiencies or material weaknesses.

During consideration of internal control in a financial statement audit, an auditor is not obligated to

Accept the confirmation but verify the source and content through a telephone call to the respondent. When responses other than mailed written communications (e.g., responses received electronically, such as by fax or email) are received, additional evidence may be required to support their validity. The auditor may wish to verify the sources by calling the purported senders or by having the sender mail the original confirmation directly to the auditor. But an electronic confirmation system may be sufficiently secure and well controlled to mitigate the risks of interception or alteration. For example, encryption, electronic signatures, or procedures to verify website authenticity may be used.

During the confirmation of accounts receivable, an auditor receives a confirmation via the client's fax machine. Which of the following actions should an auditor take?

True. The auditor is not required to communicate the problem unless it affects the applicable period under audit. However, the auditor is not precluded from providing the information to management, those charged with governance, or others within the organization.

If an auditor becomes aware of a potential future internal control deficiency while performing an audit, the auditor is not required to report the problem in the written communication on internal control unless it affects the applicable period under audit.

False. Significant deficiencies and material weaknesses should be separately defined and disclosed in the auditor's required written communication of internal control matters identified in the audit. This communication would be directed to management and those charged with governance.

If an internal control deficiency is of such magnitude as to be a material weakness, it may be, but is not required to be, separately identified and communicated from other significant deficiencies.

Individual invoices. When external confirmation of the balances of accounts receivable is difficult, confirming individual transactions represented by individual invoices is likely to be preferable. The invoices should not be difficult to reconcile with confirmed amounts.

In confirming a client's accounts receivable in prior years, an auditor found that there were many differences between the recorded account balances and the confirmation replies. These differences, which were not misstatements, required substantial time to resolve. In defining the sampling unit for the current year's audit, the auditor most likely would choose

It consulted with another CPA firm about accounting matters. Unless all those charged with governance are managers, the auditor should communicate his/her views on significant accounting and auditing matters about which management consulted with other accountants (AU-C 260).

In identifying matters for communication with an entity's audit committee, an auditor most likely would ask management whether

Management provides assurance that limitations inherent to internal control have been eliminated. By their nature, limitations inherent to internal control cannot be eliminated. Thus, management is not expected to provide such assurance.

In the audit of a nonissuer, the auditor reports on the effectiveness of an entity's internal control over financial reporting. Which of the following is not a condition of that engagement?

True. In the audit of internal control, the auditor expresses an opinion directly on the effectiveness of internal control over financial reporting.

In the audit of internal control, the auditor expresses an opinion directly on the effectiveness of internal control over financial reporting.

False. Internal control over financial reporting should provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the applicable financial reporting framework.

Internal control over financial reporting should provide maximum assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the applicable financial reporting framework.

Details of the procedures that the auditor intends to apply. The auditor should communicate an overview of the scope and timing of the audit to those charged with governance. But the auditor should not communicate the nature and timing of detailed audit procedures. The auditor exercises professional judgment in determining the appropriate procedures. To remain independent, (s)he must not subordinate this judgment to others. Also, audit testing is done on a sample basis, and management should not have knowledge of how samples are selected. With such knowledge, the audit process may be circumvented.

It would not be appropriate for the auditor to initiate discussion with the audit committee concerning

A copy of the financial statements. The current file of the auditor's audit documentation includes all working papers applicable to the current year under audit. A copy of the financial statements must be included in the current file because the amounts included in these statements are the focus of the audit.

The current file of the auditor's audit documentation ordinarily should include

Desirable by-product of an audit engagement. During an audit, the auditor may become aware of matters related to internal control that may be of interest to management and those charged with governance. Those matters meeting the definition of significant deficiencies or material weaknesses in internal control should be communicated in writing. Other deficiencies that merit attention should be communicated to management either orally or in writing. The auditor may make constructive suggestions to the client for improvements in its internal control for the benefit of management or others.

The development of constructive suggestions to a client for improvements in its internal control is a

True. 1.A rational relationship should exist between the cost of obtaining evidence and the usefulness of the information obtained. 2.The amounts and kinds of evidence needed are matters to be determined in the exercise of the professional judgment of the auditor. 3.The auditor typically has to rely on persuasive, rather than convincing, evidence. 4.The auditor must decide whether the evidence available within time and cost limits is sufficient to justify the opinion.

The difficulty and the expense involved in testing a particular item are not in themselves a valid basis for omitting the test.

Timing of inventory observation procedures to be performed. The client is responsible for taking the physical inventory. The auditor is responsible for observing this process and performing test counts. The audit procedures are dependent upon management's plans. Thus, the auditor must coordinate the collection of this evidence with management.

The element of the audit-planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the

False. Confirmation is not a generally accepted auditing procedure for liabilities because it is not likely to disclose unrecorded payables.

The existence assertion for accounts payable is required to be tested by confirmations.

True. The greater the risks, the more assurance the auditor requires from the substantive audit procedures.

The greater the risk of material misstatement (i.e., the combined assessed level of inherent and control risk), the greater the assurance to be provided by substantive tests.

False. The primary purpose of the collection of evidence for inventory is to test management's assertions about the presentation of the inventory balance in the financial statements.

The main reason to test inventory is to ensure proper sales figures.

True. The auditor should consider the motivation and opportunity for factoring or selling receivables and inquire of management as to whether such transactions have occurred. This provides evidence concerning rights and obligations.

The motivation and opportunity for factoring or selling receivables should be considered.

Low Many Likely AU-C 505 states, "Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly, the auditor should not use negative confirmation requests as the sole substantive audit procedure to address an assessed risk of material misstatement at the assertion level, unless all of the following are present: (1) the auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertion; (2) the population of items subject to negative confirmation procedures comprises a large number of small, homogeneous account balances, transactions, or conditions; (3) a very low exception rate is expected; and (4) the auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such requests." Returned negative confirmations provide evidence about assertions in the financial statements, but unreturned negative confirmation requests rarely provide significant evidence about assertions other than some aspects of existence. Unreturned requests provide no explicit evidence that the intended parties received them and verified the correctness of the information stated.

The negative request form of accounts receivable confirmation may be used when the Risk of Material Misstatement is; Number of Small Balances is; Consideration by the Recipient is

A working trial balance. Audit documentation is usually classified into permanent and current files. Current files include schedules and analyses that relate to the current year under audit. The working trial balance is maintained in the current file.

The permanent file of an auditor's audit documentation generally would not include

Credit memos for several items returned by customers had not been recorded. If credit memos for items returned by customers have not been prepared and recorded, the returned items will be reflected in the physical inventory but not in the perpetual records.

The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the following could explain the difference?

Corroborate information regarding deposit and loan balances. The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used to confirm specifically listed deposit and loan balances. The form confirms the account name, account number, interest rate, and balance for deposits.

The primary purpose of sending a standard confirmation request to financial institutions with which the client has done business during the year is to

The principal amount paid on a direct liability. The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The auditor is not concerned with the amount of a liability already paid. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and description of collateral.

The standard AICPA form directed to financial institutions requests all of the following except

No; Yes; Yes The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and a description of collateral.

The standard AICPA form to financial institutions requesting information on direct liabilities on loans asks for the following information The Principal Amount Paid; Description of Collateral; Date through which Interest is Paid

True. 1.The auditor should be aware that the standard form is not intended to elicit evidence about the completeness assertion. 2.Nevertheless, the standard confirmation form contains this language: "Although we do not request or expect you to conduct a comprehensive, detailed search of your records, if during the process of completing this confirmation, additional information about other deposit and loan accounts we may have with you comes to your attention, please include such information below."

The standard form to confirm account information is designed to substantiate only the information that is stated on the confirmation request.

The appropriate audit tasks for personal computer applications and the appropriate software to perform the selected audit tasks. The question relates to using the computer as an audit tool. To use a personal computer for this purpose effectively and efficiently, the auditor must have the appropriate hardware and software.

The two requirements crucial to achieving audit efficiency and effectiveness with a personal computer are selecting

Be unaware of all the financial relationships that the bank has with the client. The standard form is designed to substantiate only the information that is stated on the confirmation request. Thus, the auditor should be aware that the standard form is not intended to elicit evidence about the completeness assertion. The individual completing the form may not be aware of all the financial relationships that the bank has with the client.

The usefulness of the standard bank confirmation request may be limited because the bank employee who completes the form may

False. The service auditor prepares a report on a service organization's description of its internal controls on whether they were suitably designed, on whether they had been implemented, and on whether the controls tested were operating with sufficient effectiveness to provide reasonable, but not absolute, assurance that the related objectives were achieved.

The user auditor prepares a report on controls in a service organization.

Debt agreements. The permanent section of the audit documentation usually contains copies of important company documents of continuing interest. The section may include (1) the articles of incorporation, share options, contracts, and bylaws; (2) the engagement letter; (3) analyses from previous audits of accounts of special importance to the auditor; and (4) information about internal control, e.g., flowcharts.

The permanent (continuing) file of an auditor's audit documentation most likely would include copies of the

False. To confirm bank transactions and written or oral arrangements, such as contingent liabilities, lines of credit, compensating balances, and security agreements, auditors send a separate letter, signed by the client, to an official responsible for the financial institution's relationship with the client.

To confirm bank transactions and written or oral arrangements, auditors send a separate letter, signed by the auditor, to an official responsible for the financial institution's relationship with the client.

Receiving reports. The population to be tested consists of receiving reports. An accounts payable record should be available for each receiving report.

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

Scrap sales. Because scrap sales often provide little documentary evidence to corroborate cash receipts, it is difficult to detect abstraction of proceeds from unrecorded sales.

To establish illegal "slush funds," corporations may divert cash received in normal business operations. An auditor would encounter the greatest difficulty in detecting the diversion of proceeds from

True. The auditor should vouch a sample of recorded inventory items to payment records. Payment vouchers for inventory should have supporting documentation (e.g., requisition, purchase order, receiving report, and vendor invoice) and canceled checks (if payment has been made).

To establish rights and obligations to inventory, an auditor should vouch recorded purchases to documentation.

Items listed in the inventory listing schedule to inventory tags and the auditor's recorded count sheets. Validity relates to the existence assertion. To determine that the items exist, the direction of testing should be from the schedule to the inventory tags and ultimately to the auditor's count sheet.

To gain assurance that all inventory items in a client's inventory listing schedule are valid, an auditor most likely would vouch

Cost of goods sold. Inventory turnover equals cost of goods sold divided by average inventory. It provides a measure of how many times inventory requires replacement.

To measure how effectively an entity employs its resources, an auditor calculates inventory turnover by dividing average inventory into

Items in the inventory perpetual records to inventory tags and the auditor's test counts. To test whether records reflect actual inventory, the auditor most likely will select a sample of items from the records and trace them to evidence supporting existence. The inventory tags created during the client's count and confirmed by the auditor's test counts provide evidence of existence.

To obtain assurance that items reflected in a client's perpetual inventory records actually exist, an auditor would most likely trace

Request the senders to mail the original forms to the auditor. When responses other than written communications mailed to the auditor (e.g., email or faxes) are received, additional evidence may be required to support their validity. For example, the auditor may wish to verify the sources by calling the purported senders or by having the senders mail the original confirmations directly to the auditor.

To reduce the risks associated with accepting email responses to requests for confirmation of accounts receivable, an auditor most likely would

Verify the sources and contents of the faxes in telephone calls to the senders. Because establishing the source of a fax is often difficult, the auditor should ensure that the confirmations returned by fax are genuine. One way is to verify the sources by following up with telephone calls to the senders.

To reduce the risks associated with accepting fax responses to requests for confirmations of accounts receivable, an auditor most likely would

False. To test completeness for cash receipts, trace a sample of the daily remittance lists to the validated deposit tickets for the period. Tracing transactions relating to cash to the records tests whether all transactions relating to cash were recorded.

To test completeness for cash, the auditor would count cash on hand.

True. 1.A kited check overstates cash. 2.Since the kited check was not recorded, it will not be listed as outstanding.

To uncover kiting, the auditor should match the returned checks written prior to year-end from the cutoff bank statement with the outstanding checks on the bank reconciliation of the disbursing bank.

Narrative descriptions of the client's accounting procedures and internal control. The permanent section of the auditor's audit documentation usually contains copies of important entity documents. They may include (1) the articles of incorporation, share options, contracts, and bylaws; (2) the engagement letter, which is the contract between the auditor and the client; (3) analyses from previous audits of accounts of special importance to the auditor, such as noncurrent debt, PP&E, and shareholders' equity; and (4) information about internal control, e.g., flowcharts, organization charts, and questionnaires.

The permanent file section of the audit documentation that is kept for each audit client most likely contains

Shipments to customers were invoiced. Comparing the seller's copies of shipping documents (such as bills of lading) with billing documents (sales invoices) provides evidence that the amounts shipped were billed to customers. The absence of invoices for goods shipped would suggest that the related sales were unrecorded at the balance sheet date.

Tracing bills of lading to sales invoices provides evidence that

Sales billed to customers were actually shipped. Sales invoices are billing documents sent to customers. Tracing sales invoices to shipping documents tests for failure to ship.

Tracing copies of computer-prepared sales invoices to copies of the corresponding computer-prepared shipping documents provides evidence that

Shipments to customers were properly invoiced. The direction of testing to determine that shipments to customers were properly invoiced is from the shipping documents to the sales invoices.

Tracing shipping documents to prenumbered sales invoices provides evidence that

False. Accounts payable, sometimes termed trade payables, represent the most significant current liability of most firms.

Trade payables represent a minor segment of the current liability of most firms.

False. In a financial statement audit, the purpose of consideration of internal control is to plan the audit.

The purpose of consideration of internal control in a typical financial statement audit of a nonissuer is to express an opinion about the effectiveness of internal control.

False. 1.Both of these tests are used to test the completeness assertion. 2.Other tests of completeness include the reconciliation of the subsidiary ledger with the control account and various analytical procedures.

Two procedures to test the accuracy assertion for accounts receivable are accounting for the numerical sequence of documents and vouching shipping documents back to sales invoices.

True. U.S. GAAP requires financial statements to reflect liabilities at an amount necessary to retire the obligation. Debt due in the next year (or accounting cycle) should be classified as a current liability while noncurrent debt would be classified as a long term liability.

U.S. GAAP requires that debts be stated at the amount necessary to satisfy the obligation.

True. Under the AICPA Attestation Standards, a practitioner may be engaged to issue an examination report on the effectiveness of an entity's internal control over financial reporting.

Under the AICPA Attestation Standards, a practitioner may be engaged to issue an examination report on the effectiveness of an entity's internal control over financial reporting.

Include a list of items or invoices that constitute the customers' account balances. According to AU-C 505, the auditor should consider what respondents are most readily able to confirm so as to improve the response rate and the reliability of the evidence obtained. Thus, some customers may use a voucher system that facilitates responding to confirmation requests about individual invoices rather than the total balance.

Which of the following strategies most likely could improve the response rate of the confirmations of accounts receivable?

The recipients are likely to sign the confirmations without devoting proper attention to them. A positive confirmation request asks for a reply in all cases. It may ask the confirming parties to state whether they agree with the information given or to provide information. Thus, positive confirmation requests obtain evidence only when responses are received. Blank confirmation requests are used to reduce the risk that recipients will respond without verifying the information. They omit the amount or other information to be confirmed and ask the confirming parties to fill in the information. The disadvantage is a lower response rate because of the additional effort required.

Under which of the following circumstances is the use of the blank form of positive confirmation of accounts receivable most likely preferable?

When the combined assessment of inherent and control risk over the sale is high. The assessed risk of material misstatement (RMM) is the combined assessment of inherent and control risk. If the entity has entered into an unusual or complex transaction, and the assessed RMM is high, the auditor should consider confirming the terms of the transaction with the third parties in addition to examining documents.

Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?

Creditor statements are not available and internal controls relating to accounts payable are unsatisfactory. When the internal controls relevant to assertions about accounts payable are ineffective, the risk of material misstatement is increased. The greater the RMM, the greater the assurance required from substantive procedures related to an assertion. The auditor may need to change the nature, timing, or extent of substantive procedures and consider external confirmations. The auditor also should confirm accounts payable when (1) documentary evidence is lacking, (2) individual creditors have relatively large balances, (3) the client has made a major purchase from the creditor regardless of the size of the balance, (4) unusual transactions are involved, or (5) the account is secured.

Under which of the following circumstances would it be advisable for the auditor to confirm accounts payable with creditors?

When well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts. If the risk of material misstatement is acceptable and reliable perpetual inventory records are subject to effective internal control, the auditor's observation procedures usually can be performed either during or after the end of the period under audit. If the risk of material misstatement is acceptable and reliable perpetual inventory records are subject to effective internal control, the auditor's observation procedures usually can be performed either during or after the end of the period under audit.

Under which of the following conditions may an auditor's observation procedure for inventory be performed during or after the end of the period under audit?

Unpaid bills. The auditor examines the accounts payable vouchers prepared during the subsequent period to determine whether they were for amounts recorded as liabilities at year end. (S)he also examines unvouchered invoices (unpaid bills) because they could represent payables that should have been recorded prior to year end. This procedure should be performed through the date of the auditor's report.

Unrecorded liabilities are most likely to be found during the review of which of the following documents?

True. An unreturned negative confirmation request provides some evidence of existence because it has not been returned with an indication that the addressee is unknown; however, it provides no explicit evidence that the intended recipient verified the information.

Unreturned negative confirmation requests rarely provide significant evidence about assertions other than existence.

False. 1.Use of analytical procedures is not typically as effective for cash as for most other accounts because it is a managed account. 2.However, the auditor may be able to use management's budget, prepared at the beginning of the period, as an expectation with which to compare the year-end balance.

Use of analytical procedures for cash is typically very effective for testing the completeness assertion.

False. 1.Confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions. 2.The confirmation process includes a.Determining the information to be confirmed or requested b.Selecting the appropriate confirming party c.Designing the confirmation requests, including determining that requests are properly directed to the appropriate confirming party and provide for being responded to directly to the auditor d.Sending the requests, including follow-up requests, when applicable, to the confirming party

Validation is the process of obtaining and evaluating a direct communication from a third party.

True. Shipment of goods is typically the event creating the sale and receivable. Vouching recorded receivables to shipping documents, such as bills of lading, tests for existence.

Vouching recorded accounts receivable to shipping documents tests for existence.

Client-prepared statements of account that show the details of the account balances. A confirmation must be requested by the client because the receiving party has no relationship with the client's auditor. In confirming the customer's account balance, display of the details of the balance is likely to help the customer in reconciling the amount and may increase response rates.

When an auditor decides to confirm accounts receivable balances rather than individual invoices, it most likely would be beneficial to include with the confirmations

Send the customer a second confirmation request. When first requests for positive confirmation are not returned, the auditor should consider second requests. The requests should be authorized by the client and should ask the debtor to respond directly to the auditor.

When an auditor does not receive replies to positive requests for year-end accounts receivable confirmations, the auditor most likely would

Costs have been properly assigned to finished goods, work-in-process, and cost of goods sold. The cost accounting system must be tested if the risk of material misstatement is to be assessed at a low level for assertions about inventory and cost of goods sold. The elements of manufacturing costs, stated either in actual or standard amounts, are direct materials, direct labor, and manufacturing overhead. The purpose of the auditor's tests of controls is to verify that these costs are appropriately assigned to finished goods, work-in-process, and cost of goods sold. The auditor's procedures might include testing the calculation of overhead application rates, inspecting paid vendors' invoices for materials, and reviewing labor rates.

When an auditor tests a client's cost accounting system, the auditor's tests are primarily designed to determine that

Test the computation of standard overhead rates. Testing the computation of standard overhead rates is relevant to the costing of inventory. It does not determine whether the underlying items are slow-moving, etc.

When auditing a manufacturing entity, which of the following procedures would an auditor least likely perform to determine whether slow-moving, defective, and obsolete items included in inventory are properly identified?

The purpose of the audit was to report on the financial statements, not to provide assurance on internal control. According to an illustrative written communication in AU-C 265, the auditors state, "we considered the Company's internal control over financial reporting (internal control) as a basis for designing audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we do not express an opinion on the effectiveness of the Company's internal control."

When communicating significant deficiencies in internal control noted in a financial statement audit of a nonissuer, the communication should indicate that

Positive confirmation. Ideally, the blank form of positive confirmation should be used. It requests that the balance due be provided by the creditor. External confirmation need not be performed if the auditor can become satisfied as to the existence of recorded payables using evidence available directly from the entity.

When confirmation for accounts payable is undertaken, which form of confirmation should be used?

True. The blank form of positive confirmations should be used. It requests that the balance due be provided by the creditor (e.g., the vendor).

When confirming account balances with vendors, a form should be used that requires the vendor to supply the balance.

Substitution. Simultaneous verification of cash and cash equivalents, such as negotiable securities, is common practice to avoid the possibility of conversion of negotiable assets to cash to conceal a cash shortage. The auditor should control and verify all liquid assets at one time.

When counting cash on hand, the auditor must exercise control over all cash and other negotiable assets to prevent

False. 1.When customers fail to answer a second request for a positive confirmation, the accounts may be in dispute, uncollectible, or fictitious. 2.The auditor should then apply alternative procedures (examination of subsequent cash receipts, shipping documents, and other client documentation of existence) to obtain evidence about the validity of nonresponding accounts.

When customers fail to answer a second request for a positive confirmation, the account should be written off.

Make or observe some physical counts of the inventory, recompute certain inventory calculations, and test certain inventory transactions. The taking of inventory by an outside firm of nonaccountants (use of a management's specialist) does not substitute for the auditor's own observation or performance of some test counts. The auditor may, as a result, be able to reduce the extent of his/her procedures but only after an evaluation of the work of management's specialist. For example, the auditor may (1) examine its program, (2) observe its procedures and controls, (3) make or observe some physical counts, (4) recompute calculations, and (5) apply tests to post-count transactions.

When outside firms of nonaccountants specializing in the taking of physical inventories are used to count, list, price, and subsequently compute the total dollar amount of inventory on hand at the date of the physical count, the auditor will ordinarily

Observing inventory. The primary use of GAS is to select and summarize a client's records for additional testing. However, the physical observation of inventory, a required audit procedure under AU-C 501, can be done only by an auditor.

When performing procedures for a physical inventory, an auditor cannot perform which of the following steps using a generalized audit software (GAS) package?

Occurrence. A voucher signifies a liability. Its issuance is recorded in the voucher register after comparison of the vendor's invoice with the purchase requisition, purchase order, and receiving report. The direction of testing is an important consideration in addressing the RMMs. Selecting a sample of recorded entries in the voucher register to vouch to the supporting documentation provides evidence that the transactions occurred.

When performing procedures to test assertions about purchases, an auditor vouches a sample of entries in the voucher register to the supporting documents. Which relevant assertion would this procedure most likely support?

True. 1.The auditor may wish to verify the sources by calling the purported senders, or by having the sender mail the original confirmation directly to the auditor. a.Oral confirmations are not considered a direct written response and would require additional consideration by the auditor. 2.When using positive confirmations, the auditor should usually follow up with a second and, if applicable, a third request to parties who did not respond.

When responses other than written communications mailed to the auditor (e.g., FAX responses) are received, additional evidence may be required to support their validity.

The risk of material misstatement relative to financial statement assertions about receivables is acceptably low. If the risk of material misstatement for assertions about receivables is acceptably low, the auditor may decide to adopt a less effective procedure, for example, confirming these balances at interim dates rather than at year-end. The auditor is then expected to obtain assurance that conclusions formed at the interim date are still valid at the balance sheet date. Moreover, the presumption in favor of confirmation may be overcome in certain limited circumstances.

When scheduling the audit work to be performed on an engagement, the auditor should consider confirming accounts receivable balances at an interim date if

Quality. The purpose of the cutoff is to ensure that the asset and related liability are recognized in the correct period. Accordingly, merchandise included in ending inventory but not yet arrived may not be available for inspection. The quality of such merchandise cannot be assured until the inspection has been conducted after the goods are received.

When title to merchandise in transit has passed to the audit client, the auditor engaged in the performance of a purchase cutoff will encounter the greatest difficulty in gaining assurance with respect to the

Vendors with whom the entity has previously done business. When sending confirmations for accounts payable, the population of accounts should include small and zero balances as well as large balances. The auditor should use the activity in the account as a gauge for sample selection. That is, if orders are placed with a vendor on a consistent basis, a confirmation should be sent to that vendor regardless of the recorded balance due.

When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely is

Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period. The greatest risk in the audit of payables is that unrecorded liabilities exist. Omission of an entry to record a payable is a misstatement that is more difficult to detect than an inaccurate or false entry. The search for unrecorded payables should (1) include examining cash disbursements made after the balance sheet date and comparing them with the accounts payable trial balance, (2) sending confirmations to vendors with small and zero balances, and (3) reconciling payable balances with vendors' documentation.

Which of the following audit procedures is best for identifying unrecorded trade accounts payable?

Analysis and recomputation of depreciation expense. The analysis and recomputation of depreciation expense is useful in determining whether the expense and asset accounts have been properly stated. Because liabilities are not part of the depreciation recording process, analysis and recomputation of depreciation would not detect unrecorded liabilities.

Which of the following audit procedures is least likely to detect an unrecorded liability?

Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens. Testing the assertion of rights and obligations for inventories determines that the entity has legal title or similar rights to the inventories. Typically, the auditor examines paid vendors' invoices, consignment agreements, and contracts.

Which of the following audit procedures probably would provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventories?

Investigating inventory balances for possible obsolescence. Generalized audit software packages allow auditors access to data files without the need to write specialized computer programs. Typically, generalized audit software packages extract records, test extensions and footings, and summarize file data. Because obsolescence is a matter of judgment requiring consideration of many factors not reflected in the accounting records, audit software is unlikely to be useful for this task. However, it could prove useful in performing analytical procedures that might reveal some evidence of obsolescence, such as a low inventory turnover.

Which of the following audit procedures would an auditor be least likely to perform using a generalized computer audit program?

Testing the entity's computation of standard overhead rates. Manufactured goods should be recorded at cost, including direct materials, direct labor, and an allocation of overhead. The overhead allocation rate should be tested for reasonableness.

Which of the following auditing procedures most likely would provide assurance regarding a manufacturing entity's relevant assertions about inventory valuation?

1/4/Yr 2 1/5/Yr2 12/31/Yr 1 1/4/Yr 2 An error in cash cutoff occurs if one half of the transaction is recorded in the current period and one half in the subsequent period. Inspection of the Recorded in Books columns indicates the transfer was recorded as a receipt on 12/31/Yr 1 but not as a disbursement until 1/4/Yr 2. This discrepancy is an error in cutoff called a kite, and it overstates the cash balance.

Which of the following cash transfers results in a misstatement of cash at December 31, Year 1? Bank Transfer Schedule Disbursement Recorded in Books; Paid by Bank Receipt Recorded in Books; Received by Bank

01/04/Yr 2; 01/05/Yr2 12/31/Yr 1; 01/04/Yr 2 An error in cash cutoff occurs if one-half of the transaction is recorded in the books in the current period and one-half is recorded in the subsequent period. Inspection of the "per books" columns indicates that the correct answer's transfer was recorded as a receipt on 12/31/Yr 1 but not as a disbursement until 1/04/Yr 2. This discrepancy is termed a kite and results in the overstatement of cash at year end.

Which of the following cash transfers results in a misstatement of cash at December 31, Year 1? Bank Transfer Schedule; Disbursement Date Receipt Date; Per Books; Per Bank; Per Books; Per Bank

Auditor judgment. Professional judgment involves applying relevant knowledge and experience to the facts and circumstances of an audit. The auditor exercises judgment to (1) interpret ethical requirements and GAAS and (2) make informed decisions, for example, about the sufficiency and appropriateness of audit evidence. The auditor also plans and performs the audit with professional skepticism. This is an attitude that includes (1) a questioning mind, (2) being alert to possible misstatements, and (3) a critical assessment of audit evidence (AU-C 500). Thus, judgment is required to select the specific auditing procedures needed to obtain that evidence.

Which of the following elements ultimately determines the specific auditing procedures that are necessary in the circumstances to provide a reasonable basis for an opinion?

Whether the data were developed under a system with adequate controls. Reliability is affected by the source of the data and the conditions under which the data were generated. Data are considered more reliable when developed under effective internal control.

Which of the following factors would most likely influence an auditor's consideration of the reliability of data when performing analytical procedures?

Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports. Vouching a sample of recorded accounts payable to purchase orders and receiving reports provides evidence that the obligations exist at a given date. The purchase orders evidence the initiation of the transactions, and the receiving reports indicate that goods were received and that liabilities were thereby incurred. Thus, these documents provide evidence that amounts are owed to others, that the transactions occurred, and that the liabilities have been included at appropriate amounts.

Which of the following is a substantive procedure that an auditor most likely would perform to verify the existence and valuation assertions about recorded accounts payable?

To verify cash deposited during the year. The verification of cash deposits during the year is not part of the audit of revenues. Verification of cash and marketable securities is undertaken as a separate part of the audit program.

Which of the following is not a principal objective of the auditor in the audit of revenues?

The auditor is required to inform those charged with governance about misstatements discovered by the auditor and not subsequently corrected by management. The matters to be communicated to those charged with governance include uncorrected misstatements, other than those not accumulated by the auditor because they are clearly trivial. The auditor communicates uncorrected misstatements and the effect they may have, individually or aggregated, on the opinion. Furthermore, material uncorrected misstatements should be identified individually. Also, the auditor should communicate to those charged with governance the effect of uncorrected misstatements related to prior periods (AU-C 260).

Which of the following is true about the auditor's communication with those charged with governance?

The communication should be a two-way discourse between the auditor and those charged with governance. Two-way communication is expected and should provide those charged with governance an overview of the audit process and the auditor's responsibilities. It should also allow the auditor to obtain information relevant to the audit.

Which of the following is true about the auditor's communication with those charged with governance?

This communication should include disagreements with management about audit adjustments, whether or not satisfactorily resolved. The matters to be discussed with those charged with governance include (1) the auditors responsibility under GAAS; (2) significant accounting policies; (3) sensitive accounting estimates; (4) uncorrected and material corrected misstatements; (5) the quality of the accounting principles used by management; (6) auditor disagreements with management, whether or not satisfactorily resolved; (7) management's consultations with other accountants; (8) issues discussed with management prior to the auditors' retention; and (9) any serious difficulties the auditors may have had with management during the audit.

Which of the following is true about the auditor's communication with those charged with governance?

This communication should include management changes in the application of significant accounting policies. The auditor should communicate to those charged with governance, among other things, management's selection of and changes in significant accounting policies or their application. The auditor also should determine that those charged with governance are informed about the methods used to account for significant unusual transactions and the effects of significant accounting policies in controversial or emerging areas (AU-C 260).

Which of the following is true about the auditor's communication with those charged with governance?

II and III only. Only those control deficiencies considered to be significant deficiencies or material weaknesses are required to be communicated in writing to those charged with governance. (But certain deficiencies should not be reported directly to management). Other control deficiencies that merit management's attention should be reported to management orally or in writing. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of their assigned functions, to prevent misstatements or detect and correct them on a timely basis. A significant deficiency is a deficiency, or combination of deficiencies, in internal control that results in a reasonable possibility that a material misstatement of the financial statements will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility means that the probability of the event is more than remote.

Which of the following issues related to internal control over financial reporting are required to be communicated in writing to management and those charged with governance? I. Control deficiencies II. Significant deficiencies III. Material Weakness

Inventory is complete. The completeness assertion about account balances at the end of a period is that all assets, liabilities, and equity interests that should have been recorded have been recorded. The completeness assertion for inventory is to determine whether the balance contains inventory (1) on hand and (2) owned by the entity that is in transit or stored at outside locations.

Which of the following management assertions is an auditor most likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance?

Adjustments that were suggested by the auditor and recorded by management that have a significant effect on the entity's financial reporting process. Certain matters should be communicated to those charged with governance (e.g., the audit committee) if all such individuals are not involved in management. These matters include material, corrected misstatements that were brought to the attention of management as a result of audit procedures (AU-C 260).

Which of the following matters is an auditor required to communicate to those charged with governance?

Both I and II. AU-C 260, The Auditor's Communication with Those Charged with Governance, states that the matters to be discussed include (1) an overview of the planned scope and timing of the audit; (2) the auditors' responsibilities regarding the audit, such as performing the audit to obtain reasonable, not absolute, assurance about whether the statements are fairly presented; (3) significant accounting policies; (4) sensitive accounting estimates; (5) uncorrected and corrected misstatements; (6) the qualitative aspects of the entity's accounting practices; (7) significant difficulties during the audit; (8) auditor disagreements with management, whether or not satisfactorily resolved; and (9) any other findings and issues judged to be significant and relevant to those charged with governance. Under the Sarbanes-Oxley Act of 2002, a registered audit firm must communicate (1) critical accounting policies, (2) all alternative treatments of information within GAAP discussed with management, (3) the ramifications of using such treatments, and (4) the treatment preferred by the firm.

Which of the following matters is an auditor required to communicate to those in the entity charged with governance? I.Disagreements with management about matters significant to the entity's financial statements that have been satisfactorily resolved II.Initial selection of significant accounting policies in emerging areas that lack authoritative guidance

The process used by management in formulating sensitive accounting estimates. Certain accounting estimates are particularly sensitive because they are significant to the financial statements, and future events affecting them may differ from current judgments. Those charged with governance should be informed about the process used in formulating sensitive estimates, including fair value estimates, and the basis for the auditor's conclusion about their reasonableness (AU-C 260).

Which of the following matters should an auditor communicate to those charged with governance?

Evidence of a lack of objectivity by those responsible for accounting decisions. Failures in internal control include deficiencies in internal control design and failures in the operation of internal control. An example of the second type is evidence of undue bias or lack of objectivity by those responsible for accounting decisions. (AU-C 265)

Which of the following matters would an auditor most likely consider to be a significant deficiency or material weakness to be communicated to those charged with governance?

Assessing the allowance for uncollectible accounts for reasonableness. Assertions about valuation concern whether balance sheet components have been included at appropriate amounts. One such assertion is that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Hence, assessing the allowance provides assurance about the valuation of the account.

Which of the following most likely would give the most assurance concerning the valuation assertion about accounts receivable?

Effective internal control provides more assurance about the reliability of audit evidence. The more effective the internal control, the more reliable the evidence generated internally by the entity, e.g., the accounting records and financial statements.

Which of the following presumptions is correct about the reliability of audit evidence?

Search for unrecorded liabilities. A significant risk is that all payables may not be reflected in the year-end balance. The auditor will review cash disbursements made subsequent to year end to determine whether payments are for previously unrecorded liabilities. Other procedures that would not be performed prior to the balance sheet date include reviewing subsequent events, requesting the lawyer's letter, and obtaining management representations.

Which of the following procedures is least likely to be performed before the balance sheet date?

Prepare a schedule of accounts payable. Preparation of schedules is usually delegated to the entity's employees. The auditor should review and test the schedules prepared by them.

Which of the following procedures relating to the examination of accounts payable could the auditor delegate entirely to the client's employees?

Confirmation of accounts payable. The most important assertion about accounts payable is completeness, which is best tested at year end. For example, the auditor may examine subsequent cash payments to determine whether the related payables are not recorded. Although confirmation is not a required auditing procedure, it may be useful in detecting unrecorded payables if the auditor's sample includes vendors for which the risk of understatement is high, e.g., regular vendors with zero or low recorded balances.

Which of the following procedures would an auditor least likely perform before the balance sheet date?

Inspect the shipping records documenting the merchandise sold to the debtors. When customers fail to answer a second request for a positive confirmation, the accounts may be in dispute, uncollectible, or fictitious. The auditor should then apply alternative procedures (examination of subsequent cash receipts, shipping documents, and other client documentation of existence) to obtain evidence about the validity of nonresponding accounts.

Which of the following procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests?

Reconcile the amounts included in the statement of cash flows to the other financial statements' balances and amounts. The information presented on a statement of cash flows is taken from the income statement and balance sheet. Indeed, a reconciliation of net income and net operating cash flow is required to be presented. Thus, reconciliation of amounts in the statement of cash flows with other financial statements' balances and amounts is an important procedure in the audit of the statement of cash flows.

Which of the following procedures would an auditor most likely perform in auditing the statement of cash flows?

Vouch a sample of cash disbursements recorded just after year end to receiving reports and vendor invoices. The greatest risk in the audit of payables is that unrecorded liabilities exist. Omission of an entry to record a payable is a fraud or error that is more difficult to detect than an inaccurate or false entry. The search for unrecorded payables should include (1) examining cash disbursements made after the balance sheet date and comparing them with the accounts payable trial balance, (2) sending confirmations to vendors with small and zero balances, and (3) reconciling payable balances with vendors' documentation.

Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities?

Compare cash payments occurring after the balance sheet date with the accounts payable trial balance. Observance of cutoff procedures helps ensure that liabilities were recorded in the appropriate period. Tracing cash disbursements made subsequent to year end to amounts recorded at year end may disclose liabilities that were unrecorded as a result of a failure to observe such procedures. Recomputation of interest, bank confirmations, and reading the minutes of directors' meetings may also detect unrecorded liabilities.

Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?

Inspection of bank statements obtained directly from the client's financial institution. When documentation is prepared solely by client personnel, its reliability is less than that prepared by the auditor or an independent party. Ordinarily, the most reliable documentation is created outside the entity and has never been within the client's control, e.g., statements obtained from the bank, letters from attorneys, and letters from insurance brokers.

Which of the following procedures would provide the most reliable audit evidence?

A recalculation of bad debt expense. Subject to exceptions, the presumption is that the independent auditor's direct personal knowledge, obtained through physical examination, observation, computation, and inspection, is more reliable than information obtained indirectly.

Which of the following procedures would yield the most reliable evidence?

Cost of goods sold/average inventory. Near the end of the audit, the auditor performs analytical procedures to assist in forming an overall conclusion about whether the statements are consistent with the auditor's understanding of the entity (AU-C 520). The inventory turnover ratio is a good indicator of unusual or unexpected balances because this amount is usually very predictable.

Which of the following ratios would an engagement partner most likely consider in forming an overall audit conclusion?

Cash in bank and collateral for loans. The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

Which of the following sets of information does an auditor usually confirm on one form?

The auditor should communicate significant internal control related matters no later than 60 days after the report release date. Timely communication of significant deficiencies or material weaknesses should be made no later than 60 days after the report release date. However, early communication may be important because of the significance of the matters noted and the urgency of corrective action.

Which of the following statements about an auditor's communication of internal control related matters identified in an audit of a nonissuer is true?

The sufficiency and appropriateness of audit evidence is a matter of professional judgment. The auditor exercises professional judgment when forming a conclusion about whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level. Sufficiency measures the quantity of audit evidence. Appropriateness measures its quality (relevance and reliability). To form this conclusion, the auditor considers all relevant evidence, regardless of whether it corroborates or contradicts the assertions in the statements.

Which of the following statements about audit evidence is true?

A client's accounting records cannot be considered sufficient appropriate audit evidence on which to base the auditor's opinion. Audit evidence consists of accounting records (initial entries and supporting records, such as ledgers, worksheets, and spreadsheets) and other information (minutes of meetings, confirmations, information obtained by inquiry, etc.). But accounting records alone do not provide sufficient appropriate evidence as a basis for an opinion on the financial statements.

Which of the following statements about evidence is true?

Audit documentation is the property of the client. Audit documentation is the property of the auditor. Copies of documentation may be made available to the client if the validity and independence of the audit are not undermined.

Which of the following statements concerning audit documentation is false?

"If you do not report any differences within 15 days, it will be assumed that this statement is correct." An issue with respect to negative confirmation requests is whether recipients are likely to disregard them (AU-C 505). Providing a time limit encourages a recipient to respond in a timely manner.

Which of the following statements is an auditor most likely to add to the negative form of confirmation of accounts receivable to encourage timely consideration by the recipient?

Sufficient and appropriate documentation should include evidence that it has been reviewed. On or before the date of the auditor's report, the engagement partner should review the audit documentation and have discussions with the engagement team. The purpose is to be satisfied that sufficient and appropriate evidence supports the conclusions and the report (AU-C 220). The requirement to document (1) who reviewed the audit work and (2) the extent of the review does not require each working paper to bear evidence of review. But it does mean documenting (1) what work was reviewed, (2) who reviewed the work, and (3) when it was reviewed (AU-C 230).

Which of the following statements is most accurate regarding sufficient and appropriate documentation?

The more effective internal control, the more assurance it provides about the reliability of the accounting data and financial statements. Appropriate audit evidence is relevant and reliable. Evidence is usually more reliable when it (1) is obtained from independent sources; (2) is generated internally under effective internal control; (3) is obtained directly by the auditor; (4) is in documentary form, whether paper, electronic, or other medium; and (5) consists of original documents (AU-C 500).

Which of the following statements is ordinarily true about the reliability of evidence?

Suggested corrective action for management's consideration concerning a material weakness need not be communicated to the client. Although the auditor should communicate material weaknesses to management and those charged with governance, suggested corrective action need not be communicated.

Which of the following statements is true about the auditor's communication of a material weakness in internal control?

It is appropriate to use calculator tapes with names or explanations on the tapes rather than writing separate lists onto working papers. Audit documentation provides evidence of compliance with GAAS. But the auditor need not document every matter considered or judgment made. Moreover, the auditor need not document separately (e.g., in a checklist) compliance with matters for which compliance is demonstrated by documents in the audit file (AU-C 230). If calculator tapes containing names or explanations achieve the purposes of documentation, separate lists need not be written onto working papers.

Which of the following statements ordinarily is true concerning the content of audit documentation?

Bank statements obtained from the client. Evidence from independent sources outside the entity provides greater assurance of reliability for purposes of an audit than evidence secured or prepared solely within the entity. Although the bank statements are in the possession of the client, they originated outside of the client and, relative to the other responses, they are the most persuasive.

Which of the following types of audit evidence is the most persuasive?

The auditor should not perform a procedure that provides persuasive evidence rather than conclusive evidence. In most cases, evidence that is obtained to enable an auditor to draw reasonable conclusions on which to base the opinion is necessarily persuasive rather than conclusive. The cost of obtaining conclusive evidence may outweigh the benefits. But the difficulty, time, or cost is not in itself a valid reason (1) to omit an audit procedure for which no alternative exists or (2) to be satisfied with less than persuasive evidence (AU-C 200).

Which statement about audit evidence is false?

Description of the scope and nature of Price's procedures. A service auditor's report (type 1 report) includes (1) a title that includes the word independent; (2) an addressee; (3) identification of management's description of the system; (4) a reference to management's assertion and a statement of the management's responsibility for the controls; (5) a statement that the service auditor's responsibility is to express an opinion on the fairness of management's description of the system and the suitability of the design of the controls in meeting the objectives; (6) a statement that the report was conducted in accordance with the AICPA attestation standards; (7) a statement that the service auditor did not test the effectiveness of the controls; (8) statements about the scope of the service auditor's procedures; (9) a statement about the inherent limitations of controls; (10) an opinion on whether, in all material respects, management's description of the system is fairly stated and whether the controls are suitably designed; (11) a statement restricting the use of the report to management of the service organization and user entities; (12) the date of the report; and (13) the name, city, and state of the service auditor (AT 801).

Dunn, CPA, is auditing the financial statements of Taft Co. Taft uses Quick Service Center (QSC) to process its payroll. Price, CPA, is expressing an opinion on management's description of the controls implemented and their suitability of design at QSC regarding the processing of its customers' payroll transactions. Dunn expects to consider the effects of Price's report on the Taft engagement. Price's report should contain a(n)

Suspense debits that management believes will benefit future operations. Although the auditor must evaluate relevant assertions about all accounts, the greatest risks are overstated assets and understated liabilities. The unverified suspense debits represent assets that may not exist.

A client uses a suspense account for unresolved questions whose final accounting has not been determined. If a balance remains in the suspense account at year-end, the auditor would be most concerned about

True. Reports on controls implemented and tests of operating effectiveness may be relevant to a user auditor in obtaining understanding and determining the effectiveness of internal control. They may allow the user auditor to assess control risk at a low level.

A report on management's description of the controls implemented and tests of operating effectiveness in a service organization should include the service auditor's opinion on whether the controls were operating effectively, thereby providing reasonable assurance that control objectives were achieved.

Perform tests several times during the year, rather than only at year end. Accounting records and other evidence may be available only in electronic form. For example, when the Internet is used, transactions often occur by exchange of electronic messages instead of source documents. Electronic evidence may exist at a given moment in time, but it may not be retrievable after a specified period if files are changed and no backups exist. Consequently, the auditor should consider requesting retention of some information or performing procedures when information is available (AU-C 500). For example, the auditor may change the timing of audit procedures by performing them several times during the year instead of only at year end.

A retailing entity uses the Internet to execute and record its purchase transactions. The entity's auditor recognizes that the documentation of details of transactions will be retained for only a short period of time. To compensate for this limitation, the auditor most likely would

Bring to the auditor's attention possible control conditions required to be communicated to the client. The auditor is not required to search for significant deficiencies or material weaknesses in internal control. However, the auditor may identify these conditions during the audit. Significant deficiencies and material weaknesses should be communicated in writing to management and to those charged with governance (AU-C 265).

A secondary result of the auditor's understanding of internal control for a nonissuer is that the understanding may

It should state that the auditor did not test the effectiveness of the controls. A service auditor's type 1 report should contain a statement that the auditor did not test the effectiveness of the controls.

A service auditor's report on internal control may be issued on management's description of a service organization system and the suitability of the design of controls or management's description of a service organization system and the suitability and operating effectiveness of controls. Which of the following is true about a type 1 report?

False. The service auditor reports on controls at a service organization in one of the following reports: 1.Type 1 report - report on management's description of a service organization's system and the suitability of the design of controls. 2.Type 2 report - report on management's description of a service organization's system, the suitability of the design of the controls, and operating effectiveness of controls.

A service auditor's type 1 report is a report on management's description of a service organization's system, the suitability of the design of the controls, and operating effectiveness of controls.

It should include an opinion. A service auditor's report should be helpful in providing a sufficient understanding to plan the audit of the user organization. The service auditor's report may express an opinion on the fairness of the description of the controls implemented at the service organization and whether they were suitably designed. If the service auditor also has tested controls, the report may express an opinion on the operating effectiveness of the controls.

AU-C 402, Audit Considerations Relating to an Entity Using a Service Organization, applies to a financial statement audit of an entity that uses services of another organization as part of its information system. For this purpose, the user auditor may need to obtain a service auditor's report. Which of the following is a true statement about a service auditor's report?

True. Although an auditor need not search for significant deficiencies in internal control, (s)he may become aware of them during the audit. If a significant deficiency or material weakness is discovered, it must be communicated to management and those charged with governance.

According to the AICPA standards, auditors are not required to search for significant control deficiencies in internal control during an audit of the financial statements.

True. According to PCAOB AS No. 5, a significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting.

According to the PCAOB, a significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting.

Focuses on entity-level controls and then significant accounts. The top-down approach to evaluating internal control begins at the financial statement level by understanding overall risks, focusing on entity-level controls, and then working down to significant accounts. Examples of entity-level controls are controls (1) related to the control environment, (2) over management override, (3) to monitor results of operations, (4) over the period-end financial reporting process, and (5) to monitor other controls.

An auditor is conducting an integrated examination of internal control with the audit of a nonissuer's financial statements. In applying the top-down approach, the auditor first

True. 1.The auditor may issue an unmodified opinion only when there are no identified material weaknesses and when there have been no restrictions on the scope of the auditor's work. 2.The existence of a material weakness requires the auditor to express an adverse opinion on the effectiveness of internal control, while a scope limitation requires the auditor to express a qualified opinion or a disclaimer of opinion, depending on the significance of the limitation in scope.

Based on the PCAOB's AS No. 5, as well as the AICPA's AT 501, the auditor may issue an unmodified opinion only when there are no identified material weakness and when there have been no restrictions on the scope of the auditor's work.

No Yes The proper approval of credit provides assurance that the account receivable is collectible. Thus, it is related to the valuation assertion that accounts receivable are recorded at net realizable value

After making inquiries about credit granting policies, an auditor selects a sample of sales transactions and examines evidence of credit approval. This test of controls most likely supports management's financial statement assertion(s) of Rights and Valuation and obligations allocation

True. Both the PCAOB's AS No. 5 for issuers and the AICPA's AT 501 for nonissuers require that audits of internal control be conducted for financial statement audit clients only. Issuers must have audits of internal control, while audits are optional for nonissuers.

An audit of internal control must be done in conjunction with an audit of the entity's financial statements.

Working papers. Audit documentation (working papers) should be prepared to provide a clear understanding of the work performed, the audit evidence obtained and its source, and the conclusions reached.

An audit supervisor reviewed the work performed by the staff to determine if the audit was adequately performed. The supervisor accomplished this by primarily reviewing which of the following?

When reporting on an audit of financial statements, the user auditor should not refer to the service auditor's report if the opinion is unmodified. Because the service auditor is not responsible for auditing any portion of the financial statements being reported on by the user auditor, the service auditor should not be referred to in the user auditor's report if the opinion is unmodified. But if the user auditor modifies the opinion because of a modified opinion by the service auditor, the user auditor may refer to the service auditor.

An auditor (the user auditor) may decide to make use of another auditor's (the service auditor's) report on internal control at a service organization that provides certain services to the user auditor's client. When the client's transactions flow through the service organization's accounting system, consideration of internal control may be necessary. The most efficient approach is often to obtain a service auditor's report. Which of the following is a true statement about the relationship of the user and service auditors?

Auditor believes that controls are effective. In accordance with AS No. 5 and AT 501, the auditor's objective in an audit of internal control over financial reporting is to express an opinion on whether the entity maintained, in all material respects, effective internal control as of the specified date, based on the control criteria. Under AT 501, the auditor may express an opinion directly on internal control or on whether management's assertion about internal control is fairly stated.

An auditor expresses an unqualified opinion directly on internal control over financial reporting after an examination integrated with a financial statement audit. As a result, the

Board of directors. When the audit indicates the presence of error or fraud that requires a modification of the opinion, and the client refuses to accept the auditor's report as modified, the auditor should withdraw and communicate the reasons for withdrawal to the audit committee of the board. Withdrawal may or may not be appropriate in other circumstances, depending on the cooperation of management and the board.

An auditor has withdrawn from an audit engagement of an issuer after finding fraud that may materially affect the financial statements. The auditor should set forth the reasons and findings in communication to the

The same. AS No. 5 indicates that the auditor should use the same materiality considerations in the audit of internal control over financial reporting that (s)he would use in planning the audit of annual financial statements.

An auditor is auditing internal control in conjunction with the audit of financial statements for an issuer. The auditor is considering the appropriate materiality level for planning the audit of internal control. Relative to the materiality level for the audit of the financial statements, materiality levels for the audit of internal control are

The auditor's responsibility for ensuring that management and those charged with governance are aware of any significant deficiencies or material weaknesses in control that come to the auditor's attention. An auditor should accept an engagement only when the basis for audit performance is agreed through (1) establishing whether the preconditions for an audit exist and (2) confirming that the auditor and management (and, possibly, those charged with governance) have a common understanding of the terms of engagement. The agreement typically is documented in an engagement letter (AU-C 210). An engagement letter for a nonissuer should indicate that a financial statement audit is not designed to provide assurance on internal control. However, the auditor is responsible for ensuring that management and those charged with governance are aware of any significant deficiencies or material weaknesses in control that come to his/her attention.

An auditor is required to establish an understanding with a client regarding the services to be performed for each engagement. For an auditor of a nonissuer, this understanding generally includes

Contain a statement of restriction on use if the criteria have not been subjected to due process procedures and are appropriate only for a limited number of users. If the criteria were established by a regulatory agency after following due process procedures, including distribution of proposed criteria for public comment, and the criteria are available to users, a standard form of reporting may be used. If the control criteria have not been subjected to due process procedures, and the auditor determines that the criteria are appropriate only for a limited group of users (e.g., those who participated in their establishment), the appropriate form of the report should be modified to include a restriction on use stated in a paragraph following the opinion paragraph (AT 101).

An auditor reports on an examination of the effectiveness of an entity's internal control over financial reporting. If the control criteria used are established by a regulatory agency, the report should

The maximum dollar amount of misstatements that could exist without causing the financial statements to be materially misstated. The auditor is responsible for determining the levels of materiality appropriate in the audit of a client's financial statements. Only the general nature of materiality need be discussed.

An auditor would least likely initiate a discussion with a client's audit committee concerning

A review of the annual financial statements of a large corporation. Auditors are engaged to audit and express an opinion on, rather than review, the annual statements of large corporations (issuers). A review is appropriate for nonissuers that seek a report expressing only limited assurance on financial statements, not internal control.

An auditor's report on an examination of internal control over financial reporting is least likely to be issued as a result of

Provides evidence that the audit was performed in accordance with GAAS. The objectives of audit documentation are to provide (1) a sufficient and appropriate record of the basis of the auditor's report and (2) evidence that the audit was performed in accordance with GAAS and other requirements. Audit documentation is the record of (1) the audit procedures performed, (2) relevant evidence obtained, and (3) conclusions reached.

Audit documentation

False. The engagement differs from an audit of financial statements, but the service auditor should follow applicable independence standards.

Because their engagements differ from traditional audits, service auditors need not be independent.

Consider the increased risk that period-end misstatements will not be detected. Certain factors should be considered before substantive procedures are performed at interim dates. For example, the auditor should consider the risk that period-end misstatements are not detected by performing appropriate substantive procedures or a combination of tests of controls and substantive procedures to cover the remaining period.

Before performing substantive procedures at an interim date, an auditor should

Disclaim an opinion as to management's cost-benefit statement. If the assertion accompanying the auditor's report includes a statement that the cost of corrective action exceeds the benefits of implementing new controls, the auditor should include language that disclaims an opinion on the cost-benefit statements as the last paragraph of the report. Also, given material weaknesses, the auditor should express an adverse opinion on the effectiveness of internal control.

Cain Company's management engaged Bell, CPA, to examine the effectiveness of Cain's internal control over financial reporting. Bell's report, which was accompanied by management's separate report presenting its written assertion about the effectiveness of internal control, described several material weaknesses and potential errors and fraudulent activities that could occur. Subsequently, management included Bell's report in its annual report to the board of directors with a statement that the cost of correcting the weaknesses would exceed the benefits. Bell should

False. The auditor may also report matters of value to management absent a specific request. The auditor may be requested to 1.Visit specific locations 2.Assess specific control procedures 3.Perform procedures not otherwise planned 4.Report matters of less significance than provided for by the auditing standards 5.Report on conditions specified by the client 6.Report on further investigation of matters noted to identify causes

Clients may request the auditor to be alert for and report matters that are not control deficiencies. However, in the absence of a specific client request, an auditor does not report matters that are not related to control deficiencies.

Lake may not refer to Cope under the circumstances above. The service auditor was not responsible for examining any portion of the user entity's financial statements. Hence, the user auditor should not refer to the service auditor's report as a basis in part for his/her own unmodified opinion on those financial statements. If the user auditor's opinion is modified, the service auditor's work may be referred to if it is relevant to understanding the modification (AU-C 402).

Lake, CPA, is auditing the financial statements of Gill Co. Gill uses the EDP Service Center, Inc. to process its payroll transactions. EDP's financial statements are audited by Cope, CPA, who recently issued a report on EDP's internal control. Lake is considering Cope's report on EDP's internal control in assessing control risk on the Gill engagement. What is Lake's responsibility concerning making reference to Cope as a basis, in part, for Lake's own unmodified opinion?

False. Management and the auditor must agree about the application of accounting principles, the basis for accounting estimates, the scope of the audit, disclosures in the financial statements, and the wording of the audit report. 1.The auditor and those charged with governance should discuss any disagreements, even if they are satisfactorily resolved, about matters significant to the statements or the audit report.

Management and the auditor must agree about the application of accounting principles, the basis for accounting estimates, the scope of the audit, disclosures in the financial statements, and the wording of the audit report.

The auditor should communicate these control conditions in writing regardless of a decision by management and those charged with governance not to remedy them. The auditor's responsibility is to communicate in writing significant deficiencies and material weaknesses regardless of a decision by management and those charged with governance not to remedy them because of cost-benefit considerations or other factors. These should be communicated to management and those charged with governance each period within 60 days after the report release date (AU-C 265).

Management may already know of the existence of significant deficiencies or material weaknesses in internal control. Which of the following is a true statement about the auditor's communication in this situation?

The auditor may accept the engagement if management provides a statement that the identified material weakness no longer exists. PCAOB AS No. 4 applies to engagements solely to report on whether a previously reported material weakness continues to exist. Such an engagement is voluntary and may be performed as of any reasonable date selected by management. To perform such an engagement, the auditor should receive a written report from management that the identified material weakness no longer exists as of the date specified. The auditor then applies appropriate procedures to assess whether remediation has been accomplished.

Management of an issuer subject to SEC requirements requests the auditor to report on whether a previously reported material weakness in internal control continues to exist. The request comes 3 months after the annual audited financial statements and report on internal control were released.

True. 1.The auditor should discuss with those charged with governance, e.g., the audit committee, his/her responsibility for the other information, the procedures performed, and the results. 2.For example, annual reports that certain entities file with the SEC must contain a section labeled Management's Discussion and Analysis of Financial Condition and Results of Operations.

Other information prepared by management may accompany the financial statements.

Contain a disclaimer of opinion on the operating effectiveness of PDC's controls. Service auditors may report (1) on the fairness of management's description of the controls and whether the controls have been implemented and are suitably designed (type 1 report) or (2) additionally on operating effectiveness (type 2 report). The type 1 report should include a disclaimer of opinion related to operating effectiveness of the controls.

Payroll Data Co. (PDC) processes payroll transactions for a retailer. Cook, CPA, is engaged to issue a report on PDC's internal controls implemented as of a specific date. These controls are relevant to the retailer's internal control, so Cook's report may be useful in providing the retailer's independent auditor with information necessary to plan a financial statement audit. Cook's report should

True. Performing walkthroughs (following transactions through the process) will frequently be the most effective way of achieving the following objectives: 1.Understanding the flow of transactions related to relevant assertions 2.Identifying the points within the company's processes at which a material misstatement--including a misstatement due to fraud--could arise 3.Identifying the controls that management has implemented to address these potential misstatements 4.Identifying the controls that management has implemented over the prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets

Performing walkthroughs (following transactions through the process) will frequently be the most effective way of understanding likely sources of misstatement.

False. Severity of a misstatement does not depend on the actual occurrence of a misstatement.

Severity of a misstatement depends on the actual occurrence of a misstatement.

Because of inherent limitations, internal control may not prevent, or detect and correct, misstatements. The auditor's report states that because of its inherent limitations, internal control over financial reporting may not prevent, or detect and correct, misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that (1) controls may become inadequate because of changes in conditions or (2) the degree of compliance with the policies or procedures may deteriorate (AT 501).

Snow, CPA, was engaged by Master Co., a nonissuer, to examine the effectiveness of Master's internal control over financial reporting as part of an integrated audit. Snow's report should state that

May be written in a procedure-oriented language. Specialized audit software is written to fulfill a specific set of audit tasks. The purposes and users of the software are well defined before the software is written. Auditors develop specialized audit software for the following reasons: 1.Unavailability of alternative software 2.Functional limitations of alternative software 3.Efficiency considerations 4.Increased understanding of systems 5.Opportunity for easy implementation 6.Increased auditor independence and prestige

Specialized audit software

True. The auditor must evaluate the severity of each deficiency in internal control to determine whether the deficiencies, individually or in combination, are material weaknesses as of the date of management's assessment. 1. A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

Standards on the audit of internal control describe a material weakness as a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

Internal Control--Integrated Framework. Many professional and regulatory bodies, including the PCAOB, have recognized the COSO's internal control framework by incorporating its terms, definitions, and concepts into their policies, procedures, pronouncements, and other literature.

The Committee of Sponsoring Organizations (COSO) of the Treadway Commission issued a document in 1992 that has been embraced by numerous organizations, including the AICPA and the GAO. That document is titled

Provide a statement that the board approves changes in internal control procedures. SOX imposes many requirements on management, boards of directors, and auditors. Section 404 applies to internal controls and reports on them. Section 404 requires management to establish and document internal control procedures and to include in their annual reports a report on the entity's internal control over financial reporting. The report is to include (1) a statement of management's responsibility for internal control, (2) management's assessment of the effectiveness of internal control as of the end of the most recent fiscal year, and (3) identification of the framework used to evaluate the effectiveness of internal control (such as the COSO report). Because of this requirement, PCAOB AS No. 5 states that audit opinions are to be expressed on the effectiveness of those controls and on the financial statements. Section 301 addresses activities of the board but does not require the board to approve changes in controls.

The Sarbanes-Oxley Act of 2002 (SOX) requires management of issuers to do all of the following except

True. 1.The assessment must begin with a set of expectations or a framework. 2.COSO's Internal Control - Integrated Framework provides a fundamental structure for the establishment of internal control.

The assessment of internal control by management required by Sarbanes-Oxley must be performed using a suitable framework, such as the Committee of Sponsoring Organizations' (COSO) Internal Control - Integrated Framework.

For a period to satisfy applicable legal or regulatory requirements. AICPA standards require the auditor to retain audit documentation for a period sufficient to meet the needs of his/her practice and to satisfy any applicable legal or regulatory requirements, but not less than 5 years. The PCAOB's AS No. 3, Audit Documentation, implements the requirement of the Sarbanes-Oxley Act of 2002 that registered public accounting firms, when performing engagements under PCAOB standards, retain audit documentation for 7 years from the audit report release date.

The auditor is required to retain audit documentation

Yes No According to PCAOB's AS No. 5, the report states the auditor's opinion on whether the entity maintained, in all material respects, effective internal control over financial reporting as of the specified date based on the control criteria. The date typically is the end of the fiscal period. For a nonissuer, the practitioner may examine the effectiveness of internal control during a period of time (AT 501).

The auditor of an issuer must express an opinion on the effectiveness of internal control. The opinion should be expressed As of a For a Specified Specified Date Period of Time

Completeness. Tracing the details of test counts to the final inventory schedule assures the auditor that items in the observed physical inventory are included in the inventory records.

The auditor's inventory observation test counts are traced to the client's inventory listing to test for which of the following financial statement assertions?

False. An audit addresses many matters of interest to those charged with governance, e.g., internal control and whether the financial statements contain material misstatements. These matters are reported to those charged with governance, such as the audit committee, not the shareholders.

The findings and conclusions of an audit will be of limited interest to those charged with governance, such as the audit committee.

True. 1.Regardless of the type of report issued, the service auditor should obtain written representations from the service organization's management acknowledging responsibility for the design, implementation, and effectiveness of controls, as well as stating that all relevant information has been provided to the service auditor. 2.The form of representations is typically a letter drafted by the service auditor and signed by the client.

The service auditor should obtain written representations from the service organization's management acknowledging responsibility for controls.

True. 1.When the user initiates transactions, and the service organization executes and processes such transactions, the degree of interaction is high. In this case, the user may be able to implement effective controls for those transactions. 2.If the service organization initiates, executes, and processes the user's transactions, the degree of interaction is lower, and the user may not be able to implement effective controls.

The significance of the service organization's controls depends primarily on the transactions it processes for the user and the degree of interaction between its activities and those of the user.

True. 1.An audit adjustment, whether or not recorded, is a proposed correction of the financial statements that the auditor judges may not have been detected except during the audit. 2.Those charged with governance should be informed about uncorrected misstatements pertaining to the latest period that management regarded as immaterial, both individually and in the aggregate.

Those charged with governance should be informed about audit adjustments that could, individually or in the aggregate, significantly affect the entity's financial reporting process.

Performance of audit tests on a continuous basis. The audit trail for transactions processed in electronic form may be available for only a short period of time. The auditor may conclude that it is necessary to time audit procedures so that they correspond to the availability of the evidence. Thus, audit modules may be embedded in the client's software for this purpose.

Which of the following is an engagement attribute for an audit of an entity that processes most of its financial data in electronic form without any paper documentation?

An auditor's report on significant control deficiencies should include a restriction on the use of the report. A communication of significant control deficiencies should (1) state that the purpose of the audit was to report on the financial statements, not to provide assurance on internal control; (2) give the definition of significant control deficiencies and material weaknesses; and (3) state that the report is intended solely for the information and use of those charged with governance, management, and others within the organization (or specified regulatory agency) and is not intended to be, and should not be, used by anyone other than the specified parties.

Under the AICPA's auditing standards, which of the following statements about an auditor's communication of significant control deficiencies is true?

The auditor should obtain an understanding of the effect of the user organization upon the service organization. The service auditor should obtain an understanding of the service organization's system, including controls within the scope of the engagement. Understanding controls at the service organization requires understanding the complementary user entity controls (AT 801).

When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?

Use generalized audit software to extract evidence from client databases. In a largely IT environment, generalized audit software (GAS) is useful for both tests of controls and substantive procedures. It is software that is written to interface with many different client systems. In this case, assuming the control environment is effective, GAS provides the best means for gathering substantive evidence.

When companies use information technology (IT) extensively, evidence may be available only in electronic form. What is an auditor's best course of action in such situations?

Obtain management's written representation acknowledging responsibility for establishing and maintaining internal control. The auditor should obtain management's written acknowledgment of responsibility for establishing and maintaining internal control. Management also should include an assertion about the evaluation of control effectiveness and the use of control criteria. Failure to provide these representations should cause the auditor to withdraw from the engagement.

When engaged to express an opinion about the effectiveness of a nonissuer's internal control over financial reporting, the auditor should

Restriction on the use of the report. The report is a by-product of the engagement. It is intended solely for the information and use of those charged with governance, management, and others within the organization (or specified regulatory agency) and is not intended to be and should not be used by anyone other than these specified parties (AU-C 905). But law or regulation may require the report to be given to governmental authorities. For issuers, the auditor must express an opinion on whether the client maintained, in all material respects, effective internal control over financial reporting. This report is not restricted as to use.

When reporting to the audit committee on conditions relating to an entity's internal control observed during an audit of a nonissuer's financial statements, the auditor should include a

To examine the effectiveness of its internal control. The auditor's objective is to express an opinion on whether internal control is effective, in all material respects, based on the control criteria.

Which of the following best describes a CPA's responsibility to report on an issuer's (public company's) internal control over financial reporting?

Shipping documents and receiving reports. Shipping documents and receiving reports are a result of the operations of the client. As goods are shipped to customers, a shipping document is prepared by the client. As goods are received from vendors, a receiving report is prepared by the client.

Which of the following documents are examples of audit evidence generated by the client?

A potential future internal control problem having no effect on the current period. According to AU-C 265, the auditor should communicate material weaknesses and significant deficiencies in internal control to management and those charged with governance. A material weakness is a deficiency, or combination of deficiencies, in internal control such that a reasonable possibility exists that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance. However, an auditor is not required to report a potential future internal control problem unless it affects the period under audit.

Which of the following is least likely indicative of a significant deficiency or material weakness in internal control?

The communication should be a two-way discourse between the auditor and those charged with governance. Two-way communication is expected and should provide those charged with governance an overview of the audit process and of the auditor's responsibilities. It should also allow the auditor to obtain information relevant to the audit.

Which of the following is true about the auditor's communication with those charged with governance?

Auditors should communicate them to management and those charged with governance. The auditor should report certain control deficiencies in internal control observed during an audit. The communication is expected to be to management and those charged with governance. The auditor should report in writing significant deficiencies and material weaknesses in the design or operation of internal controls. The communication also should include an explanation of the potential effects of each significant deficiency and material weakness and sufficient information about the context of the communication.

Which of the following is true regarding significant deficiencies and material weaknesses in control for a nonissuer?

The degree of reliance the auditor placed on the management representation letter. Management representations are audit evidence but do not substitute for necessary auditing procedures. The auditor should use professional judgment in determining the reliability of management representations. However, (s)he need not communicate this judgment to those charged with governance.

Which of the following matters is an auditor not required to communicate to an entity's audit committee?

Evidence of a lack of objectivity by those responsible for accounting decisions. Failures in internal control include deficiencies in internal control design and failures in the operation of internal control. An example of the second type is evidence of undue bias or lack of objectivity by those responsible for accounting decisions (AU-C 265).

Which of the following matters would an auditor most likely consider to be a significant deficiency or material weakness to be communicated to those charged with governance?

An auditor's opinion is formed within a reasonable time to achieve a balance between benefit and cost. Appropriate audit evidence is relevant and reliable. Evidence is usually more reliable when it (1) is obtained from independent sources; (2) is generated internally under effective internal control; (3) is obtained directly by the auditor; (4) is in documentary form, whether paper, electronic, or other medium; and (5) consists of original documents. However, the need for (1) reporting to be timely and (2) maintaining a balance between benefit and cost are inherent limitations of the audit. Thus, for the opinion to be relevant, it must be formed within a reasonable period of time.

Which of the following presumptions is least likely to relate to the reliability of audit evidence?

An auditor may communicate significant deficiencies and material weaknesses during an audit or after the audit's completion. When early communication is important, the auditor may communicate significant matters orally during an audit. However, significant deficiencies and material weaknesses are required to be reported again in writing at the conclusion of an audit.

Which of the following statements about significant deficiencies and material weaknesses in internal control is true for an audit of a nonissuer?

Unreturned negative confirmation requests rarely provide significant explicit evidence. Unreturned negative confirmation requests rarely provide significant evidence about assertions other than certain aspects of existence. Additionally, unreturned negative confirmations do not provide explicit evidence that the intended parties received the requests and verified the information provided.

Which of the following statements is correct concerning the use of negative confirmation requests?

The auditor is required to inform those charged with governance about misstatements discovered by the auditor and not subsequently corrected by management. The matters to be communicated to those charged with governance include uncorrected misstatements, other than those not accumulated by the auditor because they are clearly trivial. The auditor communicates uncorrected misstatements and the effect they may have, individually or aggregated, on the opinion. Furthermore, material uncorrected misstatements should be identified individually. Also, the auditor should communicate to those charged with governance the effect of uncorrected misstatements related to prior periods (AU-C 260).

Which of the following statements is true about an auditor's communication to those charged with governance?

This communication should include management changes in the application of significant accounting policies. The auditor should communicate to those charged with governance, among other things, management's selection of and changes in significant accounting policies or their application. The auditor also should determine that those charged with governance are informed about the methods used to account for significant unusual transactions and the effects of significant accounting policies in controversial or emerging areas (AU-C 260).

Which of the following statements is true about an auditor's communication with those charged with governance?

The auditor should identify those significant deficiencies considered to be material weaknesses. In a financial statement audit, the auditor is not required to perform procedures specifically to identify deficiencies in internal control or to express an opinion on internal control. But the auditor should report significant deficiencies or material weaknesses in internal control of which (s)he becomes aware. In such cases, they must be communicated in writing to management and those charged with governance (AU-C 265).

Which of the following statements is true about significant deficiencies identified in an audit?