auditing chapter 3 homework

g. Which of the following is not a primary approach to auditing an accounting estimate? 1. Review and test management's process for developing the estimate 2. Review subsequent transactions 3. Confirm the amounts 4. Develop an independent estimate

3. There are three basic approaches to auditing accounting estimates: reviewing management's processes, reviewing subsequent transactions and developing an independent estimate. Confirming the amounts is not an auditing approach.

h. A primary purpose of the audit working papers is to: 1. Aid the auditors by providing a list of required procedures 2. Provide a point of reference for future audit engagements 3. Support the underlying concepts including in the preparation of the basic financing statements 4. Support the auditors opinion

4. A primary purpose of audit working papers is to support the auditor's opinion by providing evidence for the accounting firm.

e. Of the following, which is the least reliable type of audit evidence? 1. Confirmations mailed by outsiders to the auditors 2. Correspondence between the auditors and suppliers 3. Copies of sales invoices inspected by the auditors 4. Canceled checks returned in the year-end bank statements directly to the client

3. Copies of sales invoices are least reliable because they are internally generated evidence. Confirmations mailed by outsiders to the auditors and correspondence between the auditors and suppliers are held to be reliable because they are created outside as evidence. Canceled checks returned in the year-end bank statements directly to the client are generated internally but are considered reliable because they are endorsed by the check holder and a stamp by the bank.

•Primary functions

-Support the auditors' compliance with auditing standards -Support the auditors' opinion

b.Develop the expected amounts for 20x4 for each of the income statement items.

• Sales 10800 • Cogs 7468 • Gross profit 3332 • Sales commission 756 • Advertising 216 • Salaries 1124 • Payroll taxes 207 • Employee benefits 188 • Rent 63 • Depreciation 69 • Supplies 32 • Utilities 24 • Legal and accounting 43 • Miscellaneous 15 • Interest expense 252 • Net income before taxes 343 • Income taxes 75 • Net income 268

a. Which of the following is not a financial statement assertion made by management? 1. Existence of recorded assets and liabilities 2. Completeness of recorded assets and liabilities 3. Valuation of assets and liabilities 4. Effectiveness of internal control

4. Effectiveness of internal control is not a financial statement assertion made by management

•Secondary functions

-Assist continuing and new audit team members in planning and performing the audit -Serves as a record of matters of continuing audit interest -Assists in supervision and review of the audit -Demonstrates the accountability of team members -Assists internal reviewers, external peer reviewers, PCAOB inspectors, and successor auditors in performing their roles

f. Analytical procedures are most likely to detect: 1. Weaknesses of a material nature in internal control 2. Unusual transactions 3. Noncompliance with prescribed control activities 4. Improper separation of accounting and other financial duties

2. Analytical procedures are most likely to detect unusual transactions because they show a change in a relationship being investigated. Analytical procedures do not normally consider the test of internal control even though it might revel errors caused by weaknesses of material in internal control.

c. As part of their audit, auditors obtain a representation letter from their client. Which of the following is not a valid purpose of such a letter? 1. To increase the efficiency of the audit by eliminating the need for other audit procedures 2. To remind the client's management of its primary responsibility for the financial statements 3. To document in the audit working papers the clients responses to certain verbal inquires made by the auditors during the engagement 4. To provide evidence in those areas dependent upon management's future intentions

1. A client letter which shows representation for the auditor is not valid to show to eliminate the need for other auditing procedures.

j. Which of the following is not a function of audit working papers? 1. Assist management in illustrating that the financial statements are in accordance with GAAP 2. Assist audit team members responsible for supervision in reviewing the work 3. Assist auditors in planning future engagements 4. Assist peer reviewers and inspectors in performing their roles

1. Working papers assist team members in reviewing work, assists auditors in future engagements and assists peer reviews and inspections on their performing roles. The only thing that working papers do not do are assisting management in illustrating the financial statements are in accordance with GAAP.

i. In what section of the audit working papers would a long-term lease agreement be filed? 1. Current working paper files 2. Permanent working paper file 3. Lead schedule file 4. Corroborating document file

2. Long-term lease agreements would be filed in permanent working paper files because these files can affect future audits since they are long term.

d. Which of the following statements best describes why auditors investigate related party transactions? 1. Related party transactions generally are illegal acts 2. The substance of related party transactions may differ from their form 3. All related party transactions must be eliminated as a step in preparing consolidated financial statements 4. Related party transactions are a form of management fraud

2. Related parties are when one party may be able to influence the other party to the extent that the two parties do not pursue their own separate interest in conducting transactions. This is why auditors investigate related party transactions to see if the substance may differ from their form.

k. In using the work of specialist, the auditors referred to the specialist's findings in their report. This would be an appropriate reporting practice if the: 1. Client is not familiar with the professional certification, personal reputation, or particular competence of the specialist 2. Auditors, as a result of the specialist's findings, give a qualified opinion on the financial statements 3. Client understands the auditor's corroborate use of the specialist's findings in relation to the representations in the financial statements 4. Auditors, as a result of the specialist's findings, decide to indicate a division of responsibility with the specialist

2. When an auditor is referring to a specialists finding in a report its because their findings are different from the reports that management has presented, which would cause the auditor to change the reports.

l. A difference of opinion concerning accounting and auditing matters relative to a particular phase of the audit arises between an assistant auditor and the auditor responsible for the engagement. After the appropriate consultation, the assistant auditor asks to be disassociated from the resolution of the matter. The working papers would probably: 1. Remain silent on the matter since it is an internal matter of the auditing firm 2. Note that the assistant auditor is completely dissociated from responsibility for the auditors' opinion 3. Document the additional work required, since all disagreements of this type will require expanded substantive procedures 4. Document the assistant auditor's position and how the difference of opinion was resolved

4. When there is a difference of opinion, working papers are used to document the position of all involved and how the difference was resolved.

b. Which of the following business characteristics is not indicative high inherent risk? 1. Operating results that are highly sensitive to economic factors 2.Large likely misstatements detected in prior audits 3. Substantial turnover of management 4. A large amount of assets

4. A large amount of assets is not indicative as high inherent risks. Operating results highly sensitive to large past misstatements or turnover of management of all characteristics may indicate high inherent risk.

a. Describe the purpose of analytical procedures performed in the risk assessment stage of the audit.

- Analytical procedures performed as risk assessment procedures are used to assist the auditors in determining the nature, timing, and extent of further audit procedures that will be used to obtain evidence about specific accounts.

c. Uden's unaudited financial statements for the current year show a 31% gross profit rate. Assuming that this represents a misstatement from the amount that you developed as an expectation, calculate the estimated effect of this misstatement on net income before taxes for 20x4.

- My answer for gross profit was 3332 while if there was a 31% gross profit rate then the answer for gross profit would have been 3348 which would have cause a 16 increase in net income before taxes.

42. At 12 o'clock when the plant whistle sounded, George Green, an assistant auditor, had his desk completely covered with various types of working papers. Green stopped work immediately, but not wanting to leave his desk with such disorderly appearance, he took a few minutes to sort the papers into proper order, place them in a neat pile, and weight them down with a heavy paperweight. He then departed for lunch. The auditor-in-charge, who had been observing what was going on, was critical of the assistance actions. What do you think was the basis for criticism by the auditor-in-charge?

The basis of the criticism of the assistant auditor was due to the fact that the working papers, which should always be confidential, were exposed to the surrounding where anyone could gain access to them. The working papers should have been placed somewhere out of sight and out of reach of others in the office.

d. Indicate whether you believe that the difference calculated in part (c) is material. Explain your answer.

- I wouldn't consider this as material because a $16,000 misstatement is less than 5% of the total net income before taxes.

17. What are related party transactions?

Individuals or entities who may have dealings with the client in which one party is significantly influenced by the other such that it may not pursue its separate interests.