Auditing Chapter 6

Discuss the purpose of the audit program and its importance to the auditor.

An audit program specifies the actual procedures to be performed in gathering the required audit evidence about the assertions embodied in the client's financial statements. Because the audit program guides the overall conduct of the audit it is the single most important piece of documentation in an audit engagement. The program is an effective means for: ∙ Organizing and distributing audit work. ∙ Monitoring the audit process and progress. ∙ Reviewing for possible omission of material areas from the audit. ∙ Recording the audit work performed. ∙ Reviewing the completeness and persuasiveness of procedures performed

Why is the appropriateness of audit evidence obtained by the auditor important in forming an audit opinion? Describe the qualities information should have to be considered appropriate by the auditor.

Appropriateness is a measure of the quality of evidence. Audit evidence that is considered appropriate contains the characteristics of relevance and reliability. Relevant evidence refers to the assertion being tested. Reliability refers to the relative truthfulness of the assertion.

Discuss the importance of the phrase "sufficient appropriate evidence is to be obtained..." How do auditing standards define sufficiency and appropriateness?

Audit standards states that auditors must obtain sufficient appropriate evidence by performing various audit procedures in order to support the audit opinion regarding the financial statements under audit. The AICPA's AU-C 500 defines sufficiency as "the measure of the quantity of audit evidence. The quantity of the audit evidence needed is affected by the auditor's assessment of the risks of material misstatement and also by the quality of such evidence." The AICPA's AU-C 500 defines appropriateness as "the measure of the quality of audit evidence (that is, its relevance and reliability in providing support for the conclusions on which the auditor's opinion is based)."

Discuss the audit standards that must be applied to the auditor's documentation. Give five examples of the types of documentation found in the audit work papers

Auditing standards require that the auditor obtains sufficient appropriate evidence before issuing an opinion, and requires auditors to document (and retain such documentation for at least seven years) that evidence and judgments based upon it. Pursuant to all of these requirements, audit work papers will include such items as: 1. Evidence of planning such as the planning memo, risk assessments, and the audit program. 2. Evidence of the auditor's understanding and assessment of internal control over the client organization. 3. The client's trial balance and proposed audit adjustments. 4. Copies of certain internal and external documents such as letters of communication with the client and returned confirmations. 5. Audit memoranda documenting the testing process, auditor reasoning, and conclusions. 6. Results of analytical procedures and audit testing. 7. Auditor generated analysis of account balances such as the allowance for doubtful accounts.

Explain the meaning of "directional testing" and identify the reasons why directional testing leads to audit efficiency. Give examples of directional testing for the existence and completeness assertions

Directional testing involves testing transactions or balances primarily for one type of error, either overstatement or understatement, but not for both at the same time. For example, an audit test for an understatement of Accounts Payable also tests for an understatement of Purchases. Directional testing also leads to audit efficiency for the following reasons: ∙ Misstatements of some accounts are more likely to occur in one direction than the other. ∙ Directional testing of an account balance provides evidence on a complementary set of accounts. ∙ Specific assertions are normally tested directionally. An example is the testing of the existence assertion for overstatements or the completeness assertions for understatements. An example of directional testing for existence includes the sampling of assets recorded on the balance sheet, such as fixed assets and tracing those items back through the system to original source documents such as vendor invoices. This procedure tests for the possible overstatement of the fixed assets. Item(s) selected from the general ledger that are found to lack adequate supporting vendor invoices to substantiate existence are evidence of the overstatement of assets. Testing directionally for completeness, on the other hand is just the opposite. Source documents are sampled and traced forward through the journals, ledgers and to the general ledger. An example may be vendor invoices for expenses. Invoices that are not found in the general ledger balance prove that the system is incomplete. In the example of an expense, net income would be overstated and liabilities may be understated.

The Auditing Standards Board established guidelines to assist auditors in evaluating the reliability of audit evidence. Discuss the criteria for the more reliable types of evidence and include an example for each.

Evidence that is considered to be more reliable includes: ∙ Directly observable evidence such as counting inventory or observing fixed assets. ∙ Evidence derived from a client's strong internal control structure such as reconciliations or the information system itself. ∙ Evidence from independent external sources such as confirmations from banks, customers and attorneys. Examples provided by the students may vary and the instructor must use his or her judgment.

. Audit evidence used to support an audit opinion is obtained solely from audit procedures. a. True b. False

False

. The reliability of audit evidence relates to the connection between the audit procedure being performed and the assertion being audited. a. True b. False

False

Audit documentation serves as support for the financial statements. a. True b. False

False

Audit findings represent a summary of incorrect transactions detected during the audit. a. True b. False

False

Audit planning workpapers are prepared to support the foundation of the audit and are prepared for the client to assist in their understanding of the specific audit procedures that will be performed. a. True b. False

False

Auditors should mail third-party confirmations through the client's mailroom. a. True b. False

False

Inspection of an asset generally provides reliable evidence about the rights and obligations assertion related to that asset. a. True b. False

False

The amount of evidence gathered is not important to an auditor since the quality of the evidence is of primary importance. a. True b. False

False

The audit program specifies what the client must do to perform the audit in accordance with generally accepted accounting procedures. a. True b. False

False

The auditor multiplies the quantity of inventory on the inventory ledger by the cost of the inventory to arrive at total inventory balance per product number. This is an example of recalculation by footing. a. True b. False

False

The auditor utilizes the same audit program and the same procedures each year for each client in order to ensure that nothing is missed in the current year audit. a. True b. False

False

The greatest risk of recording transactions in the incorrect period occurs during the roll-forward period. a. True b. False

False

The purpose of performing analytical procedures in the planning stage of an audit is to gather audit evidence and make conclusions about account balances. a. True b. False

False

Tracing is a process that helps establish that recorded transactions are valid. a. True b. False

False

Identify and demonstrate the audit assertions and different approaches to obtaining audit evidence for an audit of cash balances in a financial statement audit.

In performing the audit of cash, the auditor is most concerned with the existence, valuation, and rights assertions. The audit of cash may use the following approaches: ∙ Observe the client's handling of the petty cash fund and the control over incoming cash and cash storage. Observe the process of cash received in the mailroom, deposits to the bank, and reconciliation by a separate individual. ∙ Physically count the petty cash, cash in drawers, and cash in safes. ∙ Examine documents such as the bank statement. ∙ Make inquiries of personnel concerning the handling of daily deposits or the mail receipts. ∙ Confirm the bank balance with financial institutions using proper confirmation procedures. ∙ Recalculate the bank reconciliation computation and trace the book balance to the general ledger. ∙ Inquire of materially aged outstanding checks and deposits in transit. ∙ Trace outstanding checks and deposits in transit clearing subsequent bank statements from a qualified source. ∙ Vouch material and unusual entries in the cash account. ∙ Perform an analysis of bank transfers at or near cutoff. ∙ Use analytical procedures to determine the reasonableness of the reported cash balance. This response is only intended to be a sample. The instructor must evaluate the quality of the student responses.

Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable

Internal documentation involves the auditor's examination of documents that have been prepared and used within the client's organization and are retained without ever going to an outside party. Examples would include duplicate sales invoices, employees' time reports, and inventory receiving reports. External documentation involves the auditor's examination of documents that have been in the hands of someone outside the client's organization. Examples include vendors' invoices, cancelled checks, cancelled notes payable, and insurance policies

. The auditor uses professional judgment to determine which audit procedures to perform. a. True b. False

True

Audit evidence consists of both information that corroborates management's assertions and information that contradicts such assertions. a. True b. False

True

In a reasonableness test, the auditor develops an expected value of an account by using data wholly or partly independent of the client's accounting information system. a. True b. False

True

Internal documentation is generally less reliable than external documentation. a. True b. False

True

Audit documentation serves as the primary support of an audit. Give at least six examples of the components of proper working paper documentation

Well prepared documentation should include: ∙ A heading that includes the name of the audit client, an explanatory title, and the balance sheet date. ∙ The initials or electronic signature of the auditor performing the audit test and the date the test was completed. ∙ The initials or electronic signature of the senior, manager, or partner who reviewed the working papers and the date the review was completed. ∙ A description of the nature of the test performed and the findings. ∙ An assessment of whether the test indicates the possibility of material misstatement in the account. ∙ Manual or electronic tick marks and a legend indicating the nature of the work performed by the auditor. ∙ A section that identifies all significant issues that arose during the audit and how they were resolved ∙ A cross-reference or electronic link to related working papers. Many of these components are electronic in nature and are resident in a paperless audit software and storage combination. Nonetheless, such components remain vital in proper documentation of audit testing and conclusions.

. The written record that forms the basis for the auditor's conclusions is referred to as what? a. Audit documentation. b. Audit adjustment. c. Accounting records. d. Footing.

a. Audit documentation.

Each of the audit procedures that an auditor could select possesses which of the following characteristics? a. Audit procedures take time, effort, and money. b. Audit procedures are difficult to perform. c. Audit procedures require multiple people from the firm to perform. d. All of the above

a. Audit procedures take time, effort, and money.

Directional testing is important to an auditor because of which of the following factors? a. Certain accounts are more prone to be misstated by overstatement than others. b. The auditor must remain organized when conducting an audit. c. The primary concern of the auditor is the understatement of asset and revenue accounts. d. It tests for existence and completeness simultaneously.

a. Certain accounts are more prone to be misstated by overstatement than others.

. Recalculations of the client's computations would not include which of the following procedures? a. Cutoff. b. Footing. c. Extension. d. Cross-footing

a. Cutoff.

. An auditor selects a sample of items recorded and traces them back to the supporting documentation. This is an example of which of the following? a. Directional testing for existence. b. Directional testing for completeness. c. Direct testing for valuation. d. Direct testing for rights.

a. Directional testing for existence.

Which of the following types of audit evidence is the least reliable? a. Evidence from the client's organization. b. Evidence derived from a well-controlled system. c. Evidence from independent outside sources. d. Original documents

a. Evidence from the client's organization.

. Which of the following is an example of inspection of documentation? a. Review shipping documents. b. Estimate the expected amount of interest income. c. Observe controls. d. Recalculate the total amount include on a sales invoice.

a. Review shipping documents.

Reprocessing of transactions involves which of the following? a. Testing forward. b. Testing backward. c. Testing at a point in time. d. Directional testing either forward or backward.

a. Testing forward.

Sufficient evidence gathered by the auditor involves which of the following? a. The quantity of evidence to be obtained. b. The type of evidence to be obtained. c. Obtaining limited evidence to achieve efficiency. d. The use of an audit program to obtain evidence.

a. The quantity of evidence to be obtained.

To be considered reliable evidence, confirmations must be controlled by which of the following parties? a. A client employee responsible for accounts receivable. b. An external auditor. c. A client's internal audit department. d. A client's controller or CFO.

b. An external auditor.

When using the audit procedure vouching, the auditor is primarily concerned with which of the following assertions? a. Completeness. b. Existence. c. Authorization. d. Classification.

b. Existence.

Performance of audit procedures at an interim date causes the risk of material misstatement occurring between the interim date and the end of the year to do which of the following? a. Decrease. b. Increase. c. Remain the same. d. Become more difficult to ascertain.

b. Increase.

The reliability of a client's internal documentation is most affected by which of the following? a. The auditor's independence. b. Management's motivation to misstate accounts. c. The type of audit report that will be issued. d. Management's ability to understand generally accepted audit standards

b. Management's motivation to misstate accounts.

The auditor normally considers both underlying accounting records and corroborating information in the audit process. Underlying accounting records do not include which of the following items? a. Evidence of controls. b. Minutes of meetings. c. Checks, invoices, and contracts. d. General and subsidiary ledgers.

b. Minutes of meetings.

Observation suffers from which of the following limitations? a. Observation of processing is rarely unobtrusive. b. Observation of processing on one day does not necessarily indicate how transactions were processed on a different day. c. All the above. d. None of the above

b. Observation of processing on one day does not necessarily indicate how transactions were processed on a different da

Appropriateness of evidence is a measure of which of the following? a. Quantity of evidence. b. Quality of evidence. c. Sufficiency of evidence. d. Meaning of evidence.

b. Quality of evidence.

Footing, cross-footing, and tests of extensions are examples of which approach to gathering evidence? a. Reprocessing. b. Recalculation. c. Vouching. d. Examination of documentatio

b. Recalculation.

. Vouching of transactions deals with which of the following? a. Testing forward. b. Testing backward. c. Testing at a point in time. d. Directional testing either forward or backward

b. Testing backward.

Which one of the following is the primary reason for documenting audit work? a. To prevent litigation by other parties that question the audit performance. b. To provide a stand-alone medium that gives audit conclusions and supports the opinion. c. To give the client a full reporting of all work performed on their behalf. d. To supply a point of reference for all auditors performing the work subsequently

b. To provide a stand-alone medium that gives audit conclusions and supports the opinion.

. Two determinants of the persuasiveness of evidence include which of the following? a. Competence and sufficiency. b. Relevance and reliability. c. Appropriateness and sufficiency. d. Independence and effectiveness

c. Appropriateness and sufficiency.

. Conclusions are typically documented by auditors in which type of work paper? a. Audit planning memo. b. Audit program. c. Audit memoranda. d. Representation letter

c. Audit memoranda.

Which of the following types of audit evidence is the most reliable? a. Evidence from the client's organization. b. Evidence from a poorly controlled system. c. Directly observable evidence. d. Facsimiles of documents.

c. Directly observable evidence.

What is determined to be appropriate and sufficient will be affected by which of the following? a. The client's risk of material misstatement. b. The risk of material weakness in internal controls. c. Either a or b. d. None of the above.

c. Either a or b

Directional testing involves testing transactions or balances for which type of error? a. Overstatement. b. Understatement. c. Either overstatement or understatement. d. Neither overstatement nor understatement.

c. Either overstatement or understatement.

Which of the following is not a factor that would impact the effectiveness of a substantive analytical procedure? a. Nature of the assertion being tested. b. Plausibility and predictability of the relationships in the data. c. Excessive disaggregation of the relevant data. d. Rigor of the analytical procedure employed

c. Excessive disaggregation of the relevant data

Which of the following is not a characteristic of quality audit documentation? a. Clear communication as to how testing was performed, the results of testing, and conclusions. b. Organization and assembly of documentation in an orderly fashion. c. Headings that include the name and signature of the client representative that the auditor interacted with while performing testing. d. Authenticated identification of the person responsible for completing the procedure and conclusions.

c. Headings that include the name and signature of the client representative that the auditor interacted with while performing testing.

In evaluating cost of evidence, which of the following evidence qualities of the audit usually has the lowest cost? a. High quality. b. Medium quality. c. Low quality. d. All cost the same.

c. Low quality.

. Which one of the following would be the most reliable type of evidence? a. Photocopies. b. Indirectly obtained evidence. c. Observation of assets. d. Inquiry with the in-house attorney.

c. Observation of assets.

The extent of procedures is affected mostly by which of the following factors? a. The sheer volume of procedures to be applied by the auditor. b. The time of year in which the client takes a physical inventory in the warehouse. c. The auditor's judgment that misstatements are probable in certain balances. d. The availability of the client's staff at or near the balance sheet date.

c. The auditor's judgment that misstatements are probable in certain balances.

Which of the following is not a type of internal documentation? a. Legal documents. b. Business documents. c. Third-party documents. d. Accounting documents.

c. Third-party documents.

The process of vouching helps establish which of the following regarding recorded transactions? a. Transactions have been recorded. b. Transactions are complete. c. Transactions are valid. d. Transactions are presented properly.

c. Transactions are valid.

Which of the following characteristics are not normally included in quality audit documentation? a. Initials of the person preparing and reviewing the document. b. An assessment of whether the test indicates the possibility of material misstatement in an account. c. A cross-reference. d. All are included in quality audit documentation.

d. All are included in quality audit documentation.

Audit documentation should contain which of the following? a. A heading that includes the name of the audit client, an explanatory title, and the balance sheet date. b. The initials or electronic signature of the auditor performing the audit test and the date the test was completed. c. The initials or electronic signature of the manager or partner who reviewed the documentation and the date the review was completed. d. All of the above.

d. All of the above.

The auditor may use analytical procedures during which phase of the audit? a. Planning the audit. b. Substantive testing. c. Completing the audit. d. All of the above.

d. All of the above.

The processes used by management in developing estimates include which of the following? a. Controls over the process. b. The reliability of underlying data in developing the estimate. c. Use of outside experts by management (for example, how they were used and their expertise). d. All of the above.

d. All of the above.

Which of the following is a factor that the auditor should consider as they affect the reliability and relevance of information produced by a management's specialist? a. Competence, capabilities, and objectivity of that specialist. b. Work performed by that specialist. c. Appropriateness of that specialist's work as audit evidence for the relevant assertion. d. All of the above.

d. All of the above.

An audit program provides an effective means for which of the following? a. Reviewing the completeness and persuasiveness of procedures performed. b. Recording the audit work performed and those responsible for performing the work. c. Organizing and distributing the work. d. All the above

d. All the above

. When using confirmations with outside parties, the auditor must assure which of the following about the outside party? a. The outside party exists. b. The outside party is able to respond objectively and independently. c. The outside party is unbiased in responding. d. All the above.

d. All the above.

An example of an external document would include which of the following? a. Vendor invoices. b. Customer orders. c. Confirmation replies from customers. d. All the above.

d. All the above.

. Which of the following is the primary source for evidence to corroborate the existence of pending litigation? a. Vendor confirmations. b. Disclosures in financial statements. c. Management representation letters. d. Attorney confirmations.

d. Attorney confirmations.

An audit program is created to specify which of the following? a. The type of audit opinion to be rendered based upon procedures performed. b. The audit procedures that will be performed every year for the client. c. How an auditor should think while performing audit procedures. d. Audit objectives and procedures to be followed during the audit process.

d. Audit objectives and procedures to be followed during the audit process.

Which of the following is not an estimate that requires significant auditor judgment and skepticism? a. Obligations for pension plans. b. Valuation of goodwill. c. Allowance for bad debt. d. Common stock and related additional paid-in capital

d. Common stock and related additional paid-in capital

Reprocessing of transactions helps establish that all valid items have been recorded. Reprocessing tests which of the following assertions? a. Occurrence. b. Rights. c. Existence. d. Completeness

d. Completeness

. Which one of the following would be considered the most reliable type of audit evidence? a. Purchase orders from vendors. b. Customer accounts receivable files. c. Computerized general ledger. d. Confirmations from banks

d. Confirmations from banks

Which one of the following would be the least reliable type of evidence? a. Confirmations returned by bank directly to the auditor. b. Letters of communication from the Securities Exchange Commission. c. Physical examination of perpetual inventory. d. Evidence from an easily overridden information system

d. Evidence from an easily overridden information system

Which of the following assertions is the primary assertion that is satisfied by physically observing the client's count of inventory? a. Rights. b. Valuation. c. Completeness. d. Existence.

d. Existence.

When may audit procedures be performed? I - on the balance sheet date. II - prior to the balance sheet date. III - subsequent to the balance sheet date. a. I only. b. I and III only. c. II only. d. I, II, and III.

d. I, II, and III.

A date at which audit evidence is collected earlier than the balance sheet date is referred to as what? a. Subsequent date. b. Cutoff period. c. Significant date. d. Interim date.

d. Interim date.

External documentation may lack reliability. Which of the following is the most probable reason for that? a. The external party may be competent in performing duties. b. The documentation may be properly understood by the client in the response. c. The auditor may decide not to use the documentation and replace it with other documents. d. The documentation may have been altered if the process is not controlled from inception.

d. The documentation may have been altered if the process is not controlled from inception.

. Inquiries of client personnel are not a frequent means of evidence gathering by an auditor. a. True b. False

false

. Inspection of tangible assets generally provides reliable evidence with respect to the completeness of the assets, but not necessarily about the existence of the assets. a. True b. False

false

Appropriateness deals with the quantity of evidence the auditor collects, whereas sufficiency deals with the quality of evidence the auditor collects. a. True b. False

false

Liabilities and expenses are most often tested for overstatements. a. True b. False

false

The client's verbal evidence is more reliable than evidence from independent outside sources. a. True b. False

false

. Analytical procedures are a type of substantive evidence. a. True b. False

true

. Confirmation statements from banks are an example of third-party external documents. a. True b. False

true

. Many related-party transactions have no higher risk of material misstatement than similar transactions between unrelated parties. a. True b. False

true

. Relevance and reliability of evidence make up the appropriateness of audit evidence. a. True b. False

true

A limitation of observation is that observing a process on one day does not necessarily indicate how the transactions were processed on a different day or over a relevant period of time. a. True b. Fals

true

An example of physical observation is the auditor's testing of inventory by counting it to substantiate the existence assertion. a. True b. False

true

An outside specialist may assist the auditor in obtaining sufficient, appropriate evidence concerning the analysis of complex tax compliance issues. a. True b. False

true

Audit documentation should generally be retained for at least seven years. a. True b. False

true

Audit documentation should include the initials or electronic signature in order to identify the audit personnel responsible for the work and the managers and partners reviewing the work. a. True b. False

true

Evidence can be directly or indirectly relevant to an assertion. a. True b. Fals

true

For an auditor to test the existence assertion of assets, testing will be performed beginning with the recorded asset and ending with the source documents. a. True b. False

true

Internal documentation is more reliable to the auditor if the internal control surrounding the documentation is considered strong than if it is considered weak. a. True b. False

true

One strategy used by auditors in testing assertions is to perform directional testing to find overstatements or understatements. a. True b. False

true

Some audit procedures may be performed prior to the end of the year under audit. a. True b. False

true

The auditor's concern for potential fraud in the financial statements will most likely result in increased testing for the overstatement of revenues. a. True b. False

true

The auditor's job is to gather sufficient appropriate audit evidence on which to base an opinion. a. True b. False

true

The direction of testing from recorded amounts toward supporting documentation provides evidence as to existence of assets and revenues. a. True b. False

true

The direction of testing from the source documents to recorded amounts provides evidence regarding the completeness of liabilities and expenses. a. True b. False

true

The primary importance of the audit program is its guidance of the overall conduct of the audit. a. True b. False

true

The relevance of audit evidence depends on the audit assertion being tested. a. True b. False

true

The reliability of audit evidence is a measure of the quality of the underlying evidence and is influenced by risk, potential management bias associated with the evidence, and the quality of the internal control system underlying the preparation of the evidence. a. True b. False

true

The type of audit procedure known as inquiry does not ordinarily provide sufficient audit evidence of the absence of a material misstatement, nor is it alone sufficient to test the operating effectiveness of controls. a. True b. False

true

Ulanda and Mudana, CPAs, are performing an audit on McArnee, Inc. Ulanda selects a sample from certain source documents and traces them forward to the accounts payable ledger. The purpose of this test is to determine the possibility of understated liabilities. a. True b. False

true

Underlying accounting records consist of evidence of controls as well as supporting records such as checks, invoices, the general and subsidiary ledger and journal entries. a. True b. False

true

Vouching recorded transactions involves taking a sample entry from a journal and obtaining the original source documents to ensure the transaction occurred. a. True b. False

true

While inspecting documents, auditors should use original documents rather than copies, because copies are easy for management to falsify. a. True b. False

true

While inspecting documents, the reliability depends on the nature and source of the documentation. a. True b. False

true