A4 - REVIEW

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events? a. Investigate changes in capital stock recorded after year end. b. Inquire about payroll checks that were recorded before year end but cashed after year end. c. Determine whether inventory ordered before the year end was included in the physical count. d. Review tax returns prepared by management after year end.

Choice "a" is correct. A change in capital stock that is recorded after the year end is an example of a subsequent event that might require disclosure in the footnotes to the financial statements

An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management's assertions about: a. Valuation and allocation. b. Rights and obligations. c. Existence. d. Understandability and classification.

Choice "a" is correct. An auditor most likely would analyze inventory turnover rates to obtain evidence concerning management's assertions about valuation and allocation (i.e., if the inventory is becoming older, an obsolescence reserve might be required).

An auditor's analytical procedures most likely would be facilitated if the entity: a. Uses a standard cost system that produces variance reports. b. Segregates obsolete inventory before the physical inventory count. c. Develops its data from sources solely within the entity. d. Corrects material weaknesses in internal control before the beginning of the audit

Choice "a" is correct. An auditor's analytical procedures are facilitated when an entity uses a standard cost system with variance reports because the comparison of actual to budget will already have been performed. In addition, it is likely that management will already be aware of significant variations from budget and will be better able to address any questions the auditor may have.

In auditing an entity's computerized payroll transactions, an auditor would be least likely to use test data to test controls concerning: a. Control and distribution of unclaimed checks. b. Overpayment of employees for hours not worked. c. Withholding of taxes and Social Security contributions. d. Missing employee identification numbers.

Choice "a" is correct. In auditing an entity's computerized payroll transactions, an auditor would be least likely to use test data to test controls concerning control and distribution of unclaimed checks, since these sorts of controls are typically not automated. Controls surrounding unclaimed checks typically rely on proper segregation of duties, which is best evaluated through the auditor's direct observation.

An auditor usually determines whether dividend income from publicly-held investments is reasonable by computing the amounts that should have been received by referring to: a. Records produced by investment services. b. Stock ledgers maintained by independent registrars. c. Annual audited financial statements of investee companies. d. Dividend records on file with the SEC.

Choice "a" is correct. Investment income from dividends is generally recalculated by comparing recorded income with dividend record books produced by investment advisory services such as "Moody's Dividend Record." These books state the dividend that was declared and paid by the investee.

Which of the following characteristics most likely would be indicative of check kiting? a. Low average balance compared to high level of deposits. b. Many large checks that are recorded on Mondays. c. High turnover of employees who have access to cash. d. Frequent ATM checking account withdrawals.

Choice "a" is correct. Kiting occurs when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank. Frequent kiting may result in a high level of deposits coupled with a low average balance.

Which of the following does not demonstrate an inappropriate segregation of duties? a. A billing clerk prepares invoices and records the resulting increase in accounts receivable. b. The purchasing manager approves vendor invoices for payment. c. The cashier performs the monthly bank reconciliation. d. An accounting clerk receives customer payments and records the resulting reduction in accounts receivable.

Choice "a" is correct. Preparing invoices and recording the related receivables are both recordkeeping functions that would not be inconsistent with each other.

Which of the following statements extracted from a client's lawyer's letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification? a. "I believe that the plaintiff will have problems establishing any liability." b. "I believe that this action has only a remote chance in establishing any liability." c. "I believe that the company will be able to defend this action successfully." d. "I believe that the plaintiff's case against the company is without merit."

Choice "a" is correct. The lawyer's comment that the plaintiff "will have problems establishing any liability" is vague...it does not provide an evaluation of the likelihood of an unfavorable outcome. Does "will have problems" mean a loss is probable, reasonably possible, or remote? The auditor would likely want to request clarification to ensure that the situation has been properly accounted for and disclosed.

Which audit procedure is most likely related to the classification and understandability of the financial statements with respect to inventory? a. Confirming inventories pledged under loan agreements. b. Examining consignment agreements. c. Analyzing inventory turnover. d. Obtaining quotations for the current market value of inventory.

Choice "a" is correct. The pledge or assignment of any inventories should be appropriately disclosed in the financial statements.

Which of the following events occurring in the year under audit would most likely indicate that internal controls utilized in previous years may be inadequate in the year under audit? a. The chief financial officer waived approvals on all checks to one vendor to expedite payment. b. The audit committee chairperson unexpectedly resigned during the year under audit. c. The frequency of accounts payable check runs was changed from biweekly to weekly. d. The entity announced that the internal audit function would be eliminated after the balance sheet date.

Choice "a" is correct. Vouchers should be approved before payment occurs. Overriding this control to expedite payment may result in unauthorized payments being made. The auditor would need to consider this change in evaluating current controls and determining the nature, timing, and extent of testing.

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 obligations Allocation and valuation a. Yes Yes b. No Yes c. No No d. Yes No

Choice "b" is correct. By ensuring that credit approval is obtained before goods are shipped to customers, the auditor is testing management's assertion that accounts receivable are collectible (allocation and valuation). Ensuring that credit approval is obtained before goods are shipped does not support the rights and obligations assertion.

An auditor is testing the reasonableness of dividend income from investments in publicly-held companies. The auditor most likely would compute the amount that should have been received and recorded by the client by: a. Reading the details of the board of directors' meetings. b. Electronically accessing the details of dividend records on the Internet. c. Confirming the details with the investee companies' registrars. d. Examining the details of the client's most recent cutoff bank statement.

Choice "b" is correct. Electronically accessing the details of dividend records on the Internet is an efficient means of verifying dividend rates for multiple investments in a short amount of time.

An auditor's inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should: a. Document the derivatives in the auditor's communication with those charged with governance. b. Examine the contracts for possible risk exposure and the need to recognize losses. c. Confirm the marketability of the derivatives with a commodity specialist. d. Perform analytical procedures to determine if the derivatives are properly valued.

Choice "b" is correct. Generally accepted accounting principles specify that, in order to qualify for hedge treatment, the entity must demonstrate and disclose a number of transaction features including risk exposure. The auditor would therefore need to examine the contracts to evaluate the character of the hedge and the degree to which losses should be recognized in the determination of income, as well as the character of any disclosures.

When control risk is assessed as low for assertions related to payroll, substantive tests of payroll balances most likely would be limited to applying analytical procedures and: a. Footing and crossfooting the payroll register. b. Recalculating payroll accruals. c. Observing the distribution of paychecks. d. Inspecting payroll tax returns.

Choice "b" is correct. If the control risk is assessed as low, less substantive testing is necessary. In such an instance, substantive testing would normally be limited to analytical procedures and recalculating year-end accruals.

In evaluating the reasonableness of an accounting estimate, an auditor most likely would concentrate on key factors and assumptions that are: a. Similar to industry guidelines. b. Deviations from historical patterns. c. Consistent with prior periods. d. Objective and not susceptible to bias.

Choice "b" is correct. In evaluating the reasonableness of an estimate, an auditor would normally concentrate on key factors and assumptions that are (1) significant to the accounting estimate, (2) sensitive to variations, (3) deviations from historical patterns, or (4) subjective and susceptible to misstatements and bias.

PCAOB standards state that the relevance of audit evidences depends on all but which of the following? a. Whether the audit procedure is designed to directly test an assertion. b. The auditor's risk assessment. c. The timing of the audit procedure. d. Whether the audit procedure is designed to test for an understatement or overstatement.

Choice "b" is correct. The auditor's risk assessment affects the nature, extent, and timing of audit procedures, but does not determine the relevance of audit evidence.

Which of the following statements extracted from a client's lawyer's letter concerning litigation, claims, and assessments most likely would cause the auditor to request clarification? a. "We believe that the plaintiff's case against the company is without merit." b. "We believe that the action can be settled for less than the damages claimed." c. "We believe that the company will be able to defend this action successfully." d. "We believe that the possible liability to the company is nominal in amount."

Choice "b" is correct. This statement seems to give some indication that the lawyer believes that there is at least some likelihood that there may be a known or estimable amount and that the case may actually result in a liability.

An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that: a. Notice of an increase in property tax rates was received by management, but was not recorded until early in the subsequent year. b. Unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities. c. Fourth quarter payroll taxes were properly accrued and recorded, but were not paid until early in the subsequent year. d. The annual provision for uncollectible accounts expense was inadequate because of worsening economic conditions.

Choice "b" is correct. Unrealized gains on available-for-sale securities should properly be recorded in other comprehensive income. If such gains were erroneously recorded in the income account for trading securities, this might be discovered through comparison of the current year and prior year revenues and expenses (assuming the error occurred only in the current year, and not in the prior year).

An auditor suspects that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor most likely would compare the: a. Individual bank deposit slips with the details of the monthly bank statements. b. Dates checks are deposited per bank statements with the dates remittance credits are recorded. c. Daily cash summaries with the sums of the cash receipts journal entries. d. Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded.

Choice "b" is correct. When lapping occurs, an employee uses current remittances to conceal remittances that have been stolen previously. Thus, a lag will exist from the time that this current payment is deposited until the current customer's account is actually credited. (The current payment is applied to the previous customer's account).

In the audit of a nonissuer, which of the following statements is correct regarding the use of external confirmations to obtain audit evidence? a. Management's refusal to allow an auditor to perform external confirmation procedures is considered a departure from GAAP sufficient to qualify the opinion. b. Negative confirmations should be used only if a very high exception rate is expected. c. A factor for an auditor to consider when designing confirmation requests is the assertion being tested. d. Negative confirmations provide more persuasive audit evidence than positive confirmations.

Choice "c" is correct. A factor for an auditor to consider when designing confirmation requests is the assertion being tested.

Generally accepted auditing procedures have not been followed in which of the following situations? a. An unusually large number of receivables confirmations are not returned, and the auditor decides to verify the related cash receipts rather than sending second requests. b. The accounts receivable balance is immaterial, so the auditor decides not to send any receivables confirmations. c. The auditor receives several faxed and emailed confirmation responses indicating that the amount stated is correct. The auditor does not perform any additional procedures related to these electronic responses. d. The auditor receives very few responses to negative confirmations sent. The auditor does not perform any additional procedures related to the non-responses.

Choice "c" is correct. Confirmation responses received electronically should be verified by calling the sender. It is possible for such responses to look like they came from the respondent when in fact they were actually generated by another party, such as the client.

Which of the following procedures would be most appropriate for testing the completeness assertion as it applies to inventory? a. Tracing inventory items from the tag listing back to the physical inventory quantities. b. Scanning perpetual inventory, production, and purchasing records. c. Performing cutoff procedures for shipping and receiving. d. Examining paid vendor invoices

Choice "c" is correct. Performing cutoff procedures provides assurance that goods in transit (shipped or received) are appropriately included or excluded from inventory and this procedure is most appropriate for testing the completeness assertion.

To gain assurance that all inventory items in a client's inventory listing schedule are valid, an auditor most likely would trace: a. Inventory tags noted during the auditor's observation to items listed in the inventory-listing schedule. b. Items listed in receiving reports and vendors' invoices to the inventory-listing schedule. c. Items listed in the inventory-listing schedule to inventory tags and the auditor's recorded count sheets. d. Inventory tags noted during the auditor's observation to items listed in receiving reports and vendors' invoices.

Choice "c" is correct. Tracing from the inventory schedule to the inventory tags and the auditor's recorded count sheets verifies the validity (existence) of the items. Note that the correct term for the directional test for existence is "vouch." However, in practice (and on the CPA Exam), the term trace is sometime used interchangeably with the term vouch.

Which of the following events least likely would indicate the existence of related party transactions? a. Maintaining compensating balance arrangements for the benefit of principal stockholders. b. Borrowing funds at an interest rate significantly below prevailing market rates. c. Writing off obsolete inventory to net realizable value just before year end. d. Making a loan with no scheduled date for the funds to be repaid.

Choice "c" is correct. Writing off obsolete inventory to net realizable value just before year end is not indicative of the existence of related party transactions.

Which of the following types of audit evidence generally is the most reliable? a. Inquiries made of management. b. Analytical procedures. c. Review of prior-year audit procedures. d. Confirmation of account information.

Choice "d" is correct. Confirmations are among the most reliable types of evidence, as they constitute external evidence sent directly to the auditor.

Which is true about the auditor's observation of physical inventory counts? I. It can provide evidence supporting the existence assertion. II. It can provide evidence supporting the completeness assertion. a. Neither I nor II are true. b. II only. c. I only. d. Both I and II.

Choice "d" is correct. Observation of physical inventory counts provides evidence about both existence and completeness. Observing the inventory provides evidence that it physically exists; observing the actual count provides evidence regarding completeness (i.e., does it appear that the client is doing a careful, accurate, and complete job of counting all of the inventory?).

Which of the following internal controls most likely would prevent direct labor hours from being charged to manufacturing overhead? a. Comparison of daily journal entries with approved production orders. b. Reconciliation of work-in-process inventory with periodic cost budgets. c. Periodic independent counts of work-in-process for comparison to recorded amounts. d. Use of time tickets to record actual labor worked on production orders.

Choice "d" is correct. The use of time tickets to record actual labor worked on production orders is the best way to prevent direct labor from being charged to manufacturing overhead.