Module 5

What section and paragraph of the AICPA's Codification of Statements on Standards for Accounting and Review Services provide an example of a standard Representation Letter?

AR-C 90.A159

What section and paragraph of the AICPA's Codification of Statements on Auditing Standards (clarified standards) define sufficiency and appropriateness of audit evidence?

AU-C 200.14

Which of the following procedures would a CPA ordinarily perform when reviewing the financial statements of a nonissuer in accordance with Statements on Standards for Accounting and Review Services (SSARS)?

Compare the financial statements with budgets or forecasts

Which of the following procedures regarding accounts payable would an accountant most likely perform during a nonissuer's review engagement?

Comparing ratios developed from recorded amounts to expectations developed by the accountant

The company shipped merchandise (F.O.B. destination) to a customer on December 29, Year 2, and recorded the sale but not the relief of inventory. The customer received the merchandise on December 31, Year 2.

Cost of Sales (dr.), Inventory (cr.)

A disbursement is made to pay an invoice for goods that have not been received.

Error Ineffective controls over matching invoices to receiving documents prior to disbursing funds

A purchase is recorded when an invoice is received from a vendor and recorded again when a duplicate invoice is sent by the vendor.

Error Ineffective controls over review and cancellation of supporting documents

Which of the following tests of details most likely would help an auditor determine whether accounts payable have been misstated?

Examining vendor statements for amounts not reported as purchases

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?

Inquiring as to whether any unusual adjustments were made after year-end Inquire about the current status of transactions that were recorded on the basis of preliminary data.

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?

Inspect the shipping records documenting the merchandise and date sold to the debtors

To which of the following matters would materiality limits not apply when obtaining written client representations?

Instances of fraud involving management

In which of the following circumstances is substantive testing of accounts receivable before the balance sheet date most appropriate?

Internal controls during the remaining period are effective.

Which of the following statements is incorrect regarding notification of third parties if the client refuses to disclose newly discovered facts and their impact on the financial statements?

The accountant's disclosure should include a brief description of the client's conduct or motive with regard to its refusal to notify third parties.

Which of the following describes a weakness in accounts payable procedures?

The accounts payable manager issues purchase orders.

Which of the following statements is false with respect to management representation letters on a review engagement?

The accountant acknowledges his or her responsibility for the fair presentation in the financial statements of financial position, results of operations, and cash flows.

Management must make a written representation to the auditor that they have complied with aspects of contractual agreements that may affect the financial statements.

True

Management needs to provide written representation that all financial records and related data have been made available to the auditor.

True

Hourly payroll tax expense Historically, hourly payroll tax expense, excluding federal unemployment tax, has been 8% of total wages. In addition, federal unemployment tax was expected to increase on October 1, year 2, from 1% to 2%. Total hourly payroll is expected to increase by 2%.

$ 1,132,200

Bonus expense Bonus expense for year 2 is expected to be 7% of total prior-year wage and salary expense if total unit sales increase by more than 5%.

$ 1,179,500

Short-term disability expense Short-term disability expense for year 2 is expected to be 2% of the prior-year wage and salary expense.

$ 337,000

Health insurance expense Total headcount was 200 employees for year 1 and 260 for year 2. Health insurance premiums are expected to increase 12% in year 2.

$ 385,840

401(k) match expense TQ matches 50% of the first 6% of total current-year compensation (salaries, wages, and bonuses) for participating employees. Historically, 80% of TQ's employees have participated in the 401(k) plan.

$ 449,940

Office salary expense Average salaries increased 4% effective July 1, year 2. Headcount was 40 in year 1 and increased to 48 on July 1, year 2.

$ 5,451,400

Horizontal analysis of accounts receivable

(AR at end of 20X2 - AR at end of 20X1) / AR at end of 20X1 = ($50,672,000 - $26,000,275) / $26,000,275 = .9489, or 94.89%

Horizontal analysis of net sales

(Net sales in 20X2 - Net sales in 20X1) / Net sales in 20X1 = ($79,396,360 - $75,900,000) / $75,900,000 = .04606, or 4.61%

Eldridge

(No entry required)

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:

-there was an improper cutoff of sales at the end of the year. -fictitious credit sales have been recorded during the year.

The accounts receivable balance is $35,750,000 and the audit requires a sample of 1,000 customer accounts. What is the Nth item to be tested?

35,750

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

A client-prepared statement of the account showing the details of the customer's account balance

Which of the following is a subsequent event that occurs after the balance sheet date but before the audit report date, and should be adjusted to the financial statements in a financial statement audit?

A lawsuit pending is settled.

Your audit team issued the financial statements. Information regarding nonexistent sales was not known at the date of the audit report. The auditors find the subsequently discovered information is both reliable and existed at the date of the auditor's report. The team determines that the inclusion of the material nonexistent sales would have affected the audit report. The audit team believes there are persons currently relying on, or likely to rely on, the financial statements. Is the auditor's responsibility with respect to the nonexistent sales different if the auditor has withdrawn or been discharged prior to undertaking or completing the investigation than if he or she were the continuing auditor? Identify the section and paragraph of the AICPA's Codification of Statements on Auditing Standards that resolve this issue.

AU-C 560.A18

During an engagement, the client's personnel make a variety of oral representations in response to questions raised by the auditor. The auditor should obtain written representations from the client's management to confirm the oral representations and to reduce any possible misunderstanding between the client and the auditor. What section of the AICPA's Codification of Statements on Auditing Standards (clarified standards) requires that the auditor obtain written representations from the client?

AU-C 580

Examine the flowchart for subsequent event discovery below. For each blank spot in the chart (identified by a letter), choose the statement in the table that should occupy that spot. Assign the letter for the empty spot to the statement in the "Location on Flowchart" column.

Accountant notifies users relying on financial statements or SEC that report cannot be relied upon (D) Issue revised financial statements and audit report (C) No action necessary (E) Accountant should advise client to disclose information (A) Accountant notifies board of directors concerning need to disclose (B)

The company shipped merchandise (F.O.B. shipping point) on December 29, Year 2, and recorded relief of inventory, but not the sale, on that date. The customer has not received the merchandise and the company has not recorded the sale as of January 3, Year 3.

Accounts Receivable (dr.), Sales (cr.)

For the fiscal year ending December 31, previous year and the current year, Justin Co. has net sales of $1,000,000 and $2,000,000; average gross receivables of $100,000 and $300,000; and allowance for uncollectible accounts receivable of $30,000 and $50,000, respectively. If the accounts receivable turnover and the ratio of allowance for uncollectible accounts receivable to gross accounts receivable are calculated, which of the following best represents the conclusions to be drawn?

Accounts receivable turnovers are 10.0 and 6.6 and the ratios of uncollectible accounts receivable to gross accounts receivable are 0.30 and 0.16, respectively. Examine allowance for possible understatement of the allowance.

Analytical procedures performed in the overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that:

Additional tests of details are required.

1339

Adjustment ($11,000) The new forklift was received and should have been capitalized in Year 2. The amount of the expense ($11,000) exceeds the materiality level, and an adjustment should be made for the full amount.

1340

Adjustment ($12,230) The specialty goods were received by the company in Year 2, and the full amount (which exceeds the materiality level of $6,000) should be recorded as an adjustment in the books.

1336

Adjustment ($12,750) Labor for the period 12/25-12/31 of Year 2 should have been recorded as an expense with an accrual (Accrued Wages) at the end of the year. The full payroll amount is $25,500 for 14 days. One-half of the pay period, or 7 days, occurred in Year 2. The amount attributable to Year 2 labor is $12,750. This amount is greater than the materiality level of $6,000, and therefore an adjustment should be made.

1337

Adjustment ($41,188) The trucking services paid for in Year 3 were for 28 days in Year 2 (12/4-12/31) and 3 days in Year 3 (1/1-1/3): 28/31 x $45,601 (total check) = $41,188 for Year 2 expenses. This amount exceeds the materiality level of $6,000, and an adjustment should be made for $41,188.

1334

Adjustment ($6,000) The legal services were provided in December of Year 2, and they should have been listed as a payable at 12/31. This item has reached the $6,000 materiality level, and an adjustment should be made for the full $6,000.

1335

Adjustment ($6,500) The telephone and computer services were provided in December of Year 2, and they should have been listed as a payable at 12/31. This item has exceeded the $6,000 materiality level, and an adjustment should be made for the full amount of $6,500.

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

Allowance for doubtful accounts

Which of the following ARE means or techniques of gathering evidence used to evaluate a client's inventory balance?

Analysis Inspection Comparison Inquiry Calculation Confirmation

Which of the following explanations best describes why an auditor may decide to reduce tests of details for a particular audit objective?

Analytical procedures have revealed no unusual or unexpected results.

In a review engagement, how should the review accountant initially respond if the reviewed financial statements have been made available to third parties and a subsequently discovered fact becomes known?

Assess whether management takes appropriate steps to ensure financial statement users are made informed, as necessary

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

Compare cash payments made after the balance sheet date with the accounts payable trial balance

Compared this year's expenses with last year's expenses and investigated unusual fluctuations.

Audit Procedure Performed: Analytical procedure Classification ofAudit Procedure: Substantive procedures

Requested responses directly from customers.

Audit Procedure Performed: Confirmation Classification ofAudit Procedure: Substantive procedures

Questioned management about subsequent events.

Audit Procedure Performed: Inquiry Classification ofAudit Procedure: Substantive procedures

Asked the accounting manager how often cash is deposited and by whom.

Audit Procedure Performed: Inquiry Classification ofAudit Procedure: Test of controls

Examined invoices to support additions to the fixed asset account during the year.

Audit Procedure Performed: Inspection Classification ofAudit Procedure: Substantive procedures

Examined sales invoices to see if they were initialed by the credit manager indicating credit approval.

Audit Procedure Performed: Inspection Classification ofAudit Procedure: Test of controls

Observed the accounting clerk record the daily deposit of cash receipts.

Audit Procedure Performed: Observation Classification ofAudit Procedure: Test of controls

Agreed sales invoices to credit files to determine whether the customer had a credit file and had been approved for credit.

Audit Procedure Performed: Reperformance Classification ofAudit Procedure: Test of controls

Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?

Authorization of credit memos by personnel who receive cash may permit the misappropriation of cash.

Perform procedures to identify accounts payable to related parties

Primary Audit Objective: Presentation and disclosure

The aggregate of net receivables in the balance sheet is fairly stated at estimated net realizable value.

C. Test the aging in the accounts receivable trial balance. I. Analyze the historical relationship of bad-debt write-offs in comparison with sales and accounts receivable.

Foot the subsidiary accounts payable ledger

Primary Audit Objective: Valuation and accuracy

Receivables at the end of Year 2 are properly cut off with respect to sales made in Year 2.

D. Trace shipping documents to the related sales invoices and orders, and to entries in the sales journal and accounts receivable subsidiary ledger. L. Identify the last number used in Year 2 and the first number used in Year 3 for prenumbered shipping documents and prenumbered sales invoices. Trace the respective numbers to postings in the sales journal and accounts receivable subsidiary ledger.

Sage

Debit AFS investments (10,500) Credit AP (10,500)

Howard

Debit Inventory (1,050) Credit AP (1,050)

The company shipped merchandise valued at $45,000 to a consignee on December 24, year 2, and recorded the sale and the relief of inventory on that date. The consignee had not sold the merchandise as of January 5, year 3. The merchandise has a profit margin of 10%. Record the necessary year 2 adjustments, if any.

Debit Inventory (45,000) Debit Sales (50,000) Credit AR (50,000) Credit COGS (45,000) Consigned inventory is not considered sold until purchased by a customer; therefore, no sale should have been recorded and the entry needs to be reversed. The cost of the inventory was given as $45,000, and with a 10% profit margin, the sale would have been recorded at $50,000 (cost of $45,000 represents 90% of the sales revenue, so $45,000 ÷ 0.90 = $50,000).

Teken

Debit Prepaids: Legal fees (2,700) Credit Legal expense (2,700)

Subsequent to the issuance of an auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next:

Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information.

A client that recently installed a new accounts payable system assigned employees a user identification code (UIC) and a separate password. Each UIC is a person's name, and the individual's password is the same as the UIC. Users are not required to change their passwords at initial login, nor do passwords ever expire. Which of the following statements does not reflect a limitation of the client's computer-access control?

Employees are not required to take regular vacations.

Depreciation expense is fairly stated.

F. Review the process of assigning expected useful life to machinery with the controller and ask if any assumptions have changed. M. Recalculate the year's depreciation expense.

Management must represent in written form that there were no uncorrected misstatements from the audit.

False

Management's representations may not be limited to matters considered either individually or collectively material to the financial statements.

False

Representations made by management should be in written format only.

False

The representation letter should not be signed by current management if they were not present during the entire period covered by the financial statements.

False

A bookkeeper prepares a check to himself and records it as having been issued to a major supplier.

Fraud Inadequate segregation of duties

The purchases journal "closed early" with this period's purchases recorded as having occurred in a subsequent period.

Fraud Inappropriate tone at the top (undue pressure to meet earnings target)

Goods are ordered but delivered to an inappropriate address and stolen.

Fraud Ineffective controls over matching invoices to receiving documents prior to disbursing funds

Fixed assets included in the balance sheet exist.

G. Vouch additions to the property, plant, and equipment subsidiary ledger. O. Make a physical inspection of major property, plant, and equipment acquisitions.

Which of the following is a false statement regarding subsequent discovery of facts existing at the date of the accountant's compilation or review report?

If the engagement was a compilation, the accountant must modify his or her report for a lack of independence.

Which of the following procedures would an auditor most likely perform in obtaining evidence about subsequent events?

Investigate changes in noncurrent debt occurring after year end.

Which of the following items would most likely require an adjustment to the financial statements for the year ended December 31, Year 1?

Loss on an uncollectible trade receivable recorded in Year 1 from a customer that declared bankruptcy in Year 2

Which of the following statements would an auditor most likely require management to indicate in a written representation letter obtained for an audit?

Management acknowledges its responsibilities for the design and implementation of programs and controls to detect fraud.

Which of the following statements ordinarily is included among the written management representations obtained by the auditor?

Management has made available to you all financial records and related data.

Which of the following management roles would typically be acknowledged in a management representation letter?

Management has the responsibility for the design of controls to detect fraud.

There are no material transactions that have not been properly recorded in the accounting records underlying the financial statements. What is the most likely source of this statement?

Management representation letter

Which of the following events that occurred after a client's calendar-year end, but before the audit report date, would require disclosure in the notes to the financial statements, but no adjustment in the financial statements?

New convertible bonds are issued to expand the company's product line.

1341

No action required ($0) The bi-weekly payroll amount exceeds the materiality level, but the entire pay period is in Year 3. Therefore, this check is recorded in the correct period and no adjustment needs to be made.

1338

No action required ($0) The petty cash replenishment of $2,002 probably covered petty cash expenses in Year 2, but the amount is less than the materiality level of $6,000 and an adjustment is not necessary.

1333

No action required ($0) The water coolers were delivered in December of Year 2 and should have been posted to Accounts Payable on 12/31. Adjustments are only recorded for items equal to or exceeding materiality. Materiality is $6,000, and the water coolers cost $3,500, so there is no need for an adjusting entry.

1342

No action required ($0) This check is for legal expenses incurred in January of Year 3. Despite the fact that the amount ($6,800) is over the materiality level of $6,000, the check is recorded in the correct accounting period. No adjustment should be made. Notice also that the check date (February 6 of Year 3) is after the final day of fieldwork as presented in the problem (February 1 of Year 3). Most likely this check would not be examined as part of the fieldwork.

Which of the following expressions most likely would be included in a management representation letter?

No events have occurred subsequent to the balance sheet date that require adjustment to, or disclosure in, the financial statements.

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

Original source documents.

Examine shipping documents for matching sales invoices

Primary Audit Objective: Completeness and cutoff

Examining underlying documentation for cash disbursements in the period after year-end

Primary Audit Objective: Completeness and cutoff

Investigation of unmatched invoices and unbilled receiving reports

Primary Audit Objective: Completeness and cutoff

Confirm accounts payable

Primary Audit Objective: Existence or occurrence

Vouch the canceled check to the vendor invoice

Primary Audit Objective: Existence or occurrence

Gil Corp. has current assets of $90,000 and current liabilities of $180,000. Which of the following transactions would improve Gil's current ratio?

Purchasing $50,000 of merchandise inventory with a short-term account payable

If not already performed during the overall review stage of the audit, the auditor should perform analytical procedures relating to which of the following transaction cycles?

Revenue

The company shipped merchandise (F.O.B. shipping point) on December 3, Year 2, to a customer, and recorded the sale and relief of inventory. The customer, unhappy with the merchandise, returned the goods on December 29, Year 2. The company records the following entry upon receipt of the goods: Inventory (dr.), Cost of Sales (cr.)

Sales (dr.), Accounts Receivable (cr.)

The company shipped merchandise to a consignee on December 16, Year 2, and did not record the transaction. The consignee returned the merchandise on December 28, Year 2. Upon receipt of the goods, the company made the following entry: Inventory (dr.), Sales (cr.)

Sales (dr.), Inventory (cr.)

Which of the following procedures is performed first for unreturned positive confirmations of accounts receivable?

Sending second requests for confirmation of accounts receivable

The company shipped merchandise valued at $75,000 F.O.B. destination on December 23, year 2, and recorded the sale and relief of inventory on that date. The customer received the merchandise on December 31, year 2. The merchandise has a profit margin of 10%. Record the necessary year 2 adjustments, if any.

Since the inventory reached its destination prior to year-end, the sale would be recognized in year 2. Although the sale and relief of inventory should have been recorded on December 31 and not December 23, no correcting entry is necessary as the sale was properly recognized in the correct year.

Determine that inventory balance is accurately stated

Substantive Tests: Perform shipping cutoff procedures

Verify existence of accounts receivable

Substantive Tests: Perform tests of subsequent cash receipts after the balance sheet date

An auditor withdrew from further association with a nonissuer entity after issuing an audit report on it. Subsequently, the auditor discovered facts that, if known to the auditor at the date of the auditor's report, could have caused the auditor to revise the report. Which of the following statements about this circumstance is correct?

The auditor should discuss the matter with management and, if it is determined that the financial statements need revision, ask how management intends to address the matter in the financial statements.

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?

The client opened a second retail outlet during the current year and its credit sales approximately equaled the older outlet.

Which of the following factors would least likely affect the quantity and content of an auditor's working papers?

The content of the representation letter

The horizontal analysis of the net sales and accounts receivable would most likely tell you what?

Why did the accounts receivable not increase the same percentage as net sales? The answer would lie in explanations that involve credit policies. If the company had not been collecting receivables, the receivables from December 31, 20X1, would still be on the book, inflating the receivables amount. If the company had granted more credit to customers (versus requiring immediate payment), the receivables would also increase without a corresponding increase in sales. However, if the company were recording fictitious sales as receivables, the sales would have to increase proportionately also. This is the other account usually affected when fictitious sales are recorded. Remember: Analytical procedures in the planning stage are meant to identify areas where risk of material misstatement may be higher and to help plan the nature, timing, and extent of further procedures. The areas of sales and accounts receivable will require further testing to explain the results of the analysis.

Management makes representations to the auditor through the audit process. Such representations:

are audit evidence, whether written or verbal.

The purpose of applying analytical procedures in planning the audit is to:

assist in planning the nature, timing, and extent of auditing procedures that will be used to obtain audit evidence for specific account balances or classes of transactions.

The primary objective of analytical procedures used in the overall review stage of an audit is to:

assist the auditor in assessing the validity of the conclusions reached.

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:

cash disbursements.

In auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of:

completeness.

The auditing technique whereby an auditor obtains an acknowledgement in writing from a third party is known as:

confirmation

During an audit of a nonissuer, if the terms of a related party transaction are found to be materially inconsistent with the explanations provided by management, an auditor should:

consider the reliability of management's explanations and representations on other significant matters.

The confirmation of customers' accounts receivable rarely provides reliable evidence about the completeness assertion because:

customers may not be inclined to report understatement errors in their accounts.

Scanning, scrutinizing, and reading documents are often referred to as _______ of the evidence.

inspection

An auditor decides to use the blank form of accounts receivable confirmation rather than the positive form. The auditor should be aware that the blank form may be less efficient because:

more nonresponses are likely to occur.

Employees of a company are taking a physical inventory account in front of the auditor. This is an example of

observation

A CPA has been requested by a former audit client to reissue the auditor's report for the prior period. Before reissuing the report, the CPA should:

obtain a letter of representation from the former client's management.

An entity's income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. The auditor most likely could have detected this by:

performing analytical procedures designed to disclose differences from expectations.

In searching for unrecorded liabilities, an auditor most likely would examine the:

receiving reports for items received before year-end, but not yet recorded.

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:

receiving reports.

An auditor's decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the:

relative effectiveness and efficiency of the tests.

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

request that the senders mail the original forms to the auditor.

The procedure, "The accountant should perform analytical procedures designed to identify relationships that appear unusual," is:

required for a review only.

The procedure, "The accountant should request written representation from members of management who have appropriate responsibilities for the financial statements...," is:

required for a review only.

If the client refuses to cooperate in disclosing the facts related to a subsequent discovery, the auditor should notify all the following except for:

the IRS.

In auditing accounts receivable, the negative form of confirmation request most likely would be used when:

the combined assessed level of inherent and control risk relative to accounts receivable is low.

The accounts receivable turnover ratio increased significantly over a 2-year period. This trend could indicate that:

the company is more aggressively collecting customer accounts.

If current audited entity management was not present during all periods covered by the auditor's report:

written representations are still required from current management on all periods covered by the auditor's report.