Auditing Final Exam
Discuss the purposes of (1) substantive tests of transactions, (2) tests of controls, and (3) tests of details of balances. Give an example of each.
(1) The purpose of substantive tests of transactions is to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions. For example, as part of the auditor's test of the accuracy objective for sales, the auditor would compare the amount recorded in the sales journal for a sample of sales transactions with the total on the corresponding sales invoices. (2) The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. For example, the auditor might observe for a month whether statements are mailed to all customers. (3) The purpose of tests of details of balances is to determine the monetary correctness of the accounts to which they relate. The confirmation of accounts receivable is an example.
Internal controls over year-end cash balances in the general account can be divided into two categories. List the two below.
1. Controls over transactions cycle affecting the recording of cash receipts and cash disbursements 2. Independent bank reconciliations
A proof of cash includes four reconciliation tasks. List below two of those tasks.
1. Reconcile the balance on the bank statement with the general ledger balance at the beginning of the proof-of-cash period 2. Reconcile cash receipts deposited per the bank with the receipts recorded in the cash receipts journal for a given period 3. Reconcile electronic payments and cancelled checks clearing the bank with those recorded in the cash disbursements journal for a given period 4. Reconcile the balance on the bank statement with the general ledger balance at the end of the proof-of-cash period
There are eight types of audit evidence: physical examination, confirmation, inspection, observation, inquiries of the client, reperformance, analytical procedures, and recalculation. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) substantive tests of transactions, (3) analytical procedures, and (4) tests of details of balances.
1. Tests of controls. Inspection, observation, inquiries of the client, reperformance 2. Substantive tests of transactions. Inspection, inquiries of the client, reperformance, recalculation 3. Analytical procedures. Inquiries of the client, analytical procedures 4. Tests of details of balances. Physical examination, confirmation, inspection, inquiries of the client, reperformance, recalculation
What should be audited on an interbank transfer schedule?
1. The accuracy of the information on the interbank transfer schedule should be verified. 2. The interbank transfers must be recorded in both the receiving and disbursing banks. 3. The date of the recording of the disbursements and receipts for each transfer must be in the same fiscal year. 4. Disbursement on the interbank transfer schedule should be correctly included in or excluded from year-end bank reconciliations as outstanding checks. 5. Receipts on the interbank transfer schedule should be correctly included in or excluded from year-end bank reconciliations as deposits in transit.
What are the three required conditions for a contingent liability to exist?
1. There is potential for future payment to an outside party or the impairment of an asset that resulted from an existing condition 2. There is uncertainty about the amount of the future payment or impairment 3. The outcome will be resolved by some future event or events
You are determining the appropriate sample size to test accounts receivable. What three factors are the most important to consider?
1. Tolerable exception rate (TER) 2. Acceptable risk of overreliance (ARO) 3. Estimated population exception rate (EPER)
What are the auditor's primary concerns in verifying the transfer of inventory from one location to another?
1. recorded transfers exist 2. all transfers are recorded 3. the quantity, description, and date of all recorded transfer are accurate
Explain what is meant by a cutoff bank statement, and discuss the purpose of the cutoff bank statement in the audit of cash.
A cutoff bank statement is a partial-period bank statement and the related copies of canceled checks, duplicate deposit slips, and other documents included in bank statements, mailed by the bank directly to the CPA firm's office. The purpose of the cutoff bank statements is to verify the reconciling items on the client's year-end bank reconciliation with evidence that is not accessible to the client.
Three factors the auditor considers when assessing control risk are: the auditor's belief concerning the effectiveness of internal controls, the results of tests of controls, and the cost-effectiveness of a reduced assessed control risk. Identify the combination of conditions for these three factors that is required before a reduction in substantive testing is permitted.
A reduction in substantive testing is permitted when (1) the auditor identifies specific controls he or she believes have been operating effectively during the period under audit, (2) the auditor believes it will be cost-effective to test those controls, and (3) the results of tests of controls indicate that the controls have indeed been operating effectively.
Based on the schedule of interbank transfers above, which of the cash transfers would not appear as an outstanding check on the December 31, 2013 bank reconciliation? A) 1 B) 2 C) 3 D) 4
A) 1
When selecting a sample size for substantive tests of balances which factor, other factors being equal, would result in a larger sample? A) A decrease in the tolerable misstatement B) Small expected misstatements C) An increase in the tolerable misstatement D) An increase in the acceptable risk of incorrect acceptance
A) A decrease in the tolerable misstatement
Which of the following audit tests is usually the least costly to perform? A) Analytical procedures B) Tests of controls C) Tests of balances D) Substantive tests of transactions
A) Analytical procedures Answer: A
Which of the following is an accurate statement regarding inventory and risk? A) Inventory with a high business risk includes products with potential obsolescence. B) Auditors often have a greater concern for misstatements when inventory is stored in one warehouse. C) Inherent risk is generally set at low for manufacturing companies. D) Performance materiality for inventory is determined before assessing client business risk.
A) Inventory with a high business risk includes products with potential obsolescence.
Which of the following is a correct statement regarding block sampling? A) It is acceptable to use block sampling only if a reasonable number of blocks are used. B) Block sampling uses sampling with replacement. C) Block sampling is a probabilistic sampling method. D) There is considerable cost and time involved when block sampling is used.
A) It is acceptable to use block sampling only if a reasonable number of blocks are used.
When controls are deemed ineffective and assessed control risk is at the maximum for a private company, which of the following would normally be true? A) No emphasis is placed on the controls. B) Relatively little emphasis is placed on the controls. C) Moderate emphasis is placed on the controls. D) Heavy emphasis is placed on the controls.
A) No emphasis is placed on the controls. Answer: A
From which of the following evidence-gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories? A) Observation of physical inventory counts B) Written inventory representations from management C) Confirmation of inventories in a public warehouse D) Auditor's recomputation of inventory extensions
A) Observation of physical inventory counts
You are auditing the inventory account and are concerned about the possibility of an inventory overstatement. What is the best audit procedure to detect damaged inventory? A) Observe the condition of inventory during the client's physical count. B) Compare the condition of inventory from the previous year's count to the current year. C) Compare inventory turnover from the previous year's inventory to the current year's inventory. D) Reconcile the inventory counts to the cost accounting records.
A) Observe the condition of inventory during the client's physical count.
Almost all companies need physical controls over their assets to prevent loss. Which of the following is not an example of such a control? A) Perpetual inventory master files B) Segregated, limited-access storage areas C) Custody of assets assigned to specific responsible individuals D) Approved prenumbered documents for authorizing movement of inventory
A) Perpetual inventory master files
________ is an automated fraud detection tool offered by most banks. A) Positive pay B) A bank confirmation C) Fraud buster D) Check matching
A) Positive pay
Which of the following is a significant audit concern related to the transfer of inventory from one location to another? A) Recorded transfers occurred. B) Transfers were properly transported. C) Transfers were properly planned. D) Transfers represent efficient movement of assets.
A) Recorded transfers occurred.
Which of the following is true? A) Tests of details of balances focus on the ending general ledger balances for both balance sheet and income statement accounts. B) Tests of details of balances focus on the transactions during the period for both balance sheet and income statement accounts. C) Tests of details of balances focus on the auditor's understanding of internal controls. D) Tests of details of balances focus on comparisons of recorded amounts to expectations developed by the auditor.
A) Tests of details of balances focus on the ending general ledger balances for both balance sheet and income statement accounts. Answer: A
McKesson & Robbins Company is a well-known audit case involving auditor responsibility. What occurred at the McKesson & Robbins Company to change the way in which auditors audit inventory? A) The company recorded nonexistent inventory. B) The auditor did not perform any audit tests of the inventory. C) The auditor and company colluded to overstate inventory balances. D) The company counted inventory three months prior to year-end.
A) The company recorded nonexistent inventory.
Which of the following is not a valid basis for omitting an audit test in forming an opinion on the clients financial statements? A) The difficulty and expense involved in testing a particular item B) The relative risk involved C) The degree of reliance on the relevant internal controls D) The relationship between the cost of obtaining evidence and its usefulness
A) The difficulty and expense involved in testing a particular item Answer: A
A proof of cash disbursements is not effective for discovering checks written for an improper amount, fraudulent checks, or misstatements in which the dollar amount appearing in the cash disbursements records is incorrect. A) True B) False
A) True
Tolerable misstatement is inversely related to sample size. A) True B) False
A) True
Substantive tests are procedures designed to test for dollar misstatements that directly affect the correctness of financial statement balances. A) True B) False
A) True Answer: A
A commitment is best described as: A) an agreement to commit the firm to a set of fixed conditions in the future. B) an agreement to commit the firm to a set of fixed conditions in the future that depends on company profitability. C) an agreement to commit the firm to a set of fixed conditions in the future that depends on current market conditions. D) a potential future obligation to an outside party for an as yet to be determined amount.
A) an agreement to commit the firm to a set of fixed conditions in the future.
When the auditor decides to select less than 100 percent of the population for testing, the auditor is said to use: A) audit sampling. B) representative sampling. C) poor judgment. D) estimation sampling
A) audit sampling.
The primary emphasis in most tests of details of balances is on the: A) balance sheet accounts. B) revenue accounts. C) cash flow statement accounts. D) expense accounts.
A) balance sheet accounts. Answer: A
If an auditor judgmentally selects a sample of one hundred items from a population and finds two exceptions, the auditor: A) can conclude that the sample exception rate is 2%. B) can conclude that the population exception rate is 2%. C) can calculate the highest exception rate expected in the population. D) cannot make any conclusions about either the sample or the population.
A) can conclude that the sample exception rate is 2%....
When an auditor observes that personnel who are responsible for physically counting inventory are not following the inventory instructions, the auditor should: A) contact a client's supervisor to correct the problem. B) modify the client's physical inventory instructions. C) not discuss the problem with client's supervisor in order to maintain independence. D) assign audit staff to the inventory count.
A) contact a client's supervisor to correct the problem.
Auditors often use the ________ to determine the estimated population exception rate. A) current year's audit results B) tolerable exception rate C) preceeding year's audit results D) estimated computed by management
A) current year's audit results
The test of details of balances procedure that requires the auditor to trace the book balance on the reconciliation to the general ledger is an attempt to satisfy the audit objective of: A) detail tie-in. B) existence. C) completeness. D) accuracy.
A) detail tie-in.
Risk assessment procedures are performed by auditors during an audit in order to: A) determine the risk of material misstatement in the financial statements. B) determine the amount of testing of internal control. C) determine the extent of testing of details of balances. D) determine the extent of testing of transactions.
A) determine the risk of material misstatement in the financial statements. Answer: A
A common inventory observation procedure is to select a random sample of tag numbers and identify the tag with that number attached to the actual inventory item. The audit objective being achieved by this procedure is: A) inventory as recorded on tags actually exists (existence). B) existing inventory is counted and tagged (completeness). C) inventory is counted accurately (accuracy). D) inventory is classified correctly (classification).
A) inventory as recorded on tags actually exists (existence).
The word below that best explains the relationship between required sample size and the acceptable risk of incorrect acceptance is: A) inverse. B) direct. C) proportional. D) indeterminate.
A) inverse.
Listing all bank transfers made a few days before and after the balance sheet date and tracing each to the accounting records for proper recording is a useful approach to test for: A) kiting. B) lapping. C) income smoothing. D) channel stuffing.
A) kiting.
The process of transferring money from one bank account to another and improperly recording the transaction is referred to as: A) kiting. B) lapping. C) scamming. D) embezzling.
A) kiting.
Auditors are likely to prepare a proof of cash when the client has: A) material control weaknesses in cash receipts and cash disbursements. B) material control weaknesses in accounts receivable and revenue. C) material control weaknesses in accounts payable and inventory. D) material control weaknesses in payroll.
A) material control weaknesses in cash receipts and cash disbursements.
When auditing inventory cost accounting, the auditor is concerned with all of the following except for: A) net realizable value. B) unit cost records. C) physical controls over inventory. D) documents and records for transferring inventory.
A) net realizable value.
If no material differences are found using analytical procedures and the auditor concludes that misstatements are not likely to have occurred: A) other substantive tests may be reduced. B) it will be necessary to increase the tests of balances. C) it will not be necessary to perform tests of balances. D) it will be necessary to increase the tests of transactions.
A) other substantive tests may be reduced. Answer: A
In order to strengthen controls over cost accounting information, a company should consider implementing: A) perpetual inventory master files. B) a job order cost accounting system. C) an accounting system that keeps separate the records of the accounting department from the records of the production department. D) an economic quantity order system.
A) perpetual inventory master files.
If tests of controls support the control risk assessment, then ________ in the audit risk model is increased. A) planned detection risk. B) planned inherent risk. C) planned fraud risk. D) planned assurance risk.
A) planned detection risk. Answer: A
Auditors who prefer statistical to nonstatistical sampling believe that the principal advantage of statistical sampling flows from its ability to: A) quantify sampling risk. B) promote a more legally defensible procedural approach. C) define the precision required to provide audit satisfaction. D) establish conclusive audit evidence with decreased audit effort.
A) quantify sampling risk.
The inventory and warehousing cycle can be thought of as having two separate but closely related systems, one involving the actual physical flow of goods, and the other the: A) related costs. B) storage of the goods. C) internal control over those goods. D) prevention of waste, obsolescence, and theft.
A) related costs.
The audit of year-end physical inventories should include steps to verify that the client's purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a: A) sale in the current period. B) sale in the subsequent period. C) purchase in the current period. D) purchase return in the subsequent period.
A) sale in the current period.
One way to evaluate sampling risk when nonstatistical sampling is used is to: A) subtract the sample exception rate from the tolerable exception rate. B) add the sample exception rate and the tolerable exception rate. C) subtract the sample exception rate from the acceptable risk of overreliance. D) add the sample exception rate and the acceptable risk of overreliance.
A) subtract the sample exception rate from the tolerable exception rate.
In addition to confirming bank balances of your audit client, a bank confirmation would normally contain: A) the client's bank loans with due date, interest rate, and collateral requested. B) the client's credit history as regards to paying back loans. C) the client's managements bank account information. D) the client's business prospects.
A) the client's bank loans with due date, interest rate, and collateral requested.
Contingent liability disclosure in the footnotes of the financial statements would normally be made when: A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the amount cannot be made by the client or auditor. B) a reasonable estimation of the loss can be made, but the outcome is not probable. C) the outcome of the accounting event is deemed probable, and a reasonable estimation as to the amount can be made. D) the outcome of the accounting event as well as a reasonable estimation of the loss cannot be made.
A) the outcome of the accounting event is deemed probable, but a reasonable estimation as to the amount cannot be made by the client or auditor.
It is frequently possible to test the physical inventory prior to the balance sheet date when: A) there are accurate perpetual inventory master files. B) year-end sales are small. C) the internal control system is no better at year-end than at an earlier point in time. D) the client counts inventory at interim dates.
A) there are accurate perpetual inventory master files.
The audit of the inventory and warehousing cycle will be affected by the results from other business processes. Identify the "other" business cycles and how they impact the audit of inventory.
Acquisition and Payment: Acquire and record raw materials, labor, overhead Sale and collection: Ship goods and record revenue and the appropriate costs
Auditors will often prepare a proof of cash when the client has material internal control weaknesses in cash receipts and cash disbursements. The purpose of the proof of cash is to determine the client's accounting records for cash are reliable. List below the four requirements the proof of cash is designed to provide for the auditor.
All recorded cash receipts were deposited All deposits in the bank were recorded in the accounting records All recorded cash disbursements were paid by the bank All amounts that were paid by the bank were recorded
Discuss the auditor's responsibilities for inventory maintained in public warehouses or with other outside custodians.
An auditor's physical examination of inventory is not required if inventory is housed in a public warehouse or overseen by outside custodians. In these situations, auditors verify inventory by confirmation with the custodian. However, the auditor may perform additional procedures if the amounts involved are significant. These additional procedures may include: an investigation of the custodian's inventory procedures, obtaining an independent accountant's report on the custodian's control procedures over the custody of goods, or observing the physical count of goods held by the custodian, if practical.
There are three stages of the audit in which analytical procedures are performed. Identify each of these three stages and, for each stage, discuss the purpose of performing analytical procedures in that stage. Also indicate in which stage(s) analytical procedures are required by current professional auditing standards.
Analytical procedures are performed in the audit planning stage to help the auditor decide the other evidence needed to satisfy sufficient competent evidence requirements. Analytical procedures can also be performed as substantive tests in the testing phase of the audit. Analytical procedures are performed in the audit completion phase as a final test of reasonableness. Auditing standards require that analytical procedures be performed in the planning and completion phases of every audit.
A common source of business risk for inventory is the reliance on a few key suppliers. A) True B) False
Answer: A
A major part of the auditor's risk assessment procedures is done to obtain an understanding of internal control. A) True B) False
Answer: A
A proof of cash involves a combination of substantive tests of transactions and tests of details of balances. A) True B) False
Answer: A
A proof of cash receipts is not useful for uncovering the theft of cash receipts or the recording and deposit of an improper amount of cash. A) True B) False
Answer: A
An exception in a test of control provides only an indication of the likelihood of monetary misstatements in the financial statements because tests of controls do not reveal whether monetary misstatements have actually occurred. A) True B) False
Answer: A
Analytical procedures are normally designed at the account level, whereas tests of controls and substantive tests of transactions are normally designed at the transaction-related objective level. A) True B) False
Answer: A
Auditors are not always required to obtain bank confirmations. A) True B) False
Answer: A
Current professional auditing standards make it clear that management, not the auditor, is responsible for identifying and deciding the appropriate accounting treatment for contingent liabilities. A) True B) False
Answer: A
If the auditor concludes that the CUER is 5% at a 8% sampling risk, this means that the exception rate in the population is no greater than 5% with an 8% risk of the exception rate exceeding 5%. A) True B) False
Answer: A
In estimating the population misstatement, the first step in projecting from the sample to the population is to: A) make a point estimate. B) revise the upper error bound. C) calculate the precision interval. D) determine the population mean.
Answer: A
In job cost systems, costs are accumulated by individual jobs. A) True B) False
Answer: A
In practice, auditors do not know whether a sample is representative, even after all testing is complete. A) True B) False
Answer: A
It is virtually impossible to reduce sampling risk to zero. A) True B) False
Answer: A
Many of the audit procedures for finding contingencies are usually performed as an integral part of various segments of the audit rather than as a separate activity near the end of the audit. A) True B) False
Answer: A
Nonprobabilistic selection methods are not based on mathematical probabilities; therefore: A) the extent to which a sample is representative of the population may be difficult to determine. B) they are discouraged by the AICPA. C) they are not allowed by the Statements on Auditing Standards. D) they are not as effective as statistical sampling.
Answer: A
Ordinarily, all deposits-in-transit listed on the year-end bank reconciliation should appear as deposits on the cutoff bank statement. A) True B) False
Answer: A
Required sample size increases as the auditor's tolerable misstatement for an account balance or class of transactions decreases. A) True B) False
Answer: A
Tests of controls are generally more costly to perform than analytical procedures. A) True B) False
Answer: A
Tests of controls provide evidence about the likelihood for misstatements in a client's financial statements. A) True B) False
Answer: A
The adequacy of internal controls over the physical count of inventory is one of the key determinants of the amount of time needed to test inventory. A) True B) False
Answer: A
The auditor must extend the audit procedures in the audit of year-end cash when there are inadequate internal controls. A) True B) False
Answer: A
The auditor's understanding of internal control performed as part of risk assessment procedures provides the basis for the auditor's initial assessment of control risk. A) True B) False
Answer: A
The extent and timing of an auditor's physical examination of inventory is significantly influenced by the adequacy of the client's perpetual inventory records. A) True B) False
Answer: A
The final step in the evaluation of the audit results is the decision to: A) accept the population as fairly stated or to require further action. B) determine sampling error and calculate the estimated total population error. C) project the point estimate. D) determine the error in each sample.
Answer: A
The receipt of raw materials is a part of the acquisition and payment cycle. A) True B) False
Answer: A
The results of tests of controls and substantive tests of transactions affect the design of tests of details of balances. A) True B) False
Answer: A
The transfer of money from one bank account to another and improperly recording the transfer so that the amount is recorded as an asset in both banks is referred to as kiting. A) True B) False
Answer: A
To test for proper sales cutoff, an auditor would obtain the number of the last bill of lading issued during the period under audit and verify that the item shipped had been excluded from the inventory listing. A) True B) False
Answer: A
Tracing outstanding checks to subsequent period bank statements tests the cutoff audit objective. A) True B) False
Answer: A
When auditing the year-end cash balance, one of the areas of focus is on the accuracy objective. A) True B) False
Answer: A
When auditors wish to evaluate a sample statistically, an acceptable selection method is: A) systematic sample selection. B) judgmental selection. C) haphazard selection. D) block sample selection.
Answer: A
When part of the client's inventory is in a public warehouse or in the possession of other outside custodians, the auditor does not need to observe a physical count of the inventory if a written confirmation is obtained directly from the inventory custodians. A) True B) False
Answer: A
When verifying the transfer of inventory from one location to another, the audit objectives with which the auditor is primarily concerned are occurrence of recorded transfers, completeness of recorded transfers, and accuracy of recorded transfers. A) True B) False
Answer: A
While separate perpetual inventory records are normally kept for raw materials and finished goods, most companies do not use perpetual records for work-in-process. A) True B) False
Answer: A
A sample in which every possible combination of items in the population has an equal chance of constituting the sample is a: A) random sample. B) statistical sample. C) judgment sample. D) representative sample.
Answer: A...
Acceptable risk of overreliance is normally lower for a public company audit than a private company audit. A) True B) False
Answer: A...
An advantage of using statistical sampling techniques is that such techniques: A) mathematically measure risk. B) eliminate the need for judgmental decisions. C) define the values of precision and reliability required to provide audit satisfaction. D) have been established in the courts to be superior to judgmental sampling.
Answer: A...
An auditor plans to examine a sample of 40 canceled checks for a countersignature which is prescribed in the client's control procedures manual. Two of the checks in sample cannot be located by the company or the auditor. The auditor would most likely: A) treat the missing checks as a deviation when evaluating the results of the sample. B) draw a conclusion on a sample size of 38. C) substitute two more checks to get to a sample size of 40. D) recalculate the sample excluding the original 40 checks.
Answer: A...
Companies may purchase marketable securities as a way to temporarily invest excess cash. A) True B) False
Answer: A...
For stratified sampling, the auditor selects samples independently from each stratum. A) True B) False
Answer: A...
If the auditor decides to assess control risk at the moderate level in a private company audit, when in previous years the auditor set control risk at the maximum level, then tests of controls for the current year would be: A) increased in number. B) reduced in number. C) not performed. D) unchanged from prior planned settings.
Answer: A...
If the result obtained from a particular sample for control and substantive tests of transactions is critical to the formation of an audit opinion, which of the following is the most important to the auditor in concluding of the appropriateness and sufficiency of evidence gathered? A) Acceptable risk of overreliance B) Estimated population exception rate C) Tolerable exception rate D) Size of the population
Answer: A...
In systematic sample selection, the population size is divided by the number of sample items desired in order to determine the: A) sampling interval. B) tolerable exception rate. C) computed upper exceptions rate. D) mean.
Answer: A...
One way to control sampling risk is to increase sample size. A) True B) False
Answer: A...
The advantage of systematic sample selection is that: A) it is easy to use. B) there is limited possibility of it being biased. C) it is unnecessary to determine if the population is arranged randomly. D) it automatically selects items material to the financial statements.
Answer: A...
The starting point for the verification of the balance in the general bank account is to obtain: A) a bank reconciliation from the client. B) the client's cash account from the general ledger. C) a cutoff bank statement directly from the bank. D) the client's year-end bank statement.
Answer: A...
When choosing the appropriate acceptable risk of overreliance, the auditor needs to: A) rely on his/her professional judgment. B) err on the side of conservatism. C) consult the professional standards. D) follow SEC guidelines.
Answer: A...
Whenever auditors use sampling, they risk making incorrect conclusions about the population. The risk that the auditor concludes that controls are nore effective than they actually are is known as the: A) risk of overreliance. B) risk of underreliance. C) risk that the sample is not representative of the population. D) risk that the sample conclusions cannot be useful because of nonprobability sampling.
Answer: A...
A proof of cash includes a reconciliation of cash receipts deposited in the bank with the cash disbursements records for a given period. A) True B) False
Answer: B
Acceptable audit risk and acceptable risk of incorrect acceptance are inversely related; that is, as AAR increases, ARIA decreases. A) True B) False
Answer: B
An approved purchase requisition form authorizes shipment of goods to customers. A) True B) False
Answer: B
Analytical procedures are the most expensive type of audit test to perform because of the expertise and training required to properly use them. A) True B) False
Answer: B
As the amount of misstatements expected in the population approaches tolerable misstatement, the planned sample size will: A) decrease. B) increase. C) vary based on characteristics of the population. D) be unaffected.
Answer: B
Auditing standards recommend that auditors observe physical inventory counts by the client. A) True B) False
Answer: B
Auditors must perform tests of controls separately from substantive tests of transactions. A) True B) False
Answer: B
Because of the high cost of tests of details of balances, auditors do not perform this type of testing unless fraud is suspected. A) True B) False
Answer: B
Examples of cash equivalents include time deposits, certificates of deposit, and marketable securities. A) True B) False
Answer: B
If an auditor does a test in the wrong direction, sampling risk will increase. A) True B) False
Answer: B
If inherent risk is increased to medium from low, tests of details of balances can be reduced. A) True B) False
Answer: B
If internal controls are tested and are considered effective, the auditor generally will increase both substantive tests of transactions and tests of details of balances. A) True B) False
Answer: B
Inherent risk is typically assessed at a low level for inventory due to the nature of the asset. A) True B) False
Answer: B
Inventory compilation tests are used to verify that the inventory is recorded at the lower of cost or market. A) True B) False
Answer: B
Management typically allocates overhead using total raw materials as the basis for the allocation. A) True B) False
Answer: B
Many of the auditor's audit procedures in the audit of cash center around the client's bank confirmations. A) True B) False
Answer: B
Production personnel should ordinarily be responsible for maintaining perpetual inventory records. A) True B) False
Answer: B
Tests for kiting are performed using only a schedule of intrabank transfers. A) True B) False
Answer: B
Tests of controls are performed to support a reduced assessment of detection risk. A) True B) False
Answer: B
Tests of controls should be performed after substantive tests of transactions. A) True B) False
Answer: B
The auditor is generally concerned about the realizable value and the rights to cash. A) True B) False
Answer: B
The auditor would design which of the following audit tests to detect possible monetary errors in the financial statements? A) Control tests B) Analytical procedures C) Risk assessment procedures D) Tests of operating effectiveness of controls over revenue and cash
Answer: B
The choice of which types of tests to use and how extensively they need to be performed must be the same for all audits. A) True B) False
Answer: B
The client may mail the bank confirmation requests if the auditor believes doing so will increase the likelihood that the confirmation will be returned promptly. A) True B) False
Answer: B
The evidence mix includes risk assessment procedures. A) True B) False
Answer: B
The physical observation of the inventory and the acquisition of raw materials are part of the inventory and warehousing cycle. A) True B) False
Answer: B
The reliance the auditor places on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily: A) parallel. B) inverse. C) direct. D) equal.
Answer: B
The starting point for the verification of the balance in the general bank account is to obtain a bank cut-off statement. A) True B) False
Answer: B
The three most important audit objectives for cash are accuracy, existence, and classification. A) True B) False
Answer: B
When auditing the general cash account, receipt of a standard bank confirmation is the starting point for verifying the company's general cash account balance. A) True B) False
Answer: B
When the client's perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date. A) True B) False
Answer: B
While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. Which of the following is the least likely auditor reaction to this discovery? A) Perform expanded audit tests in the relevant areas. B) Increase detection risk in the relevant areas. C) Increase the sample size. D) Take no action until tests of other audit areas are completed.
Answer: B
An imprest petty cash fund would least likely be used to pay for which of the following items? A) Minor office supplies B) Monthly interest expense C) Stamps for small mailings D) Small contributions to a local charity
Answer: B...
Auditors usually design bank confirmations that address the client's specific circumstances. A) True B) False
Answer: B...
Because cash is the most desirable asset for people to steal, it has a higher: A) control risk. B) inherent risk. C) detection risk. D) liquidity risk.
Answer: B...
Factors considered by an auditor to determine the possibility that the true population misstatement exceeds a tolerable amount in a nonstatistical sample include all of the following except for: A) the extent to which items in the population have been audited 100%. B) the difference between the point estimate and acceptable control risk. C) whether misstatements tend to be offsetting or in only one direction. D) the amounts of individual misstatements.
Answer: B...
If the misstatement in a population is larger then tolerable misstatement without considering sampling error, the population will be considered unacceptable. A) True B) False
Answer: B...
One of the causes of nonsampling risk is: A) improper supervision and instruction of the client's employees. B) ineffective audit procedures. C) inadequate sample size. D) exceptions being found in the sample.
Answer: B...
The AICPA audit sampling formula for computing nonstatistical tests of details of balances sample size is to multiply the population recorded amount by the ________ and then divide by the ________. A) confidence factor, ARIA B) confidence factor, tolerable misstatement C) ARO, tolerable misstatement D) risk of incorrect acceptance, confidence factor
Answer: B...
The conjoined sample exception rate is the auditor's "best estimate" of the actual exception rate in the entire population. A) True B) False
Answer: B...
The primary factor affecting the auditor's decision about acceptable risk of incorrect acceptance (ARIA) is assessed inherent risk. A) True B) False
Answer: B...
The purpose of stratified sampling is to achieve a greater confidence level (lower risk of incorrect acceptance) for a given sample size. A) True B) False
Answer: B...
The reason for testing the client's bank reconciliation is to verify whether the client's recorded bank balance is the same amount as the actual cash in bank, except for deposits in transit, checks outstanding, and other reconciling items. The information needed to complete the tests of the reconciliation are provided by the: A) client's records and ledgers for the year under audit. B) cutoff bank statement. C) client's records and ledgers for the subsequent year. D) canceled checks for the year under audit.
Answer: B...
To test the client's list of outstanding checks on the bank reconciliation for completeness, the auditor should trace from the list to the checks included with the cutoff bank statement. A) True B) False
Answer: B...
When selecting a stratified sample, the sample size is: A) determined for the unstratified population and then apportioned to each stratum. B) determined for each stratum and selected from that stratum. C) determined for each stratum and selected randomly from the entire unstratified population. D) always larger than if unstratified sampling had been used.
Answer: B...
Which of the following is most correct when using audit sampling for exception rates? A) Auditor is concerned with the lowest rate. B) Auditor is concerned with the highest rate. C) Auditor is concerned with the average on previous audits. D) This doesn't impact the auditor's decision.
Answer: B...
Which of the following occurrences would be least likely to warrant further audit attention for the auditor? A) Deviations from client's established control procedures B) Deviations from client's budgeted values C) Monetary misstatements in populations of transaction data D) Monetary misstatements in populations of account balance details
Answer: B...
Which of the following would normally be discovered as part of the audit of the bank reconciliation? A) Failure to bill a customer B) Failure to include a deposit in transit on the bank reconciliation C) Duplicate payment of a vendor's invoice D) Payment to an employee for more hours than she worked
Answer: B...
Which one of the choices below is most correct regarding a cause of sampling risk? A) Ineffective use of audit procedures B) Testing less than the entire population C) Use of extensive tests of controls D) The use of random sampling
Answer: B...
You are auditing Raji and Company. You discover an item of inventory with an audited value of $5,000 with a recorded amount of $3,000. If this is the only error you discover the projected misstatement for the sample would be: A) $5,000. B) $2,000. C) $3,000. D) $4,000.
Answer: B...
Which of the following is generally not included in the "evidence mix"? A) Tests of controls B) Substantive tests of transactions C) Risk assessment procedures D) Tests of details of balances
Answer: C
All of the following would not be uncovered by a bank reconciliation except for: A) duplicate payment of a vendor's invoice. B) improper payments of officers' personal expenditures. C) payments on notes payable debited directly to the the bank account by the bank but not recorded on the books. D) payment to an employee for more hours than he worked.
Answer: C...
If no exceptions were found in the substantive tests of transactions: A) ARIA would stay the same. B) the sample size would stay the same. C) ARIA would increase. D) the sample size would increase.
Answer: C...
In an effort to satisfy the completeness objective, the auditor could perform which of the following test of details of balance procedures? A) Trace the book balance on the reconciliation to the general ledger. B) Trace outstanding checks to subsequent period bank statements. C) Perform a four-column proof of cash. D) Review financial statements to make sure that material savings accounts and certificates of deposit are disclosed separately.
Answer: C...
In performing a review of a client's cash disbursements, an auditor uses systematic sample selection with a random start. The primary disadvantage of this technique is population items: A) may occur twice in the sample. B) must be reordered in a systematic pattern before the sample can be drawn. C) may occur in a systematic pattern, thus negating the randomness of the sample. D) must be replaced in the population after sampling to permit valid statistical inference.
Answer: C...
One of the steps involved in planning the sample for the tests of details of balances is to: A) select the sample. B) perform the audit procedures. C) define a misstatement. D) analyze the misstatements.
Answer: C...
Place the following steps in their proper order: 1. Analyze exceptions 2. Select the sample 3. Define attributes and exception conditions 4. State the objectives of the audit test 5. Specify the tolerable exception rate A) 1, 3, 2, 4, 5. B) 4, 3, 1, 2, 5. C) 4, 3, 5, 2, 1. D) 1, 2, 3, 4, 5.
Answer: C...
The acceptable risk of overreliance: A) is the risk that the auditor will erroneously conclude that the controls are less effective than they actually are. B) is less of a concern to the auditors than the risk of underreliance. C) represents the auditor's measure of sampling risk. D) is determined by a statistical formula, and not by professional judgment.
Answer: C...
The appropriate assumption to make regarding the overall percent of error in those population items containing an error is: A) determined using random number tables. B) set after a quantitative analysis of client's internal control system. C) based on the auditor's personal judgment in the circumstances. D) based on statistical analysis using confidence limits.
Answer: C...
The highest estimated exception rate in the population at a particular acceptable risk of assessing control risk too low is: A) the upper exception rate. B) estimated population exception rate. C) the computed upper exception rate. D) the tolerable exception rate.
Answer: C...
The risk which the auditor is willing to take in accepting a control as being effective when the true population exception rate is greater than a tolerable rate is the: A) finite correction factor. B) tolerable exception rate. C) acceptable risk of overreliance. D) estimated population exception rate.
Answer: C...
The sample exception rate equals: A) the number of exceptions in the population divided by the sample size. B) the number of items in the population multiplied by the number of exceptions in the sample. C) the number of exceptions in the sample divided by the sample size. D) the number of exceptions in the population divided by the population size.
Answer: C...
The test of details of balances procedure that requires the auditor to foot the outstanding check list and deposits in transit is an attempt to satisfy which audit objective? A) Cutoff B) Presentation and disclosure C) Detail tie-in D) Completeness
Answer: C...
To determine if a sample is truly representative of the population, an auditor would be required to: A) conduct multiple samples of the same population. B) never use sampling because of the expense involved. C) audit the entire population. D) use systematic sample selection.
Answer: C...
When defining the population and the sampling unit for tests of details of balances: A) the population is defined as all of the transactions in the journal for the period. B) the sampling unit must be the same for all balance sheet accounts. C) if sampling for completeness, the sampling unit will be customers with zero balances. D) if sampling for completeness, the sampling unit will be the items making up the recorded population.
Answer: C...
Which of the following statements is most correct with respect to the evaluation of nonprobabilistic sample results? A) It is acceptable to make nonprobabilistic evaluations only when probabilistic sample selection is used. B) It is acceptable to make nonprobabilistic evaluations only if the auditor cannot quantify sampling risk. C) It is never acceptable to evaluate a nonprobabilistic sample using statistical methods. D) All of the above are correct.
Answer: C...
A useful starting point for becoming familiar with the client's inventory is for the auditor to: A) read the AICPA's Industry Audit Guide. B) review accounting theory covering special inventory problems. C) read the client's accounting manual. D) tour the client's facility.
Answer: D...
Which of the following must be set prior to testing a sample? A) Sample exception rate B) Achieved upper precision limit C) Computed exception rate D) Tolerable exception rate
Answer: D...
Which of the following statements is most correct? A) A sample of all items of a population will eliminate sampling risk, but increase nonsampling risk. B) The use of an appropriate sample selection technique ensures a representative sample. C) The auditor's failure to recognize an exception is a significant cause of sampling risk. D) The use of inappropriate audit procedures is a significant cause of nonsampling risk.
Answer: D...
List the two ways auditors can control sampling risk.
Auditors can control sampling risk by: 1. adjusting the sample size 2. using an appropriate method of selecting sample items from the population.
Briefly explain why auditors utilize audit sampling.
Auditors use sampling techniques primarily because it is generally impractical to audit all transactions or balances. Consequently, auditors must design strategies to select items from the population that are likely to be representative of the remaining unaudited population items. In addition, auditors often use sampling techniques because of economic realities. That is, clients generally do not want to incur the substantial fees associated with auditing every transaction or balance.
Shown below (1 through 5) are the five types of tests which auditors use to determine whether financial statements are fairly stated. Which three are substantive tests? 1. Risk assessment procedures 2. Tests of controls 3. Tests of transactions 4. Substantive analytical procedures 5. Tests of details of balances A) 1, 2, and 3. B) 3, 4, and 5. C) 2, 3, and 5. D) 2, 3, and 4.
B) 3, 4, and 5.
The auditors test the client's monthly bank reconciliation to verify whether the client's recorded bank balance is the same amount as the actual cash in the bank. Which of the following would not explain a difference between the company's cash balance and the bank's balance for the client? A) Deposits in transit B) Checks are written by the client in the same month the checks clear the bank. C) Other reconciling items D) Outstanding checks
B) Checks are written by the client in the same month the checks clear the bank.
Which of the following is not a term related to evaluating results in audit sampling until after a sample is tested and evaluated? A) Sample exception rate B) Estimated population exception rate C) Computed upper exception rate D) Exception
B) Estimated population exception rate
Which of the following is the exception rate that the auditor expects to find before testing? A) Sample exception rate B) Estimated population exception rate C) Computed exception rate D) Tolerable exception rate
B) Estimated population exception rate
Which of the following is not a common audit procedure used to search for contingent liabilities? A) Examine letters of credit. B) Examine payroll reports. C) Review internal revenue agent reports. D) Analyze legal expense.
B) Examine payroll reports.
Procedures to obtain an understanding of internal control generally provide sufficient appropriate evidence that a a control is operating effectively. A) True B) False
B) False Answer: B
Which of the following results in a larger sample size? A) Decrease the estimated population exception rate and decrease the tolerable exception rate. B) Increase the estimated population exception rate and decrease the tolerable exception rate. C) Decrease the estimated population exception rate and increase the tolerable exception rate. D) Increase the estimated population exception rate and increase the tolerable exception rate.
B) Increase the estimated population exception rate and decrease the tolerable exception rate.
Which of the following statements is not correct regarding probabilistic and nonprobabilistic sample selection? A) In probabilistic selection, every population item has a known chance of being selected. B) It is acceptable to evaluate a nonprobabilistic sample using statistical methods. C) Probabilistic selection is required for all statistical sampling methods. D) Both methods are acceptable and commonly used.
B) It is acceptable to evaluate a nonprobabilistic sample using statistical methods.
________ accumulate costs by individual jobs as material is issued into production and labor costs are incurred. A) Just-in-time production systems B) Job order cost systems C) Process cost systems D) Manufacturing systems
B) Job order cost systems
Which of the following is the risk that audit tests will not uncover existing exceptions in a sample? A) Sampling risk B) Nonsampling risk C) Audit risk D) Detection risk
B) Nonsampling risk
Which one of the following procedures would not be appropriate for an auditor in discharging his responsibilities concerning the client's physical inventories? A) Confirmation of goods in the hands of public warehouses B) Supervising the taking of the annual physical inventory C) Carrying out physical inventory procedures at an interim date D) Obtaining written representation from the client as to the existence, quality, and dollar amount of the inventory
B) Supervising the taking of the annual physical inventory
Which of the following statements is not true? A) Analytical procedures emphasize the overall reasonableness of transactions and balances. B) Tests of controls are concerned with evaluating whether controls are sufficiently effective to justify reducing control risk and thereby reducing analytical review procedures. C) Substantive tests of transactions emphasize the verification of transactions recorded in the journals and then posted in the general ledger. D) Tests of details of balances emphasize the ending balances in the general ledger.
B) Tests of controls are concerned with evaluating whether controls are sufficiently effective to justify reducing control risk and thereby reducing analytical review procedures. Answer: B
If an auditor concludes that internal controls are likely to be effective, the preliminary assessment of control risk can be reduced, leading to which of the following impacts on the acceptable risk of incorrect acceptance? A) The acceptable risk of incorrect acceptance will be reduced. B) The acceptable risk of incorrect acceptance will be increased. C) The acceptable risk of incorrect acceptance will be eliminated. D) The acceptable risk of incorrect acceptance will not be impacted.
B) The acceptable risk of incorrect acceptance will be increased.
A deficiency uncovered in the audit of internal control is explained by which of the following in relation to a financial statement misstatement? A) The amount of the misstatement B) The likelihood of the misstatement C) The amount, likelihood, and classification of the misstatement D) The amount and the classification of the misstatement
B) The likelihood of the misstatement
When there are no perpetual inventory files and inventory is material: A) an audit cannot be performed, so the auditor must issue a disclaimer. B) a physical inventory should be taken by the client near year-end. C) the auditor will have to perform the inventory count and determine valuation. D) the auditor need not observe inventory counts but must do test counts.
B) a physical inventory should be taken by the client near year-end.
The auditor generally decides whether the inventory count can be taken before year-end primarily on the basis of: A) audit efficiency. B) accuracy of the perpetual inventory master files. C) client convenience. D) audit staff availability.
B) accuracy of the perpetual inventory master files.
Handling the receipt of ordered goods is a part of the ________ cycle. A) purchasing B) acquisition and payment C) inventory D) inventory and warehousing
B) acquisition and payment
If the population is not considered acceptable, one step the auditor is likely to take is to: A) retest all internal controls. B) ask the client to adjust the account balance. C) test the entire population. D) decrease inherent risk.
B) ask the client to adjust the account balance.
When auditors observe the client counting inventory, they should be careful to do all of the following except: A) inquire about items that are likely to be obsolete or damaged. B) calculate the unit cost of the inventory items. C) discuss with management the reasons for excluding any material items. D) observe the counting of the most significant items.
B) calculate the unit cost of the inventory items
You are auditing Rodgers and Company. After performing substantive analytical procedures you conclude that, for the accounts tested, the client's balance appears reasonable. This may indicate that: A) details test of balances can be eliminated for those accounts. B) certain tests of details of balances may be eliminated for those accounts. C) control tests may be eliminated for those accounts. D) control tests may be reduced for those accounts.
B) certain tests of details of balances may be eliminated for those accounts.
When using statistical sampling, the auditor would most likely require a smaller sample if the: A) population increases. B) desired reliability decreases. C) desired precision interval narrows. D) expected exception rate increases.
B) desired reliability decreases.
You are auditing Rodgers and Company. You are aware of a potential loss due to non-compliance with environmental regulations. Management has assessed that there is a 40% chance that a $10M payment could result from the non-compliance. The appropriate financial statement treatment is to: A) accrue a $4 million liability. B) disclose a liability and provide a range of outcomes. C) since there is less than a 50% chance of occurrence, ignore. D) since there is greater that a remote chance of occurrence, accrue the $10 million.
B) disclose a liability and provide a range of outcomes.
Tests of controls are directed toward the control's: A) efficiency. B) effectiveness. C) cost and effectiveness. D) cost benefit ratio.
B) effectiveness. Answer: B
On the last day of the fiscal year, the cash disbursements clerk drew a company check on bank A and deposited the check in the company account in bank B to cover a previous theft of cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by: A) examining the composition of deposits in both bank A and bank B subsequent to year-end. B) examining paid checks returned with the bank statement of the next account period after year-end. C) preparing, from the cash disbursements records, a summary of bank transfers for one week prior to and subsequent to year-end. D) comparing the detail of cash receipts as shown by the client's cash receipts records with the detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year-end.
B) examining paid checks returned with the bank statement of the next account period after year-end.
The audit of cost accounting begins with the internal transfer of assets from raw materials to work-in-process to: A) manufacturing overhead. B) finished goods inventory. C) the perpetual inventory master files. D) retail sales.
B) finished goods inventory.
When the auditor goes through a population and selects items using nonprobabilistic selection methods, without regard to their size, source, or other distinguishing characteristics, it is called: A) block sample selection. B) haphazard selection. C) systematic sample selection. D) statistical selection.
B) haphazard selection.
While performing a substantive test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was not materially misstated. It was, in fact, materially misstated. This situation illustrates the risk of: A) incorrect rejection. B) incorrect acceptance. C) assessing control risk too low. D) assessing control risk too high.
B) incorrect acceptance.
An exception or deficiency found in a test of controls: A) indicates a financial statement misstatement. B) indicates the likelihood of a misstatement. C) indicates that the financial statements are fairly stated. D) indicates that an adverse opinion is warranted on the audit of internal control.
B) indicates the likelihood of a misstatement. Answer: B
The purpose of tests of controls is to provide reasonable assurance that the: A) accounting treatment of transactions and balances is valid and proper. B) internal control procedures are functioning as intended. C) entity has complied with GAAP disclosure requirements. D) entity has complied with requirements of quality control.
B) internal control procedures are functioning as intended. Answer: B
There is a(n) ________ relationship between acceptable risk of overreliance and planned sample size. A) direct. B) inverse. C) proportional. D) exponential.
B) inverse.
If a potential loss on a contingent liability is remote, the liability usually is: A) disclosed in footnotes, but not accrued. B) neither accrued nor disclosed in footnotes. C) accrued and indicated in the body of the financial statements. D) disclosed in the auditor's report but not disclosed on the financial statements.
B) neither accrued nor disclosed in footnotes.
Auditor tests of the physical controls over raw materials, work in process, and finished goods are generally limited to: A) observation and confirmation. B) observation and inquiry. C) inquiry and reconciliation. D) observation and reconciliation.
B) observation and inquiry.
The main difference between job order and process costing systems is that: A) one accumulates costs by materials issued and the other by labor incurred. B) one accumulates costs by individual jobs and the other by particular processes. C) one emphasizes costs accumulated in completed products and the other emphasizes costs associated with work-in-process. D) one emphasizes costs adding value to the product and the other emphasizes costs incurred because of waste, scrap, and obsolescence.
B) one accumulates costs by individual jobs and the other by particular processes.
When determining the sample size for the number of items the auditor should count during the physical inventory: A) it is easy to quantify the number of items based on a formula developed by the AICPA. B) one of the key determinants that must be considered is internal control over the physical count. C) one of the key determinants that must be considered is the time involved. D) generally accepted auditing standards require that at least 80% of the dollar value of the inventory should be included in the sample.
B) one of the key determinants that must be considered is internal control over the physical count.
To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditor should review and test the: A) terms of the open purchase orders. B) purchase cutoff procedures. C) contractual commitments made by the purchasing department. D) purchase invoices received on or around year-end.
B) purchase cutoff procedures.
Receipt of ordered materials by the receiving department will generate the completion of a form called the: A) bill of lading. B) receiving report. C) materials requisition. D) inventory acquisition summary.
B) receiving report.
The audit and accounting concern addressed in a monthly proof of cash is with: A) adjusting account balances. B) reconciling the amounts recorded in the books with the amounts included in the bank statement. C) determining the month-end balance. D) identifying cash transfers.
B) reconciling the amounts recorded in the books with the amounts included in the bank statement.
When using the probability threshold for contingencies, the likelihood of the occurrence of the event is classified as: A) not likely, likely, or highly likely. B) remote, reasonably possible, or probable. C) slight, moderate, great. D) remote, likely, possible.
B) remote, reasonably possible, or probable.
A sample in which the characteristics of the sample are the same as those of the population is a(n): A) variables sample. B) representative sample. C) attributes sample. D) random sample.
B) representative sample. Answer: B
The bank reconciliation: A) must be done on a daily basis if the client uses electronic banking. B) should be performed by someone independent of the handling or recording of cash receipts. C) should be performed by someone who handles cash disbursements. D) ensures that no cash has been embezzled.
B) should be performed by someone independent of the handling or recording of cash receipts.
When a population is divided into subpopulations, usually by dollar size, and larger samples are taken from the subpopulation with the larger sizes, ________ is being used. A) sampling with probability proportional to size B) stratified sampling C) block sampling D) haphazard sampling
B) stratified sampling
A procedure designed to test for monetary misstatements directly affecting the correctness of financial statement balances is a: A) test of controls. B) substantive test. C) test of attributes. D) monetary-unit sampling test.
B) substantive test. Answer: B
When dealing with contingencies: A) all material contingencies must be disclosed or footnoted. B) the auditor must exercise considerable professional judgment when evaluating whether the client has applied the appropriate treatment. C) it is easy for the auditor to uncover contingencies without management's cooperation. D) the review for contingent liabilities is only performed at the beginning and the end of the audit.
B) the auditor must exercise considerable professional judgment when evaluating whether the client has applied the appropriate treatment.
Auditors need to understand the client's physical inventory count controls before the count of the inventory begins so that: A) the auditors can accurately count and tag the inventory for the client. B) the auditors can make constructive suggestions as to the adequacy of the procedures. C) the client will be informed on exactly what items the auditor intends to test count. D) the auditor can communicate any weaknesses directly to the audit committee.
B) the auditors can make constructive suggestions as to the adequacy of the procedures.
When analyzing exceptions, the auditor should keep in mind that: A) all exceptions must be reported to management. B) they should determine the breakdown in the internal controls that allowed the exceptions to occur. C) the nature of an exception and its causes have no effect on the qualitative evaluation of the system. D) exceptions do not need to be analyzed if it is too costly.
B) they should determine the breakdown in the internal controls that allowed the exceptions to occur.
An auditor selects a random sampling of tag numbers and identifies the tag with that number attached to the actual inventory. The purpose of the procedure is to: A) obtain proper cutoff information. B) uncover the inclusion of nonexistent items as inventory. C) to determine if the client has adequately priced the inventory item. D) to verify that the client has not changed the recorded counts after the auditor left the premises.
B) uncover the inclusion of nonexistent items as inventory.
Which of the following is a correct statement? A) When internal controls are effective, control risk can be reduced, and therefore the auditor will decrease the ARIA. B) There is a direct relationship between ARIA and the required sample size. C) A lower control risk risk requires a lower ARO in testing the controls. D) ARO measures the auditor's desired assurance for an account balance.
C) A lower control risk risk requires a lower ARO in testing the controls.
With which of the following client personnel would it generally not be appropriate to inquire about commitments or contingent liabilities? A) Controller B) President C) Accounts receivable clerk D) Vice president of sales
C) Accounts receivable clerk
Which of the following statements is correct regarding the audit of inventory cost accounting? A) Cost accounting systems and controls are the same for all manufacturing companies. B) All companies that have work-in-process must use a perpetual inventory system. C) Auditors test perpetual inventory master files by examining documentation that supports additions and reductions of inventory amounts in the master files. D) Manufacturing companies keep their cost accounting records separate from the production and other accounting records.
C) Auditors test perpetual inventory master files by examining documentation that supports additions and reductions of inventory amounts in the master files.
Which of the following conditions would lead to a larger sample size? A) Larger tolerable misstatement B) Low inherent risk C) High control risk D) Smaller account balance
C) High control risk
________ is normally characterized as a difficult and complex account to audit. A) Property, plant and equipment B) Cash C) Inventory D) Prepaid insurance
C) Inventory
Which of the following is a correct statement? A) A proof of cash receipts is a test of the balance in the cash account at a point in time. B) The proof of cash disbursements is effective for discovering a check written for the incorrect amount for which the dollar amount in cash disbursements is also incorrect. C) It is extremely difficult for an auditor to detect thefts of cash, especially omitted transactions and account balances. D) Segregation of duties is not an important control procedure for cash in a small business.
C) It is extremely difficult for an auditor to detect thefts of cash, especially omitted transactions and account balances.
Which of the following groups has the responsibility for identifying and deciding the appropriate accounting treatment for recording or disclosing contingent liabilities? A) Auditors B) Legal counsel C) Management D) Management and the auditors
C) Management
Which of the following items would not normally appear on bank reconciliations? A) Balance per bank B) List of deposits in transit C) Outstanding deposits D) Outstanding checks
C) Outstanding deposits
Which of the following controls would be appropriate regarding the release of materials from a stockroom? A) Production employees request materials be delivered to their work areas as they need them. B) Stockroom employees deliver materials to work areas throughout the day to maintain acceptable levels of safety stock — no written records are maintained. C) Production employees submit approved requisition forms to the stockroom for materials needed. D) Production employer in need of materials should personally pick up needed materials from the stockroom.
C) Production employees submit approved requisition forms to the stockroom for materials needed.
Which of the following further audit procedures are used to determine whether all six transaction-related audit objectives have been achieved for each class of transactions? A) Tests of controls B) Risk assessment procedures C) Substantive tests of transactions D) Preliminary analytical procedures
C) Substantive tests of transactions
Which of the following procedures would most likely be performed in response to the auditor's assessment of the risk of monetary misstatements in the financial statements? A) Ratio analysis B) Tests of controls C) Tests of details of balances D) Risk assessment procedures
C) Tests of details of balances
Which of the following verifications would generally not be performed by the auditor in the month subsequent to the balance sheet date? A) Foot the lists of all canceled checks, debit memos, deposits, and credit memos. B) Verify the bank statement balances when the footed totals are used. C) Verify the book statement balances tie to the cash receipts and disbursements journals for the year under audit. D) Review the items included in the footings to make sure that they were cancelled by the bank
C) Verify the book statement balances tie to the cash receipts and disbursements journals for the year under audit.
The auditor's tour of the client's inventory facilities should be led by: A) a member of the audit committee. B) the CFO. C) a plant supervisor. D) the company president.
C) a plant supervisor.
A proof of cash represents: A) a test of controls and substantive test of transactions. B) a substantive test of transactions. C) a substantive test of transactions and test of details of balances. D) a test of details of balances.
C) a substantive test of transactions and test of details of balances.
In the context of an audit of financial statements, substantive tests are audit procedures that: A) may be eliminated under certain conditions. B) are designed to discover significant subsequent events. C) are designed to test for dollar misstatements. D) will increase proportionately with the auditor's reliance on internal control.
C) are designed to test for dollar misstatements. Answer: C
The auditor's primary concern relative to presentation and disclosure-related objectives is: A) accuracy. B) existence. C) completeness. D) occurrence.
C) completeness.
If the auditor concludes that physical controls over inventory are so inadequate that the inventory will be difficult to count, the auditor should ordinarily: A) withdraw from the engagement. B) issue a qualified audit report. C) conduct expanded observation tests of physical inventory. D) hire a specialist to assist the auditor.
C) conduct expanded observation tests of physical inventory.
An increased extent of tests of controls is most likely to occur when: A) it is a first-year audit. B) the auditor is doing a "fraud audit." C) controls are effective and the preliminary control risk assessment is low. D) controls are ineffective and the preliminary control risk assessment is high.
C) controls are effective and the preliminary control risk assessment is low. Answer: C
Master files, spreadsheets, and reports that accumulate material, labor, and overhead as the costs are incurred are: A) accounting systems. B) storeroom documents. C) cost accounting records. D) finished goods inventory records.
C) cost accounting records.
A system walkthrough is primarily used to help the auditor: A) test the ending account balances. B) test the details of transactions. C) determine whether internal controls are in place. D) determine whether the audit engagement should be accepted.
C) determine whether internal controls are in place. Answer: C
Boxes or other containers holding inventory should also be opened during test counts to determine the ________ of the inventory. A) classification B) detail tie-in C) existence D) realizable value
C) existence
When a physical count of inventory is performed at an interim date, the auditor observes it at that time and tests the perpetual records for transactions: A) throughout the year. B) which are a representative sample of the period under audit. C) from the date of the count to year-end. D) from the date of the count to the end of the audit field work.
C) from the date of the count to year-end.
If analytical procedures are performed with no indications of likely misstatements, ARIA will ________ and the sample size will ________. A) remain the same, increase B) decrease, decrease C) increase, decrease D) decrease, increase
C) increase, decrease
The audit tests to verify that the client is using an inventory method which is generally accepted and to verify that physical counts were correctly summarized are performed during the audit of the: A) acquisition and payments cycle. B) payroll and personnel cycle. C) inventory and warehousing cycle. D) sales and collection cycle.
C) inventory and warehousing cycle.
When auditing manufacturing overhead costs assigned to inventory, auditors should keep in mind that: A) GAAP has strict procedures that must be followed when assigning overhead to work-in-process inventory. B) overhead costs must be allocated to raw materials, work-in-process, and finished goods inventory. C) management typically allocates overhead using total direct labor dollars as the basis for the allocation. D) determining the reasonableness of the allocation method is relatively simple for work-in-process inventory.
C) management typically allocates overhead using total direct labor dollars as the basis for the allocation.
A major difficulty in the verification of inventory cost records for the purpose of inventory valuation is in determining the reasonableness of the: A) direct labor hourly rate. B) raw material per unit cost. C) manufacturing overhead costs. D) number of direct labor hours applied.
C) manufacturing overhead costs.
There are three phases in both statistical and nonstatistical sampling. The first phase is to: A) generate random numbers for the sample. B) evaluate the results. C) plan the sample. D) select the sample.
C) plan the sample.
One of the primary approaches in dealing with uncertainties in loss contingencies uses a ________ threshold. A) monetary B) materiality C) probability D) analytical
C) probability
If the perpetual inventory master files show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded: A) sales. B) sales discounts. C) purchases. D) purchase discounts.
C) purchases.
Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which: A) materials are ordered for purchase until the finished product is sold. B) the customer's order is received until the finished product is shipped. C) raw materials are requisitioned until the finished product is sent to storage. D) raw materials are requisitioned until the finished product is completely manufactured.
C) raw materials are requisitioned until the finished product is sent to storage.
A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is: A) classification. B) cutoff. C) realizable value. D) rights.
C) realizable value.
The direct receipt of a confirmation from every bank with which the client does business is: A) required by auditing standards for every audit. B) not necessary unless material fraud is suspected. C) recommended but not required by auditing standards. D) necessary for every audit except when there are an unusually large number of active accounts.
C) recommended but not required by auditing standards.
There must be a periodic physical count by the client of the inventory items on hand: A) only if the client uses the LIFO method. B) only if the client uses a lower-of-cost-or-market method. C) regardless of the client's inventory valuation method. D) only if the client uses either the LIFO or FIFO method.
C) regardless of the client's inventory valuation method.
An auditor must inquire about consigned or customer inventory included on the client's premises to satisfy the balance-related audit objective of: A) cutoff. B) classification. C) rights. D) completeness.
C) rights.
Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls, represent the auditor's: A) audit strategy. B) tests of controls. C) risk assessment procedures. D) tests of transactions
C) risk assessment procedures.
Many auditors perform extensive analytical procedures on audits because: A) they are required by GAAS. B) they pinpoint errors in accounts. C) they indicate areas of potential risk and misstatement. D) they are required for tests of controls.
C) they indicate areas of potential risk and misstatement. Answer: C
If a client intends to count inventory at an interim date, the auditor should expect there to be all of the following except: A) controls over the preparation and maintenance of perpetual inventory records. B) competent personnel assigned to count the inventory. C) third-party inventory counting specialists. D) an adequately designed plan to count the inventory.
C) third-party inventory counting specialists.
Define the term contingent liability and discuss the criteria accountants and auditors use to classify these accounting events.
Contingent liability: a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. Three conditions are required for a contingent liability to exist: (1) there is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the amount for the future payment or impairment; and (3) the outcome will be resolved by some future event or events. Accounting standards describe three levels of likelihood of occurrence and the appropriate financial statement treatment for each likelihood as follows: a. Probable-future event likely to occur and amount can be reasonably estimated then the financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a footnote disclosure is necessary. b. Reasonably possible-chance of occurring is more than remote, but less than probable. Footnote disclosure is necessary. c. Remote-chance of occurrence is slight, no disclosure is necessary.
Based on the schedule of interbank transfers above, which of the cash transfers would appear as a deposit in transit on the December 31, 2013 bank reconciliation? A) 1 B) 2 C) 3 D) 4
D) 4
The standard bank confirmation form has been agreed upon by the: A) SEC and FASB. B) AICPA and the SEC. C) SEC and the American Bankers' Association. D) AICPA and the American Bankers' Association.
D) AICPA and the American Bankers' Association.
To assure proper segregation of duties, who should maintain the perpetual inventory master files? A) Production personnel B) Inventory storeroom personnel C) Inventory receiving personnel D) Accounting department personnel
D) Accounting department personnel
A proof of cash is effective at identifying which of the following misstatements? A) Checks written for incorrect amounts B) Checks issued to invalid vendors C) Fraudulent checks D) Checks recorded in the books for an amount different from that on the check
D) Checks recorded in the books for an amount different from that on the check
Which of the following is not considered a commitment? A) Agreements to purchase raw materials B) Pension plans C) Agreements to lease facilities at set prices D) Each of the above is a commitment.
D) Each of the above is a commitment.
Inventory is a complex area to audit for all but which of the following reasons? A) Inventory is often in different locations. B) There are several acceptable valuation methods and some entities use different methods for different types of inventory. C) Inventory is often the largest account on the balance sheet. D) Inventory valuation includes few estimates.
D) Inventory valuation includes few estimates.
Which of the following is not a "cash equivalent"? A) Time deposits B) Certificates of deposit C) Money market funds D) Marketable securities
D) Marketable securities
The most important balance-related audit objectives in the audit of cash include all but which of the following? A) Existence B) Accuracy C) Completeness D) Occurrence
D) Occurrence
Which of the following is not a function within the inventory and warehousing cycle? A) Process the goods B) Store raw materials C) Ship finished goods D) Process invoices for shipped goods
D) Process invoices for shipped goods
Which of the following would not be considered further audit procedures? A) Tests of controls B) Analytical procedures C) Tests of details of balances D) Risk assessment procedures
D) Risk assessment procedures
A proof of cash is not an effective procedure for identifying which of the following types of misstatements? A) All recorded disbursements were paid by the bank. B) All recorded cash receipts were deposited. C) All amounts that were paid by the bank were recorded. D) Some checks were written for incorrect amounts.
D) Some checks were written for incorrect amounts.
Which of the following is ordinarily designed to detect material dollar errors on the financial statements? A) Tests of controls B) Analytical review procedures C) Computer controls D) Tests of details of balances
D) Tests of details of balances Answer: D
In order to promote audit efficiency the auditor considers cost in selecting audit tests to perform. Which of the following audit tests would be the most costly? A) Analytical procedures B) Risk assessment procedures C) Tests of controls D) Tests of details of balances
D) Tests of details of balances Answer: D
If the auditor concludes that there are contingent liabilities, he or she must evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements. Which of the following statements is not true? A) The potential liability is sufficiently well known in some instances to be included in the financial statements as an actual liability. B) Disclosure may be unnecessary if the contingency is highly remote or immaterial. C) A CPA firm often obtains a separate evaluation of the potential liability from its own legal counsel rather than relying on management or management's attorneys. D) The client's attorneys must remain independent when evaluating the likelihood of losing the lawsuit.
D) The client's attorneys must remain independent when evaluating the likelihood of losing the lawsuit.
Which of the following is an internal control weakness for a company whose inventory of supplies consists of a large number of individual items? A) The cycle basis is used for physical counts. B) Supplies of relatively little value are expensed when purchased. C) Perpetual inventory records are maintained only for items of significant value. D) The storekeeper is responsible for maintenance of perpetual inventory records.
D) The storekeeper is responsible for maintenance of perpetual inventory records.
Comparing the physical counts with the perpetual inventory master files satisfies the balance-related audit objective of: A) classification. B) observation. C) completeness. D) accuracy.
D) accuracy.
In most manufacturing companies, the inventory and warehousing cycle begins with the: A) receipt of a customer's order. B) completion of production of a customer's order. C) initiation of production of a customer's order. D) acquisition of raw materials for production of an order.
D) acquisition of raw materials for production of an order.
One of the auditor's primary concerns in verifying the transfer of inventory from one location to another is that: A) recorded transfers exist. B) all actual transfers are recorded. C) the quantity, date, and description of all recorded transfers are accurate. D) all of the above.
D) all of the above
When defining the population: A) it may be necessary to define separate populations for different audit procedures. B) the auditor may generalize only about the population that has been sampled. C) auditors can define the population to include any items they want. D) all of the above.
D) all of the above. Answer: D
The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been deleted is associated with the audit objective of: A) accuracy. B) existence. C) detail tie-in. D) completeness.
D) completeness.
When the auditor believes the year-end bank reconciliation may be intentionally misstated, it is appropriate to perform extended tests of the year-end bank reconciliation. Assuming the client has a October 31 year-end, these extended tests would not include: A) comparing all September 30 reconciling items with canceled checks and other documents in the October bank statement. B) comparing all canceled checks and deposit slips in the October bank statement with the October cash disbursements and receipts records. C) carrying out all proper procedures subsequent to the end of the year with the use of the bank cutoff statement. D) determining that all outstanding checks had cleared by the date of the bank cutoff statement.
D) determining that all outstanding checks had cleared by the date of the bank cutoff statement.
The reliability of perpetual inventory master files affects the timing and ________ of the auditor's physical examination of inventory. A) cutoff B) accuracy C) nature D) extent
D) extent
A major consideration in the audit of the general cash balance is the possibility of fraud. The auditor must extend his or her procedures in the audit of year-end cash to determine the possibility of a material fraud when there are: A) large cash balances at the end of the year. B) large cash receipts and disbursements during the year. C) no imprest accounts used for payroll. D) inadequate internal controls.
D) inadequate internal controls.
If an auditor waits until the subsequent period bank statement is available to verify reconciling items, it is primarily a test for: A) errors. B) omissions. C) kiting. D) intentional misstatements.
D) intentional misstatements.
Auditors test the quantity of materials charged to work-in-process by tracing these quantities to: A) cost ledgers. B) perpetual inventory records. C) receiving reports. D) material requisitions.
D) material requisitions. Answer: D
Audit procedures related to contingent liabilities are initially focused on: A) accuracy. B) completeness. C) existence. D) occurrence.
D) occurrence.
Analytical procedures: A) involve comparisons of recorded amounts to expectations developed by management. B) are only performed during the planning stage of the audit. C) are required to be performed when auditing an account balance. D) provide substantive evidence.
D) provide substantive evidence. Answer: D
The most important part of the observation of inventory is to determine whether: A) all counts are accurate. B) the inventory-takers are qualified. C) obsolete inventory has been identified. D) the physical count is being taken in accordance with the client's instructions.
D) the physical count is being taken in accordance with the client's instructions.
A well-designed computerized system of perpetual inventory master files includes information about the: A) units of inventory purchased, sold, and on hand. B) unit costs of inventory purchased, sold, and on hand. C) units of raw materials, work-in-process, and finished goods. D) units and unit costs of inventory purchased, sold, and on hand.
D) units and unit costs of inventory purchased, sold, and on hand.
Identify each of the seven factors that influence sample size for nonstatistical tests of details of balances, and state whether each factor is directly or inversely related to sample size.
Factors that influence sample size for nonstatistical tests are: • Control risk. Control risk is directly related to sample size; as control risk increases, sample size also increases. • Results of other substantive tests related to the same assertion. Directly related to sample size; as these risks increase, sample size also increases. • Dollar amount of the population. Directly related to sample size, smaller account balances lead to smaller sample size and larger account balances lead to larger sample sizes. • Tolerable misstatement for a specific account. Inversely related; as tolerable misstatement increases, sample size decreases. • Inherent risk. Directly related; as inherent risk increases, sample size also increases. • Expected size and frequency of misstatements. Directly related; as the size and frequency of expected misstatements increase, sample size also increases. • Number of items in the population. Directly related, but has only a minor effect on sample size.
Bank reconciliation audit tests are designed to detect misstatements other than through the improper payment of cash or failure to receive cash normally would not be detected as part of the tests of the bank reconciliation. List below at least THREE misstatements that are designed to be detected by bank reconciliation.
Failure to include a check that has not cleared the bank on the outstanding checklist, even though it has been recorded on the cash disbursement journal Cash received by the client subsequent to the balance sheet date, but recorded as cash receipts in the current year Deposits recorded as cash receipts near the end of the year, deposited in the bank in the same month, and included in the bank reconciliation as a deposit in transit Payments on notes payables debited directly to the bank balance by the bank but not entered in the client's records
Although systematic sample selection is easy to use, its primary disadvantage is that it is not a probabilistic sampling method. A) True B) False
False
Sampling used for tests of details of balances provides results in terms of exception rates. A) True B) False
False
The extent of tests of details of balances cannot be reduced when transaction-related audit objectives have been satisfied by tests of controls or substantive tests of transactions. A) True B) False
False
When the SER exceeds the TER, the auditor should decide whether to increase sample size or to revise assessed control risk on the basis of cost versus benefit. A) True B) False
False
Describe each of the four types of sample selection methods commonly associated with statistical audit sampling.
Four types of sample selection methods commonly associated with statistical audit sampling are: • Simple random sample selection. Every possible combination of elements in the population has an equal chance of constituting the sample. • Systematic sample selection. A probabilistic method of sampling in which the auditor calculates an interval (the population size divided by the number of sample items desired) and selects the items for the sample based on the size of the interval and a randomly selected number between zero and the interval size. • Probability proportional to size sample selection. The probability of selecting any individual population item is proportional to its recorded amount. • Stratified sample selection. A probabilistic method of sampling in which the population is divided into subpopulations, and samples are taken from each of the subpopulations.
Explain kiting, and discuss how it is performed.
Kiting is the transfer of money from one bank to another and improperly recording the transaction to cover a theft of cash. Near the balance sheet date, a check is drawn on one bank account and immediately deposited in a second account for credit before the end of the accounting period. In making this transfer, the embezzler is careful to make sure that the check is deposited at a late enough date so that it does not clear the first bank until after the end of the period. If the interbank transfer is not recorded until after the balance sheet date, the amount of the transfer is recorded as an asset in both banks.
Describe the differences between statistical and nonstatistical sampling in terms of (1) the sample selection methods used, and (2) quantification of sampling risk.
Nonstatistical sampling differs from statistical sampling in that non-probabilistic sampling can be used for the former but not the latter. In addition, sampling risk can be quantified when using statistical sampling but not when using nonstatistical sampling.
When using nonstatistical sampling, the auditor must subjectively consider whether the true population misstatement exceeds a tolerable amount. This is done by considering five factors. One factor is the difference between the point estimate and tolerable misstatement. State the other four factors the auditor must consider.
Other factors the auditor must consider are: • The extent to which items in the population have been audited 100%. • Whether misstatements tend to be offsetting or in only one direction. • The amounts of individual misstatements. • Sample size.
Discuss what is meant by "sampling risk" and "nonsampling risk."
Sampling risk is the risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population. Sampling risk is an inherent part of sampling that results from testing less than the entire population. Nonsampling risk is the risk that the auditor reaches an incorrect conclusion for any reason not related to the sampling risk.
The most important difference among tests of controls, substantive tests of transactions, and tests of details of balances lies in what the auditor wants to measure. Explain what each type of test attempts to measure.
Tests of controls focus on testing the effectiveness of internal controls. In substantive tests of transactions, the auditor is concerned about both the effectiveness of internal controls and the monetary correctness of transactions in the accounting system. In tests of details of balances, the concern is determining whether the dollar amount of an account balance is materially misstated.
With what types of contingencies might an auditor be concerned?
The auditor is generally concerned with contingencies arising from: pending litigation for patent infringement, product liability or other actions, income tax disputes product warranties notes receivable discounted guarantees of obligations of others unused balances of outstanding letters of credit
Discuss the four aspects of the audit of cost accounting with which the auditor is most concerned.
The auditor is most concerned with: • Physical controls over inventory. Generally limited to observation and inquiry to determine if inventory is protected from theft and misuse. • Documents and records for transferring inventory. The auditor's primary concerns in verifying the transfer of inventory from one location to another are that the recorded transfers exist, the transfers that have actually taken place are recorded, and the quantity, description, and date of all recorded transfers are accurate. • Perpetual inventory master files. The adequacy of perpetual inventory master files has a major effect on the timing and extent of the auditor's physical examination of inventory. • Unit cost records. To maintain accurate cost data, clients must integrate their cost accounting records with production and other accounting records. The auditor is concerned that there is accurate cost data for raw materials, direct labor, and manufacturing overhead to ensure that raw materials, work-in-process, and finished goods inventories are fairly stated.
Consider the steps in sampling for tests of details and for tests of controls. Explain the differences in applying sampling to these two types of tests.
The differences are as follows: Tests of Details 1. Define a misstatement 2. Specify tolerable misstatement 3. Specify acceptable risk of incorrect acceptance 4. Estimate misstatements in the population 5. Analyze misstatements Tests of Controls 1. Define attributes and exception conditions 2. Specify tolerable exception rate 3. Specify acceptable risk of overreliance 4. Estimate population exception rate 5. Analyze exceptions
Bank reconciliation
The document usually prepared by client personnel of the differences between the cash balance recorded in the general ledger and the amount in the bank account.
An environmental clean-up lawsuit is pending against your client. What information about the lawsuit would you as the auditor need in order to determine the proper accounting treatment?
The first step is to determine if a contingency exists. Three conditions are required for a contingent liability to exist: (1) there is a potential future payment to an outside party or the impairment of an asset that resulted from an existing condition; (2) there is uncertainty about the amount for the future payment or impairment; and (3) the outcome will be resolved by some future event or events. Since the lawsuit meets the criteria for a contingent liability, the next step is to evaluate the significance of the potential liability and the nature of the disclosure needed in the financial statements to obtain evidence about the occurrence and right and obligations presentation and disclosure objective. Accounting standards describe three levels of likelihood of occurrence and the appropriate financial statement treatment for each likelihood as follows: a. Probable-future event likely to occur and amount can be reasonably estimated then the financial statement accounts are adjusted. If amount cannot be reasonably estimated, then a footnote disclosure is necessary. b. Reasonably possible-chance of occurring is more than remote, but less than probable. Footnote disclosure is necessary. c. Remote-chance of occurrence is slight. No disclosure is necessary
The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor.
The five parts are: • Acquire and record raw materials, labor, and overhead. This is tested during the audits of the acquisition and payment cycle, and the payroll and personnel cycle. • Internally transfer assets and costs. This is tested in the inventory and warehousing cycle. • Ship goods, and record revenue and costs. This is tested during the audit of the sales and collection cycle. • Physically observe inventory. This is tested in the inventory and warehousing cycle. • Price and compile inventory. This is tested in the inventory and warehousing cycle.
Describe the five types of audit tests. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk.
The five types of audit tests used to determine whether financial statements are fairly stated are: risk assessment procedures, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Substantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk.
What is the key advantage and disadvantage associated with systematic sample selection? How must auditors address this disadvantage?
The key advantage is its ease of use. Generally, systematic samples are easily drawn from the population and supporting documentation is easily developed. The key disadvantage is the potential for bias. Once the first item in the sample is selected, all other items are chosen automatically. Auditors should be careful to consider any potential pattern in the data prior to selecting their sample to ensure that their selection considers the possible bias.
Discuss the key control procedures relating to the client's physical count of inventory.
The key control procedures relating to the client's physical count of inventory include: 1. proper instructions for the physical count 2. supervision by responsible personnel 3. independent internal verification of the counts 4. independent reconciliations of the physical counts with perpetual inventory master files 5. adequate control over count sheets or tags.
Instead of receiving a cutoff bank statement, auditors can wait until the subsequent period bank statement is available to verify reconciling items. Discuss the purpose of reviewing the subsequent period bank statement and list the verifications the auditor performs on this bank statement.
The purpose of such a proof is to test whether the client's employees have omitted, added, or altered any of the documents accompanying the statement. The audit procedures include footing all the cancelled checks, debit memos, deposits, and credit memos; verifying that the bank statement balances when the footed totals are used; and reviewing the items included in the footings to make sure that they were cancelled by the bank in the proper period and do not include any erasures or alterations.
Explain the purpose of testing the client's bank reconciliation, and discuss the major audit procedures involved
The purpose of testing the client's reconciliation is to verify whether the client's recorded bank balance is the same amount as the actual cash in the bank. Procedures include: • Verify that the client's bank reconciliation is mathematically accurate. • Trace the balance on the bank confirmation and/or the beginning balance on the cutoff statement to the balance per bank on the bank reconciliation to ensure they are the same. • Trace checks written and recorded before year-end and included with the cutoff bank statement to the list of outstanding checks on the bank reconciliation and to the cash disbursements journal in the period or periods prior to the balance sheet date. • Investigate all significant checks included on the outstanding check list that have not cleared the bank on the cutoff statement. • Trace deposits in transit to the cutoff bank statement. • Account for other reconciling items on the bank statement and bank reconciliation.
State the six functions that make up the inventory and warehousing cycle and, for each function, identify the related documents and/or records that would be used by a manufacturing company.
The six functions are: • Process purchase orders. Related documents are the purchase requisition and the purchase order. • Receive raw materials. Related documents are the receiving report and the vendor's invoice. • Store raw materials. Related record is the raw materials perpetual inventory master file. • Process the goods. Related documents and records are the raw materials requisition and the cost accounting records. • Store finished goods. Related records are the finished goods perpetual inventory master file and the cost accounting records. • Ship finished goods. Related documents and records are the shipping document, the finished goods perpetual inventory master file, and the cost accounting records.
Discuss each of the six possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount.
The six possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount are: • Take no action until tests of other audit areas are completed. If offsetting misstatements are found in other parts of the audit, the auditor may conclude that the population is acceptable. • Perform expanded audit tests in specific areas. • Increase the sample size. As sample size increases, sampling error is reduced if the rate of misstatements in the expanded sample, their dollar amount, and their direction are similar to those in the original sample. This may result in the population being acceptable. • Adjust the account balance. In some circumstances, if the client corrects the misstatements discovered by the auditor, the book value of the account may become acceptable. • Request the client to correct the population. • Refuse to give an unqualified opinion. If none of the prior courses of action results in an acceptable population, the auditor will have to qualify the audit report in an appropriate manner.
There are 14 steps to audit sampling for details of balances, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss 5 of the 9 steps included in the "plan the sample" section for nonstatistical sampling.
The steps comprising the "plan the sample" section are: 1. State the objectives of the audit test. For tests of details of balances, the objective is to determine whether the account balance being audited is fairly stated. 2. Decide whether audit sampling applies. In certain situations, the auditor may choose to test all large items and no small items. In those situations, the auditor has not sampled. 3. Define a misstatement. A misstatement exists whenever a sample item is misstated. 4. Define the population. The population is defined as the items making up the recorded dollar population. 5. Define the sampling unit. For nonstatistical sampling in tests of details of balances, the sampling unit is almost always the items making up the account balance. 6. Specify tolerable misstatement. This is the amount of materiality allocated to the account under audit. 7. Specify the acceptable risk of incorrect acceptance. This is the risk that the auditor is willing to take of accepting a balance as correct when the true misstatement in the balance is greater than tolerable misstatement. 8. Estimate misstatements in the population. The auditor typically makes this estimate based on prior experience with the client and by assessing inherent risk, considering the results of test of controls, substantive tests of transactions, and analytical procedures already performed. 9. Determine the initial sample size. In nonstatistical sampling, this is determined judgmentally considering the previous eight factors.
There are 14 steps to audit sampling for details of balances, divided into three sections: plan the sample, select the sample and perform the audit procedures, and evaluate the results. Discuss each of the steps included in the "evaluate the results" section for nonstatistical sampling.
The steps included in the "evaluate the results" section are: 1. Generalize from the sample to the population. This involves (1) projecting misstatements found in the sample to the population and (2) allowing for sampling risk. 2. Analyze the misstatements. The auditor should evaluate the nature and cause of each misstatement found in the sample. 3. Decide the acceptability of the population. If the projected misstatement (point estimate), combined with the allowance for sampling risk, is less than tolerable misstatement, the auditor will accept the population as fairly stated.
Explain the effect on sample size of increasing each of the following: (1) tolerable exception rate, (2) estimated population exception rate, (3) acceptable risk of overreliance, and (4) population size.
The tolerable exception rate and acceptable risk of overreliance are inversely related to sample size; that is, as TER or ARO increase, sample size will decrease. The estimated population exception rate and the population size are directly related to sample size; that is, as EPER increases, sample size will also increase, and as population size increases, sample size may slightly increase.
Discuss two causes of nonsampling risk. Also discuss ways the auditor can control nonsampling risk.
The two causes of nonsampling risk are (1) the auditor's failure to recognize exceptions and (2) inappropriate or ineffective audit procedures. The auditor can control nonsampling risk through careful design of audit procedures and through proper instruction, supervision, and review.
What types of exceptions are auditors most concerned with when evaluating populations of accounting data?
There are three types of exceptions that auditors are generally concerned with when evaluating populations of accounting data. They are: 1. Deviations from client's established controls. 2. Monetary misstatements in populations of transaction data. 3. Monetary misstatements in populations of account balance details.
A lawsuit has been filed against your client. If, in the opinion of legal counsel, the likelihood your client will lose the lawsuit is remote, no financial statement accrual or disclosure of the potential loss would generally be required. True or False
True
Analytical procedures are the least costly type of audit test. A) True B) False
True
Auditors use analytical procedures and tests of details of balances to satisfy planned detection risk. A) True B) False
True
Only tests of details of balances involve physical examination and confirmation. A) True B) False
True
The bank reconciliation control is enhanced when a qualified employee reviews the monthly reconciliation as soon as possible after its completion. A) True B) False
True
The larger the sample size, the more confident the auditor can be that the point estimate is close to the true population value. A) True B) False
True
The only way to know with certainty whether a sample is representative is to subsequently audit the entire population. A) True B) False
True
When an auditor believes that analytical procedures indicate a reasonable possibility of misstatement, the auditor usually would: (Yes or No) a. Perform additional tests of controls b. Decide to modify tests of details of balances
a. No b. Yes
An auditor can increase the likelihood that a sample is representative by using care in: (Yes or No) a. Designing the sampling process b. Designing the sample selection
a. Yes b. Yes
Which of the following methods of sample selection is appropriately used when selecting a random sample? (yes or no) a. Auditor's judgmental selection of items b. Use of random number generators c. Generalized audit software
a. no b. yes c. yes
Which of the following balance-related objectives applies to auditing the general cash account? (yes no) a. Rights b. Classification c. Realizable value
a. no b. no c. no
Which of the following statements is correct regarding the auditor's responsibility with respect to the year-end inventory procedures of an audit client? (yes or no) a. The auditor is responsible for setting up the procedures for taking an accurate physical inventory. b. The auditor is responsible for taking and compiling the inventory. c. The auditor is responsible for observing the physical counting of inventory.
a. no b. no c. yes
A danger in setting the acceptable risk of overreliance too low is: (yes or no) a. The risk that the auditor is willing to take of accepting a control as ineffective when it is effective b. The risk that the auditor is willing to take of accepting a control as effective when it is ineffective
a. no b. yes
Inquiries of management regarding the possibility of unrecorded contingencies will be useful in uncovering: (yes no) a. Management's intentional failure to disclose existing contingencies. b. When management does not comprehend accounting disclosure requirements.
a. no b. yes
What is the purpose of applying stratified sampling to a population? (yes or no) a. To avoid items that may contain misstatements b. To emphasize certain items and deemphasize others
a. no b. yes
Auditor tests of physical controls over raw materials, work-in-process, and finished goods are performed by: (yes or no) a. Examination b. Observation c. Inquiry
a. no b. yes c. yes
If a bank does not respond to a bank confirmation request, the auditor would most likely: (yes or no) a. Perform alternative procedures b. Send a second request c. Ask the client to communicate with the bank to ask them to complete and return the confirmation
a. no b. yes c. yes
Sampling risk may be controlled by: (Yes or No) a. Adjusting the sample size b. Using an appropriate method of selecting sample items
a. yes b. Yes
Tolerable misstatement is used to: (yes or no) a. Determine sample size b. Select the sample. c. Evaluate results.
a. yes b. no c. yes
An auditor using nonstatistical sampling cannot formally measure sampling error and therefore must subjectively consider the possibility that the true population misstatement exceeds a tolerable amount. Which of the following factors should be considered by the auditor in making this assessment? (yes or no) a. The dollar difference between the point estimate and tolerable misstatement. b. The extent to which items in the population have been audited 100 percent.
a. yes b. yes
Both sampling and nonsampling risks are associated with: (yes or no) a. Tests of controls. b. Substantive tests of transactions.
a. yes b. yes
The auditor uses a proof of cash to determine whether: (yes no) a. All recorded cash disbursements were paid by the bank. b. All amounts that were paid by the bank were recorded.
a. yes b. yes
The physical counting of inventory may be performed at which of the following times? (yes or no) a. Interim dates b. On a cycle basis during the year
a. yes b. yes
When may auditors observe the physical inventory count? (yes or no) a. At an interim date b. At year-end
a. yes b. yes
Which of the following is a contingent liability with which an auditor is particularly concerned? (yes or no) a. Notes receivable discounted b. Product warranties
a. yes b. yes
Which of the following needs to be considered when the auditor generalizes from the sample to the population? (yes or no) a. Acceptable risk of incorrect acceptance b. Sampling error
a. yes b. yes
Tests for rates of occurrence are appropriately used in all but which of the following situations? (yes or no) a. Testing of internal controls b. Substantive testing of transactions c. Substantive testing of details of balances
a. yes b. yes c. no
If an auditor concludes there are contingent liabilities, then he or she must evaluate the: (yes no) a. Materiality of the potential liability. b. Nature of the disclosure to be included in the financial statements.
a. yes b. yes
Listed below are four interbank cash transfers, indicated by the numbers 1, 2, 3, and 4, of a client for late December 2013 and early January 2014: Bank Account One Disbursing Date (Month/Day) Per Bank Per Books 1. 12/31 12/30 2. 1/2 12/30 3. 1/3 12/31 4. 1/3 12/31 Bank Account Two Receiving Date (Month/Day) Per Bank Per Books 12/31 12/30 12/31 12/31 1/2 1/2 1/2 12/31 9) Based on the schedule of interbank transfers above, which of the cash transfers indicates an error in cash cutoff at December 31, 2013? A) 1 B) 2 C) 3 D) 4
c. 3
In process cost systems, costs are accumulated by individual jobs. A) True B) False
false
In the audit of inventory, the auditor and client are jointly responsible for making and recording the count of physical inventory; while the auditor is responsible for drawing conclusions about the adequacy of the physical inventory. A) True B) False
false
A proof of cash helps the auditor determine whether all recorded cash receipts were deposited in the bank and whether all recorded cash disbursements were paid by the bank. A) True B) False
true
Auditors sometimes prepare a proof of cash when the client has material internal control weaknesses in cash. List two procedures that the proof of cash determines were or were not done.
• All recorded cash receipts were deposited • All deposits in the bank were recorded in the accounting records • All recorded cash disbursements were paid by the bank • All amounts that were paid by the bank were recorded
"Failure to bill a customer" is an example of an error that results in the failure to receive cash, but would not be discovered as part of the audit of the bank reconciliation. State three other examples of errors or irregularities that result in the improper payment of, or failure to receive, cash, but that would not be discovered during the audit of the bank reconciliation. How are these types of misstatements normally uncovered in the audit?
• An embezzlement of cash by interception of cash receipts from customers before they are recorded with the account charged off as a bad debt. • Duplicate payment of a vendor's invoice. • Improper payments of officers' personal expenditures. • Payment for raw materials that were not received. • Payment to an employee for more hours than he or she worked. • Payment of interest to a related party for an amount in excess of the going rate. If these misstatements are to be uncovered in the audit, their discovery must occur through tests of controls and substantive tests of transactions.
Auditing standards require that auditors satisfy themselves about the effectiveness of the client's methods of counting inventory and the reliance they can place on the client's representations about the quantities and physical condition of the inventories. To meet this requirement auditors must perform four activities. List below.
• Be present at the time the client counts the inventory • Observe the client's counting procedures • Make inquiries of client personnel about their counting procedures • Make their own independent tests of the physical count
Describe each of the major types of cash accounts maintained by business entities.
• General cash account. This is the focal point of cash for most organizations because virtually all cash receipts and disbursements flow through this account. • Imprest payroll account. As a means of improving internal control, many companies establish a separate imprest bank account for making payroll payments to employees. In such an account, a fixed balance, such as $1,000, is maintained. Immediately before each pay period, one check is drawn on the general cash account to deposit the total amount of the net payroll in the imprest payroll account. • Branch bank account. For a company operating in multiple locations, it is often desirable to have a separate bank balance at each location. Branch bank accounts are useful for building public relations in local communities and permitting the centralization of operations at the branch level. • Imprest petty cash fund. This fund is used for small cash acquisitions that can be paid more conveniently and quickly by cash than by check, or for the convenience of employees in cashing personal or payroll checks. • Cash equivalents. Excess cash accumulated during certain parts of the operating cycle that will be needed in the reasonably near future is often invested in short-term, highly liquid cash equivalents such as time deposits, certificates of deposit, and money market funds.
Discuss three audit procedures commonly used to search for contingent liabilities.
• Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. • Review current and previous years' internal revenue agent reports for income tax settlements. • Review the minutes of directors' and stockholders' meetings for indications of lawsuits or other contingencies. • Analyze legal expense for the period under audit, and review invoices and statements from legal counsel for indications of contingent liabilities. • Obtain a letter from each major attorney performing legal services for the client as to the status of pending litigation or other contingent liabilities. • Review audit documentation for any information that may indicate a potential contingency. • Examine letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balances.
What are two factors affecting the complexity of the audit of inventory?
• Inventory is often the largest account on the balance sheet. • Inventory is often in different locations. • Diverse items in inventory are often difficult to value. • Inventory valuation is difficult due to the estimates involved. • There are several acceptable methods of valuing inventory and some entities use different methods for different parts of the inventory, which is acceptable under accounting standards
You are designing the audit plan for Mathews & Company. You are a strong proponent for statistical sampling over nonstatistical sampling. Make your case.
• More efficient samples • Quantifies sampling risk • Improved correlation between the sample and the population
List each of the five types of audit tests and give at least two types of evidence that may be obtained from each type of test.
• Risk assessment procedures - documentation, observation, inquiries of the client, and reperformance • Tests of controls - documentation, observation, inquiries of the client, and reperformance • Substantive tests of transactions - documentation, inquiries of the client, and reperformance • Analytical procedures - inquiries of the client and analytical procedures • Tests of details of balances - physical examination, confirmation, documentation, inquiries of the client, and reperformance
