Audit Test 3

As lower acceptable levels of the risk of incorrect acceptance and performance materiality are established, the auditor should plan more work on individual accounts to A. Find smaller misstatements. B. Decrease the risk of overreliance. C. Increase the tolerable misstatement in the accounts. D. Find larger misstatements.

A : A lower performance materiality means that the tolerable misstatement in an account is smaller. As a result, the auditor must plan for a larger sample size and more audit work on the accounts to discover smaller misstatements. For substantive tests of details, the sample size depends on the auditor's desired assurance (1.0 - the risk of incorrect acceptance) that tolerable misstatement is not less than actual misstatement in the population. The desired assurance may be based on, among other things, the following: (1) the assessed risk of material misstatement, (2) the assurance provided by other substantive procedures related to the same assertion, (3) tolerable misstatement, and (4) expected misstatement for the population. Accordingly, as the acceptable risk of incorrect acceptance decreases, the desired assurance increases, and the auditor decreases the tolerable misstatement.

Which of the following best describes the primary purpose of audit procedures? A. To comply with generally accepted accounting principles. B. To gather evidence. C. To detect fraud or error. D. To verify the accuracy of account balances.

B : According to AU-C 500, Audit Evidence, most of the auditor's work in forming an opinion on financial statements consists of obtaining and evaluating audit evidence. Audit evidence is the information used by the auditor in drawing the conclusions on which the auditor's opinion is based. It includes the information contained in the accounting records and sources of information other than accounting records.

As a result of control testing, a CPA has decided to reduce control risk. What is the impact on substantive testing sample size if all other factors remain constant? A. The sample size would be irrelevant. B The sample size would be lower. C. The sample size would be higher. D. The sample size would be unaffected.

B : As the assessed level of control risk decreases, the auditor's allowable risk of incorrect acceptance for the substantive tests of details increases. Thus, the required sample size decreases.

Which of the following statements about evidence is true? A. Appropriate evidence supporting management's assertions should be conclusive rather than merely persuasive. B. A client's accounting records cannot be considered sufficient appropriate audit evidence on which to base the auditor's opinion. C. The cost of obtaining evidence is not an important consideration to an auditor in deciding what evidence should be obtained. D. Effective internal control contributes little to the reliability of the evidence created within the entity.

B : Audit evidence consists of accounting records (initial entries and supporting records, such as ledgers, worksheets, and spreadsheets) and other information (minutes of meetings, confirmations, information obtained by inquiry, etc.). But accounting records alone do not provide sufficient appropriate evidence as a basis for an opinion on the financial statements.

Which statement about audit evidence is false? A. The auditor is seldom convinced beyond all doubt with respect to all aspects of the statements being audited. B. The auditor should not perform a procedure that provides persuasive evidence rather than conclusive evidence. C. The auditor balances the benefits of the evidence and the cost to obtain it. D. The auditor evaluates the degree of risk involved in deciding the kind of evidence to gather.

B : In most cases, evidence that is obtained to enable an auditor to draw reasonable conclusions on which to base the opinion is necessarily persuasive rather than conclusive. The cost of obtaining conclusive evidence may outweigh the benefits. But the difficulty, time, or cost is not in itself a valid reason (1) to omit an audit procedure for which no alternative exists or (2) to be satisfied with less than persuasive evidence (AU-C 200).

As a result of tests of controls, an auditor overrelied on controls and decreased substantive testing. This assessment occurred because the true deviation rate in the population was A. More than the risk of overreliance, based on the auditor's sample. B. More than the deviation rate in the auditor's sample. C. Less than the risk of overreliance, based on the auditor's sample. D. Less than the deviation rate in the auditor's sample.

B : In the case of a test of controls, overreliance is the erroneous conclusion that controls are more effective than they actually are. Overreliance occurs if the sample has fewer observed deviations than the true deviation rate in the population.

Which of the following is usually included or shown in the audit documentation? A. Analyses that are designed to be a part of, or a substitute for, the client's accounting records. B. Excerpts from authoritative pronouncements that support the underlying generally accepted accounting principles used in preparing the financial statements. C. A summary of how significant findings were addressed. D. The procedures used by the auditor to verify the personal financial status of members of the client's management team.

C : Auditors may document a summary, or completion memorandum, describing the significant findings or issues identified and how they were addressed. This summary facilitates (1) reviews of the audit documentation, (2) the auditor's consideration of significant findings and issues, and (3) determination of whether any individual audit objective cannot be achieved that will prevent achievement of the overall audit objectives.

The auditing standards define external confirmation as "a direct written response to the auditor from a third party (the confirming party), either in paper form or by electronic or other medium." The assertions for which confirmation of accounts receivable balances provides primary evidence are A. Valuation and rights and obligations. B. Existence and completeness. C. Rights and obligations and existence. D. Completeness and valuation.

C : Confirmation by means of direct (independent) communication with debtors is the generally accepted auditing procedure for accounts receivable. Properly designed requests may address any assertion in the financial statements, but they are most likely to be effective for the existence and rights and obligations assertions. Thus, confirmation provides evidence that (1) receivables are valid, (2) the client has ownership of the accounts and the right of collection, and (3) the debtor has the obligation to pay.

Which of the following statements is true concerning monetary-unit sampling (MUS), also known as probability-proportional-to-size sampling? A. The sampling interval is calculated by dividing the number of physical units in the population by the sample size. B. Overstated units have a lower probability of sample selection than units that are understated. C. The auditor controls the risk of incorrect acceptance by specifying that risk level for the sampling plan. D. The sampling distribution should approximate the normal distribution.

C : MUS is one technique whereby the auditor can measure and control the risks associated with observing less than 100% of the population. The auditor can quantify and measure the risk of accepting a client's recorded amount as fair when it is materially misstated.

To quantify the risk that sample evidence leads to erroneous conclusions about the sampled population, A. The precise number of items in the population must be known. B. Each item in the sampled population must have a chance of being selected that is proportional to its carrying amount. C. Each item in the sampled population must have an equal or known probability of being selected. D. Each item in the sampled population must have an equal chance of being selected.

C : Probability (random) sampling is used in any sampling plan in which every item in the population has an equal (or known) and nonzero probability of being chosen. A probability sample permits the use of statistical methods based on the laws of probability to quantify an estimate of sampling risk.

Which of the following elements ultimately determines the specific auditing procedures that are necessary in the circumstances to provide a reasonable basis for an opinion? A. Reasonable assurance. B. Materiality C. Auditor judgement D. Audit risk

C : Professional judgment involves applying relevant knowledge and experience to the facts and circumstances of an audit. The auditor exercises judgment to (1) interpret ethical requirements and GAAS and (2) make informed decisions, for example, about the sufficiency and appropriateness of audit evidence. The auditor also plans and performs the audit with professional skepticism. This is an attitude that includes (1) a questioning mind, (2) being alert to possible misstatements, and (3) a critical assessment of audit evidence (AU-C 500). Thus, judgment is required to select the specific auditing procedures needed to obtain that evidence.

A principal advantage of statistical methods of attribute sampling over nonstatistical methods is that they provide a scientific basis for planning the A. Tolerable deviation rate. B. Risk of overreliance. C. Sample size. D. Expected population deviation rate.

C : Statistical theory permits the auditor to measure sampling risk and to restrict it to an acceptable level. Statistical methods determine the sample size that will accomplish the auditor's objectives.

Which of the following sets of information does an auditor usually confirm on one form? A. Inventory on consignment and contingent liabilities. B. Accounts payable and purchase commitments. C. Cash in bank and collateral for loans. D. Accounts receivable and accrued interest receivable.

C : The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

Which of the following is an engagement attribute for an audit of an entity that processes most of its financial data in electronic form without any paper documentation? A. Increased emphasis on the completeness assertion. B. Discrete phases of planning, interim, and year-end fieldwork. C. Performance of audit tests on a continuous basis. D. Increased effort to search for evidence of management fraud.

C : The audit trail for transactions processed in electronic form may be available for only a short period of time. The auditor may conclude that it is necessary to time audit procedures so that they correspond to the availability of the evidence. Thus, audit modules may be embedded in the client's software for this purpose.

Audit documentation that records the procedures used by the auditor to gather evidence should be A. Viewed as the connecting link between the books of account and the financial statements. B. Designed to meet the circumstances of the particular engagement. C. Destroyed when the audited entity ceases to be a client. D. Considered the primary support for the financial statements being audited.

C : The auditor should retain audit documentation for a period sufficient to meet the needs of his or her practice and to satisfy any applicable legal or regulatory requirements of records retention. For issuers, audit documentation should be maintained for at least 7 years from the date of the release of the audit report.

In performing tests of controls over authorization of cash disbursements, which of the following statistical sampling methods would be most appropriate? A. Stratified. B. Ratio. C. Attributes. D. Variables.

C : The auditor uses attribute sampling to test the effectiveness of controls. The auditor should consider the occurrence rate of deviations in the population. Attribute sampling enables the auditor to estimate these occurrence rates and to determine whether the estimated rates are within an acceptable range.

Which of the following management assertions is an auditor most likely testing if the audit objective states that all inventory on hand is reflected in the ending inventory balance? A. Inventory is properly presented in the financial statements. B. Inventory is properly valued. C. Inventory is complete. D. The entity has rights to the inventory.

C : The completeness assertion about account balances at the end of a period is that all assets, liabilities, and equity interests that should have been recorded have been recorded. The completeness assertion for inventory is to determine whether the balance contains inventory (1) on hand and (2) owned by the entity that is in transit or stored at outside locations.

Which of the following is the best reason an auditor should consider observing a client's distribution of regular payroll checks? A. Separation of payroll duties is not effective enough to reduce control risk. B. The auditor did not observe the distribution of the entire regular payroll during the audit in the prior year. C. Employee turnover is excessive. D. Total payroll costs are a significant part of total operating costs.

A : A surprise observation of the client's payroll distribution is especially desirable when the various phases of payroll are not sufficiently segregated. The observation should establish whether payment is made only to bona fide employees.

An auditor discovers that an account balance believed not to be materially misstated based on an audit sample was materially misstated based on the total population of the account balance. This is an example of which of the following sampling types of risks? A. Incorrect acceptance. B. Underreliance. C. Overreliance. D. Incorrect rejection.

A : An auditor is concerned with two aspects of sampling risk in performing substantive tests of details: the risk of incorrect acceptance and the risk of incorrect rejection. The risk of incorrect acceptance is the risk that an auditor erroneously concludes that a material misstatement does not exist when, in fact, it does.

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 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 paid checks returned with the bank statement of the next accounting period after year end. B. Preparing from the cash disbursements book a summary of bank transfers for one week prior to and subsequent to year end. C. Examining the composition of deposits in both bank A and B subsequent to year end. D. Comparing the detail of cash receipts as shown by the cash receipts records with the detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year end.

A : Because the check used to make the bank transfer is not recorded in the current period, the check is not listed as outstanding on the reconciliation of the bank account on which it was drawn. The auditor detects kiting by comparing paid checks, returned in the next period and dated prior to year end, with the checks listed as outstanding on the related bank reconciliation. In other words, the auditor searches for checks that should have been listed as outstanding but were not.

When a client engages in transactions involving derivatives, the auditor should A. Determine whether the applicable reporting framework specifies the means of measuring fair value. B. Notify the audit committee about the risks involved in derivative transactions. C. Confirm with the client's broker whether the derivatives are for trading purposes. D. Add an emphasis-of-matter paragraph to the auditor's report describing the risks associated with each derivative.

A : Derivatives are measured at fair value. Thus, the auditor should (1) determine whether the applicable reporting framework specifies the method for measuring fair value and (2) evaluate whether the measurement is consistent with the method. Fair value estimates may be obtained from a third-party source (e.g., a broker-dealer). The auditor should understand the method used by the source to make the estimate and consider the significance of the work of the management's specialist. If the entity has used a valuation model, the auditor applies AU-C 540, Auditing Accounting Estimates, including Fair Value Accounting Estimates, and Related Disclosures.

An auditor who uses statistical sampling for attributes in testing internal controls should reduce the planned reliance on a prescribed control when the A. Sample rate of deviation plus the allowance for sampling risk exceeds the tolerable population deviation rate. B. Sample rate of deviation is less than the expected population deviation rate used in planning the sample. C. Sample rate of deviation plus the allowance for sampling risk equals the tolerable population deviation rate. D. Tolerable population deviation rate minus the allowance for sampling risk exceeds the sample rate of deviation.

A : If the sample deviation rate plus the allowance for sampling risk exceeds the tolerable population deviation rate, the sample results do not support the planned risk of overreliance. Thus, the risk of overreliance should be assessed at a higher level. The result is a lower acceptable level of detection risk for a given audit risk and an increase in the assurance to be provided by substantive testing

During the year under audit, a client issued a substantial amount of bonds to an insurance company (a private placement). Which of the following is the most important step in the auditor's plan for the audit of bonds payable? A. Tracing the cash received from the issue to the accounting records. B. Recomputing the annual interest cost and the effective yield. C. Confirming the amount issued with the SEC. D. Examining the bond records maintained by a third party such as a transfer agent.

A : In a private placement of bonds, one not involving the use of an independent trustee, the auditor is most concerned that the cash received from the issue is accurately recorded. The auditor also is concerned that the cash is adequately safeguarded by the CFO's department. Failure to employ a trustee substantially increases the risks of material misstatement for all aspects of bond issues.

Each time an auditor draws a conclusion based on evidence from a sample, an additional risk, i.e., sampling risk, is introduced. An example of sampling risk is A. Drawing an erroneous conclusion from sample data. B. Properly applying an improper audit procedure to sample data. C. Improperly applying a proper audit procedure to sample data. D. Projecting the results of sampling beyond the population tested.

A : Sampling risk is the risk that the auditor's conclusion based on a sample may differ from the conclusion if the same audit procedure were applied to every item in the population. Sampling risk can result in two types of erroneous conclusions: those affecting effectiveness or those affecting efficiency (AU-C 530).

When few property and equipment transactions occur during the year, the continuing auditor usually obtains an understanding of the related internal controls and performs A. Extensive tests of current year property and equipment transactions. B. A thorough examination of the balances at the beginning of the year. C. Tests of controls. D. Analytical procedures to verify current year additions to property and equipment.

A : Testing the details of transactions is the preferable procedure for property, plant, and equipment. The beginning balance has been audited, and subsequent transactions in the account ordinarily are few. The auditor also may not rely on controls after obtaining an understanding of internal control because (s)he believes that (1) no effective controls are relevant to the assertion or (2) testing controls would be inefficient.

An auditor analyzes repairs and maintenance accounts primarily to obtain evidence in support of the relevant assertion that all A. Expenditures for property and equipment have not been charged to expense. B. Noncapitalizable expenditures for repairs and maintenance have been properly charged to expense. C. Noncapitalizable expenditures for repairs and maintenance have been recorded in the proper period. D. Expenditures for property and equipment have been recorded in the proper period.

A : The auditor should vouch significant debits from the repairs and maintenance expense account to determine whether any should have been capitalized.

When a company's stock record books are maintained by an outside registrar or transfer agent, the auditor should obtain confirmation from the registrar or transfer agent concerning the A. Number of shares issued and outstanding. B. Amount of dividends paid to related parties. C. Proper authorization of stock rights and warrants. D. Expected proceeds from stock subscriptions receivable.

A : The independent stock registrar is a financial institution employed to prevent improper issuances of stock, especially over-issuances. The transfer agent maintains detailed shareholder records and facilitates transfer of shares. Both are independent and reliable sources of evidence concerning total shares issued and outstanding.

Which of the following factors would least likely affect the form, content, and extent of audit documentation? A. The medium in which it is recorded and maintained. B. The nature of the auditing procedures. C. The risks of material misstatement. D. The extent of exceptions identified.

A : The medium used to prepare and maintain the audit documentation, e.g., paper or digital, does not affect its nature and extent. The form, content, and extent of documentation are determined by (1) the risks of material misstatement, (2) the extent of judgment involved in performing the work and evaluating the results, (3) the nature of the auditing procedures, (4) the significance of the evidence obtained, (5) the nature and extent of exceptions identified, (6) the need to document a conclusion or the basis for a conclusion, (7) audit methods, and (8) size and complexity of the entity.

When title to merchandise in transit has passed to the audit client, the auditor engaged in the performance of a purchase cutoff will encounter the greatest difficulty in gaining assurance with respect to the A. Quality. B. Terms. C. Price. D. Quantity.

A : The purpose of the cutoff is to ensure that the asset and related liability are recognized in the correct period. Accordingly, merchandise included in ending inventory but not yet arrived may not be available for inspection. The quality of such merchandise cannot be assured until the inspection has been conducted after the goods are received.

Which of the following statements is true concerning the auditor's use of statistical sampling? A. An auditor needs to estimate the dollar amount of the standard deviation of the population to use classical variables sampling. B. A classical variables sample needs to be designed with special considerations to include negative balances in the sample. C. The selection of zero balances usually does not require special sample design considerations when using monetary-unit sampling. D. An assumption of monetary-unit sampling is that the underlying accounting population is normally distributed.

A : Variables sampling is used to estimate the amount of misstatement in, or the value of, a population. In auditing, this process entails estimating the monetary value of an account balance or other accounting total. The estimated population standard deviation is used in the sample size formula for variables estimation. Hence, it should be stated in dollar terms.

An auditor who has confirmed accounts receivable may discover that the sales journal was held open past year end if A. Most of the returned positive confirmation requests indicate that the debtor owes a smaller balance than the amount being confirmed. B. Most of the returned negative confirmation requests indicate that the debtor owes a larger balance than the amount being confirmed. C. Positive confirmation requests sent to debtors are not returned. D. Negative confirmation requests sent to debtors are not returned.

A : When the majority of the returned positive confirmation requests indicate smaller balances at year end than those in the client's records, the client may have held open the sales journal after year end. Thus, the client debited customers' accounts for the period under audit rather than for the subsequent period. The effect is to overstate sales and receivables.

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

B : Lapping involves recording current cash payments on accounts receivable as credits to prior customers' accounts to conceal a theft of cash. Comparing the date that a customer's check was deposited with the date a record was made to reduce the balance determines whether the deposit was made prior to the recording date.

Which of the following is the primary objective of monetary-unit sampling (MUS)? A. To identify items to which controls were not properly applied. B. To identify overstatement errors. C. To identify zero and negative balances. D. To increase the proportion of smaller-value items in the sample.

B : MUS gives each monetary unit in the population an equal chance of selection. However, the auditor does not examine an individual monetary unit but uses it to identify an entire transaction or balance to audit (the logical sampling unit). MUS is useful only for tests of overstatements (e.g., of assets) because a systematic selection method is applied (every nth monetary unit is selected). Accordingly, the larger the transaction or balance, the more likely it will be selected. This method is inappropriate for testing a population (e.g., liabilities) when understatement is the primary audit consideration.

The use of the ratio estimation sampling technique is most effective when A. A relatively small number of differences exist in the population. B. The calculated audit amounts are approximately proportional to the client's carrying amounts. C. Estimating populations whose records consist of quantities but not carrying amounts. D. Large overstatement differences and large understatement differences exist in the population.

B : Ratio estimation calculates the population misstatement by multiplying the carrying amount of the population by the ratio of the total audit amount of the sample items to their total carrying amount. The precision is determined by considering the variances of the ratios of carrying amount to audited amount. Thus, the more homogeneous the ratios, the smaller the precision.

In performing tests concerning the granting of stock options, an auditor should A. Confirm the transaction with the Secretary of State in the state of incorporation. B. Trace the authorization for the transaction to a vote of the board of directors. C. Verify the existence of option holders in the entity's payroll records or stock ledgers. D. Determine that sufficient treasury stock is available to cover any new stock issued.

B : Shareholders' equity transactions, for example, issuances of stock, purchases of treasury stock, declarations of dividends, and the issuance of share options to employees or others require authorization by the board of directors. Thus, the auditor should inspect minutes of board meetings to verify that share options were authorized.

The objective of tests of details of transactions performed as substantive procedures is to A. Attain assurance about the reliability of the accounting system. B. Detect material misstatements at the relevant assertion level. C. Comply with generally accepted auditing standards. D. Evaluate whether management's policies and procedures operated effectively.

B : Substantive procedures are (1) tests of the details of transaction classes, balances, and disclosures and (2) substantive analytical procedures. They are performed to detect material misstatements at the relevant assertion level. The auditor performs substantive procedures as a response to the related assessment of the RMMs (AU-C 330).

The auditor observes the count of marketable securities on December 31. (S)he records the serial number of each security and checks the serial number and number of shares (or principal amount) against company records. Which error or bad practice has the best chance of being detected by this procedure? A. The no par stock of Sure-Shot Mines split two for one on November 19. The stock certificate for the additional shares was received directly by the CFO who made no record of the receipt and misappropriated the shares. B. The CFO misappropriated and sold securities on April 4. (S)he speculated successfully with the proceeds and replaced the misappropriated securities on December 29. C. The CFO misappropriated interest receipts by clipping coupons from company-owned bonds and redeeming them in his or her own name. D. The CFO borrowed securities on May 15 to use as collateral for a personal loan. (S)he repaid the loan and replaced the securities on December 2.

B : The auditor is most likely to detect a misappropriation and replacement of securities by comparing information for the securities counted with the entity's records. The records would indicate that the recorded serial numbers differ from those of securities counted by the auditor.

An auditor testing investments would ordinarily use analytical procedures to ascertain the reasonableness of the A. Valuation of trading securities. B. Completeness of recorded investment income. C. Existence of unrealized gains or losses. D. Classification as available-for-sale or trading securities.

B : The auditor may develop expectations regarding the completeness assertion for recorded investment income from stocks by using dividend records published by standard investment advisory services to recompute dividends received. Interest income from bond investments can be calculated from interest rates and payment dates noted on the certificates. Income from equity-based investments can be estimated from audited financial statements of the investees. Thus, applying an expected rate of return to the net investment amount may be an effective means of estimating total investment income.

Which of the following procedures would an auditor most likely perform in searching for unrecorded liabilities? A. Trace a sample of accounts payable entries recorded just before year end to the unmatched receiving report file. B. Vouch a sample of cash disbursements recorded just after year end to receiving reports and vendor invoices. C. Scan the cash disbursements entries recorded just before year end for indications of unusual transactions. D. Compare a sample of purchase orders issued just after year end with the year-end accounts payable trial balance.

B : The greatest risk in the audit of payables is that unrecorded liabilities exist. Omission of an entry to record a payable is a fraud or error that is more difficult to detect than an inaccurate or false entry. The search for unrecorded payables should include (1) examining cash disbursements made after the balance sheet date and comparing them with the accounts payable trial balance, (2) sending confirmations to vendors with small and zero balances, and (3) reconciling payable balances with vendors' documentation.

An auditor's audit documentation will least likely show how the A. Understanding of the client's internal control was obtained and the risks of material misstatement were assessed. B. Client's schedules were prepared. C. Significant issues were resolved. D. Engagement was planned.

B : The objectives of audit documentation are to provide (1) a sufficient and appropriate record of the basis of the auditor's report and (2) evidence that the audit was performed in accordance with GAAS and other requirements. Audit documentation is the record of (1) the audit procedures performed, (2) relevant evidence obtained, and (3) conclusions reached. But how the client's schedules were prepared may not be relevant to the audit.

To establish the existence and rights of an investment in the common stock of a publicly traded company, an auditor ordinarily performs a security count or A. Assesses the risks of material misstatement at a low level if the auditor has reasonable assurance that controls are being applied as prescribed. B. Confirms the number of shares owned that are held by an independent custodian. C. Confirms the number of shares owned with the issuing company. D. Determines the market price per share at the balance sheet date from published quotations.

B : To test the existence and rights and obligations (ownership) assertions, the auditor may (1) inspect the securities; (2) read partnership or similar agreements; (3) confirm the number of shares with the issuer, custodian, or counterparty; (4) trace dividend or interest revenue; and (5) confirm unsettled transactions by the broker-dealer. An independent custodian provides the greatest security for assets because of the segregation of responsibilities. External confirmation also provides reliable evidence that the stock exists and that the client has rights to it. Evidence from external, independent sources provides greater assurance than that secured solely within the entity.

An auditor initially planned to use unrestricted random sampling with replacement in the audit of accounts receivable. Later, the auditor decided to use unrestricted random sampling without replacement. As a result of this decision, the sample size should A. Increase. B. Decrease. C. Remain the same. D. Either increase or decrease, but the direction cannot be determined.

B : Unrestricted random sampling means that each item in the population has an equal and nonzero chance of being selected. Sampling with replacement means that an item may be included more than once in the sample. Sampling without replacement removes an item from the population after selection. Thus, sampling without replacement uses information about the population more efficiently. It results in a smaller sample, if other things are held constant, because the sample size formula for sampling with replacement is multiplied by the finite population correction factor (always less than 1.0).

Which of the following statements is correct concerning the use of negative confirmation requests? A. Negative confirmation requests are effective when audit risk is low. B. Unreturned negative confirmation requests rarely provide significant explicit evidence. C. Unreturned negative confirmation requests indicate that alternative procedures are necessary. D. Negative confirmation requests are effective when understatements of account balances are suspected.

B : Unreturned negative confirmation requests rarely provide significant evidence about assertions other than certain aspects of existence. Also, unreturned negative confirmations do not provide explicit evidence that the intended parties received the requests and verified the information provided.

Which of the following in a predecessor's audit documentation is the auditor least likely to be interested in reviewing? A. Analysis of noncurrent balance sheet accounts. B. Analysis of contingencies. C. Analysis of income statement accounts. D. Analysis of current balance sheet accounts.

C : The predecessor auditor ordinarily should allow the auditor to review audit documentation of matters of continuing accounting and auditing significance, such as the schedule of uncorrected misstatements and analyses of balance sheet accounts and contingencies. The auditor should obtain sufficient appropriate evidence about whether (1) the opening balances of the current-year statements are materially misstated and (2) accounting policies are consistently applied (or changes are appropriate) (AU-C 510). However, analyses of income statement accounts have less significance for an initial audit because they have no beginning balances.

In statistical sampling methods used in substantive testing, an auditor most likely would stratify a population into meaningful groups if A. The auditor's estimated tolerable misstatement is extremely small. B. Monetary-unit sampling (MUS) is used. C. The population has highly variable recorded amounts. D. The standard deviation of recorded amounts is relatively small.

C : The primary objective of stratification is to reduce the effect of high variability by dividing the population into subpopulations. Reducing the effect of the variance within each subpopulation allows the auditor to sample a smaller number of items while holding precision and the confidence level constant.

An auditor may decide to increase the risk of incorrect rejection when A. Initial sample results do not support the assessed risk of material misstatement. B. Increased reliability from the sample is desired. C. The cost and effort of selecting additional sample items are low. D. Many differences (audit amount minus recorded amount) are expected.

C : The risk of incorrect rejection is the risk that the sample supports the conclusion that the recorded account balance is materially misstated when it is not. This risk relates to the efficiency, not the effectiveness, of the audit. Incorrect rejection ordinarily results in the application of additional procedures that finally lead the auditor to the proper conclusion. If the cost and effort of selecting additional sample items are low, a higher risk of incorrect rejection may be acceptable.

If an auditor of a nonissuer discovers an unexpectedly high number of deviations during procedures performed on a sample to test management's review and approval of time sheets, then the auditor would most appropriately A. Propose an audit adjustment. B. Increase the tolerable rate of deviation. C. Increase the assessed risks of material misstatement. D. Extrapolate the impact of the exceptions on other key controls requiring management review.

C : The tolerable deviation rate for a control is the maximum that the auditor can accept without increasing the assessed risk of material misstatement. Deviations increase the probability of misstatements in the accounting records, but they do not always cause misstatements. If deviations from a control on which the auditor intends to rely occur, the auditor should investigate the deviations and their consequences. The auditor then should evaluate whether (1) the tests of controls justify reliance, (2) additional tests of controls are needed, or (3) the potential risks of misstatement should be addressed by performing substantive procedures.

Which of the following is a true statement about statistical sampling in tests of controls? A. As the population size doubles, the sample size also should double. B. Deviations from controls at a given rate usually result in misstatements at a higher rate. C. The relationship between the sample size and the tolerable population deviation rate is inverse. D. The qualitative aspects of deviations are not considered by the auditor.

C : The tolerable population deviation rate is set by the auditor. The auditor seeks to obtain appropriate assurance that this rate is not exceeded by the actual rate. The sample size and the tolerable population deviation rate have an inverse relationship because the degree of assurance to be provided by the sample is higher (lower) when the tolerable population deviation rate is lower (higher).

An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by A. An unrealized loss from an increase in the fair value of available-for-sale debt securities was recorded by crediting equity securities and debiting earnings. B. A substantial fluctuation in the price of the investee's common stock on a national stock exchange. C. An error in recording amortization of the excess of the investor's cost over the investment's underlying carrying amount. D. The investee's decision to reduce cash dividends declared per share of its common stock.

C : The transaction to record the amortization is a recurring entry that, if miscalculated, could result in a lower return than expected.

In gathering evidence in the performance of substantive procedures, the auditor most likely A. Uses the test month approach. B. Expresses an adverse opinion if (s)he has substantial doubt as to any assertion of material significance. C. Relies on persuasive rather than conclusive evidence in the majority of cases. D. Considers the client's documentary evidence less reliable than evidence gathered orally by inquiry of management.

C : To be appropriate, audit evidence should be relevant and reliable. Also, because of the inherent limitations of the audit, most audit evidence is persuasive rather than conclusive. However, although the cost of obtaining evidence and its usefulness should be rationally related, the matter of difficulty, time, or cost is not in itself a valid basis for (1) omitting a procedure when no alternative exists or (2) being satisfied with less than persuasive evidence.

To test for unsupported entries in the ledger, the direction of audit testing should be from the A. Externally generated documents. B. Journal entries C. Ledger entries D. Original source documents.

C : To discover unsupported entries in the ledger, a sample of entries should be selected to determine whether any entry lacks proper support. The direction of testing is from the ledger entries to the books of original entry, then to the source documents.

An auditor who has confirmed accounts receivable may discover that the sales journal was held open past year end if A. Negative confirmation requests sent to debtors are not returned. B. Positive confirmation requests sent to debtors are not returned. C. Most of the returned positive confirmation requests indicate that the debtor owes a smaller balance than the amount being confirmed. D. Most of the returned negative confirmation requests indicate that the debtor owes a larger balance than the amount being confirmed.

C : When the majority of the returned positive confirmation requests indicate smaller balances at year end than those in the client's records, the client may have held open the sales journal after year end. Thus, the client debited customers' accounts for the period under audit rather than for the subsequent period. The effect is to overstate sales and receivables.

Assume that an auditor estimates that 10,000 checks were issued during the accounting period. If a computer application control that performs a limit check for each check request is to be subjected to the auditor's test-data approach, the sample should include A. A number of test items determined by the auditor's reference to the appropriate sampling tables. B. A number of test items determined by the auditor to be sufficient under the circumstances. C. Approximately 1,000 test items. D. One transaction.

D : A limit check compares an input with a limit (e.g., the number of the month cannot exceed 12). If the limit is exceeded, an error message is printed. Because this is a mechanical check (done by the computer), only one transaction need be in the sample. The transaction should exceed the limit to verify that the limit check is operating correctly.

Which of the following objectives is achieved when an auditor decides to employ classical variable sampling? A. To determine the reliability of voucher processing. B. To determine the efficiency of the payroll system. C. To determine the completeness of billing transactions. D. To determine the inventory quantities on hand.

D : After taking a sample and drawing a conclusion about the population, the auditor either accepts or rejects the reported number. This method provides the auditor with evidence to determine the inventory quantities on hand.

While performing a test of details during an audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. It was, in fact, not materially misstated. This situation illustrates the risk of A. Underreliance. B. Overreliance. C. Incorrect acceptance. D. Incorrect rejection.

D : An auditor is concerned with two aspects of sampling risk in performing substantive tests of details: the risk of incorrect acceptance and the risk of incorrect rejection. The second is the risk that the sample supports the conclusion that the recorded account balance is materially misstated when it is not materially misstated.

An audit of owners' equity normally would not include A. Determining that the declared dividend amount was closed into retained earnings. B. Determining that dividend declarations have been in compliance with debt agreements. C. Tracing the authorization of the dividend from the directors' minutes. D. Detail checking from the dividend payment list to the capital stock records.

D : An auditor normally does not perform detail checking from the dividend payment list to the capital stock records. (S)he may test certain large dividend payments but, because the amount of each dividend is usually small, detail checking is minimal. The need for extensive checking is reduced when the entity uses an independent financial institution as its agent for dividend payments. The stock transfer agent often performs this function because it maintains detailed records of shareholders. The arrangement substantially decreases the risks of material misstatement.

Which of the following audit procedures most likely will involve sampling? A. Tests of automated application controls when effective information technology general controls are present. B. Analyses of controls to determine the appropriate segregation of duties. C. Risk assessment procedures performed to obtain an understanding of internal control. D. Testing of process for approval of credit to customers for sales on account.

D : Attribute sampling tests binary (yes/no or error/non-error) questions. It tests the effectiveness of controls by estimating a rate of occurrence of control deviations in a population. Testing of process for approval of credit is most likely to involve sampling.

Tracing bills of lading to sales invoices provides evidence that A. Shipments to customers were recorded as sales. B. Recorded sales were shipped. C. Invoiced sales were shipped. D. Shipments to customers were invoiced.

D : Comparing the seller's copies of shipping documents (such as bills of lading) with billing documents (sales invoices) provides evidence that the amounts shipped were billed to customers. The absence of invoices for goods shipped would suggest that the related sales were unrecorded at the balance sheet date.

An auditor traces the serial numbers on equipment to a nonissuer's sub-ledger. Which of the following management assertions is supported by this test? A. Rights and obligations. B. Valuation and allocation. C. Presentation and disclosure. D. Completeness.

D : The completeness assertion tests whether all items of equipment that should have been recorded have been recorded. Tracing serial numbers on equipment to a nonissuer's sub-ledger determines whether all existing items of equipment are reflected in the entity's records.

The size of a sample designed for dual-purpose testing should be A. More than the larger of the samples that would otherwise have been designated for the two separate purposes, but less than the combined total of the samples that would otherwise have been designed for the two separate purposes. B. The smaller of the samples that would otherwise have been designed for the two separate purposes. C. The combined total of the samples that would otherwise have been designed for the two separate purposes. D. The larger of the samples that would otherwise have been designed for the two separate purposes.

D : Dual-purpose testing is the use of a sample for both tests of controls and substantive testing. It is customarily used when the auditor believes that the rate of deviations from the prescribed control in the population is acceptable. Thus, a related substantive procedure might be planned at a level of risk that anticipates a low assessed risk of material misstatement. The sample size should be the larger of the samples that would otherwise have been designed for the two separate purposes.

Vouching selected items from the payroll journal to employee time cards that have been approved by supervisory personnel provides evidence that A. Only bona fide employees worked and their pay was properly computed. B. Internal controls relevant to assertions about payroll disbursements were operating effectively. C. Payroll checks were signed by an appropriate officer independent of the payroll preparation process. D. Employees worked the number of hours for which their pay was computed.

D : Effective internal control segregates the authorization, timekeeping, and payroll preparation functions. Preparation should be based on a list of authorized employees and pay rates originating in the human resources department and time records forwarded from the timekeeping department. By vouching entries from the payroll journal to approved employee time cards, the auditor can obtain evidence that the employees worked the number of hours for which their pay was computed.

If the objective of an auditor's test of details is to detect a possible understatement of sales, the auditor most likely would trace transactions from the A. Sales invoices to the shipping documents. B. Cash receipts journal to the sales journal. C. Sales journal to the cash receipts journal. D. Shipping documents to the sales invoices.

D : If a shipment occurred, matching shipping documents to recorded sales would disclose the understatement if no recorded sale could be found.

Many of the Granada Corporation's convertible bondholders have converted their bonds into stock during the year under audit. The independent auditor should review the Granada Corporation's statement of cash flows and related disclosures to ascertain that they show A. Only the cash used to reduce the convertible debt. B. Nothing relating to the conversion because it does not affect cash. C. Only the cash provided by the issuance of stock. D. The issuance of the stock and reduction in convertible debt.

D : Information about noncash financing and investing activities must be reported in related disclosures but not on the face of the statement of cash flows. Exclusion of such transactions from the statement avoids complicating it and emphasizes the entity's cash receipts and payments. The issuance of stock and the reduction of convertible debt should therefore be disclosed in a related but separate schedule. All financing (and investing) activities during the period should be reported, including those that do not directly affect cash.

When an auditor uses monetary-unit sampling to examine the total value of invoices, each invoice A. Has an unknown probability of being selected. B. Can be represented by no more than one monetary unit. C. Has an equal probability of being selected. D. Has a probability proportional to its monetary value of being selected.

D : Monetary-unit sampling results in the selection of every nth monetary unit. Thus, a $1,000 item is 1,000 times more likely to be selected than a $1 item. The probability of selection of a sampled item is directly proportional to the size of the item.

Specialized audit software A. Is written to interface with many different client systems. B. May be written while its purposes and users are being defined. C. Requires the auditor to have less computer expertise than generalized audit software. D. May be written in a procedure-oriented language.

D : Specialized audit software is written to fulfill a specific set of audit tasks. The purposes and users of the software are well defined before the software is written. Auditors develop specialized audit software for the following reasons: Unavailability of alternative software Functional limitations of alternative software Efficiency considerations Increased understanding of systems Opportunity for easy implementation Increased auditor independence and prestige

Which of the following is the most effective audit procedure for verification of dividends earned on investments in marketable equity securities? A. Recomputing selected extensions and footings of dividend schedules and comparing totals to the general ledger. B. Comparing the amounts received with preceding year dividends received. C. Tracing deposit of dividend checks to the cash receipts book. D. Reconciling amounts received with published dividend records.

D : Standard investment advisory services publish dividend records for all listed stocks. They show amounts and payment dates for dividend declarations and permit the auditor to recompute the client's reported dividend income.

A principal advantage of statistical methods of attribute sampling over nonstatistical methods is that they provide a scientific basis for planning the A. Expected population deviation rate. B. Risk of overreliance. C. Tolerable deviation rate. D. Sample size.

D : Statistical theory permits the auditor to measure sampling risk and to restrict it to an acceptable level. Statistical methods determine the sample size that will accomplish the auditor's objectives.

In which of the following situations is attribute sampling likely to be used? A. Making selections from a cash disbursements journal to test liabilities for understatement. B. Inquiring of the client the number of occurrences of fraud during the year. C. Examining invoices and canceled checks in support of recorded operating expenses. D. Determining the estimated number of occurrences of improperly authorized cash disbursements.

D : The auditor uses attribute sampling to test the effectiveness of control. This sampling method allows the auditor to determine the occurrence rate of deviations and its relation to the tolerable rate of deviation. A control, such as the proper approval and authorization of cash disbursements, can be tested for effectiveness using attribute sampling.

If the size of the sample to be used in a particular test of attributes has not been determined by using statistical concepts, but the sample has been chosen in accordance with random selection procedures, A. No inferences can be drawn from the sample. B. The auditor has caused nonsampling risk to increase. C. The auditor will have to evaluate the results by reference to the principles of discovery sampling. D. The auditor may or may not achieve desired precision at the desired level of confidence.

D : The determination of sample size for a test of attributes is a function of (1) the allowable risk of overreliance, (2) the tolerable deviation rate, (3) the expected population deviation rate, and (4) the size of the population. When the auditor does not use these criteria to determine sample size, (s)he risks not meeting the audit objectives.

Tracing shipping documents to prenumbered sales invoices provides evidence that A. No duplicate shipments or billings occurred. B. All goods ordered by customers were shipped. C. All prenumbered sales invoices were accounted for. D. Shipments to customers were properly invoiced.

D : The direction of testing to determine that shipments to customers were properly invoiced is from the shipping documents to the sales invoices.

The standard AICPA form directed to financial institutions requests all of the following except A. The interest rate of a direct liability. B. Due date of a direct liability. C. Description of collateral for a direct liability. D. The principal amount paid on a direct liability.

D : The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The auditor is not concerned with the amount of a liability already paid. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and description of collateral.

The two requirements crucial to achieving audit efficiency and effectiveness with a personal computer are selecting A. Audit procedures that are generally applicable to several clients in a specific industry and the appropriate audit tasks for personal computer applications. B. Client data that can be accessed by the auditor's personal computer and audit procedures that are generally applicable to several clients in a specific industry. C. The appropriate software to perform the selected audit tasks and audit procedures that are generally applicable to several clients in a specific industry. D. The appropriate audit tasks for personal computer applications and the appropriate software to perform the selected audit tasks.

D : The question relates to using the computer as an audit tool. To use a personal computer for this purpose effectively and efficiently, the auditor must have the appropriate hardware and software.

Which of the following characteristics most likely would be an advantage of using classical variables sampling rather than monetary-unit (MUS) sampling? A. The auditor need not consider the preliminary judgments about materiality. B. The sampling process can begin before the complete population is available. C. The sample will result in a smaller sample size if few misstatements are expected. D. The selection of negative balances requires no special design considerations.

D : When an auditor uses MUS sampling, items with zero or negative balances have no chance of selection. Thus, to select negative balances, the auditor is required to consider special designs that are not necessary with classical variables sampling.