Evidence

A client's procurement system ends with the assumption of a liability and the eventual payment of the liability. Which of the following best describes the auditor's primary concern with respect to liabilities resulting from the procurement system? a. Accounts payable are not materially understated. b. Authority to incur liabilities is restricted to one designated person. c. Acquisition of materials is not made from one vendor or one group of vendors. d. Commitments for all purchases are made only after established competitive bidding procedures are followed.

a

"In connection with an audit of our financial statements, management has prepared, and furnished to our auditors a description and evaluation of certain contingencies." The forgoing passage most likely is from a(n) a. Audit inquiry letter to legal counsel. b. Management representation letter. c. Audit committee's communication to the auditor. d. Financial statement footnote disclosure.

a An audit inquiry letter to the legal counsel includes such a sentence.

The auditor is most likely to verify accrued commissions payable in conjunction with the a. Sales cutoff review. b. Verification of contingent liabilities. c. Review of post balance sheet date disbursements. d. Examination of trade accounts payable.

a Commissions are directly related to sales in verifying accrued commission payable; the auditor seeeks to determine that both are recorded in the proper period

Treetop Corporation acquired a building and arranged mortgage financing during the year. Verification of the related mortgage acquisition costs would be least likely to include an examination of the related a. Deed. b. Canceled checks. c. Closing statement. d. Interest expense.

a Deeds generally consist of a legal conveyance of rights to use real property. Frequently the sales price is not even specified and the related mortgage acquisition costs are much less likely to be stated in the deed.

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

a This statement is unclear and dos not help the auditors to determine whether such legal matters have been properly reported.

Auditors should request that an audit client send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide a. Information concerning the progress of cases to date. b. Corroborative audit evidence. c. An estimate of the dollar amount of the probable loss. d. An expert opinion as to whether a loss is possible, probable, or remote.

b A letter of audit inquiry to the client's lawyer is the auditor's primary means of obtaining corroboration of the information furnished by management concerning litigation, claims, and assessment.

Under which of the following circumstances would an auditor be most likely to intensify an examination of a $500 imprest petty cash fund? a. Reimbursement vouchers are not prenumbered. b. Reimbursement occurs twice each week. c. The custodian occasionally uses the cash fund to cash employee checks. d. The custodian endorses reimbursement checks.

b A petty cash fund is most frequently used for small expenditures and one would not expect to find one in which the imprest amount of $500 was being reimbursed twice weekly. The auditor would be likely to intensify an examination of the petty cash fund if this situation occurred C is wrong because a petty cash fund could be used to cash employee checks. This would be a normal use of the petty cash fund and would not cause the auditor to intensify the examination.

Which of the following would detect an understatement of a purchase discount? a. Verify footings and crossfootings of purchases and disbursement records. b. Compare purchase invoice terms with disbursement records and checks. c. Compare approved purchase orders to receiving reports. d. Verify the receipt of items ordered and invoiced.

b By comparing the purchase invoice with disbursement records and checks, any differences will be detected. The purchase invoice serves as evidence of the amount payable, and the disbursement record and checks provide evidence of amounts actually paid. Therefore, a comparison will lead to the identification of any understated or unrecorded purchase discounts.

An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily in order to a. Verify the cash balance reported on the bank confirmation inquiry form. b. Verify reconciling items on the client's bank reconciliation. c. Detect lapping. d. Detect kiting.

b Cutoff bank statement will include canceled checks and deposit slips for the period immediately following year-end. The auditor, therefore, able to test whether the reconciling items at year-end have been handeld properly

Which of the following tests of details most likely would help an auditor determine whether accounts payable have been misstated? a. Examining reported purchase returns that appear too low. b. Examining vendor statements for amounts not reported as purchases. c. Search for customer-returned goods that were not reported as returns. d. Reviewing bank transfers recorded as cash received from customers.

b Examining vendor statements for amounts not reported as purchases is likely to reveal purchases that should have been recorded to increase accounts payable but were not. That is, the vendor may show a different balance due, leading the auditor to discover the accounts payable misstatement.

When applying analytical procedures during an audit, which of the following is the best approach for developing and evaluating expectations? a. Considering unaudited account balances and ratios to calculate what adjusted balances should be. b. Identifying reasonable explanations for unexpected differences before talking to client management. c. Considering the pattern of several unusual changes without trying to explain what caused them. d. Comparing client data with client-determined expected results to reduce detailed test of account balances.

b Identifying reasonable explanation for unexpected differences before talking to client management will help the auditor to consider why the differences might have occurred and the reasonableness of management's replies

Which of the following statements is correct regarding the predictability of analytical procedures in a financial statement audit? a. Relationships involving only balance sheet accounts tend to be more predictable than relationships involving income statement accounts. b. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. c. Relationships involving transactions subject to management discretion tend to be more predictable than automated transactions. d. Relationships in a dynamic environment tend to be more predictable than relationships in a stable environment.

b Income statement account relationships tend to be more predictable than relationship involving only balance sheet accounts because income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time.

When title to merchandise in transit has passed to the audit client, the auditor examining a vendor's invoices as a purchase cutoff on December 31, the last day of the client's year, will encounter the greatest difficulty in gaining assurance with respect to the a. Quantity. b. Quality. c. Price. d. Terms.

b The auditor will rely on the vendor's invoice for information about the merchandise in transit. Ordinarily, this invoice will not provide the auditor with much information on the quality of the goods.

Jones, CPA, examined the 20X5 financial statements of Ray Corp. and issued an unmodified opinion on March 10, 20X6. On April 2, 20X6, Jones became aware of a 20X5 transaction that may materially affect the 20X5 financial statements. This transaction would have been investigated had it come to Jones' attention during the course of the examination. Jones should a. Take no action because an auditor is not responsible for events subsequent to the issuance of the auditor's report. b. Contact Ray's management and request their cooperation in investigating the matter. c. Request that Ray's management disclose the possible effects of the newly discovered transaction by adding an unaudited footnote to the 20X5 financial statements. d. Contact all parties who might rely upon the financial statements and advise them that the financial statements are misleading.

b The first step is to contact the firm's management and request cooperation in investigation of the matter D is wrong because it is impossible to contact all parties who might rely upon the financial statements.

Auditors may use positive and/or negative forms of confirmation requests for accounts receivable. An auditor most likely will use a. The positive form to confirm all balances regardless of size. b. A combination of the two forms, with the positive form used for large balances and the negative form for the small balances. c. A combination of the two forms, with the positive form used for trade receivables and the negative form for other receivables. d. The positive form when controls related to receivables are satisfactory, and the negative form when controls related to receivables are unsatisfactory.

b The professional standards suggest the use of the positive form for large balances and the negative form for small balances.

Which of the following steps should an auditor perform first to determine the existence of related parties? a. Examine invoices, contracts, and purchasing orders. b. Request a list of all related parties from management. c. Review the company's business structure. d. Review proxy and other materials filed with the SEC.

b. The professional standards require that auditors first evaluate the company's procedures for identifying such transactions and then ask management for a list of related parties. A is wrong because examining documentation such as invoices, contracts, and purchasing orders ordinarily occurs subsequently.

A typical objective of an operational audit is for the auditor to a. Determine whether the financial statements fairly present the entity's operations. b. Evaluate the feasibility of attaining the entity's operational objectives. c. Make recommendations for improving performance. d. Report on the entity's relative success in attaining profit maximization.

c A frequent objective of operational audits is to develop recommendations for improving performance. Other objectives include assessing performance and identifying improvement opportunities.

The audit working papers often include a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. This aging is best used by the auditor to a. Evaluate internal control over credit sales. b. Test the accuracy of recorded charge sales. c. Estimate credit losses. d. Verify the validity of the recorded receivables.

c Aging accounts receivable estimates the adequacy of the allowance for doubtful accounts

As one of the year-end audit procedures, the auditor instructed the client's personnel to prepare a standard bank confirmation request for a bank account that had been closed during the year. After the client's treasurer had signed the request, it was mailed by the assistant treasurer. What is the major flaw in this audit procedure? a. The confirmation request was signed by the treasurer. b. Sending the request was meaningless because the account was closed before the year-end. c. The request was mailed by the assistant treasurer. d. The CPA did not sign the confirmation request before it was mailed.

c Allowing the client to mail the confirmation directly violated the requirement that the confirmations remain under the auditor's control. The auditor is unable to ascertain whether the confirmation reached the proper party

Which of the following procedures most likely could assist an auditor in identifying related-party transactions? a. Performing tests of controls concerning the segregation of duties. b. Evaluating the reasonableness of management's accounting estimates. c. Reviewing confirmations of compensating balance arrangements. d. Scanning the accounting records for recurring transactions.

c Auditors review confirmation of compensating balance arrangement for indications that balances are or were maintained for (or by) related parties. D is wrong because recurring transactions are ordinarily normal business transactions, most frequently with nonrelated parties.

Which of the following ratios would an engagement partner most likely consider in the overall review stage of an audit? a. Total liabilities/net sales. b.. Accounts receivable/inventory. c. Cost of goods sold/average inventory. d. Current assets/quick assets.

c COGS/ Average inventory represents the turnover of inventory and provides information related to inventory valuation.

Which of the following items would most likely require an adjustment to the financial statements for the year ended December 31, year 1? a. Uninsured loss of inventories purchased in year 1 as a result of a flood in year 2. b. Settlement of litigation in year 2 over an event that occurred in year 2. c. Loss on an uncollectible trade receivable recorded in year 1 from a customer that declared bankruptcy in year 2. d. Proceeds from a capital stock issuance in year 2 which was being approved by the board of directors in year 1.

c The loss on the trade receivable may be a "type 1" subsequent event requiring an adjustment if the company was in weak financial condition as of the end of year 1; note that while the question does not make clear the situation regarding the receivable, the other replies are much less likely to require adjustment under any circumstances.

When an auditor decides to confirm accounts receivable balances rather than individual invoices, it most likely would be beneficial to include with the confirmations a. Copies of the client's shipping documents that support the account balances. b. Lists of the customers' recent payments that the client has already recorded. c. Client-prepared statements of account that show the details of the account balances. d. Copies of the customers' purchase orders that support the account balances.

c When client-prepared statements of account show details of account balances, it is likely that customers will be able to reply regardless of whether they maintain their payable records by invoice or month-end balance.

Which of the following procedures would provide the most reliable audit evidence? a. Inquiries of the client's internal audit staff held in private. b. Inspection of prenumbered client purchase orders filed in the vouchers payable department. c. Analytical procedures performed by the auditor on the entity's trial balance. d. Inspection of bank statements obtained directly from the client's financial institution.

d Audit evidence obtained from independent sources outside the entity provide greater assurance of reliability than that secured solely within the entity.

Which of the following is generally included or shown in the auditor's working papers for the audit of a nonpublic company? a. The procedures used by the auditor to verify the personal financial status of members of the client's management team. b. Analyses that are designed to be a part of, or a substitute for, the client's accounting records. c. Excerpts from authoritative pronouncements that support the underlying generally accepted accounting principles used in preparing the financial statements. d. The manner in which exceptions and unusual matters disclosed by the auditor's procedures were resolved or treated.

d Audit workpapers generally include the manner in which exceptions and unusual matters were resolved. The workpapers should contain support for the auditor's conclusions concerning significant aspects of the examination.

An example of a transaction which may be indicative of the existence of related parties is a. Borrowing or lending at a rate of interest which equals the current market rate. b. Selling real estate at a price that is comparable to its appraised value. c. Making large loans with specified terms as to when or how the funds will be repaid. d. Exchanging property for similar property in a nonmonetary transaction

d Exchanging property for similar property in a nonmonetary transaction may indicate the existence of related parties (the exchange may or may not approximate what would occur in an arm's length transactions).

During the first part of the current fiscal year, the client company began dealing with certain customers on a consignment basis. Which of the following audit procedures is least likely to bring this new fact to the auditor's attention? a. Tracing of shipping documents to the sales journal. b. Test of cash receipts transactions. c. Confirmation of accounts receivable. d. Observation of physical inventory.

d Observation of physical inventory would not indicate that shipments have been made on a consignment basis. Irrespective of whether sales are on a regular basis or a consignment basis, the inventory would not be in the client's possession.

Which of the following procedures would an auditor most likely perform prior to the balance sheet date? a. Review subsequent events. b. Perform search for unrecorded liabilities. c. Send inquiry letter to client's legal counsel. d. Review detail and test significant travel and entertainment expenses.

d The auditor may review the detail and test significant expenses prior to that date and then update the analysis at a subsequent date. b is wrong because the search for unrecorded liabilities emphasizes transactions recorded after year-end.

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. The entity has rights to the inventory. b. Inventory is properly valued. c. Inventory is properly presented in the financial statements. d. Inventory is complete.

d The completeness assertion most directly relates to whether "all" of an item is reflected

Which of the audit procedures listed below would be least likely to disclose the existence of related-party transactions of a client during the period under audit? a. Reading "conflict-of-interest" statements obtained by the client from its management. b. Scanning accounting records for large transactions at or just prior to the end of the period under audit. c. Inspecting invoices from law firms. d. Confirming large purchase and sales transactions with the vendors and/or customers involved.

d The confirmation of large purchase and sales transactions by itself will generally not disclose related-party transactions.

Which of the following analyses appearing in a predecessor's working papers is the successor auditor least likely to be interested in reviewing? a. Analysis of noncurrent balance sheet accounts. b. Analysis of current balance sheet accounts. c. Analysis of contingencies. d. Analysis of income statement accounts.

d The successor will normally review working papers of continuing accounting significance. Prior income statement accounts are less likely to have continuing significance than are balance sheet accounts and contingencies a is wrong because the successor auditor will normally review working papers of continuing accounting significance. The noncurrent balance sheet accounts would be of continuing significance and should be revied.