Auditing The Art And Science Of Assurance Engagements, Canadian 12th Edition By Arens – Test Bank

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Auditing The Art And Science Of Assurance Engagements, Canadian 12th Edition By Arens – Test Bank

Auditing, 12e (Arens)

Chapter 5   Audit Responsibilities and Objectives

 

5.1   Describe the objective of conducting an audit of financial statements

 

1) The objective of the audit of financial statements by the auditor is the expression of an opinion on

  1. A) the accuracy of the financial statements.
  2. B) the balance sheet and income statement.
  3. C) the fairness of the financial statements.
  4. D) the annual report.

Answer:  C

Diff: 1     Type: MC     Page Ref: 102

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

2) CAS 200 explains that the purpose of the financial statement audit is to express an opinion on the financial statements. This opinion is an assessment of whether the financial statements are presented fairly using

  1. A) Canadian generally accepted accounting principles (GAAP) only.
  2. B) an applicable financial reporting framework.
  3. C) Management’s assertions.
  4. D) Rules of professional conduct.

Answer:  B

Diff: 2     Type: MC     Page Ref: 102

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

3) The reason auditors accumulate evidence is to

  1. A) defend themselves in the event of a lawsuit.
  2. B) justify the conclusions they have otherwise reached.
  3. C) satisfy the requirements of the relevant provincial securities regulations.
  4. D) enable them to reach conclusions about the fairness of the financial statements and issue an appropriate audit report.

Answer:  D

Diff: 1     Type: MC     Page Ref: 102

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

4) The auditor gives an audit opinion on the fair presentation of the financial statements and associates his or her name with it when, on the basis of adequate evidence, the auditor concludes that the financial statements are unlikely to mislead

  1. A) a prudent user.
  2. B) management.
  3. C) the reader.
  4. D) investors.

Answer:  A

Diff: 2     Type: MC     Page Ref: 102

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

5) The responsibility for adopting a sound and appropriate financial reporting framework and corresponding accounting policies, maintaining adequate internal controls, and making fair representations in the financial statements rests

  1. A) with management.
  2. B) with the auditor.
  3. C) equally with management and the auditor.
  4. D) with the internal audit department.

Answer:  A

Diff: 2     Type: MC     Page Ref: 102

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

6) The audit process has three categories of audit phases: risk assessment, risk response and reporting. Which of the following are the phases that are part of the risk assessment process?

  1. A) preplanning, design further audit procedures, tests of control
  2. B) client risk profile, plan the audit, design further audit procedures
  3. C) preplanning, client risk profile, plan the audit
  4. D) preplanning, plan the audit, design further audit procedures

Answer:  C

Diff: 2     Type: MC     Page Ref: 103

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

7) There are three phases in the risk response category of the audit process (design further audit procedures, tests of control, substantive tests). When will the auditor conduct tests of controls?

  1. A) when there are poor internal controls
  2. B) if the auditor plans to rely upon them
  3. C) when a substantive audit approach is selected
  4. D) when there are low risks of material error

Answer:  B

Diff: 3     Type: MC     Page Ref: 103

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

8) The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to

  1. A) the auditor.
  2. B) management.
  3. C) both management and the auditor equally.
  4. D) management for the statements and the auditor for the notes.

Answer:  B

Diff: 2     Type: MC     Page Ref: 104

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

 

9) Professional skepticism during the financial statement audit requires an appropriate state of mind, being impartial and objective and continuing to be throughout the whole audit engagement. Which of the following illustrates an appropriate state of mind?

  1. A) not having any ownership in the client’s shares or being a debt-holder
  2. B) carefully assessing documents and not being the company’s advocate
  3. C) matching documents to make sure that they are accurate and fair
  4. D) being aware that there could be material misstatements in the financial statements

Answer:  D

Diff: 3     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

10) The requirement for an attitude of skepticism means that the auditor should

  1. A) not be blind to evidence that suggests the documents, books or records have been altered or are incorrect.
  2. B) plan and conduct the audit with an attitude of distrust in management.
  3. C) perform additional tests of controls to increase the probability of discovering fraud or errors.
  4. D) not consider management’s explanation as evidence on any subject.

Answer:  A

Diff: 2     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

11) The auditor has considerable responsibility for notifying users whether the financial statements are fairly stated. This imposes upon the auditor a duty to

  1. A) be an insurer of the fairness in the statements.
  2. B) be a guarantor of the fairness in the statements.
  3. C) be equally responsible with management for the preparation of the financial statements.
  4. D) provide reasonable assurance that material misstatements will be detected.

Answer:  D

Diff: 2     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

12) The factor which distinguishes an error from fraud and other irregularity is

  1. A) materiality.
  2. B) intent.
  3. C) whether it is a dollar amount or a process.
  4. D) whether it is a caused by the auditor or the client.

Answer:  B

Diff: 1     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

 

13) Which of the following is an example of fraudulent financial reporting (management fraud)?

  1. A) intentional overstatement of sales to increase reported earnings
  2. B) managers or others taking bribes from accounts payable suppliers
  3. C) the purchasing manager submitting travel expenses twice (i.e. duplicate payment)
  4. D) a clerk taking cash at the time a sale is made and not recording the sale

Answer:  A

Diff: 3     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

14) In comparing management fraud with employee fraud, the auditor’s risk of failing to discover the fraud is greater for

  1. A) employee fraud because of the larger number of employees in the organization.
  2. B) employee fraud because of the higher crime rate among blue collar workers.
  3. C) management fraud because of management’s ability to override existing internal controls.
  4. D) management fraud because managers are inherently smarter than employees.

Answer:  C

Diff: 2     Type: MC     Page Ref: 105

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

15) If the auditor were responsible for making certain that all the assertions of management in the statements were correct,

  1. A) bankruptcies could no longer occur.
  2. B) bankruptcies would be reduced to a very small number.
  3. C) audits would be much easier to complete.
  4. D) audits would not be economically feasible.

Answer:  D

Diff: 2     Type: MC     Page Ref: 107

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

16) When comparing the auditor’s responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility

  1. A) more on discovering errors than employee fraud.
  2. B) more on discovering employee fraud than errors.
  3. C) equally on discovering either one.
  4. D) on the senior auditor for detecting errors and on the manager for detecting employee fraud.

Answer:  A

Diff: 2     Type: MC     Page Ref: 107

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

 

17) The auditor’s evaluation of the likelihood of material employee fraud is normally done initially as a part of

  1. A) the assessment of whether to accept the audit engagement.
  2. B) understanding the entity’s internal controls.
  3. C) the tests of controls.
  4. D) the tests of transactions.

Answer:  B

Diff: 3     Type: MC     Page Ref: 107

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

18) What is the auditor’s role in the detection of computer fraud?

  1. A) use computer assisted audit techniques to make sure that the computer programs do not have any unauthorized processing
  2. B) use test data to make sure that the computer programs are functioning as described by the client
  3. C) investigate unusual relationships or patterns, conduct the audit properly, and report to management
  4. D) only detect fraud if it has been ongoing for a long period of time and leaves many different types of evidence

Answer:  C

Diff: 3     Type: MC     Page Ref: 107

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

19) Auditing standards regarding the detection of illegal acts clearly state that the auditor provides

  1. A) no assurance that they will be detected.
  2. B) the same reasonable assurance provided for other items.
  3. C) assurance that they will be detected, if material.
  4. D) assurance that they will be detected, if highly material.

Answer:  A

Diff: 3     Type: MC     Page Ref: 107

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

20) Which of the following is an example of a direct-effect illegal act that could be performed by a client? Violation of

  1. A) environmental protection laws for the production facility.
  2. B) insider securities trading regulations by senior management.
  3. C) employment equity laws for a large group of non-unionized employees.
  4. D) income tax laws and incorrect calculation of income taxes payable.

Answer:  D

Diff: 3     Type: MC     Page Ref: 108

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

 

21) What is one of the first things that an auditor would do upon discovering an illegal act at an audit client?

  1. A) resign from the audit
  2. B) inform the Board of Directors
  3. C) consult with a lawyer
  4. D) call the police

Answer:  C

Diff: 2     Type: MC     Page Ref: 108

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

22) A financial statement audit typically consists of three sections. Identify each of the three sections of an audit and discuss the major activities performed by the auditor in each section.

Answer:

I: Risk assessment. In this section, the auditor obtains an understanding of the client’s business and industry. In addition, the auditor obtains an understanding of the client’s internal control structure and makes a preliminary assessment of control risk. The planning takes place in this phase by developing a strategic audit approach overall and by cycle.

II: Risk Response. In this section, the auditor develops audit programs and tests internal controls. The auditor also performs substantive tests and assesses the impact upon the risk of material misstatements. The results of the tests are evaluated and risk is reassessed if required. Final evidence and documentation is gathered.

III: Reporting. In this section, the auditor communicates with the audit committee and management as required. A final quality control review is also performed before the report is issued.

Diff: 3     Type: ES     Page Ref: 103

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

23) In May 2012, the firm of Chang and Crown (C&C) became the auditors of Laua Limited (LL) for the fiscal year ended December 31, 2011. LL’s shareholders and Board approved the change from its previous audit firm on the recommendation of LL’s senior management. One of the new board members is a bit confused about management’s role with respect to the financial statements and thought that Chang and Crown would be preparing the financial statements. He was also glad that the auditors would be able to help prevent illegal acts and fraud.

Required:

 

  1. A) Distinguish between management’s responsibility and the auditor’s responsibility for the financial statements under audit.

 

  1. B) Explain to the board member why the auditor does NOT help prevent illegal acts and fraud. What is the role of the auditor with respect to illegal acts and fraud?

 

Answer:

  1. A)

Management:

Management is responsible for adopting appropriate accounting policies, maintaining adequate internal control, and making fair representations in the financial statements.

Auditor:

The auditor is required to plan and perform the audit with an attitude of professional skepticism, recognizing that circumstances may exist that cause the financial statements to be materially misstated.

  1. B) Since management is responsible for maintaining internal control, it is management’s responsibility to design and monitor internal controls to help prevent and detect illegal acts and fraud.

 

The auditor considers fraud and illegal acts in the context of whether they have a material effect upon the financial statements. Accordingly, the auditor is responsible for obtaining reasonable assurance that the financial statements are free of material error, which includes illegal acts that may have a material indirect effect on the financial statements, and material fraud, which may have a direct effect on the financial statements.

 

Audits cannot be expected to provide the same degree of assurance for the detection of material management fraud, since concealment by management makes fraud more difficult for auditors to find.

Diff: 1     Type: ES     Page Ref: A102; B104-108

Learning Obj.:   5-1  Describe the objective of conducting an audit of financial statements

 

24) Frank has come to you because he is worried about recovering the cost of his share of a law firm partnership. His partner, Jennifer, is exercising the “shotgun” clause in their partnership agreement, and wants to buy him out. Over the last two years, Frank and Jennifer have had numerous battles over the way that Frank handles his accounts receivable. Frank is lenient with his customers, and has converted many of his accounts into long term notes extending two and three years into the future. He is confident that these amounts are collectible, because every one of his clients continues to make small monthly payments.

Frank thinks that Jennifer may have been hiding profits from him and collecting some of her accounts in cash. He wants you to audit the books so that he can figure out what the ‘true’ profits are and how much Jennifer should pay him for his share of the partnership.

Required:

 

  1. A) Explain to Frank what you would be able to do during the audit engagement.

 

  1. B) List the management assertions that may have been violated. Justify your answer.

 

Answer:

  1. A)

∙     The purpose of an audit is to provide reasonable assurance that the financial statements are free of material error or fraud.

∙     The financial statements may not be 100% accurate.

∙     Since management fraud is difficult to detect, it would be impossible for you to quantify the amount of money that Jennifer has taken, if any.

∙     Frank might not be happy with the audit results, because one of the things that you would have to do would be to assess the collectability of the accounts receivable.

  1. B)

Existence: some accounts receivable may not be recorded, if Jennifer took funds.

 

Completeness: some sales may not have been recorded, if Jennifer took the funds.

 

Valuation: accounts receivable may be overvalued for Frank’s receivables, if they are not collectible.

 

Classification: If some receivables are long term rather than current, they may be incorrectly recorded as current in the financial statements.

Diff: 3     Type: ES     Page Ref: A)104-108, B)125-127

Learning Obj.:  5-1  Describe the objective of conducting an audit of financial statements; 5-5  Describe management assertions about financial information

 

25) Your PA firm has been auditing Ontario Pulp Company for three years. Two years ago, a letter was received from the provincial government informing them that they needed to reduce the level of contaminants that they were releasing into the air and into local waterways. The deadline for this reduction is three months from today. The letter indicates significant fines (several hundred thousand dollars) if the targets are not met. Alternatively, the Company will need to shut down operations until the targets are met.

During your audit planning process management informed you that they have not taken any action, but plan to start construction of the new pollution devices next month.

Required:

Explain the impact the above situation has upon your audit planning process.

Answer:

∙     The above situation seems to indicate that management does not take the letter from the provincial government seriously.

∙     This could affect the ability of the company to continue as a going concern, and as a minimum would require disclosure in the financial statements, with possibly a qualification.

∙     The audit planning process would need to include gathering knowledge about other companies in this sector—have they also received such letters and have they complied? Have there been charges laid by the provinces where compliance did not occur? The answers to these questions will help assess the potential impact upon the client.

∙     The auditor should also look at any proposals that the company has received about implementing the anti-pollution equipment to see how quickly it can be implemented.

∙     The negative attitude about the anti-pollution equipment may also apply to other areas of the business.

∙     The auditor will need to assess the quality of corporate governance and of management integrity and assess the effect upon the engagement. Why has management really decided to wait so long?

Diff: 3     Type: ES     Page Ref: 102, 112-118

Learning Obj.:  5-1  Describe the objective of conducting an audit of financial statements; 5-5  Describe management assertions about financial information

 

26) The controller who had been with Bianca Limited for six years was fired last month, allegedly for pocketing cash. Unfortunately, there was a fire in the accounting department the week before he was fired, destroying the accounting records, including the computer equipment and current backup disks.

The only records available for the current year is a copy of the computer system that is a month old. There are also disks for the year ends going back three years. These were at the president’s home, the place where the company kept archival records.

Required:

Explain how this situation might affect the audit process.

Answer:

∙     The absence of records will make it difficult to complete the audit; management actions with respect to reconstructing the one month of lost records will need to be assessed and the potential for material error considered.

∙     If records cannot be obtained from alternative sources (e.g. customers and suppliers and financial institutions) then a qualified audit report may be required.

∙     Due to the possible management fraud, it will be necessary to conduct extensive additional testing; it may not be possible to quantify the amount of the fraud (if any).

∙     It will be necessary to look at the quality of internal controls—if this fraud was possible, then other errors and irregularities could also have occurred at the business.

∙     It will not be possible to conduct tests of internal controls or tests of details of balances if there are no records.

Diff: 3     Type: ES     Page Ref: 102, 112-118

Learning Obj.:  5-1  Describe the objective of conducting an audit of financial statements; 5-5  Describe management assertions about financial information

 

5.2   Examine the preplanning steps that the auditor completes before accepting the financial statement audit engagement

 

1) At what point during the audit should the auditor conduct an independence threat analysis?

  1. A) after the audit evidence assessment and collection process
  2. B) prior to the acceptance of the engagement
  3. C) after gathering sufficient knowledge of the client’s business
  4. D) prior to signing the audit report

Answer:  B

Diff: 2     Type: MC     Page Ref: 108-109

Learning Obj.:   5-2  Examine the preplanning steps that the auditor completes before accepting the financial statement audit engagement

 

2) The decision to continue doing the audit of an existing client is

  1. A) as important as deciding whether or not to accept a new client.
  2. B) less important than deciding whether or not to accept a new client.
  3. C) more important than deciding whether or not to accept a new client.
  4. D) only to be reconsidered if the client’s operations or upper management has changed.

Answer:  A

Diff: 1     Type: MC     Page Ref: 110

Learning Obj.:   5-2  Examine the preplanning steps that the auditor completes before accepting the financial statement audit engagement

5.3   Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

1) Your PA firm has just obtained a new client and you have been assigned the task of preparing the knowledge of business section of the file. Which of the following best describes the process of gathering the knowledge of business for a client?

  1. A) discussing processes and business objectives with company employees
  2. B) gathering information about the industry and regulatory environment
  3. C) understanding the client’s business, industry, and regulatory environment
  4. D) examining the legal expenses file for possible regulatory infractions

Answer:  C

Diff: 2     Type: MC     Page Ref: 116

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

2) Analytical procedures are those that

  1. A) evaluate the accuracy of the account balances.
  2. B) assess the overall reasonableness of account balances or other data.
  3. C) review the effectiveness of internal controls.
  4. D) analyze the effect of management procedures on the accounting system.

Answer:  B

Diff: 1     Type: MC     Page Ref: 116

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

3) Where the auditor has decided to rely upon internal controls, he or she will then

  1. A) eliminate the need to gather evidence in that area.
  2. B) test the effectiveness of the controls in that area.
  3. C) proceed to expand the sample sizes in that area.
  4. D) negotiate with management to determine which controls will be tested in that area.

Answer:  B

Diff: 1     Type: MC     Page Ref: 117

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

4) Tests of details of balances are specific procedures intended to

  1. A) identify the details of internal controls.
  2. B) prove that the accounts with material balances are classified correctly.
  3. C) test for monetary errors in the financial statements.
  4. D) prove that the trial balance is in balance.

Answer:  C

Diff: 1     Type: MC     Page Ref: 117

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

5) After the auditor has completed all the procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on

  1. A) generally accepted auditing standards.
  2. B) the provincial institutes’ Rules of Professional Conduct.
  3. C) generally accepted accounting principles.
  4. D) the auditor’s professional judgment.

Answer:  D

Diff: 2     Type: MC     Page Ref: 118

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

6) You have been assigned the in-charge-auditor for a new client, Beltair House. Beltair House is a non-profit charitable organization which operates a home for unwed mothers who have decided that they would like to keep their child. In the past, the organization had been almost fully funded by the provincial government. However, due to recent budget cut-backs, Beltair has to raise operating funds from public donations.

Because of financial constraints, there is now only one full time manager, Joan Ng. Joan has the help of several volunteers, and the residents help out with the chores and with maintenance and cleaning. Ng has been able to arrange for a local food bank to provide a large portion of the food required for meals. Door-to-door canvassers have been able to raise money to keep the House going, but Ng is concerned that this will change.

Required:

Identify issues that you will need to consider that affect the risk of this audit engagement.

Answer:  Factors impacting risk include:

∙    a first time audit engagement (increases inherent risk)

∙    the reduction in government funding, affecting the going concern of the House

∙    numerous financial statement users (e.g. government, donors)

∙    cash collected by volunteers is subject to theft (receipts may not be issued for all donations      —this may result in a need to qualify the audit report)

∙    a lack of segregation of duties (there is only one employee)

∙    there may be inexperienced people recording accounting transactions, leading to the potential for more errors (especially if accounting transactions are recorded by volunteers)

∙    since the food bank is providing a large portion of the food, this donation may need to be recorded at fair market value (need to determine how it is being recorded, and whether there are any additional services that need to be recorded)

∙    the lack of volunteers will hinder the canvassing to raise money and prevent the chores they perform from getting done (which threatens the viability and continuity of the      charity).

Diff: 3     Type: ES     Page Ref: 115-116

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

7) Sean Clem has done a review engagement and prepared the tax return for your web design business for the last five years. The books and records have always been well organized, although year end adjusting entries have been required. You do some of the accounting yourself and the rest of the accounting records are handled by your wife, who is also an employee of the business.

This year, you would like to expand your business to provide ISP (internet service provider) services to your clients. This would entail you purchasing additional computer equipment and software. You are also considering hiring an additional employee (you currently have three), and you are looking at obtaining a loan for $100,000 from the bank. The bank says that you should have your records audited, but you are not sure what this will mean.

Required:

  1. A) What would Sean say to you about the differences between an audit and a review?
  2. B) Identify the issues that Sean needs to consider during the planning of the audit.

 

Answer:

  1. A)

∙    An audit has a higher degree of assurance, so additional work will be required.

∙    This will result in a higher fee for the work completed.

∙    It will be important to clearly document the role of the auditor and management.

∙    The report may be qualified if it is not possible to audit the opening balances.

∙    It may be possible to continue to have a review engagement rather than an audit if the owner (you) has other collateral to offer—then the bank would not require such a high level of assurance.

B)

∙    This is a first audit engagement, so additional time will be needed to develop a client risk profile, document knowledge of business and knowledge of the industry.

∙    There is a need to conduct an independence threat analysis.

∙    Since the bank will be requiring the audit to possibly review the collectability of the loan, this increases the risk of the engagement.

∙    Internal controls will be poor since records are kept by a husband and wife team.

∙    Risks of management override or management deception are high because of the incentive to obtain the bank loan.

∙    Any bank covenants imposed on the new loan and the ability of the client to meet them.

Diff: 3     Type: ES     Page Ref: 112-118

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

8) Pet Shop Ltd. is a large retail outlet with ten full time employees in addition to the owner. You dropped by on your way home one day to organize the audit planning process for the coming year, and noticed brand new terminals at the cashier’s desk. One of the employees was having fun zapping inventory items. The owner teased him about the new laser scanning devices and told him to get to work to see which items needed to be ordered. It turns out that Pet Shop Ltd. has implemented a new point of sale computer system that is integrated with inventory. The last time you were there to buy dog food (about three months ago) there were old computer terminals that were no longer functional and recorded sales transactions manually in the sales journal.

Required:

List the three sections of the audit. For each section, explain how these new computer systems might affect the audit process.

Answer:

Risk assessment:

∙    The auditor will need to gather information about how internal controls have changed with the use of the new computer system.

∙    Since there are two different systems of internal control, the audit will need to consider both systems during the risk assessment, planning and execution phases.

∙    Depending upon the nature of the information that was stored in the old systems, the auditor may need to conduct a conversion audit.

Risk Response:

∙    The controls will be different, so the auditor will need to design different tests of controls for each of the two systems. The audit programs will need to be updated.

∙    The system conversion will also have to be tested to ensure that data integrity was not compromised.

∙    Particular attention should also be given to the inventory and sales account. Given the scanning of items by the employee, it is possible that this recorded false sales and also recorded false decreases in inventory.

∙    Analytical procedures will need to take account of the fact that there may be a large shift in amounts in the accounts (for example, there may be capital expenditures for the computer equipment and software; inventory amounts may be lower if inventory management has improved with the new system).

Reporting:

∙    The audit report will be prepared and total evidence gathered in the risk response section will be analyzed to determine if there is a material misstatement. An audit opinion will be formed based on the results and the audit report can be issued.

Diff: 3     Type: ES     Page Ref: 112-118

Learning Obj.:   5-3  Describe the eight phases of a financial statement audit and provide an overview of the audit process

 

 

5.4   Show how transactions underlying financial statements are divided into cycles

 

1) Prior to looking at the specific cycles, the auditor will first

  1. A) inquire and document corporate governance systems.
  2. B) perform tests of controls on significant cycles.
  3. C) perform analytical review of specific accounts.
  4. D) perform a risk assessment for the audit of the organization.

Answer:  A

Diff: 2     Type: MC     Page Ref: 118

Learning Obj.:   5-4  Show how transactions underlying financial statements are divided into cycles

2) Marianne is currently performing tests of controls on the presence of an employee code of conduct, the presence of a whistle blower line and on how management responded and implemented systematic penalties for instances where violations of the code of conduct existed. Marianne is currently evaluating the

  1. A) industry and business environment.
  2. B) risk of fraud.
  3. C) client acceptance.
  4. D) entity-level controls.

Answer:  D

Diff: 3     Type: MC     Page Ref: 118

Learning Obj.:   5-4  Show how transactions underlying financial statements are divided into cycles

 

3) Transaction cycles begin and end at

  1. A) the beginning and end of the fiscal period.
  2. B) the balance sheet date.
  3. C) January 1 and December 31.
  4. D) the origin and final disposition of the company.

Answer:  D

Diff: 3     Type: MC     Page Ref: 122

Learning Obj.:   5-4  Show how transactions underlying financial statements are divided into cycles

 

4) For the most part, auditors treat each transaction cycle

  1. A) separately as the audit is being performed.
  2. B) as an interrelated unit with the other cycles throughout the entire audit.
  3. C) as a separate business unit with different audit teams.
  4. D) as a joint venture with other clients in the same industry.

Answer:  A

Diff: 3     Type: MC     Page Ref: 123

Learning Obj.:   5-4  Show how transactions underlying financial statements are divided into cycles

 

 

5) Often, numerous classes of transactions affect the ending balance of a particular general ledger account. This is handled during the audit engagement by

  1. A) ensuring that tests are conducted for each class of transactions.
  2. B) obtaining a high level of assurance for at least one of the transaction types.
  3. C) using a combination of assurance for each class of transactions and for the ending balance.
  4. D) testing only the ending balance, as this is the significant amount on the financial statements.

Answer:  C

Diff: 3     Type: MC     Page Ref: 123-124

Learning Obj.:   5-4  Show how transactions underlying financial statements are divided into cycles

6) Your PA firm audits the Barney Bloke Parts company, which manufactures plastic bumpers and other automobile parts in eight factories scattered across southern Ontario. The company has a December year end. It is now November 14.

The planning file indicates that internal controls in the accounts receivable area are poor, as there has been significant employee turnover. A review of the prior year’s working paper file indicates that there was a poor response to the accounts receivable and accounts payable confirmation requests. There were several errors in inventory pricing and problems with obsolescence.

Required:

List the financial statement cycles that need to be tested. For each cycle, identify at least one transaction that needs to be examined. For that transaction, identify a management assertion that may have a high risk of error associated with it and explain why you believe the risk of error is high.

Answer:

Financial statement cycle Transaction to be tested Management assertion at risk with reason
Sales and collection Cash receipts Cutoff: new employees may record the transaction in the wrong period or on the wrong date
Acquisition and payment Cash disbursement Classification: new employees may post transactions to the wrong account
Human resources and payroll Payroll disbursement Accuracy: employees could be  paid the wrong wage rate
Inventory and distribution Inventory issuance Accuracy: inventory issued might be recorded at the wrong cost or wrong sales price
Capital acquisition and repayment Note payment Cutoff: payments may be recorded in the wrong period or on the wrong date

[Note: Students may select other transactions that are at high risk. Above is a representative response.]

Diff: 3     Type: ES     Page Ref: 122, 125-127

Learning Obj.:  5-4  Show how transactions underlying financial statements are divided into cycles; 5-5  Describe management assertions about financial information

 

 

5.5   Describe management assertions about financial information

 

1) Management assertions are

  1. A) stated in the footnotes to the financial statements.
  2. B) implied or expressed representations about the accounts in the financial statements.
  3. C) explicitly expressed representations about the financial statements.
  4. D) provided to the auditor in the engagement letter, but are not disclosed on the financial statements.

Answer:  B

Diff: 2     Type: MC     Page Ref: 125

Learning Obj.:   5-5  Describe management assertions about financial information

2) Management assertions are

  1. A) directly related to auditing standards.
  2. B) directly related to accounting standards.
  3. C) indirectly related to auditing standards.
  4. D) indirectly related to accounting standards.

Answer:  B

Diff: 2     Type: MC     Page Ref: 125

Learning Obj.:   5-5  Describe management assertions about financial information

 

3) Frankinfurter Limited decided that it wanted to improve earnings. To do this, it understated its expenses by omitting unpaid expenses from the accrued liabilities account at year end. Which management assertion has been violated?

  1. A) existence
  2. B) disclosure
  3. C) rights and obligations
  4. D) completeness

Answer:  D

Diff: 3     Type: MC     Page Ref: 126

Learning Obj.:   5-5  Describe management assertions about financial information

 

4) Gabori Company would like to pay less income tax this year. It decided that it could do this by understating its inventory values, increasing costs of goods sold. This was done by deliberately pricing the inventory at incorrect amounts, so that it would be shown at a lower value than it was really worth (for example, items worth five dollars each were shown at fifty cents each). Which management assertion has been violated?

  1. A) valuation
  2. B) accuracy
  3. C) statement presentation
  4. D) completeness

Answer:  B

Diff: 3     Type: MC     Page Ref: 126

Learning Obj.:   5-5  Describe management assertions about financial information

 

 

5) If the purchase of a long-term note receivable is included as cost of goods sold, there is a violation of the

  1. A) existence objective.
  2. B) completeness objective.
  3. C) classification objective.
  4. D) timing objective.

Answer:  C

Diff: 1     Type: MC     Page Ref: 126

Learning Obj.:   5-5  Describe management assertions about financial information

 

6) When considering each material type (or class) of transactions during the audit, which general transaction-related audit objectives are assessed during the audit?

  1. A) those transaction-related audit objectives where there is the highest risk of error
  2. B) all five transaction-related audit objectives
  3. C) those transaction-related audit objectives where there are poor internal controls
  4. D) primarily completeness, occurrence and accuracy, since this is where most errors occur

Answer:  B

Diff: 3     Type: MC     Page Ref: 127

Learning Obj.:   5-5  Describe management assertions about financial information

7) XYZ Brick Company decided to inflate sales by recording fictitious sales. Several non-existent clients were created and the sales were added into the sales journal throughout the year. The general transaction-related audit objective affected by these actions is

  1. A) occurrence.
  2. B) completeness.
  3. C) accuracy.
  4. D) posting and summarization.

Answer:  A

Diff: 3     Type: MC     Page Ref: 128

Learning Obj.:   5-5  Describe management assertions about financial information

 

8) Georgina was working as the part time accountant for three small businesses. Whenever she could, she pocketed cash and neglected to record the sale in the sales system. The general transaction-related audit objective affected by her actions is

  1. A) occurrence.
  2. B) completeness.
  3. C) accuracy.
  4. D) posting and summarization.

Answer:  B

Diff: 3     Type: MC     Page Ref: 128

Learning Obj.:   5-5  Describe management assertions about financial information

 

 

9) Flagpole Company Limited recently upgraded its accounting software due to changes in the payroll income tax rates. Unfortunately, there was an error in the software, and income tax was calculated incorrectly. The general transaction-related audit objective affected by these errors is

  1. A) occurrence.
  2. B) completeness.
  3. C) accuracy.
  4. D) posting and summarization.

Answer:  C

Diff: 3     Type: MC     Page Ref: 128

Learning Obj.:   5-5  Describe management assertions about financial information

 

10) Big Bank had a program failure occur on Sunday night due to a maintenance program error. Transaction posting was interrupted, with several errors occurring in posting to the master files. Although sales had been posted to the general ledger, individual accounts were not recorded until subsequent days. The general transaction-related audit objective affected by this activity is

  1. A) timing.
  2. B) accuracy.
  3. C) occurrence.
  4. D) classification.

Answer:  B

Diff: 3     Type: MC     Page Ref: 130

Learning Obj.:   5-5  Describe management assertions about financial information

11) In testing for cutoff, the objective is to determine

  1. A) whether all of the current period’s transactions are recorded.
  2. B) that no transactions from the prior period are included in the current period’s balances.
  3. C) that no transactions of the current period have been delayed and recorded in a future period.
  4. D) whether transactions are recorded in the proper period.

Answer:  D

Diff: 2     Type: MC     Page Ref: 130

Learning Obj.:   5-5  Describe management assertions about financial information

 

12) Heavy Manufacturing Company is in the business of making steel plates, forming heavy metal slabs and drilling and scoring metals. Recently, it upgraded many of its forming machines. Fortunately, the company was able to sell its old equipment at a reasonable price. The effect was that sales for the quarter are substantially improved over the same period in the prior year. The general transaction-related audit objective affected by this activity is

  1. A) timing.
  2. B) accuracy.
  3. C) occurrence.
  4. D) classification.

Answer:  D

Diff: 3     Type: MC     Page Ref: 130

Learning Obj.:   5-5  Describe management assertions about financial information

 

 

13) Balance-related audit objectives are applied to which types of general ledger accounts?

  1. A) balance sheet accounts only
  2. B) income statement accounts only
  3. C) balance sheet accounts and some income statement accounts
  4. D) accounts that affect the cash flow statement

Answer:  C

Diff: 2     Type: MC     Page Ref: 130

Learning Obj.:   5-5  Describe management assertions about financial information

 

14) Heavy Manufacturing Company is in the business of making steel plates, forming heavy metal slabs and drilling and scoring metals. Recently, it upgraded many of its forming machines. There were five machines purchased on four different invoices. Unfortunately, one of the invoices was recorded twice, resulting in five invoices being recorded. The general balance-related audit objective affected by this activity is

  1. A) completeness.
  2. B) accuracy.
  3. C) classification.
  4. D) existence.

Answer:  D

Diff: 3     Type: MC     Page Ref: 130

Learning Obj.:   5-5  Describe management assertions about financial information

15) Camilla is preparing the audit program for the inventory of Summers, a large department store. Camilla listed “select a sample of invoices from suppliers to verify that the risks and rewards of the inventory were transferred to Summers”. Camilla is concerned that some of the inventory in the store might be on consignment. The account balance related objective that Camilla is concerned about is

  1. A) rights and obligation (ownership).
  2. B) accuracy.
  3. C) valuation.
  4. D) existence.

Answer:  A

Diff: 2     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

16) The sole shareholder of Jade Company had a contractor pave the parking lot at the company building, and also pave the driveway of his home. Both paving jobs were billed to the company on a single invoice. The general balance-related audit objective affected by this activity is

  1. A) existence.
  2. B) allocation.
  3. C) completeness.
  4. D) rights and obligations.

Answer:  D

Diff: 3     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

 

17) The Big Insurance Company implemented a new computer system to track and record insurance premiums receivable. The program automatically prints invoices and sends them to customers when premiums are due. Due to a program error, a whole series of invoices were included in sales but not in accounts receivable. The general balance-related audit objective affected by this activity is

  1. A) completeness.
  2. B) accuracy.
  3. C) classification.
  4. D) existence.

Answer:  A

Diff: 2     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

18) Radio Supplies Limited sells parts and components to organizations that repair radios and other forms of audio equipment. It has many parts on its inventory listing at cost that were purchased up to fifteen years ago. Some of these parts have not seen any movement in the last ten years. The general balance-related audit objective affected by this activity is

  1. A) completeness.
  2. B) accuracy.
  3. C) valuation.
  4. D) existence.

Answer:  C

Diff: 3     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

19) To help improve the cash balance on the financial statements, the controller recorded several deposits from early January in the month of December. The general balance-related audit objective affected by this activity is

  1. A) allocation timing.
  2. B) accuracy.
  3. C) classification.
  4. D) existence.

Answer:  A

Diff: 2     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

20) Jane’s employer purchased a new calculator this month. When Jane added up the sales for the day, she was a bit confused with the new calculator and made numerous adding errors. The daily sales total for the next week was incorrectly posted to the general ledger. The general balance-related audit objective affected by this activity is

  1. A) cutoff.
  2. B) accuracy (of allocation).
  3. C) classification.
  4. D) existence.

Answer:  B

Diff: 2     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

21) Formamould Inc. sells plastic moulds to a variety of companies. Some moulds are custom made and cost thousands of dollars. To help customers finance these purchases, Formamould uses a variety of methods, such as payment terms stretched over three years, delayed payment, and pay-as-you-produce models tailored to the individual customer’s needs. The outstanding balance is included in current accounts receivable. The general balance-related audit objective affected by this activity is

  1. A) completeness.
  2. B) accuracy.
  3. C) allocation to accounts.
  4. D) existence.

Answer:  C

Diff: 3     Type: MC     Page Ref: 131

Learning Obj.:   5-5  Describe management assertions about financial information

 

 

22) In the following table, there are listed common audit objectives for accounts payable or purchases. For each procedure, list the management assertion, and the related general audit objective. State whether the audit objective is transaction-related or balance-related.

 

Accounts payable or purchases objectives Management assertion Audit objective Transaction-related? (Y/N) Balance-

related? (Y/N)

1. Accounts payable in the accounts payable trial balance are for valid purchases.        
2. Recorded acquisitions are for goods and services received, consistent with the best interests of the client.        
3. All acquisition transactions are recorded.        
4. Recorded acquisition transactions are recorded at the correct amount.        
5. Acquisition transactions are correctly allocated between current and long-term.        
6. Acquisition transactions are recorded on the correct dates.        
7. Purchase transactions are properly included in the vendor and inventory master files, and are correctly posted to the general ledger.        
8. The accounts payable recorded in liabilities are obligations of the company.        

 

 

Answer:

Accounts payable or purchases objectives Management assertion Audit objective Transaction-related? (Y/N) Balance-

related? (Y/N)

1. Accounts payable in the accounts payable trial balance are for valid purchases. Existence Existence   Y
2. Recorded acquisitions are for goods and services received, consistent with the best interests of the client. Occurrence Occurrence Y  
3. All acquisition transactions are recorded. Completeness Completeness Y  
4. Recorded acquisition transactions are recorded at the correct amount. Accuracy Accuracy Y  
5. Acquisition transactions are correctly allocated between current and long-term. Classification Classification Y  
6. Acquisition transactions are recorded on the correct dates. Cutoff Cutoff Y  
7. Purchase transactions are properly included in the vendor and inventory master files, and are correctly posted to the general ledger. Classification Classification Y  
8. The accounts payable recorded in liabilities are obligations of the company. Rights and obligations Rights and obligations   Y

 

Diff: 3     Type: ES     Page Ref: 125-132

Learning Obj.:   5-5  Describe management assertions about financial information

 

23) Bratlett Company has purchased all of the shares of another company, but does not want to consolidate its financial statements. Management has drafted a rather long and confusing note to the financial statements that describes the transaction that took place briefly, and states that debt has been acquired in a foreign currency. In your view, the transaction, its effect on the company and the accounts have not properly been disclosed.

Required:

List the audit objectives about presentation and disclosure that have been affected and explain how they are affected.

Answer:  Rights and obligations: Assets and liabilities belonging to the consolidated entity, such as the nature of the debt and of the new entity, will not be properly disclosed in the financial statements.

Completeness: Disclosures about the debt and the consolidation are inadequate.

Accuracy: Account balances shown in the financial statements are inaccurate because they are not consolidated.

Valuation: Accounts such as goodwill may be inaccurately valued.

Classification: Amounts are shown in the incorrect accounts since they are not consolidated.

Understandability: The economic events that have taken place (the purchase, the financing and the combined results of operations) are not fully disclosed in an understandable way.

Diff: 3     Type: ES     Page Ref: 129, 132

Learning Obj.:   5-5  Describe management assertions about financial information

 

Auditing, 12e (Arens)

Chapter 13   Completing the Tests in the Sales and Collection Cycle: Accounts Receivable

 

13.1   Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

1) Tests of details of balances relate to which part of the Audit Risk Model?

  1. A) control risk
  2. B) inherent risk
  3. C) substantive risk
  4. D) planned detection risk

Answer:  D

Diff: 1     Type: MC     Page Ref: 410

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

2) A risk of material misstatement in accounts receivable associated with the rights and obligations balance-related audit objective is that “consignment goods are recorded as revenue, overstating both revenue and accounts receivable. Which of the following tests of detail of balances would respond to this risk?

  1. A) include confirmation of terms of sale with accounts receivable confirmations
  2. B) check cash received after the year end and trace to accounts receivable master file
  3. C) read the notes to the financial statements and compare to audited financial information
  4. D) compare accounts receivable balances by customer last year end to this year

Answer:  A

Diff: 2     Type: MC     Page Ref: 412

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

3) A risk of material misstatement in accounts receivable associated with the accuracy balance-related audit objective is that “sales recorded at the incorrect price result in revenue and accounts receivable that are over or under stated.” Which of the following tests of detail of balances would respond to this risk?

  1. A) select a sample of master file change forms and verify that all sales prices changes were appropriately authorized
  2. B) use audit software to match sales invoice price details to authorized prices in the sales price master files
  3. C) inquire of management with respect to the procedures used to update sales price master file
  4. D) match shipping details for a sample of invoices to the invoice details, on an item by item basis

Answer:  B

Diff: 3     Type: MC     Page Ref: 412

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

4) A risk of material misstatement in accounts receivable associated with the allocation balance-related audit objective is that “long term service revenue is recorded as current revenue or in the wrong period, overstating revenue and accounts receivable.” Which of the following tests of detail of balances would respond to this risk?

  1. A) read customer contracts and audit the criteria used to allocate revenue to components of the sales contract
  2. B) check cash received after the year end and trace to accounts receivable master file
  3. C) read the notes to the financial statements and compare to audited financial information
  4. D) inquire of management about the process used to make sure that revenue is recorded in the correct period

Answer:  A

Diff: 2     Type: MC     Page Ref: 412

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

5) Audit risk is assessed for

  1. A) the financial statements as a whole and is not usually allocated to various accounts or objectives.
  2. B) the financial statements as a whole and then allocated to various accounts.
  3. C) various accounts but not for the financial statements as a whole.
  4. D) various accounts and objectives, and the sum is then assigned to the financial statements as a whole.

Answer:  A

Diff: 3     Type: MC     Page Ref: 413

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

6) The two primary classes of transactions in the sales and collection cycle are

  1. A) sales and sales returns.
  2. B) sales and sales discounts.
  3. C) sales and accounts receivable.
  4. D) sales and cash receipts.

Answer:  D

Diff: 1     Type: MC     Page Ref: 413

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

 

7) For sales, the occurrence transaction-related audit objective affects the existence balance-related audit objective. For cash receipts, the occurrence transaction-related audit objective affects which balance-related audit objective?

  1. A) existence
  2. B) completeness
  3. C) cut-off
  4. D) valuation

Answer:  B

Diff: 2     Type: MC     Page Ref: 414

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

8) For cash receipts, the occurrence transaction-related audit objective affects the completeness balance-related audit objective of accounts receivable. Which accounts receivable balance-related audit objective does the cash receipts transaction-related audit objective of completeness affect?

  1. A) allocation
  2. B) completeness
  3. C) rights and obligations
  4. D) existence

Answer:  D

Diff: 2     Type: MC     Page Ref: 414

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

9) Two accounts receivable balance-related audit objectives are not affected by assessed control risk for the sales and cash receipts classes of transactions. These are

  1. A) valuation allocation.
  2. B) allocation, rights and obligations.
  3. C) valuation, rights and obligations.
  4. D) accuracy, existence.

Answer:  C

Diff: 3     Type: MC     Page Ref: 414

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

10) Three presentation and disclosure audit objectives are not affected by assessed control risk for the sales transactions. These are

  1. A) rights and obligations, valuation, understandability.
  2. B) understandability, valuation, occurrence.
  3. C) valuation, rights and obligations, classification.
  4. D) classification, understandability, rights and obligations.

Answer:  A

Diff: 3     Type: MC     Page Ref: 414

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

11) In the planning phase, Denis conducted an analytical procedure to compare the allowance for doubtful accounts balance to the accounts receivable balance. In the prior years, the allowance for doubtful accounts/ accounts receivable ratio was between 2.5% to 3.5%. This year, the number is 1.25%. What should Denis do?

  1. A) Change the assessed inherent risk
  2. B) Conduct additional testing to justify the lower bad debt
  3. C) Advise management that they should increase the allowance for doubtful accounts provision
  4. D) Document this difference and continue with audit work to see if this is pervasive bias of management

Answer:  B

Diff: 3     Type: MC     Page Ref: 415

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable; 13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

12) At every audit engagement, the auditor is required to consider that there could be significant risks of misstatement for revenue recognition. At ABC Ltd., the auditor has concluded that, yes, there are material risks of misstatement associated with revenue recognition. How does this affect the extent of testing for accounts receivable?

  1. A) audit risk will be increased
  2. B) inherent risks will be decreased
  3. C) decreased control testing is required
  4. D) increased substantive testing is required

Answer:  D

Diff: 2     Type: MC     Page Ref: 415

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

13) Your audit client has many different types of accounts receivable: Canadian, American, and other international accounts, short term and long-term. There are also some sales on consignment. The company has used forward exchange contracts to reduce its exposure due to foreign exchange fluctuations. How will this affect the audit engagement?

  1. A) control risk will increase
  2. B) inherent risks of error will decrease
  3. C) risk of material misstatement increases
  4. D) audit risk will be increased

Answer:  C

Diff: 2     Type: MC     Page Ref: 415

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

 

14) In the sales and collection cycle, the results of the tests of controls determine

  1. A) the extent to which planned detection risk is satisfied for each accounts receivable objective.
  2. B) whether assessed control risk for sales and cash receipts needs to be revised.
  3. C) if tests of details of balances need to be performed.
  4. D) whether positive or negative confirmations should be used for this engagement.

Answer:  B

Diff: 2     Type: MC     Page Ref: 415

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

 

 

15) You are the auditor for GreenAcres, a non-profit home for homeless elderly. GreenAcres has a December 31 year end. It receives government funding, and also relies upon donations for revenue. GreenAcres has a major funding drive in November, when it collects pledges by means of activities at a garage sale, a walkathon, and fall bake sale events in the community.

 

During late February you had a meeting with Ellen Famous, the President of GreenAcres, at the organization’s premises. Ellen reviews and approves bank statements and is the second and final cheque signer. Two other accounting staff have the following responsibilities:

 

  • Paul approves pledge write-offs (which normally average about 15%), opens the mail, endorses cheques received in the mail, prepares and delivers bank deposits, and posts transactions into the accounting system.

 

  • Diana, a retired bookkeeper, volunteers about 10 hours per week to reconcile the bank account, review journal entries posted to the general ledger, and prepare payroll and accounts payable transactions for processing.

 

Ellen normally reviews pledge write-offs, but was very busy in February, so she took a look while you were there. To her surprise, she found that about 40% of the pledges had been written off. She asked Diana to investigate, and Diana found that most of the write-offs had actually been paid.

 

Required:

  1. A) What are possible causes of the inconsistency with the pledge write-offs?
  2. B) What are the weaknesses in internal control that could allow the excess write-offs to occur? Provide recommendations for improvement.
  3. C) Identify audit procedures that you would complete to quantify any potential misstatement with respect to the pledges receivable balance as at December 31.

 

Answer:

  1. A) The inconsistency could be due to either fraud (Paul stealing the funds) or error, i.e. too many accounts written off.
  2. B) Paul controls the cash and cheques received, deposits the funds into the bank and records the amounts in the accounting system. He has control over the physical assets (the cheques and cash) and the accounting records. He could receive a cheque, deposit it in his own account, and write it off.

Recommendations for improvement:

  • Write-offs should be approved by Ellen (as she is independent of the custody of the assets and of accounting).
  • Mail should be opened by an independent individual, perhaps a volunteer.
  • Cheques should be restrictively endorsed by the mail opener (stamped with the GreenAcres stamp).
  • Custody of the cash and cheques should be separated from the accounting – perhaps Ellen could take these amounts to the bank.
  • Bank deposit amounts should be agreed to the accounting records (cash receipts listing).

 

  1. C) In the absence of a suspicion of fraud, the auditor would likely limit testing of pledges to testing of subsequent cash receipts and tracing of unpaid amounts to either a pledges receivable register or to a write-off listing.

With the suspicion of fraud, the auditor might consider extended procedures such as confirmation with individual donors with respect to the amount of their pledges and whether these amounts have been paid or not (similar to positive confirmations of accounts receivable).

Diff: 3     Type: ES     Page Ref: 413-415

Learning Obj.:  13-1  Identify and describe the risk-based process for designing tests of details of balances for accounts receivable

13.2   Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

1) Comparing bad debt expense as a percentage of gross sales with previous years will detect what kind of possible misstatement?

  1. A) cut-off errors in recording cash receipts
  2. B) overstatement of sales and accounts receivable
  3. C) understatement of sales and accounts receivable
  4. D) understatement of allowance for uncollectible accounts

Answer:  A

Diff: 3     Type: MC     Page Ref: 415

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

2) As part of audit planning, you have calculated gross margin for the last five years, and compared gross margin to industry averages. Your client’s gross margin has increased by about 5% in the current year, while the industry gross average has declined. One possible cause of this increased gross margin is

  1. A) higher cost of goods sold.
  2. B) increased bad debt expenses.
  3. C) fictitious revenue.
  4. D) fictitious expenses.

Answer:  C

Diff: 2     Type: MC     Page Ref: 416

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

 

3) As part of audit planning, you have calculated gross margin for the last five years, and compared gross margin to industry averages. Your client’s gross margin has increased by about 5% in the current year, while the industry gross average has declined. One possible cause of this increased gross margin is

  1. A) higher cost of goods sold.
  2. B) increased bad debt expenses.
  3. C) premature revenue recognition.
  4. D) fictitious expenses.

Answer:  C

Diff: 2     Type: MC     Page Ref: 416

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

4) As part of audit planning, you have calculated accounts receivable turnover for the last five years, and compared it to industry averages. Your client’s accounts receivable has decreased by about 1.25 times in the current year, while the industry rate has improved. One possible cause of this lowered accounts receivable turnover is

  1. A) higher cost of goods sold.
  2. B) increased bad debt expenses.
  3. C) fictitious revenue.
  4. D) fictitious expenses.

Answer:  C

Diff: 2     Type: MC     Page Ref: 416

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

5) Analytical procedures are substantive tests and, if the results of the analytical procedures are favourable, they will reduce

  1. A) the extent of tests of details of balances.
  2. B) the extent of tests of controls.
  3. C) the analytical procedures.
  4. D) all of the other tests.

Answer:  A

Diff: 2     Type: MC     Page Ref: 417

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

6) Comparison of individual customer balances with previous years will detect what type of possible misstatement?

  1. A) misstatement in gross profit and bad debt expense
  2. B) overstatement or understatement of bad debt expense
  3. C) overstatement or understatement of allowance for uncollectible accounts
  4. D) misstatements in accounts receivable and related income statement accounts

Answer:  D

Diff: 3     Type: MC     Page Ref: 417

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

 

7) Stefano is performing a review of the accounts receivable for large and unusual amounts. Of the following accounts receivables, Stefano should pay special attention to an account receivable

  1. A) from a related party.
  2. B) for a large dollar amount.
  3. C) recorded close to year end.
  4. D) that is recurring.

Answer:  A

Diff: 3     Type: MC     Page Ref: 418

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

8) Discuss three examples of analytical procedures an auditor might perform while auditing the sales and collection cycle. Also discuss the potential misstatement(s) that may be revealed by each analytical procedure.

Note: students could also be asked to separately discuss ratios for planning and ratios as substantive tests.

Answer:  Analytical procedures applicable to the audit of the sales and collection cycle, and possible misstatements, include:

 

ANALYTICAL PROCEDURE

 

POSSIBLE MISSTATEMENT

 

Compare gross margin percentage with previous years. Overstatement or understatement of sales and accounts receivable.
Compare sales by month over time.

 

Overstatement or understatement of sales and accounts receivable.
Compare sales returns and allowances as a percentage of gross sales with previous years. Overstatement or understatement of sales returns and allowances and accounts receivable.
Compare individual customer balances over a stated amount with previous years. Misstatements in accounts receivable and related income statement accounts.
Compare bad debt expense as a percentage of gross sales with previous years. Uncollectible accounts receivable that have not been provided for.

 

Compare number of days that accounts receivable are outstanding with previous years. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.
Compare aging categories as a percentage of accounts receivable with previous years. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.
Compare allowance for uncollectible accounts as a percentage of accounts receivable with previous years. Overstatement or understatement of allowance for uncollectible accounts and bad debt expense.

Diff: 2     Type: ES     Page Ref: 415-418

Learning Obj.:  13-2  Explain when and why analytical review procedures are completed as part of the audit of sales and accounts receivable

13.3   Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

1) Glee Inc. is a manufacturer of musical instruments and its year end is September 30th. Copa Loca, a local music school, has purchased some instruments from Glee, but was not satisfied with the quality and returned the goods to Glee during the last week of September. Being very busy with year end, Glee received the goods from Copa Loca on September 30th, but only processed the returned merchandised and issued a credit note in October. This represents a

  1. A) cut-off (allocation) misstatement.
  2. B) understandability misstatement.
  3. C) significant misstatement.
  4. D) classification misstatement.

Answer:  A

Diff: 2     Type: MC     Page Ref: 418

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

2) Which of the following presentation and disclosure related audit objectives has a matching transaction related audit objective, but not a matching balance-related audit objective?

  1. A) accuracy
  2. B) classification
  3. C) occurrence
  4. D) completeness

Answer:  B

Diff: 2     Type: MC     Page Ref: 418, 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

3) Which of the following presentation and disclosure related audit objectives does not have a parallel audit objective for both the transaction related audit objectives and balance-related audit objectives?

  1. A) allocation
  2. B) classification
  3. C) understandability
  4. D) rights and obligations

Answer:  C

Diff: 2     Type: MC     Page Ref: 418, 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

4) The most important test of details of balances to determine the existence of recorded accounts receivable is

  1. A) tracing sales entries to shipping documents.
  2. B) tracing the credits in accounts receivable to bank deposits.
  3. C) tracing sales returns entries to credit memos issued and receiving room reports.
  4. D) sending external confirmations of customers’ balances.

Answer:  D

Diff: 2     Type: MC     Page Ref: 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

5) A common way to evaluate the adequacy of the bad debt allowance is to

  1. A) review the results of tests of controls that are concerned with the client’s credit policy.
  2. B) inspect carefully the noncurrent accounts on the aged trial balance to determine which ones have not been paid subsequent to the balance sheet date.
  3. C) examine the program logic that is used to prepare the aged trial balance and to monitor the implementation of credit policies.
  4. D) send positive confirmations to all accounts with balances over 90 days based upon the aged trial balance.

Answer:  B

Diff: 3     Type: MC     Page Ref: 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

6) As part of the audit testing, the auditor is conducting substantive analytical review over time (trend analysis) of bad debts to evaluate the quality of the accounts receivable. Which audit assertion is this associated with?

  1. A) valuation
  2. B) classification
  3. C) rights and obligations
  4. D) occurrence

Answer:  A

Diff: 3     Type: MC     Page Ref: 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

7) The auditor has elected to conduct the following audit tests: reperform addition of the aged accounts receivable trial balance for the total column and for the columns depicting the aging. Which audit objective is associated with these audit tests?

  1. A) valuation
  2. B) classification
  3. C) accuracy
  4. D) occurrence

Answer:  C

Diff: 3     Type: MC     Page Ref: 421

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

8) The auditor would like to conduct dual purpose tests verifying that the programs performing the totaling and aging of accounts receivable are functioning correctly as well as quantifying any error. Which of the following is a dual purpose test that the auditor could use?

  1. A) use analytical review and compare amounts from current to prior
  2. B) inquire how the calculations are performed
  3. C) use test data and observe how the invoice(s) of the test are aged
  4. D) use generalized audit software to reperform the calculations

Answer:  D

Diff: 2     Type: MC     Page Ref: 421

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

9) When the client’s internal control structure is adequate, the cutoff can usually be verified by

  1. A) the client’s representation letter.
  2. B) inquiries of the controller.
  3. C) obtaining the last shipping document number of the year and comparing it with current and subsequent period recorded sales.
  4. D) confirmation of the receivable for the last recorded sale.

Answer:  C

Diff: 2     Type: MC     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

10) Celebra sold some goods to Frankfurt Corp. Frankfurt sent a cheque to Celebra to pay for the goods on December 24th. Celebra received the check on January 4th. At December 31st, Celebra still showed an account receivable from Frankfurt while Frankfurt no longer had an account payable to Celebra. This situation represents a

  1. A) cut-off error.
  2. B) timing difference.
  3. C) error in presentation.
  4. D) lack of communication between the two companies.

Answer:  B

Diff: 3     Type: MC     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

11) If the internal controls for recording sales returns and allowances are evaluated as ineffective,

  1. A) a larger sample is needed to verify cutoff.
  2. B) sampling is not appropriate.
  3. C) all sales returns must be traced to supporting documentation.
  4. D) all sales returns must be confirmed with the customer.

Answer:  A

Diff: 2     Type: MC     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

12) IFRS, ASPE and ASNPO require that related party transactions be disclosed. Gregorio Limited has a materiality threshold of $50,000. Which of the following standards apply to the disclosure of related party transactions for Gregorio Limited? Disclose

  1. A) all transactions that are greater than the current year’s materiality.
  2. B) all related party transactions, even those below materiality.
  3. C) those related party transactions that relate to officers or directors of the corporation.
  4. D) those related party transactions that could affect the decisions of a user.

Answer:  B

Diff: 2     Type: MC     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

13) If accounts receivable accounts with credit balances are significant, they should be

  1. A) written off.
  2. B) reclassified as accounts payable.
  3. C) corrected by making adjusting entries.
  4. D) moved to the debit side.

Answer:  B

Diff: 2     Type: MC     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

14) Trade accounts receivable should exclude

  1. A) accounts receivables denominated in foreign currencies.
  2. B) past-due accounts receivable.
  3. C) related party accounts receivable.
  4. D) accounts receivable of clients entitled to receive discounts.

Answer:  C

Diff: 3     Type: MC     Page Ref: 423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

15) One of the most important test of details of balances for accounts receivable is

  1. A) recalculation of the aged receivables and uncollectible accounts.
  2. B) confirmations.
  3. C) tracing from shipping documents to journals to the accounts receivable ledger.
  4. D) tracing credit memos for returned merchandise to receiving room reports.

Answer:  B

Diff: 2     Type: MC     Page Ref: 423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

16) Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide evidence concerning the

  1. A) collectability of the balances confirmed.
  2. B) ownership of the balances confirmed.
  3. C) existence of the balances confirmed.
  4. D) internal control over balances confirmed.

Answer:  C

Diff: 2     Type: MC     Page Ref: 423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

17) Confirmation is most likely to be a relevant form of evidence with regard to assertions about accounts receivable when the auditor has concerns about the accounts receivable’s

  1. A) valuation.
  2. B) classification.
  3. C) existence.
  4. D) completeness.

Answer:  C

Diff: 2     Type: MC     Page Ref: 423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

18) The primary purpose of accounts receivable confirmation is to satisfy the

  1. A) existence objective.
  2. B) existence and cutoff objectives.
  3. C) accuracy and cutoff objectives.
  4. D) existence, accuracy, and cutoff objectives.

Answer:  D

Diff: 3     Type: MC     Page Ref: 423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

19) There are two important assumptions that underly the auditor’s use of external confirmations. The first is that the person returning the confirmation is independent of the company and so will provide an unbiased response. The second is that

  1. A) only authorized employees of the company have prepared the response.
  2. B) the person completing the response has carefully checked the data being confirmed.
  3. C) the respondent has not been coerced or bribed to respond to the confirmation.
  4. D) adequate controls exist at the client company to prevent unauthorized responses.

Answer:  B

Diff: 3     Type: MC     Page Ref: 424

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

20) A communication addressed to the debtor requesting him or her to confirm whether the balance as stated on the communication is correct or incorrect is a

  1. A) legal confirmation.
  2. B) negative confirmation.
  3. C) positive confirmation.
  4. D) bank confirmation.

Answer:  C

Diff: 1     Type: MC     Page Ref: 424

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

21) A positive confirmation is more reliable evidence than a negative confirmation because

  1. A) the auditor has a document which can be used in court.
  2. B) follow-up procedures can be performed if a response is not received from the debtor.
  3. C) the debtor’s lack of response indicates agreement with the stated balance.
  4. D) fewer confirmations can be sent out.

Answer:  B

Diff: 2     Type: MC     Page Ref: 425

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

22) Negative confirmations of accounts receivable is less effective than positive confirmations of accounts receivable because

  1. A) a majority of recipients usually lack the willingness to respond objectively.
  2. B) some recipients may report incorrect balances that require extensive follow-up.
  3. C) the auditor cannot infer that all nonrespondents have verified their account information.
  4. D) negative confirmations do not produce evidential matter that is statistically quantifiable.

Answer:  C

Diff: 2     Type: MC     Page Ref: 425

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

23) The auditor obtains corroborating audit evidence for accounts receivable by using positive or negative confirmation requests. Under which of the following circumstances might the negative form of the accounts receivable confirmation be useful?

  1. A) A substantial number of accounts are in dispute.
  2. B) Internal control over accounts receivable is ineffective.
  3. C) Client records include a large number of relatively small balances.
  4. D) The auditor believes that recipients of the requests are unlikely to give them consideration.

Answer:  C

Diff: 2     Type: MC     Page Ref: 425

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

24) Which one of the following circumstances would indicate that positive confirmations should be used on this engagement?

  1. A) A significant portion of the total accounts receivable balance is represented by a small number of accounts with large balances.
  2. B) The internal control over accounts receivable is good.
  3. C) The recipients are mostly businesses rather than individuals.
  4. D) The auditor is unaware of disputed or inaccurate accounts.

Answer:  A

Diff: 2     Type: MC     Page Ref: 426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

25) The use of the negative (as opposed to the positive) form of receivables confirmation is indicated when

  1. A) internal control surrounding accounts receivable is considered to be ineffective.
  2. B) there is reason to believe that a substantial number of accounts may be in dispute.
  3. C) a large number of small balances are involved.
  4. D) accounts receivable consists of current balances only.

Answer:  C

Diff: 2     Type: MC     Page Ref: 426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

26) Beltrand, PA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents’ delinquent property taxes or receivables over the due date. The internal controls at the municipality are weak. To determine the existence of the accounts receivable balances at the balance sheet date, Beltrand would most likely

  1. A) send positive confirmation requests.
  2. B) send negative confirmation request.
  3. C) examine evidence of subsequent cash receipts.
  4. D) inspect the internal records such as copies of the tax invoices that were mailed to the residents.

Answer:  A

Diff: 2     Type: MC     Page Ref: 425-426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

27) The most reliable evidence from confirmations is obtained when they are sent

  1. A) several months before the year-end, so the auditor will have adequate time to perform alternate procedures if they are required.
  2. B) at various times throughout the year to different sections of the sample, so that the entire sample is representative of account balances scattered throughout the year.
  3. C) as close to the balance sheet date as possible.
  4. D) at various times throughout the year to the same group in the sample, so that the sample will not have a time bias.

Answer:  C

Diff: 3     Type: MC     Page Ref: 426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

28) Frag Jones Company has a December year end, with a tight reporting deadline, so the auditors confirmed the accounts receivable as of November 30 using positive confirmations. In addition to following up confirmation discrepancies, the auditor should

  1. A) test December transactions.
  2. B) send negative confirmations as of the end of December.
  3. C) text November transactions.
  4. D) do cut-off testing for the month of October.

Answer:  A

Diff: 3     Type: MC     Page Ref: 426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

29) After the items for confirmation have been selected, the auditor must maintain control of the confirmations until

  1. A) the names are provided to client’s personnel to type the envelopes.
  2. B) the sealed envelopes are provided to client’s personnel to be mailed.
  3. C) the responses are received by the client with the return mail.
  4. D) they are returned by the debtor to the auditor.

Answer:  D

Diff: 2     Type: MC     Page Ref: 427-428

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

30) An auditor should perform alternative procedures to substantiate the existence of accounts receivable when

  1. A) no reply to a positive confirmation request is received.
  2. B) no reply to a negative confirmation request is received.
  3. C) collectability of the accounts receivable is in doubt.
  4. D) pledging of the accounts receivable is probable.

Answer:  A

Diff: 2     Type: MC     Page Ref: 428

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

31) Positive accounts receivable confirmations were circularized, and there were many differences where the client stated that the goods had not been received as of the date of the confirmation. In addition to the possibility that the goods were not received by the client, this type of reported difference could be an indication of

  1. A) a cutoff misstatement.
  2. B) timing differences with respect to recording sales returns.
  3. C) improper recording of sales allowances.
  4. D) theft of cash or lapping.

Answer:  A

Diff: 3     Type: MC     Page Ref: 428

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

32) State the five specific balance-related audit objectives as applied to accounts receivable.

Answer:  The five specific balance-related audit objectives as applied to accounts receivable are:

The accounts receivable on the aged accounts receivable trial balance exist. (existence)

 

The accounts receivable are valid receivables that are due to the company. (rights and obligations)

 

All existing accounts receivable have been included in the records, and are fully summarized and posted. (completeness)

 

Accounts receivable are stated at net realizable value, with any valuation adjustments appropriately recorded. (valuation)

 

Accounts receivable balances are appropriately recorded (accurately, in the correct period, in the correct account), including any related adjustments. (allocation)

Diff: 2     Type: ES     Page Ref: 418

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

33) You are the auditor of Foundry Inc., a company that manufactures chocolate bars and assorted candies. The description of the sales and collection cycle for Foundry is as follow:

 

Clients & Credit Limits

Foundry has 50 clients as they mostly sell to grocery stores’ central purchasing departments or distributors. For each customer, Foundry performs a credit check prior to setting the credit limit for the client. The credit limit is reviewed each year.

In the past year, the credit limits were increased by 10%. This is due to the growth in product lines of Foundry and increased demand from customers. This also came at the same time the CEO of Foundry set the objective of growing the company’s revenue by 25% over the next two years. Increasing the credit limit has helped Foundry move towards that objective.

 

Allowance for Doubtful Accounts

The allowance for doubtful accounts is calculated by the controller by taking a percentage of the total sales for the month. The controller has been taking 3% of total sales. The estimate has not been revised in the current year, but it has always been sufficient to cover for any write-off incurred.

 

Required: For each of the two areas discussed above, identify the risk areas and the most likely misstatements for Foundry.

Answer:

Clients and Credit Limits

– Risk is mitigated because Foundry does not have a large number of clients.

– However, risk increased in the current year as the credit limits have been increased. Since all credit limits were increased by 10%, it is probable that some clients did not deserve such an increase and, as a result, increases the likelihood that accounts receivable will not be collected.

– The information that the CEO is setting an aggressive goal for growth also places more pressure on management to increase sales and accounts receivable as a result. This increases overall audit risk and should be considered in the audit.

 

Allowance for doubtful accounts

– Valuation requires professional judgment to determine if the balance is sufficient or if it is too large. In the case of Foundry, the risk appears to be high as there was no formal review of the percentage done this year. Given that the credit limits were increased this year is an indication that a review should have been performed. Further, the fact that the provision has been sufficient for the accounts written off in the prior year is not sufficient to conclude that the process is adequate. Some accounts relating to this period might have to be written off in the following period or it could also be that the current provision is too high.

Diff: 3     Type: ES     Page Ref: 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

34) Discuss the alternative procedures an auditor can perform to test the existence objective for accounts receivable when customers do not respond to confirmation requests.

Answer:  For any positive confirmation not returned, the auditor can examine the following to verify the existence of individual sales transactions making up the ending balance in accounts receivable:

  • Subsequent cash receipts-evidence of the receipt of cash subsequent to the confirmation date includes examining remittance advices and entries in the cash receipts records.
  • Duplicate sales invoices.
  • Shipping documents.
  • Correspondence between the customer and the client.

Diff: 2     Type: ES     Page Ref: 428

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

35) A) An auditor is concerned that accounts receivable may be understated due to sales to customers that have been omitted from the sales journal and from the accounts receivable master file. Describe the procedure(s) the auditor should perform in these circumstances.

 

  1. B) Describe how the auditor tests the classification objective for accounts receivable.

 

Answer:

  1. A) The understatement of sales and accounts receivable is best uncovered by substantive tests of transactions for shipments made but not recorded by tracing from a sample of shipping documents (bills of lading) to the sales journal to verify that each shipment has been recorded. (Note: this test is described in Chapter 12.)
  2. B) The classification objective is tested by reviewing the aged trial balance for material amounts receivable from affiliates, officers, directors, or other related parties. If notes receivable or accounts that should not be classified as a current asset are included with the regular accounts, these should also be segregated. Finally, if credit balances in accounts receivable are significant, it is appropriate to reclassify them as accounts payable.

Diff: 3     Type: ES     Page Ref: 422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

36) A) Assuming the client’s internal controls are adequate, describe how the auditor can verify proper cutoff of sales transactions.

 

  1. B) Describe how the auditor tests the rights objective for accounts receivable.

 

Answer:

  1. A) Assuming the client’s internal controls are adequate, the auditor can verify proper cutoff of sales transactions by obtaining the shipping document number for the last shipment made at the end of the period and comparing this number with current and subsequent period recorded sales.
  2. B) The auditor can test the rights objective for accounts receivable by reviewing the client’s minutes, discussions with the client, confirmation with banks, and the examination of correspondence files to determine whether accounts receivable may have been pledged as collateral, assigned to someone else, factored, or sold.

Diff: 2     Type: ES     Page Ref: 420-422

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

37) A) Describe the differences between positive and negative confirmations. Which type is more reliable?

 

  1. B) Discuss the advantages and disadvantages of using negative accounts receivable confirmations rather than positive confirmations.

 

  1. C) Discuss the circumstances in which it is acceptable to use negative confirmation requests.

 

  1. D) The auditor’s decision regarding the type of accounts receivable confirmation to use involves a continuum, starting with using no confirmations in some circumstances, to using only negatives, to using both positives and negatives, to using only positives. Discuss the primary factors affecting this decision.

 

Answer:

  1. A) A positive confirmation requests the recipient to respond regardless of whether the balance as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation requests the recipient to respond only if the balance as stated on the confirmation is incorrect. Positive confirmations are more reliable because the auditor can perform follow-up procedures if a response is not received from the customer and requires the customer to respond. A non-response will initiate a subsequent procedure to complete.
  2. B) The primary advantage of negative confirmations is that they are less expensive than positive confirmations because there are no second requests and no follow-up of nonresponses. The primary disadvantage of negative confirmations is that they are less reliable than positive confirmations because a nonresponse is regarded as a correct response, even though the debtor may have ignored the confirmation request.
  3. C) CAS 505 states that negative confirmation should be used only when risks of material misstatement are low and when the following are true:
  • The items to be confirmed are homogeneous (i.e., similar in nature) and comprise small account balances.
  • No or few exceptions are likely.
  • There is an expectation that the negative confirmations will be read and considered.
  1. D) The primary factors affecting the decision regarding the type of confirmation to use are the materiality of total accounts receivable, the number and size of individual accounts, control risk, inherent risk, the effectiveness of confirmations as audit evidence, and the availability of other audit evidence.

Diff: 2     Type: ES     Page Ref: 424-426

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

38) You are conducting an audit and have obtained the following figures with respect to sales and accounts receivable:

 

2012                2011

 

Accounts receivable                     $ 3,343,000     $ 2,694,000

Allowance for doubtful accounts      212,150           207,660

Sales                                              25,640,000      24,630,000

 

Required:

 

  1. A) What are the audit implications of these figures?

 

  1. B) Identify key audit steps that you would perform for any of the above accounts.

 

Answer:

  1. A) Accounts receivable has increased substantially over the prior year, where there has been only a small increase in sales. This could indicate that there is an increase in uncollectible accounts. Also, accounts receivable has increased substantially, but there has been only a small increase in the allowance for doubtful accounts. This could mean that there is an increased risk of misstatement in the allowance for doubtful accounts.
  2. B) Additional work should be performed on the allowance for doubtful accounts. The following techniques are suggested:
  • Test the accuracy of the aged trial balance.
  • Review the aged trial balance for unusually old amounts.
  • Review the older amounts in the aged trial balance (perhaps over 90 days) for large amounts or for customers that have not made any payments.
  • Test subsequent receipts after year end.
  • Confirm old and large accounts receivable amounts.

Diff: 3     Type: ES     Page Ref: 420

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

39) Following are three different situations with respect to the audit of accounts receivable and sales. For each, specify the evidence mix that you would use (tests of control, substantive tests, type of confirmation/timing), and explain why.

 

  1. A) The client is in a volatile industry, selling products that can quickly become technically obsolete. Total accounts receivable is $65 million, with a bad debt allowance of $7 million. The company has recently laid off three accounting staff to save money.

 

  1. B) A small company has 45 different customers, with balances ranging from $500 to $25,000 per customer. There is one accountant on staff, and a professional accountant comes in once per week for three hours to review the work and prepare journal entries. Bad debts are rare, as the owner is actively involved in accounts receivable collection.

 

  1. C) Big Department Store Finance Corporation has fifty staff in the accounting department, a sophisticated software package, and about $250 million in accounts receivable. The corporation manages the department store credit cards. About 100,000 credit card customers have balances less than $300 on their accounts, while the balances for the remaining customers range up to a maximum of $5,000.

 

Answer:

  1. A) It is likely that internal controls are poor, due to the reduction in accounting staff. Accordingly, substantive tests would be increased, particularly of the bad debt allowance, which is high (more than 10% of total accounts receivable). Positive confirmations would be used, since it is likely that the amounts due to individual customers could be large. Due to the lack of internal controls, confirmations would need to be sent at year end.
  2. B) Since the owner is actively involved in accounts receivable, the likelihood of misstatement from the accounting staff is low. However, the potential for management override (and collection of cash for personal use) is high. Thus, there would be no reliance on internal controls, and substantive tests only would be conducted. Positive confirmations of larger balances would be sent as of the year end date.
  3. C) Since there are likely excellent internal controls, a combined audit approach can be used (internal controls testing and substantive tests). Confirmations could be sent prior to the year end date, if needed. Negative confirmations would likely be used, as the amounts are all small, particularly for the 100,000 accounts that are less than $300.

Diff: 3     Type: ES     Page Ref: 424-427

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

40) Your audit client is a large retail chain with its own credit card, with annual sales of about $100 million. On December 31, there were approximately 40,000 open accounts with total receivables of approximately $18.5 million. Very few customer balances exceed $1,000. The company’s general office maintains the accounts receivable records. The large volume of transactions processed by the company has necessitated extensive segregation of duties and frequent balancing of data during processing. Accordingly, the company’s general and system controls are considered to be very good. A complete record of each customer’s account is stored on a relational database and includes the following information:

 

Description of field contents

Type of account (personal, corporate)            Customer account number

Customer name and address                           Credit limit (code for 8 credit levels)

Status code (Active, inactive, bad debt)        Number of transactions this month

Current month’s charges                                 Current month’s payments

Total Outstanding Balance                             Aged balance over 30 days

Aged balance over 60 days                             Aged balance over 90 days

Aged balance over 120 days                           Year account opened

Year last active                                               Total purchases this year to date

Total returns this year to date                         Number of months active

Total purchases last year                                 Number of months active last year

 

Source transactions are store purchase invoices, payments, and adjustments. Daily, all the orders are received and entered into the computer and processed against the customer master file. Each account is updated and automatically analyzed to determine whether the transactions just processed have created a condition that should be brought to the attention of the authorization or collection sections. Exception reports are automatically printed and forwarded to these groups.

The company sends monthly statements to customers on a cyclical basis. About 2,000 statements are mailed each billing day. As the accounts are updated, the day’s transactions are accumulated and added to the starting control figure for each cycle. The new control figures are balanced with the sum of all the individual accounts in the cycle (accumulated as each account is processed). In addition, a detailed transaction and cycle control report is prepared, providing an audit trail in customer account number sequence.

 

Required:

Describe the audit procedures you would perform in your year end audit work of accounts receivable for this company. For each audit test, state the relevant audit assertion(s). Be sure to include different types of tests as necessary (e.g. manual, or using computer assisted audit techniques), and clearly identify those tests that can be completed using CAATs.

Answer:  There are many possible valid answers for this question. One appropriate method would be to organize by audit assertion. Following are all substantive tests (normally year end tests of accounts receivable would be substantive). Those that can be completed using CAATs are marked with an *.

Analytical review:

– * compare totals, bad debts, significant customers to prior periods

– * statistical analysis (e.g. regression) for a number of fields, e.g. balances, payments, returns


Completeness Assertion:

– * add the file and compare the total to the general ledger balance for accounts receivable

– * extract large/unusual balances for confirmation or for other follow up

– * discuss with client the cyclical billing process. Gain an understanding on weather this impacts cut-off in anyway and if it provides consistent and reasonable results on an annual basis

– * estimate unbilled amounts as at the end of the year.

Accuracy Assertion:

– * select a sample of customers for confirmation:

– * stratify by size/nature of customer

– * will need to tie into cycle billing process

– * look for duplicates: address of customer or customer names

Valuation (and existence) assertions:

– * analysis of ratio of returns/purchase, especially in new year

– * analysis of inactive accounts: balances should be zero

– * look at customer balances that exceed credit limit

– * look at accounts where there has been no payment in the last 30 days – could identify a potential bad debt

– * subsequent payments for confirmed accounts (may need to be manual)

– * recalculate the bad debt allowance and compare to statistics for reasonableness

– * look for credit balances and consider reclassification to accounts payable

Existence Assertion:

– * trace a sample of shipping documents to sales invoices and to the balances in the accounts receivable master file

Diff: 3     Type: ES     Page Ref: 420-423

Learning Obj.:  13-3  Describe the accounts receivable tests of detail audit tests that would be completed for each audit assertion

 

 

13.4   Illustrate the risk assessment and substantive tests of accounts receivable using Hillsburg Hardware Limited

 

1) In monetary-unit sampling, the values of the estimated likely maximum misstatements are referred to as the

  1. A) point estimates.
  2. B) precision intervals.
  3. C) confidence intervals.
  4. D) misstatement bounds.

Answer:  D

Diff: 3     Type: MC     Page Ref: 437

Learning Obj.:  13-4  Illustrate the risk assessment and substantive tests of accounts receivable using Hillsburg Hardware Limited

 

2) When errors are found, a common and standard assumption in practice is to assume

  1. A) a 100% assumption for all errors.
  2. B) that the actual sample errors are representative of the population errors.
  3. C) that the population errors are larger than the sample errors.
  4. D) that the population errors are smaller than the sample errors.

Answer:  B

Diff: 2     Type: MC     Page Ref: 438

Learning Obj.:  13-4  Illustrate the risk assessment and substantive tests of accounts receivable using Hillsburg Hardware Limited

 

3) Whenever a statistical method is used, a decision rule determines whether the population is acceptable. The decision rule for dollar-unit sampling is “Accept the conclusion that the book value is not misstated by a material amount if

  1. A) the upper error bound falls between the understatement and overstatement tolerable misstatement amounts.”
  2. B) both the lower and upper error bound falls between the understatement and overstatement tolerable misstatement amounts.”
  3. C) both the understatement and overstatement tolerable misstatement amounts fall between the upper and lower error bound.”
  4. D) the overstatement tolerable misstatement amount falls between the lower and upper error bound.”

Answer:  B

Diff: 3     Type: MC     Page Ref: 442

Learning Obj.:  13-4  Illustrate the risk assessment and substantive tests of accounts receivable using Hillsburg Hardware Limited

 

Auditing, 12e (Arens)

Chapter 21   Assurance Services: Review and Compilation Engagements

 

21.1   Describe how assurance engagement general standards are different from and similar to audit standards

 

1) “An engagement where, pursuant to an accountability relationship between two or more parties, a practitioner is engaged to issue a written communication expressing a conclusion concerning a subject matter for which the accountable party is responsible” is the definition of a(n)

  1. A) audit engagement.
  2. B) assurance engagement.
  3. C) review engagement.
  4. D) compilation engagement.

Answer:  B

Diff: 2     Type: MC     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

2) “An engagement where the practitioner expresses a conclusion on a written assertion about a subject prepared by a party accountable for the assertion, such as management” is the definition of a(n)

  1. A) audit engagement.
  2. B) attestation engagement.
  3. C) review engagement.
  4. D) assurance engagement.

Answer:  B

Diff: 2     Type: MC     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

3) You have just signed off the audit report on the financial statements of your client. What type of engagement did you complete?

  1. A) Review
  2. B) Direct reporting
  3. C) Attest and assurance
  4. D) Operational

Answer:  C

Diff: 3     Type: MC     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

 

4) Thermos Inc. is having its financial statements audited by Pilott & Levy, a PA firm.  Leon Levy is the auditor in charge of the audit.  The accountable party in this assurance engagement is

  1. A) Leon Levy.
  2. B) Pilott & Levy.
  3. C) management of Thermos Inc.
  4. D) the board of directors of Thermos Inc.

Answer:  C

Diff: 2     Type: MC     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

5) The Federal Auditor General provides the results of operational audits to Parliament in Auditor General reports. What type of engagements are these?

  1. A) direct reporting
  2. B) attest engagement
  3. C) review engagement
  4. D) compilation engagement

Answer:  A

Diff: 2     Type: MC     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

6) Locker Building is a new apartment building in a Vancouver suburb.  In order to receive a subsidy from the municipality, it needs to prove that it has complied with the city’s new rules about “green efficiency”.  The “green efficiency” rules are described on the municipality’s website and list the requirements a building must meet to be considered green and efficient.  Your firm, with the help of an environmental scientist, has been asked to perform a direct reporting engagement for Locker building.  The suitable criteria in this case are the

  1. A) green efficiency rules.
  2. B) auditor’s judgment.
  3. C) environmental scientist’s judgment.
  4. D) federal environmental laws.

Answer:  A

Diff: 3     Type: MC     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

7) For the conduct of an assurance engagement, the practitioner is required to identify or develop criteria to evaluate the subject matter. Identify some characteristics of suitable criteria.

  1. A) relevance, reliability, neutrality, understandability, completeness
  2. B) reliability, accuracy, neutrality, timeliness
  3. C) understandability, completeness, timeliness, free from bias
  4. D) completeness, timeliness, free from bias, competent

Answer:  A

Diff: 3     Type: MC     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

8) In addition to having modifications of wording for the financial statement audit opinion, other types of opinions can have modifications as well. Which one of the following describes a situation where there would be a qualification or disclaimer of opinion for a direct reporting engagement? The

  1. A) subject matter does not conform to the criteria.
  2. B) information is not presented fairly.
  3. C) practitioner conducted alternative procedures where there was a scope limitation.
  4. D) practitioner and management disagree about the content of the report.

Answer:  A

Diff: 3     Type: MC     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

9) Leon Levy, a partner at the audit firm where you work, asked you to work on the audit of the balance sheet of Geminy Corp.  Geminy is not a public company and has not been required to have audited financial statements in the past.  This year, due to a new bank loan, its bank requested that audited financial statements be provided.  Who are the primary users in this assurance engagement?

  1. A) Leon Levy
  2. B) The bank
  3. C) Management of Geminy Corp
  4. D) Shareholders of Geminy Corp

Answer:  B

Diff: 3     Type: MC     Page Ref: 621

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

10) What is the purpose of an auditor reporting on the effectiveness of internal control over financial reporting? To

  1. A) attest to the effectiveness and efficiency of internal controls at an organization.
  2. B) state an opinion on management’s assessment of the effectiveness of internal controls.
  3. C) provide an alternative to the operational audits conducted by internal auditors.
  4. D) state that the controls are in conformity with standards with respect to internal controls.

Answer:  B

Diff: 3     Type: MC     Page Ref: 619-621

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

 

11) An engagement for applying specified auditing procedures to financial information other than financial statements provides no assurance. This results in

  1. A) a report that can be readily tailored to any type of engagement.
  2. B) a broad set of audit procedures being conducted for specific information.
  3. C) frequent disagreement between auditor and client with respect to results.
  4. D) distribution of the report normally being restricted.

Answer:  D

Diff: 3     Type: MC     Page Ref: 621

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

12) Which of the following matters would be addressed in a report on the results of applying specified auditing procedures to financial information other than financial statements?

  1. A) An opinion with respect to the quality of the information examined
  2. B) Explanations of the differences between audit, review and special engagements
  3. C) The factual results of the procedures
  4. D) Provision of negative assurance with respect to the accounts examined

Answer:  C

Diff: 3     Type: MC     Page Ref: 621

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

13) Define “assurance engagements.”

Answer:  An assurance engagement is “an engagement where, pursuant to an accountability relationship between two or more parties, a practitioner is engaged to issue a written communication expressing a conclusion (opinion) concerning a subject matter for which the accountable party is responsible.”

Diff: 2     Type: ES     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

14) Define “attest engagements.”

Answer:  Engagements where the auditor expresses a conclusion (opinion) on a written assertion about a subject prepared by a party accountable for the assertion.

Diff: 2     Type: ES     Page Ref: 618

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

15) Define “direct reporting engagements.”

Answer:  Engagements where the auditor expresses a conclusion (opinion) on his or her evaluation of subject matter using certain criteria.

Diff: 2     Type: ES     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

 

 

16) Outline the three performance standards of CICA Handbook section 5025, “Standards for Assurance Engagements.”

Answer:

  • The work should be adequately planned, and there should be proper supervision.
  • The practitioner should consider both significance and engagement risk when planning and performing the engagement.
  • Sufficient evidence should be gathered to support the conclusion (opinion) the practitioner expresses in his or her report.

Diff: 2     Type: ES     Page Ref: 619

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards

17) As part of a loan agreement that it is thinking of obtaining, Always Quick Manufacturing Limited has decided that it will use accounts receivable and inventory as security for working capital funds.

The bank has indicated that in addition to an annual financial statement audit, that it would require quarterly assurance on the accounts receivable and inventory amounts. The type of assurance required has not been stated.

The bank has told Jose, the owner of the company, that he would need to provide a detailed inventory list and an aged accounts receivable trial balance on the fifteenth of each month for the information as at the preceding month end. Jose would like to know what his alternatives are.

 

Required:

Your partner is going to meet with Jose next week, and would like you to prepare a memo to file that will be used as part of the meeting. The memo should include a list of alternative types of engagements that could be used to provide assurance on the accounts receivable and inventory balances.

Answer:

  1. Review of Financial Information other than Financial Statements (Section 8500)

This report would provide negative assurance. Materiality would need to be set at a lower level than for the audit since it would relate only to the accounts recievable and inventory. However, less field work is required as the plausibility of the information is addressed.

  1. Report on the Results of Applying Specified Auditing Procedures to Financial Information other than Financial Statements (Section 9100).

This report does not provide any assurance, so it might not be suitable for the bank. Specific audit procedures would need to be selected and agreed upon with the client and likely the bank.

Diff: 3     Type: ES     Page Ref: 621, 626

Learning Obj.:  21-1  Describe how assurance engagement general standards are different from and similar to audit standards; 21-2  Explain the importance of review and compilation services

 

 

21.2   Explain the importance of review and compilation services

 

1) Which of the following would be required in a compilation?

  1. A) An understanding between the client and the accountant for the services to be provided
  2. B) A formal engagement letter signed by the client
  3. C) Management’s acknowledgements for its responsibility with regards to the financial statements
  4. D) A confirmation of the auditor’s independence

Answer:  A

Diff: 3     Type: MC     Page Ref: 622

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

2) A review engagement requires what amount of evidence to be accumulated?

  1. A) Minimal
  2. B) Moderate
  3. C) Extensive
  4. D) Maximum

Answer:  B

Diff: 2     Type: MC     Page Ref: 622

Learning Obj.:  21-2  Explain the importance of review and compilation services

3) Four different engagements that the auditor can complete are: compilation, bookkeeping, audit and review. Rank these engagements with respect to the level of assurance provided from highest assurance level to lowest assurance level.

  1. A) audit, review, compilation, bookkeeping
  2. B) audit, compilation, review, bookkeeping
  3. C) review, audit, compilation, bookkeeping
  4. D) review, audit, bookkeeping, compilation

Answer:  A

Diff: 3     Type: MC     Page Ref: 622

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

4) The level of assurance that is provided by the public accountant on a compilation report is

  1. A) none.
  2. B) low.
  3. C) medium.
  4. D) high.

Answer:  A

Diff: 2     Type: MC     Page Ref: 622

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

5) Which of the following components of an engagement letter would apply to both a review engagement and a compilation engagement?

  1. A) negative assurance will be provided, so there is no assurance that fraud will be detected
  2. B) no assurance will be provided, since only mathematical accuracy will be verified
  3. C) procedures used during the engagement will be limited to analytical review and inquiry
  4. D) a statement that an audit is not to be performed and that no opinion will be expressed

Answer:  D

Diff: 2     Type: MC     Page Ref: 623

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

6) Which of the following components of an engagement letter would apply to both a review engagement and a compilation engagement?

  1. A) negative assurance will be provided, so there is no assurance that fraud will be detected
  2. B) no assurance will be provided, since only mathematical accuracy will be verified
  3. C) procedures used during the engagement will be limited to analytical review and inquiry
  4. D) a statement that each page of the statements should be clearly marked “unaudited”

Answer:  D

Diff: 2     Type: MC     Page Ref: 623

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

7) Performing inquiry, analytical procedures and discussion with the limited objective of assessing whether the information being reported on is plausible within the framework of appropriate criteria, is the definition of a(n)

  1. A) compilation.
  2. B) review.
  3. C) audit.
  4. D) examination.

Answer:  B

Diff: 1     Type: MC     Page Ref: 623

Learning Obj.:  21-2  Explain the importance of review and compilation services

8) A review engagement includes

  1. A) obtaining an understanding of the internal controls.
  2. B) tests of controls or transactions.
  3. C) inquiry, analytical procedures and discussion.
  4. D) independent confirmation or physical examination.

Answer:  C

Diff: 1     Type: MC     Page Ref: 623

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

9) Before performing a review of an entity’s financial statements, an accountant should

  1. A) complete a series of inquiries concerning the entity’s procedures for recording, classifying, and summarizing transactions.
  2. B) apply analytical procedures to provide limited assurance that no material modifications should be made to the financial statements.
  3. C) obtain a sufficient level of knowledge of the accounting principles and practices of the industry in which the entity operates.
  4. D) inquire whether management has omitted substantially all of the disclosures required by generally accepted accounting principles.

Answer:  C

Diff: 3     Type: MC     Page Ref: 623

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

10) As part of the review engagement for a small manufacturing company, which of the following would be a typical review procedure for the sales cycle?

  1. A) review of internal controls over the granting of credit
  2. B) examination of sales documents to ensure credit approval is documented
  3. C) recalculation of the taxes and extensions on a sample of invoices
  4. D) comparison of sales and gross profit to the prior year

Answer:  D

Diff: 3     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

11) As part of the conduct of a review engagement, which of the following would be a typical procedure used for the assessment of the ending accounts receivable balance?

  1. A) circularization of positive confirmations to all balances exceeding materiality
  2. B) comparison of the age of the accounts receivable to the prior year
  3. C) use of negative confirmations on all large balances
  4. D) detailed examination of all accounts over 120 days to assess the bad debt allowance

Answer:  B

Diff: 3     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

12) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of inventory?

  1. A) discussion with management with respect to the costing method used
  2. B) observation of the inventory count
  3. C) observation of the warehouse, paying particular attention to dusty and damaged goods
  4. D) confirmation with customers that are holding consignment inventory with respect to quantity and condition of the inventory

Answer:  A

Diff: 3     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

13) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of accounts payable?

  1. A) sending zero balance confirmations to frequently used suppliers
  2. B) use of negative confirmations to suppliers with material balances
  3. C) comparison of the accounts payable balances by supplier to the prior year
  4. D) examination of invoices received after the year end to ensure that they were recorded in the proper period

Answer:  C

Diff: 3     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

14) You have just recently become a member of your local non-profit housing co-op by moving into the largest unit. The Board of Directors has asked that you handle the review engagement, but you are concerned about independence. What is a practical way for you to stay in the co-op but also perform the review engagement?

  1. A) Request a bylaw stating that the accountant cannot vote for Board members.
  2. B) Do a compilation rather than a review engagement.
  3. C) Have all the preparation work for the review engagement completed by a Board member.
  4. D) Include a paragraph in the review engagement report stating that you are not independent.

Answer:  A

Diff: 3     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

15) When assessing the plausibility of the financial statements for a review engagement, the auditor will use which of the following criteria for auditing a small, privately held company?

  1. A) standards of efficiency and effectiveness
  2. B) the audit objectives associated with the audit of financial statements
  3. C) an acceptable reporting framework such as ASPE
  4. D) an enterprise risk management framework, to help detect fraud

Answer:  C

Diff: 2     Type: MC     Page Ref: 624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

16) An accountant who reviews the financial statements of an entity should issue a report stating that a review

  1. A) does not constitute an audit.
  2. B) provides negative assurance that the internal control structure is functioning as designed.
  3. C) provides only limited assurance that the financial statements are fairly presented.
  4. D) is substantially more in scope than a compilation.

Answer:  A

Diff: 2     Type: MC     Page Ref: 625

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

17) When would the public accountant conduct audit procedures during a review engagement? When

  1. A) junior staff are assigned to the engagement.
  2. B) required to assess plausibility.
  3. C) it is a first time review engagement.
  4. D) a higher level of assurance is required for the bank.

Answer:  B

Diff: 3     Type: MC     Page Ref: 624-625

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

18) When conducting a review engagement, how is materiality calculated?

  1. A) materiality is not calculated as a lower level of assurance is being provided
  2. B) the concept of significance is used, rather than the concept of materiality
  3. C) always as a percentage of net income before income taxes
  4. D) in the same manner as an audit engagement

Answer:  D

Diff: 3     Type: MC     Page Ref: 625

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

19) When is negative assurance used during a review engagement?

  1. A) when the standards applicable to a review engagement have been met
  2. B) if a qualification is required during the review engagement
  3. C) when the criteria associated with a review engagement have not been satisfied
  4. D) when the practitioner is unable to set appropriate criteria for the review engagement

Answer:  A

Diff: 3     Type: MC     Page Ref: 625

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

20) Why is it important for the review engagement report to state that the review is not an audit?

  1. A) to make sure that the public accountant is not sued
  2. B) to clarify that only review engagement procedures were used during the engagement
  3. C) to make users aware that a review provides a lower level of assurance
  4. D) so that the user does not ask any unnecessary questions about the engagement

Answer:  C

Diff: 3     Type: MC     Page Ref: 625

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

21) The statement that “nothing came to our attention which would indicate that these statements are not fairly presented” expresses which of the following?

  1. A) disclaimer of an opinion
  2. B) negative assurance
  3. C) negative confirmation
  4. D) piecemeal opinion

Answer:  B

Diff: 1     Type: MC     Page Ref: 626

Learning Obj.:  21-2  Explain the importance of review and compilation services

22) The fact that a client has a material accounting departure for failure to follow ASPE would require the accountant to disclose that fact in a separate reservation paragraph, when the accountant is performing

  1. A) a compilation.
  2. B) a review and an audit.
  3. C) either a compilation or a review.
  4. D) neither a compilation nor a review, only an audit.

Answer:  B

Diff: 1     Type: MC     Page Ref: 626

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

23) Which of the following techniques would be conducted by a practitioner when conducting a review of compliance with agreements and regulations?

  1. A) use of a specialist to ensure that the terms of the agreement are complied with
  2. B) inquire about how the client monitors its compliance with the provisions
  3. C) testing control procedures throughout the year that pertain to the provisions of the agreement
  4. D) discussions with client’s legal counsel to identify any legal liabilities with respect to potential violations of the agreements

Answer:  B

Diff: 3     Type: MC     Page Ref: 626

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

24) Richard is performing a compilation engagement.  Richard is concerned that the information is

  1. A) arithmetically correct.
  2. B) accurate.
  3. C) complete.
  4. D) in accordance with ASPE.

Answer:  A

Diff: 1     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

25) A compilation presents information, in the form of financial statements, that is the representation of management. The public accountant who prepares the compilation undertakes to express

  1. A) limited assurance on the statements.
  2. B) minimal assurance on the statements.
  3. C) no assurance on the statements.
  4. D) full assurance on the statements.

Answer:  C

Diff: 2     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

26) Which one of the following engagements would most likely be a compilation engagement? An engagement with respect to financial statements

  1. A) attached to a personal tax return.
  2. B) for a large public company.
  3. C) for a company that has a large bank loan.
  4. D) that accompany future oriented information to obtain financing.

Answer:  A

Diff: 3     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

27) Which one of the following procedures would most likely be conducted by an accountant during a compilation engagement?

  1. A) Enquire of management with respect to the purpose of new capital assets.
  2. B) Compare gross profit on a year-by-year basis over the last five years.
  3. C) Circularize negative accounts receivable confirmations.
  4. D) Assemble and re-calculate the financial statement allocations.

Answer:  D

Diff: 3     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

28) The accountant is working on an engagement with respect to the client’s financial statements. Which of the following engagements would omit an assessment of the client’s accounting policies’ compliance with GAAP?

  1. A) Review
  2. B) Compilation
  3. C) Audit
  4. D) Attestation

Answer:  B

Diff: 2     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

29) Which of the following items includes criteria for accepting a compilation engagement?

  1. A) evaluation of whether the financial statements are in accordance with ASPE
  2. B) no reason to believe that the financial statements are false or misleading
  3. C) completion of an independence threat analysis, ensuring that there are no threats to independence
  4. D) completion of a client risk analysis, with the conclusion that risks are low

Answer:  B

Diff: 3     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

30) A public accounting firm can issue a compilation report

  1. A) only if the partners are independent.
  2. B) only if all the partners and the staff in the office performing the engagement are independent.
  3. C) if the partners have no material or direct immaterial interest in client.
  4. D) even if it is not independent.

Answer:  D

Diff: 1     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

31) You are a public accountant retained by the manager of a cooperative retirement village to do “write-up work.” You are expected to prepare unaudited financial statements with each page marked “unaudited” and accompanied by a disclaimer of opinion stating no audit was made. In performing the work, you discover that there are no invoices to support $25,000 of the manager’s claimed disbursements. The manager informs you that all the disbursements are proper. What should you do?

  1. A) Submit the expected statements but omit $25,000 of unsupported disbursements
  2. B) Include the unsupported disbursements in the statements since you are not expected to make an audit
  3. C) Obtain, from the manager, a written statement that you informed him of the missing invoices and include his assurance that the disbursements are proper
  4. D) Obtain further information about the $25,000 unsupported items and withdraw if the situation is not satisfactorily resolved

Answer:  D

Diff: 2     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

32) Which one of the following is a professional standard that must be followed by an accountant when conducting a compilation engagement?

  1. A) work being adequately planned and properly executed
  2. B) having adequate technical training and proficiency in auditing
  3. C) obtaining an adequate understanding of the business and its industry
  4. D) documenting the processes used to compile and record transactions

Answer:  A

Diff: 3     Type: MC     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

33) A financial statement review emphasizes four broad areas, one of which is to “Perform analytical procedures.” State the other three areas emphasized.

Answer:

  • Obtain knowledge of the client’s business.
  • Have discussions with management concerning information received and the information being reported on.
  • Make inquiries of client personnel to determine whether the financial statements are fairly presented.

Diff: 2     Type: ES     Page Ref: 623-624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

34) Yvan is preparing the audit plan for Share the Wealth, a non-profit organization.  Share the Wealth is a large Montreal based organization and receives corporate donations and also has many stores that collect and re-sell costume jewelry and clothing.  The purpose of the organization is to build recreation areas for children in less fortunate areas of the city.

Share the Wealth was started by two sisters.  One of the sisters is still actively involved in the organization, but the other sister has been devoting less time to the organization since she has had triplets.

Share the Wealth has a total of 8 stores in the city where individuals can drop off donations and where customers can also purchase the second hand clothing and costume jewelry.  Share the Wealth has a total of 12 employees who work in the different stores across the city.  Depending on the schedule and availability, the employees will randomly be assigned to a store for the week.

 

Required:

Provide three procedures that Yvan should consider when performing the review engagement of Share the Wealth?

Answer:

– Awareness of fraud risk:  Is leadership organized?  Is there volunteer and staff rotation?  In the case of Share the Wealth, risk is increased since it appears that only one of the sisters is managing the operations now.  Risk that she is overwhelmed or unable to run the operations on her own.  On the other hand, the risk of fraud is diminished since it appears that the staff changes location each week.  This will help early detection of fraud.

Further, Yvan should also inquire how the revenues (funds) were spent during the year.  He should ask whether the funds are spent for valid operating expenses and the remaining spendings are in line with the objective of building recreation spaces in less fortunate communities.

– Yvan should perform analystical procedures (eg. comparing gross profit by location)

– Yvan should inquire of management how regulatory filings are handled

(Note: other examples of procedures are possible.)

Diff: 2     Type: ES     Page Ref: 623-624

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

35) Describe the professional standards that must be followed when undertaking a compilation engagement as specified by the CICA Handbook.

Answer:

  • The services should be performed and the communication prepared by a person having adequate technical training and proficiency in accounting, with due care.
  • The work should be adequately planned and properly executed and if assistants are employed, they should be properly supervised.
  • The person performing the services should resign from the engagement if they become aware of transaction manipulations or deliberate hiding of material information.

Diff: 2     Type: ES     Page Ref: 627

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

36) Identify the reporting standards for compilation engagements.

Answer:

  • state that the public accountant compiled the statement from information provided by management
  • state that the public accountant did not audit, review or otherwise attempt to verify the accuracy or completeness of such information
  • caution readers that the statement may not be appropriate for their purposes
  • not express any form of opinion or negative assurance.
  • provide a “Notice to Reader” opinion and indicate on each page of the financial statements that they were not audited.

Diff: 2     Type: ES     Page Ref: 627-628

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

37) Always Quick Manufacturing Limited is a small business that manufactures metal and plastic components for a variety of industries. The bulk of the business is in the computing industry, although the occasional contract is for the automotive industry.

Jose, the owner, would like to expand the business so that he can bid on larger contracts. This requires an investment of about $500,000 to finance capital assets and about $300,000 for a working capital loan. Jose has financed the business himself to this point, and has been given some alternatives by the bank.

The alternatives pertain to which assets are used as guarantees, and whether Jose also guarantees the loans personally (as he has substantial personal assets). The bank also stated that if Jose personally guarantees the loan, the company will only require a review engagement, whereas if the loan is only secured by corporate assets, then an audit of the company will be required.

Jose understands the differences among the guarantees, but is not sure about the difference between a review and audit engagement. Presently, the company financial statements are prepared using a compilation engagement.

 

Required:

Explain to Jose the difference between a review and audit engagement in the context of his present compilation engagement.

Answer:  The compilation engagement does not provide any assurance with respect to the financial statements. For a review engagement, the objective of the review is to determine whether the financial statements are “plausible” whereas for an audit, the objective is to assess whether the financials are “fairly stated.”

Moving from each engagement to the next level that provides greater assurance also increases the amount of work that needs to be conducted, as the auditor needs to gather evidence to support the opinion. It also requires a greater level of independence, which is required for reviews and audits (but not compilations).

For a compilation engagement, the auditor prepared the financial statements based upon information provided by management without assessing the information. For a review engagement, the procedures consist mainly of enquiry, analytical procedures and discussion. For an audit, evidence is obtained through inspection, observation, and examination of documentation both internal to and external to the organization. Corroborative information, such as observation of inventory counts, is also required.

A major difference in an audit is that the auditor needs to document and evaluate internal controls to assess risks and plan audit procedures.

Each type of engagement also has a different type of report that will be attached to the financial statements. The reports reflect the level of assurance provided, i.e. the compilation report indicates that no assurance is provided, the review that nothing has come to the attention of the accountant that could cause him or her to believe that the financial statements are misleading, while for an audit an opinion with respect to the fairness of the financial statements is provided.

Diff: 3     Type: ES     Page Ref: 621-628

Learning Obj.:  21-2  Explain the importance of review and compilation services

 

 

21.3   Describe the type of report that the public accountant provides for interim financial information for public companies

 

1) What is the title of a compilation report?

  1. A) Opinion
  2. B) Criteria Schedule
  3. C) Engagement Report
  4. D) Notice to Reader

Answer:  D

Diff: 2     Type: MC     Page Ref: 628

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

2) Prospective financial information prepared using assumptions reflecting management’s judgment as to the most probable courses of action for the entity is called a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

Answer:  A

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

3) ABC Company has requested PA to prepare prospective financial information to assist with the acquisition of a bank loan. The prospective financial information is being prepared using management’s best estimate of future sales and expenses. The type of information being prepared is a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

Answer:  A

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

4) Financial information prepared using one or more assumptions (hypotheses) that do not necessarily reflect the most likely course of action in management’s judgment is called a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

Answer:  B

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

5) ABC Company is considering three different alternatives with respect to expansion. To assist with the decision process, the company has requested PA to perform simulations and prepare prospective financial information using several sets of assumptions. Some of these assumptions are likely, while others are less likely. What type of information is being prepared? A(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

Answer:  B

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

6) Special use prospective financial statements are intended for

  1. A) internal management only.
  2. B) any third party.
  3. C) third parties with whom negotiations are being conducted directly by the responsible party.
  4. D) the relevant provincial securities commissions.

Answer:  C

Diff: 2     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

7) With respect to working on an engagement to examine a financial forecast or projection included in a prospectus or other public offering document, the public accountant and the client should agree upon

  1. A) allocation of the responsibility of creating the assumptions to the public accountant.
  2. B) the period of time to be covered.
  3. C) delegation of forecast preparation to the public accountant.
  4. D) the fact that the forecast may not be prepared in accordance with standards.

Answer:  B

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

8) Prior to accepting an engagement to examine a financial forecast or projection included in a prospectus or other public offering document, the public accountant should

  1. A) obtain an understanding of the controls over preparation of internal forecasts such as budgets.
  2. B) increase the risk profile of the client with respect to management integrity.
  3. C) ensure that management will provide sufficient evidence to conduct the engagement.
  4. D) inform the client that the engagement may not detect errors in the client’s forecasts.

Answer:  C

Diff: 3     Type: MC     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

9) A public accountant has been engaged to conduct an examination of future-oriented financial information. Which of the following procedures would be included in the examination?

  1. A) creation of assumptions that fit the projected information
  2. B) developing the hypotheses with the assistance of management
  3. C) assessment of internal controls over the development of internal future-oriented information, such as budgets
  4. D) assessing the plausibility of hypotheses

Answer:  D

Diff: 3     Type: MC     Page Ref: 630

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

10) What type of opinion does the auditor provide with respect to FOFI (future-oriented financial information)? An opinion about the

  1. A) underlying assumptions.
  2. B) achievability of the forecast.
  3. C) statistical nature of projections.
  4. D) plausibility of forecasts.

Answer:  A

Diff: 1     Type: MC     Page Ref: 630

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

 

11) Describe the purpose of

  1. i) a forecast
  2. ii) a projection, and

iii) prospective financial statements

Answer:

  1. i) a forecast

A forecast is prospective financial information prepared using assumptions reflecting management’s judgment as to the most probable courses of action for the entity. The information is presented to the best of management’s knowledge and belief.

  1. ii) a projection

A projection is prepared using one or more assumptions (hypotheses) that do not necessarily reflect the most likely course of action in management’s judgment.

iii) prospective financial statements

Prospective financial statements refer to predicted or expected financial statements in some future period (income statement) or at some future date (balance sheet). They can be for either general use or special use. General use refers to use by any third party. An example of general use would be inclusion of a financial forecast in a prospectus for the sale of shares of a large public company. Special use refers to use by third parties with whom the responsible party is negotiating directly. An example of special purpose future-oriented financial information would be the inclusion of a financial projection in a takeover bid circular aimed at current shareholders of the company or in an entity’s application for a bank loan.

Diff: 2     Type: ES     Page Ref: 629

Learning Obj.:  21-3  Describe the type of report that the public accountant provides for interim financial information for public companies

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