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 2   The Public Accounting Profession

 

2.1   Describe the various organizational structures of public accounting firms

 

1) One of the main advantages of a “big” public accounting firm is the

  1. A) lower professional fees due to economies of scale.
  2. B) ability to share knowledge and experience of similar companies they audit with the client.
  3. C) ability to serve all major international cities as globalization of businesses increases.
  4. D) increased reliance that can be placed on the audit report by financial statement users.

Answer:  C

Diff: 2     Type: MC     Page Ref: 27

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

2) National accounting firms in 2012 are those with

  1. A) offices in most major cities and revenues over $100 million.
  2. B) international representation in most cities around the world.
  3. C) offices in all major cities in Canada and revenues over $75 million.
  4. D) national and international affiliations providing services in all major centres.

Answer:  A

Diff: 3     Type: MC     Page Ref: 27

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

3) Most international and national accounting firms in Canada are comprised of professional accountants with the designations

  1. A) CGA or CMA.
  2. B) CMA or CIA.
  3. C) CA [CPA] or CGA.
  4. D) CIA or CISA.

Answer:  C

Diff: 2     Type: MC     Page Ref: 27

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

4) How many public accounting firms are there in Canada that have more than 50 professional staff?

  1. A) 25
  2. B) 50
  3. C) 75
  4. D) 100

Answer:  B

Diff: 3     Type: MC     Page Ref: 28

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

 

5) What is the size of most public accounting firms in Canada?

  1. A) fewer than 25 employees
  2. B) between 25 and 49 employees
  3. C) between 50 and 75 employees
  4. D) more than 75 employees

Answer:  A

Diff: 3     Type: MC     Page Ref: 28

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

6) The most common organizational form used by public accounting firms is

  1. A) sole proprietorship or partnership.
  2. B) professional corporation.
  3. C) corporation.
  4. D) co-operative.

Answer:  A

Diff: 1     Type: MC     Page Ref: 28

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

7) What are the three main factors that influence the organizational structure of all Public Accounting firms?

Answer:

  1. The need for independence from clients. Independence permits auditors to remain unbiased in drawing conclusions about their client’s financial statements.
  2. The importance of a structure to encourage competence. The ability of the structure to encourage competence permits auditors to conduct audits and perform other services efficiently and effectively.
  3. The increased litigation risk faced by auditors. Firms continue to experience increases in litigation-related costs from lawsuits. Some organizational structures afford a degree of protection to individual firm members.

Diff: 2     Type: ES     Page Ref: 28

Learning Obj.:   2-1  Describe the various organizational structures of public accounting firms

 

 

2.2   Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

1) What is one of the ways that high-profile business failures such as Enron, WorldCom and Nortel have affected the auditing profession?

  1. A) raised the cost of hiring accounting firm professionals
  2. B) resulted in a need for decreased paperwork on audits
  3. C) lowered the number of professionals working on an audit engagement
  4. D) created an increasing focus on standards and high-quality audits

Answer:  D

Diff: 1     Type: MC     Page Ref: 29

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

2) How has the Canada Business Corporation Act given authority to Canadian accounting and auditing standard setters? By stating that financial statements

  1. A) must be compiled in accordance with International Financial Reporting Standards.
  2. B) should be prepared in accordance with the standards in the CICA Handbook.
  3. C) must be audited by accountants that reside in Canada.
  4. D) should be prepared in accordance with local financial reporting standards.

Answer:  B

Diff: 2     Type: MC     Page Ref: 30

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

3) When the criteria to be used in the financial statement audit is established, the auditor’s responsibility is to

  1. A) evaluate the reporting framework used.
  2. B) select the acceptable financial reporting framework.
  3. C) make a recommendation to management for selecting the framework.
  4. D) create and document the framework used.

Answer:  A

Diff: 2     Type: MC     Page Ref: 30

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

4) The reason for adopting the CASs is to

  1. A) comply with the requirement from the Canada Business Corporations Act.
  2. B) respond to the increased litigation risks faced by the auditors.
  3. C) be consistent with the international standards of auditing.
  4. D) to simplify the auditing process.

Answer:  C

Diff: 2     Type: MC     Page Ref: 31

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

5) Independence is assessed in the eyes of external users and regulators. Which of the following is a tool that helps the auditor identify whether the auditor is independent for a particular audit engagement?

  1. A) completion of independence forms at time of employment
  2. B) the use of an independence threat analysis
  3. C) audit risk model assessment for each engagement
  4. D) professional skepticism when assessing control risks

Answer:  B

Diff: 2     Type: MC     Page Ref: 30-31

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

6) The implementation of the Sarbanes-Oxley requirements in the US resulted in the creation of the PCAOB to oversee listed companies’ auditors and develop audit standards. The impact of this requirement in Canada was the

  1. A) creation of new auditing standards to ensure better quality control of the audit.
  2. B) revisions of the rules of professional conduct for CAs.
  3. C) additional training requirements to become an auditor.
  4. D) creation of the CPAB to oversee Canadian audit professionals.

Answer:  D

Diff: 3     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

7) The implementation of the Sarbanes-Oxley requirements in the US resulted in increased independence requirements for the auditors. The impact of this requirement in Canada was

  1. A) creation of the CPAB to oversee Canadian audit professionals.
  2. B) revisions of the rules of professional conduct for PAs.
  3. C) additional training requirements to become an auditor.
  4. D) modification of the type of opinion provided in an assurance engagement by the auditor.

Answer:  B

Diff: 3     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

8) What is the auditor required to do with respect to the financial reporting framework at a client?

  1. A) assess whether the framework selected by management is suitable
  2. B) select an applicable framework for use with the financial statements
  3. C) make sure that ASPE or ASNPO are in use for publicly listed companies
  4. D) select the accounting principles to be used as part of the reporting framework

Answer:  A

Diff: 2     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

9) Sarbanes-Oxley in the U.S. and regulatory reporting requirements in Canada provide the clout to make management directly responsible for the financial statements. What is one of the ways that this is implemented in the CASs (Canadian Auditing Standards)?

  1. A) all listed company management must certify the accuracy of the evidence provided
  2. B) management must provide evidence to support financial statement data
  3. C) management must implement and carry out development of high quality internal controls
  4. D) companies must use internal auditors to assess the quality of the financial statements

Answer:  B

Diff: 3     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

10) Sarbanes-Oxley in the U.S. and regulatory reporting requirements in Canada provide the clout to make management directly responsible for the financial statements. What is one of the ways that this is implemented in the CASs (Canadian Auditing Standards)?

  1. A) all listed company management must certify the accuracy of the evidence provided
  2. B) management must implement and carry out development of high quality internal controls
  3. C) management must acknowledge and understand its responsibilities
  4. D) companies must use internal auditors to assess the quality of the financial statements

Answer:  C

Diff: 2     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

11) Canadian auditing standards (CASs) require that the audit be conducted using

  1. A) a controls testing approach.
  2. B) a risk assessment approach.
  3. C) a substantive approach.
  4. D) a standard approach.

Answer:  B

Diff: 3     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

12) The first step in the financial statement audit using a risk assessment approach is to

  1. A) identify risks of material misstatement.
  2. B) gather evidence to assess the likelihood of material misstatement.
  3. C) evaluate audit evidence.
  4. D) evaluate the reporting framework.

Answer:  A

Diff: 3     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

13) The risk response phases of conducting the financial statement audit using a risk assessment approach includes

  1. A) conducting an independence threat analysis to evaluate independence.
  2. B) preparation of the final auditor’s report in response to audit findings.
  3. C) identification of risks of material misstatement at the client.
  4. D) gathering evidence to assess the likelihood of material misstatement.

Answer:  D

Diff: 2     Type: MC     Page Ref: 32

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

14) During which phases of the financial statement audit does the auditor “evaluate evidence” when conducting the financial statement audit using a risk assessment approach? During

  1. A) the risk assessments.
  2. B) the risk responses.
  3. C) the reporting process.
  4. D) risk assessment, risk response and reporting phases.

Answer:  D

Diff: 3     Type: MC     Page Ref: 33

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

15) The codes of professional conduct of the various accounting bodies are meant to

  1. A) provide a standard of conduct for all members, including those in public practice.
  2. B) interpret the assurance recommendations and views of the AASB.
  3. C) provide the rules underlying the audits and related service activities carried on by the accountants.
  4. D) establish the norms for quality control of an audit.

Answer:  A

Diff: 2     Type: MC     Page Ref: 33

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

16) General qualifications and conduct standards indicate that performance of all aspects of auditing should be performed with due care. This means that the auditor must fulfill his/her duties

  1. A) in accordance with the CAS.
  2. B) carefully and in a timely manner.
  3. C) to the satisfaction of the client.
  4. D) diligently and carefully.

Answer:  D

Diff: 2     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

17) Adequate technical training and proficiency in auditing is a requirement of which category of generally accepted auditing standards?

  1. A) General
  2. B) Examination
  3. C) Reporting
  4. D) Quality control

Answer:  A

Diff: 2     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

18) Adequate planning and execution to reduce risk to an acceptable level is a requirement of which category of generally accepted auditing standard?

  1. A) General
  2. B) Examination
  3. C) Reporting
  4. D) Quality

Answer:  B

Diff: 2     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

19) Communicating the findings of the audit in accordance with the CASs is a requirement of which category of generally accepted auditing standard?

  1. A) General
  2. B) Examination
  3. C) Reporting
  4. D) Quality

Answer:  C

Diff: 2     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

20) Canadian GAAS (Generally Accepted Auditing Standards) are best described as

  1. A) the CICA Handbook, plus published research and public accounting firm practices in auditing.
  2. B) Canadian generally accepted auditing practices developed by public accounting firms.
  3. C) material that is fully codified in the CICA Handbook developed in Canada.
  4. D) the existing research that has been published about auditing that is used by firms.

Answer:  A

Diff: 1     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

21) CAS 200 provides overall objectives of the Independent Auditor during the conduct of an audit in three categories: qualifications and conduct, performance of the audit, and reporting of results. How do these standards provide guidance to auditors? They

  1. A) detail what an auditor should do during each financial statement audit.
  2. B) represent a framework for further discussion of detailed standards.
  3. C) provide specific rules about how work should be done for evidence gathering.
  4. D) explain how the audit report should be developed and distributed.

Answer:  B

Diff: 2     Type: MC     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

22) CAS 200 explains that as part of general qualifications and conduct the auditor should be professionally competent. Which of the following help the auditor achieve competence?

  1. A) the use of due care in the performance of all aspects of auditing
  2. B) have an objective state of mind and independence from the client
  3. C) formal education, practical experience and continuing education
  4. D) conducting the audit using a risk-based approach and being skeptical

Answer:  C

Diff: 3     Type: MC     Page Ref: 34-35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

23) CAS 200 explains that as part of general qualifications and conduct the auditor should exercise due care in the performance of all aspects of auditing. Which of the following is an illustration of due care?

  1. A) having an objective state of mind and independence from the client
  2. B) completing formal education and having practical experience in the conduct of auditing
  3. C) issue a standard audit report using the CICA Handbook specified wording
  4. D) considering the completeness of the working papers

Answer:  D

Diff: 3     Type: MC     Page Ref: 35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

24) Larger audits may have established procedures that utilize an audit committee whenever there is a dispute between management and the auditors. What is the purpose of such procedures?

  1. A) make sure that the auditor understands management’s point of view
  2. B) improves the competence of the financial statement auditors
  3. C) facilitate the auditors’ independence from management
  4. D) helps make sure the audit is conducted following GAAS

Answer:  C

Diff: 2     Type: MC     Page Ref: 35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

25) Who do the external auditors and the internal auditors usually report to?

  1. A) senior management
  2. B) the audit committee
  3. C) chief executive officer
  4. D) director of internal audit

Answer:  B

Diff: 1     Type: MC     Page Ref: 35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

26) A strategic and risk-based audit approach means that the client must be assessed in the context of the business environment, including which of the following?

  1. A) ensuring that accounting complies with IFRS or ASPE
  2. B) completion of an independence threat analysis with supporting documentation
  3. C) corporate governance process and quality of internal controls
  4. D) talking to those audit committee members who are also part of management

Answer:  C

Diff: 2     Type: MC     Page Ref: 35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

27) Which of the following rights is in the CBCA (Canada Business Corporations Act) and is necessary for the completion of the audit? The right to

  1. A) obtain copies of all documentation needed to conduct the audit.
  2. B) advise management regarding how it should set up its records.
  3. C) publish information when management engages in fraud.
  4. D) have access to the necessary records, information and explanations.

Answer:  D

Diff: 3     Type: MC     Page Ref: 35

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

28) When the CICA Handbook is silent on an auditing issue, which of the following is the best of other authoritative sources that the auditor could use?

  1. A) audit technique studies
  2. B) audit firm practice manuals
  3. C) past practice at the client
  4. D) reference to audit standards partner

Answer:  A

Diff: 2     Type: MC     Page Ref: 35-36

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

29) What is the purpose of exposure drafts issued by the AASB (Auditing and Assurance Standards Board) in Canada? To

  1. A) expose the newly established standards to as many groups as possible.
  2. B) provide current copies of the standards in advance of being placed in the CICA Handbook.
  3. C) provide supporting reference material and other resources.
  4. D) explain how standards will be changed and solicit feedback.

Answer:  D

Diff: 2     Type: MC     Page Ref: 37

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

30) The most authoritative requirements for public accountants performing financial statement audits in Canada are the

  1. A) standards used by the client.
  2. B) industry specific standards.
  3. C) CICA handbook requirements.
  4. D) assurance guidelines.

Answer:  C

Diff: 2     Type: MC     Page Ref: 37

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

31) When conducting an audit, the auditor should look at Canadian GAAS as

  1. A) minimum standards of performance.
  2. B) normal standards of performance.
  3. C) ultimate standards of performance.
  4. D) practical standards of performance.

Answer:  A

Diff: 2     Type: MC     Page Ref: 37

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

32) A PA firm is conducting the audit of a company that has operations in both Canada and Finland. There is a conflict between ISAs (International Statements on Auditing) and CASs (Canadian Auditing Standards) for the foreign operations that will be consolidated with the Canadian operations. Which reporting standards should the PA firm follow?

  1. A) reporting standards of Finland
  2. B) international reporting standards
  3. C) Canadian reporting standards
  4. D) the best of Canadian or international

Answer:  C

Diff: 3     Type: MC     Page Ref: 37

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

 

33) The CICA is the professional accounting organization for Chartered Accountants (CAs). Describe the role and responsibilities of the organization in serving its members.

Answer:

Research and Publication: The CICA publishes the CA Magazine along with accounting and auditing research studies. The CICA also coordinates the UFE exam.

Continuing Education: The CICA provides courses, seminars and on-line material to update their members on a variety of topics relating to accounting and auditing. It also has six specific specializations for its members.

Establishing standards and rules: The AASB sets accounting and auditing standards that are published by the CICA and that must be followed by public accountants.

Diff: 2     Type: ES     Page Ref: 29-30

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

34) For each of the following situations, state which element of the profession or society encourages the public accountant to conduct himself at a high level.

 

  1. A) Marco attended a seminar on the topic of business combinations to ensure he was up to date with the new standard.

 

  1. B) Barbara referred to the standard on hedging to ensure that her client had the appropriate documentation to qualify for hedge accounting.

 

  1. C) Gretchen refused to perform the audit of her uncle’s restaurant chain.

 

  1. D) Walid worked overtime all week to ensure that the file was properly documented and met the quality control requirements.

 

  1. E) Sarah took the summer off to study for the Uniform Final Examination (UFE) to ensure that she would pass the entrance exam to become a chartered accountant.

 

Answer:

  1. A) Continuing Education
  2. B) CICA Handbook
  3. C) Code of professional conduct
  4. D) CPAB review and quality control
  5. E) Professional examination.

Diff: 2     Type: ES     Page Ref: 33

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

35) The generally accepted auditing standards can be divided into three categories of standards. List the three categories and provide an example of each.

Answer:  Note: Two examples are provided. Others are possible.

  1. General qualifications and conduct:
  • the auditor complies with ethical and independence requirements
  • implementation of ethical and independence requirements is monitored using control procedures
  1. Examination, performance of the audit:
  • the audit should be planned and performed using professional skepticism
  • the audit shall be conducted using a risk-based approach
  1. Reporting results:
  • provide a report on the financial statements that matches the auditor’s findings
  • communicate findings in accordance with the CASs

Diff: 2     Type: ES     Page Ref: 34

Learning Obj.:   2-2  Link the market forces that help ensure that audit and assurance engagements are completed to high standards of quality

 

2.3   Examine the characteristics of quality control for financial statement audits

 

1) A PA firm has an organizational structure that assures the technical review of every engagement by a partner who has expertise in the client’s industry. This is an example of good

  1. A) entity level controls.
  2. B) adherence to professional standards.
  3. C) business risk management.
  4. D) quality controls.

Answer:  D

Diff: 3     Type: MC     Page Ref: 38

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

2) CPAB’s purpose is to

  1. A) develop auditing standards.
  2. B) provide training and continuing education to auditors.
  3. C) clarify and communicate the role of the auditor to the public.
  4. D) improve the public’s confidence in independent auditing.

Answer:  D

Diff: 2     Type: MC     Page Ref: 38

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

3) A key difference between the PCAOB in the U.S. and CPAB in Canada is that

  1. A) CPAB is involved in the development of auditing standards.
  2. B) PCAOB is involved in the development of auditing standards.
  3. C) PCAOB conducts practice inspections of public company auditors.
  4. D) CPAB conducts practice inspections of public company auditors.

Answer:  B

Diff: 2     Type: MC     Page Ref: 38

Learning Obj.:   3-3  Examine the threats to independence and explain how the threats can be mitigated

4) There are many elements of quality control at the firm level. Which element does “an organizational culture that provides quality should be present for audit and review engagements” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) general ethical requirements
  3. C) general human resource policies
  4. D) engagement performance

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   3-3  Examine the threats to independence and explain how the threats can be mitigated

 

5) There are many elements of quality control at the firm level. Which element does “quality control procedures should be developed, documented, implemented and communicated” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) general ethical requirements
  3. C) general human resource policies
  4. D) engagement quality control review

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   3-3  Examine the threats to independence and explain how the threats can be mitigated

 

6) There are many elements of quality control at the firm level. Which element does “management within a firm should ensure that qualified personnel monitor and address non-compliance with quality control procedures” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) general ethical requirements
  3. C) general human resource policies
  4. D) engagement quality control review

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   3-3  Examine the threats to independence and explain how the threats can be mitigated

 

7) There are many elements of quality control at the firm level. Which element does “a firm should establish a formal code of conduct that includes procedures for individuals to disclose differences of opinion and any inappropriate conduct” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) general ethical requirements
  3. C) general human resource policies
  4. D) engagement quality control review

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   3-3  Examine the threats to independence and explain how the threats can be mitigated

8) Farah is currently auditing Software Synx, a public company. After a long day of work, Farah goes for a drink with her friend John who mentions that he owns shares of Software Synx. Farah indicates that John should hold on to his shares as they will go up next week when the financial statements are released and show an increase of 12% for revenues. Which element of quality control is compromised by Farah?

  1. A) General ethical requirements
  2. B) Independence
  3. C) General human resource policies
  4. D) Engagement performance

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

9) Gary West is a sole practitioner. He has conducted the audit of Reggie’s Farm for the past 12 years. In the current year, Reggie’s Farm expanded by acquiring two other farms, installed a new accounting system and also started to export to the United States. Gary accepted the audit of Reggie’s Farm for the upcoming year even though he has no experience with exports to the US or companies of the size of Reggie’s Farm. Which element of quality control is compromised for Gary’s firm?

  1. A) Independence
  2. B) Client acceptance or continuance
  3. C) Extent of professional development
  4. D) General ethical requirements

Answer:  B

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

10) Dimitri works at a large public accounting firm. Dimitri referred one of his friends for a junior auditor position. Dimitri’s friend was hired despite the fact that he had a criminal record dating from 3 years ago. The partner did not perform a background check on Dimitri’s friend since he was recommended by an employee. Which element of quality control is compromised?

  1. A) General ethical requirements
  2. B) Independence
  3. C) General human resource policies
  4. D) Engagement performance

Answer:  C

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

 

11) There are many elements of quality control at the firm level. Which element does “adequate hiring policies (and documentation of their implementation) that ensure competence and integrity of personnel should be in place” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) independence
  3. C) general human resource policies
  4. D) extent of professional development

Answer:  C

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

12) There are many elements of quality control at the firm level. Which element does “ongoing professional development of personnel should exist, with assignment to work that matches employee competence, and performance evaluations related to audit quality” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) independence
  3. C) general human resource policies
  4. D) extent of professional development

Answer:  C

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

13) There are many elements of quality control at the firm level. Which element does “employees should be adequately trained in the skills needed to conduct audits and reviews” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) independence
  3. C) general human resource policies
  4. D) extent of professional development

Answer:  D

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

14) Jessica is a summer junior at Branes & Castle, a PA firm. Jessica has only completed 3 accounting courses in university and has not yet taken her auditing class. A team of auditors from Branes & Castle are starting the audit and Jessica was sent to help them. Jessica

  1. A) can perform work for the audit engagement as long as she is supervised and proper review of her work is performed.
  2. B) should not perform any work pertaining to the audit engagement since she doesn’t have sufficient knowledge.
  3. C) should be limited to assisting the audit team with support functions such as photocopies and file assembly.
  4. D) can perform work for the audit engagement on cycles where risk was assessed as low.

Answer:  A

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

15) There are many elements of quality control at the firm level. Which element does “adequate processes and procedures should be in place to ensure that the audit or review is conducted in accordance with GAAS, that quality control procedures are followed for each engagement, and that the audit is appropriately documented” belong to?

  1. A) leadership and responsibilities within the firm
  2. B) general human resource policies
  3. C) extent of professional development
  4. D) engagement performance

Answer:  D

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

16) There are many elements of quality control at the firm level. Which element does “policies in place should include use of second or independent partner review, technical review, documentation, and compliance with quality control processes” belong to?

  1. A) engagement performance
  2. B) engagement quality control review
  3. C) documentation
  4. D) general human resource policies

Answer:  B

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

17) There are many elements of quality control at the firm level. Which element does “processes should exist for following up internal and external complaints” belong to?

  1. A) engagement performance
  2. B) engagement quality control review
  3. C) documentation
  4. D) general human resource policies

Answer:  B

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

18) During which phases of the financial statement audit does the auditor “conduct quality control” when conducting the financial statement audit using a risk assessment approach? During

  1. A) the risk assessments.
  2. B) the risk responses.
  3. C) the reporting process.
  4. D) risk assessment, risk response and reporting phases.

Answer:  D

Diff: 2     Type: MC     Page Ref: 39

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

 

19) For a CA or CGA working as a sole practitioner or working in a small public accounting office, the provincial practice inspectors will likely come to review audit files

  1. A) every three years.
  2. B) every five years.
  3. C) every year.
  4. D) files sent, not reviewed in person.

Answer:  A

Diff: 1     Type: MC     Page Ref: 40

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

20) How do practice inspections affect the ability of a PA firm to have articling students work at the firm? Practice inspectors

  1. A) only permit students to work there if the quality controls are good.
  2. B) review the ability of the office to provide sufficient, appropriate hours.
  3. C) require that students work only on audit engagements, not reviews.
  4. D) consider only work completed by qualified PAs, not students.

Answer:  B

Diff: 3     Type: MC     Page Ref: 40

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

21) Which of the following is a typical consequence to a PA or PA firm if practice inspectors find any files or quality control procedures to be unsatisfactory? The PA

  1. A) will lose the right immediately to conduct audit engagements.
  2. B) will no longer be allowed to sign audit reports for a period of time (such as a year).
  3. C) may be required to revise processes or attend training courses.
  4. D) will be required to rewrite the professional qualification examinations.

Answer:  C

Diff: 2     Type: MC     Page Ref: 40

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

22) Stafford & Sandiford is a Public Accounting firm with 30 clients who are reporting issuers. Stafford & Sandiford can expect to be inspected by the CPAB

  1. A) once per year.
  2. B) once every 3 years.
  3. C) once every 5 years.
  4. D) randomly.

Answer:  B

Diff: 1     Type: MC     Page Ref: 40

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

 

23) Securities regulations in Canada are the responsibility of

  1. A) national securities commission.
  2. B) provincial securities commissions.
  3. C) the professional accounting organizations.
  4. D) office of the auditor general of Canada.

Answer:  B

Diff: 1     Type: MC     Page Ref: 41

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

24) Canadian GAAS (including the CICA Handbook) are the authoritative standards for the conduct of financial statement audits in Canada. How would this affect the audit of a Canadian company that is owned by a Swedish company that must also report using Swedish (International) auditing standards?

Answer:

  • the audit of the foreign subsidiary must be conducted using Canadian GAAS
  • as long as the audit complies with Canadian GAAS, it may also be conducted in accordance with international GAAS
  • the auditor may report that the audit was conducted using both Canadian and Swedish (International) GAAS
  • Canadian GAAS would be the floor (or minimum standards)
  • differences between the two sets of standards may need to identified
  • where there are differences between the two sets of standards, the auditor should follow Canadian reporting standards
  • the CICA Handbook takes precedence over the ISAs when there is a conflict

Diff: 3     Type: ES     Page Ref: 37-38

Learning Obj.:   2-3  Examine the characteristics of quality control for financial statement audits

 

Auditing, 12e (Arens)

Chapter 12   Audit of the Sales and Collection Cycle; Tests of Controls

 

12.1   Identify and describe typical records and transactions in the sales cycle

 

1) The overall objective in the audit of the sales and collection cycle is to evaluate whether

  1. A) the sales account and the accounts receivable account are free of errors.
  2. B) the sales account and the accounts receivable account are free of material errors.
  3. C) the sales account and the accounts receivable account are presented fairly in accordance with an applicable financial reporting framework.
  4. D) the account balances affected by the cycle are fairly presented in accordance with an applicable financial reporting framework.

Answer:  D

Diff: 1     Type: MC     Page Ref: 362

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

2) Which of the following actions is more likely to be a result of error rather than fraud?

  1. A) consignment sales are knowingly recorded as revenue
  2. B) orders are shipped to a customer with a bad credit rating
  3. C) fictitious revenue transactions are recorded and reported
  4. D) subsequent period revenue is deliberately recorded in the current period

Answer:  B

Diff: 2     Type: MC     Page Ref: 363

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

3) There are three main types of revenue manipulations. Which of the following revenue manipulations affects the occurrence objective?

  1. A) recording subsequent period sales as current period sales
  2. B) the use of “bill and holds” (goods are invoiced but not shipped)
  3. C) understatement of bad debts
  4. D) creation of fictitious sales that are misclassified as revenue

Answer:  D

Diff: 3     Type: MC     Page Ref: 363

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

4) There are three main types of revenue manipulations. Which of the following revenue manipulations affects the cutoff objective?

  1. A) avoiding recording of returns and allowances for the year
  2. B) recording subsequent period sales as current period sales
  3. C) understatement of bad debts
  4. D) creation of fictitious sales that are misclassified as revenue

Answer:  B

Diff: 3     Type: MC     Page Ref: 363

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

5) There are three main types of revenue manipulations. Which of the following revenue manipulations affects the valuation objective?

  1. A) recording subsequent period sales as current period sales
  2. B) the use of “bill and holds” (goods are invoiced but not shipped)
  3. C) understatement of bad debts
  4. D) creation of fictitious sales that are misclassified as revenue

Answer:  C

Diff: 3     Type: MC     Page Ref: 363

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

6) Which of the following controls pertains to audit trails in the batch processing of sales transactions?

  1. A) groups of documents are totalled
  2. B) audit trail is available in electronic form
  3. C) the focus is on preventing incorrect transactions
  4. D) remittance advice information is matched to sales invoice numbers

Answer:  A

Diff: 3     Type: MC     Page Ref: 365

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

7) What is the primary focus with respect to error detection and correction for the online processing of sales transactions?

  1. A) reject groups of transactions when one transaction is in error
  2. B) trace daily sales totals from the journals to the general ledger
  3. C) account for numeric sequencing of input documents
  4. D) prevent the entering of incorrect transactions using data entry edits

Answer:  D

Diff: 3     Type: MC     Page Ref: 365

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

8) What information would be considered semi-permanent as well as transaction information?

  1. A) Customer number or code
  2. B) Customer credit limit
  3. C) Transaction amount
  4. D) Current balance outstanding

Answer:  A

Diff: 2     Type: MC     Page Ref: 366

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

 

9) Which of the following data elements would be included in the customer master file as semi-permanent information?

  1. A) transaction date
  2. B) credit limit
  3. C) transaction amount
  4. D) amount paid

Answer:  B

Diff: 3     Type: MC     Page Ref: 366

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

10) Which of the following is an example of a data entry input edit that could be used to improve the accuracy of online data entry of sales orders?

  1. A) matching of customer number to master file
  2. B) automatic posting of sales to the general ledger account
  3. C) reconciliation of the customer master file to accounts receivable
  4. D) daily point-of-sales control totals matched to cash receipts

Answer:  A

Diff: 3     Type: MC     Page Ref: 366

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

11) Before goods are shipped on account to a new customer, a properly authorized person must

  1. A) prepare the sales invoice.
  2. B) approve the journal entry.
  3. C) approve credit.
  4. D) verify that the unit price is accurate.

Answer:  C

Diff: 1     Type: MC     Page Ref: 366, 368

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

12) Which of the following documents and records is used to record the packages, weights and sizes shipped using an external trucking company?

  1. A) remittance advice
  2. B) shipping advice containing shipment tracking number
  3. C) returns receiving report
  4. D) bill of lading

Answer:  D

Diff: 1     Type: MC     Page Ref: 367

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

 

13) A document sent to each customer showing his or her beginning accounts receivable balance and the amount and date of each sale, cash payment received, credit memo issued, and the ending balance is the

  1. A) accounts receivable subsidiary ledger.
  2. B) monthly statement.
  3. C) remittance advice.
  4. D) sales invoice.

Answer:  B

Diff: 1     Type: MC     Page Ref: 367

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

14) A document that describes which accounts receivable accounts are to be written off and why is called a(n)

  1. A) uncollectible account authorization form.
  2. B) journal entry authorization form.
  3. C) master file change form.
  4. D) sales returns and allowances journal.

Answer:  A

Diff: 2     Type: MC     Page Ref: 367

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

15) A document that is used to describe and authorize additions, changes or deletion of sales prices or customer data is called a(n)

  1. A) uncollectible account authorization form.
  2. B) journal entry authorization form.
  3. C) master file change form.
  4. D) transaction file change form.

Answer:  C

Diff: 2     Type: MC     Page Ref: 367

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

16) Poor controls over credit limit approval or in changing the credit limit in the master file may result in

  1. A) confused and frustrated customers.
  2. B) incomplete sales records.
  3. C) financial statement errors for sales and AR accounts.
  4. D) excessive bad debts and uncollectible account receivables.

Answer:  D

Diff: 2     Type: MC     Page Ref: 368

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

 

17) Which of the following control weaknesses could result in problems with collectability of accounts receivable?

  1. A) Unauthorized individuals can establish or change credit limits.
  2. B) Matching shipping documents to sales records is done weekly.
  3. C) When there is one error in a batch of transactions, the whole batch is rejected.
  4. D) Cash receipts are matched to the customer accounts rather than against specific invoices.

Answer:  A

Diff: 3     Type: MC     Page Ref: 368

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

18) A document prepared for shipment of the goods sold using a trucking company is called the

  1. A) sales order.
  2. B) bill of lading.
  3. C) sales invoice.
  4. D) customer order.

Answer:  B

Diff: 1     Type: MC     Page Ref: 368

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

19) Most companies recognize sales when

  1. A) a customer order is received.
  2. B) the merchandise is shipped.
  3. C) the merchandise is received by the customer.
  4. D) cash is received on account.

Answer:  B

Diff: 2     Type: MC     Page Ref: 368

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

20) Some companies use a lockbox system, whereby customers mail payments to a post office box address. The lockbox contents could be handled by a bank, another external organization, or the owner of the company. One of the advantages of using a lockbox is that

  1. A) improves segregation of duties.
  2. B) results in more accurate bank deposits.
  3. C) results in more accurate accounts receivables.
  4. D) provides more detailed bank deposit information.

Answer:  A

Diff: 1     Type: MC     Page Ref: 369

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

 

21) The document that is used to prepare and reconcile the deposit of cash and improve the control over the custody of assets (cash) is the

  1. A) sales invoice.
  2. B) credit memo.
  3. C) remittance advice.
  4. D) cash receipts journal.

Answer:  C

Diff: 2     Type: MC     Page Ref: 369

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

22) Zhang Corporation returned $6,000 of defective goods to Meli Inc. Meli has a strict policy of no cash refund. Meli should

  1. A) write off the account receivable.
  2. B) issue a credit memo to Zhang.
  3. C) wait until Zhang places its next order to record the return.
  4. D) not adjust their accounting records since $6,000 is not material for Meli.

Answer:  B

Diff: 2     Type: MC     Page Ref: 370

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

23) Proper accounting requires that an account receivable must be written off by the client when

  1. A) the client company concludes that an amount is no longer collectible.
  2. B) the customer files for bankruptcy.
  3. C) a collection agency cannot inspire the customer to pay the debt.
  4. D) the account is at least six months old.

Answer:  A

Diff: 2     Type: MC     Page Ref: 370

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

24) A) Describe the four business functions that result in sales transactions in a typical sales and collection cycle and, for each function, state the key documents and records involved.

 

  1. B) State the five classes of transactions that comprise the sales and collection cycle.

 

  1. C) The sales and collections cycle is comprised of nine business functions. The first four functions result in sales transactions. Discuss each of the remaining five business functions that occur after sales transactions, and identify the key documents and records involved in each of those five functions.

 

Answer:

  1. A) The four business functions that result in sales transactions, and related documents and records, are:
  • Processing customer sales orders. Key documents include customer purchase order and sales order.
  • Granting credit. External credit report, credit change form, accounts receivable trial balance.
  • Shipping goods. Shipping document (bill of lading), change of address form.
  • Billing customers and recording sales. Sales invoice, sales journal, summary sales report, monthly statements.
  1. B) The six classes of transactions that comprise the sales and collection cycle are:
  • Sales (cash and sales on account)
  • Cash receipts
  • Sales returns and allowances
  • Write-off of uncollectible accounts
  • Bad debt expense
  • Master file changes
  1. C) The four business functions that occur after sales transactions, and related key documents and records, are:

– Processing and recording cash receipts: remittance advice, cash prelisting, bank deposit slips, bank deposit listing, cash receipts journal

– Processing and recording sales returns and allowances: returns receiving report, credit memo, sales returns and allowances journal

– Writing of uncollectible accounts receivable: uncollectible account authorization form

– Providing for bad debts: journal entry authorization

– Maintaining semi-permanent data: master file change form, master file change report

Diff: 3     Type: ES     Page Ref: 364-365, 367

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

25) During your lunch, your audit team went to a local mall, in the food court, since they needed to be quick today. You dropped off a photofinishing film at a film developer, saying that you would pick it up after work that day. After telling you that she preferred using her digital camera to using regular film, your supervisor said,

“Next week, you are going to be working at a client that just happens to be a group of photography stores. Tell me, what controls do you think should be programmed into the cash register to help ensure that sales transactions are accurate and complete?”

 

Required:

Answer your supervisor’s question.

Answer:  Check digits and validity checks: for example, the cash register could check for valid store clerk user identification codes, and valid transaction codes (e.g. film type and processing type), as well as for valid inventory transaction codes (for items sold).

 

Automatic retrieval of information: if information is scanned (such as product UPC code), the cash register should automatically retrieve price information from the master files.

 

Limit checks: There should be maximum numbers for items (e.g. 10 for film, 1 for large items such as expensive cameras).

 

Automatic calculations: Extensions, totals, should be automatic, as should be calculations of sales tax and gst or hst. The cash register system probably also keeps totals of each payment method daily (such as cash, credit card, debit card).

 

Field checks: Required fields must be entered, or the transaction will not be completed (e.g. quantity, price, payment method).

Diff: 3     Type: ES     Page Ref: 365-366

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle

 

 

26) Gonzo is an on-line dating agency. Gonzo has been in business for 5 years and has been able to reach revenues of $1 million last year. Given its recent expansion, Gonzo’s shareholders have required that the company’s financial statements be audited for the first time this year. You have been assigned to the audit team for this mandate.

The senior manager asked you to review the process description for the sales of Gonzo. The manager asked you to identify the controls in place that could be tested and used for the audit and also, any controls that might be missing. Briefly explain the impact on the audit.

Gonzo’s CEO provided you with the following description of their processes and activities for the past year:

Sales

Gonzo’s web-site is operational 24 hours per day. All of the sales for Gonzo are done on-line when the customer opens a profile. A customer will pay $50 to open a profile and will then pay $10 per month to keep his profile active. Most customers pay on-line with their credit cards and the sale is automatically recorded in the sales ledger of Gonzo at the time of payment.

Gonzo also had a promotion for the last 3 months of the year. If the customer wanted to subscribe for one year, they could pay $100 upfront to keep their profile active for the full year instead of paying $10 each month for 12 months. This proved to be a popular sales tactic as customers enjoyed the $20 savings.

Web-Site Security

In the past year, one hacker managed to intrude the web-site and steal the credit card information of 25 Gonzo customers. To ensure quality of customer service, Gonzo reimbursed a total of $10,000 to the customers to compensate them for the amounts that were stolen as a result of the intrusion on their web-site. Since then, Gonzo hired a third party, Mindster Box, to update the security features of their web-site. Mindster Box performs monthly updates to the security features and monitors any intrusion attempt. Gonzo did not have a problem since.

Collection and Reconciliation

As most of the sales are done by credit card, Gonzo receives the money from large credit card companies on a by-weekly basis.

When the money is received from the credit card company, Jo-Ann, the accounting manager of Gonzo, reconciles the detail of the payments received by the credit card company to the sales ledger of Gonzo. Jo-Ann has often complained that this is nearly impossible to do since the accounting system of Gonzo keeps track of the payment by the on-line user name which is often very different from the actual name of the person as stated on the detailed report provided by the credit card company.

Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust revenues reported by Gonzo.
Answer:
Controls in place & Audit Implications
1. Automated recording of sales by the system: A test of control can be done to compare the number of sales and total amount of sales recorded by the system to the number of sales and total amount of sales recorded by the credit card company. A sample of days could be selected.

  1. Third party security updates: This control was not in place for the entire year, but can help increase assurance with regards to the security and accuracy of sales recorded by the system for the period where it was in place. If the system is secure, we will be able to place more reliance on the system during our audit. To do this, we could inquire about the experience and knowledge of Mindster Box. A review of their monthly updates could also be done to ensure that they were performed and were appropriate.
  2. Third party report of sales: Gonzo has access to the sales recorded by the credit card company. This is good evidence as it comes from an independent third party. Since the internal records from the system might not be reliable for the full year, we could obtain a report from the credit card company attesting to the proper functioning of their internal control in order to use their reports as audit evidence.

Control Weaknesses & Audit Implications

  1. Upfront revenue recognition issue: With the promotion of upfront monthly fees for the last 3 months of the year, combined with the fact that the system records revenues when the customer pays on-line, it is possible that the revenues are overstated as the current year’s revenue include monthly membership fees that relate to the following year. There was no indication by Gonzo that a review with regards to the cut-off of revenues was performed. This will be an area of concern for the audit.
  2. Web-site intrusion: It appears that the security over the web-site of Gonzo was not working as well as they had expected, at least for a portion of the year. This will increase the risk of the audit as there might have been other undetected intrusions which could result in financial statement errors or further liability for Gonzo. This should be considered in the audit planing and assessment of the audit risk.
  3. Gonzo’s system does not keep track of the sales by customer name. This makes the reconciliation done by Jo-Ann not very useful. Gonzo should consider changing their system so that the sale is recorded by the name the customer enters as the <name on the credit card> rather than their user name for the web-site. At that point, the control of the sales reconciliation could be used in the audit.

Diff: 3     Type: ES     Page Ref: 366-380

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle; 12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

27) You have just been assigned to manage the audit for a new large client of your firm, Cheap Music Downloads Inc. (CMD). CMD is a subsidiary of a client of your firm that manufactures audio and video equipment for international distribution. CMD has been in operation for two years, when its custom information systems were established.

 

CMD runs a web site that allows customers to order songs using their credit card only. There are tens of thousands of small transactions daily. Once the credit card has been authorized by the credit card processing intermediary, CMD’s web sales system generates a 16 digit sequential code that the customer uses to access the song via the web site. CMD will then record both the sale and the royalty for the song.

 

Quarterly, CMD remits royalties to artists based upon the number of copies of the song that has sold, if the accumulated royalty exceeds $25.00 for that artist. Artist royalties that do not exceed $25.00 will be paid every two years if there has not been a payment during that time.

 

All contracted royalty rates, artist names and song titles are recorded in CMD’s database tables.

 

Required:

Describe three internal controls that should exist over sales or royalty transactions or over the database tables. For each control:

(i) State the control

(ii) Describe (not just state) the audit assertion associated with the control

(or state the purpose of the control)

(iii) Provide an audit test that you could use to test the control

 

Answer:

Desired Control Assertion or Purpose Audit Test
1. The 16 digit sales code is only generated when credit has been confirmed by the credit card processor. Valuation. Ensure that CMD is able to collect and reduces chance of fraud through bad debt. Review bad debts and any credit card chargebacks to ensure that credit cards are authorized prior to releasing 16 digit codes.
2. The credit card authorization number must be logged and entered into the Sales system prior to the 16 digit code being issued to the customer Valuation. Ensure that CMD is able to collect and reduces chance of fraud through bad debt. Check that for each sales transaction, there is a credit card authorization number logged.
3. The system prevents sales transactions from being recorded without a valid 16 digit sales code. Existence / Occurrence. Ensures that fake sales transactions are not created. Check whether there are any manual sales transactions or sales transactions without a 16 digit code.
4. The 16 digit code can only be used once to download the song. Existence / Occurrence. Prevents fraudulent sharing of 16 digit code where multiple copies can be made but only paid for once by the customer. Purchase one copy and try using the 16 digit code again to download another copy using your customer ID and other customer IDs. See if the system prevents you from using it.
5. The 16 digit code entered by the customer will be checked against the database of system issued 16 digit codes for validity. Existence / Occurrence.

Prevents fraudulent input of fake 16 digit codes to obtain free song downloads

Check for any out-of-sequence 16 digit codes.

 

Match system issued 16 digit codes to 16 digit codes entered in by customers

6. Access to change Royalty Transaction Table data should be restricted. Completeness / Accuracy. Ensures that company is not understating royalty expense or underpaying artists. Test for any deleted records by looking at transaction log. Note any gaps in 16 digit code sequence.
7. Customers should be required to log in with a unique user ID and password Existence / Occurrence. Control is to prevent unauthorized use of customer’s account by fraudsters. Attempt to login to the system with guest credentials.
8. Reconciliation exists between the number of song codes purchased to the number of song codes on which royalties paid. Completeness. Ensures that all royalties are captured for payment. Agree number of song codes purchased to the number of royalties paid.

Review reconciliation performed and ensure reviewed by management.

 

 

9. Credit card information is encrypted and kept confidential

Existence / Occurrence. Control is in place to prevent fraudulent use of credit card for purchases not authorized by the user. Check sales table and note whether credit card information is fully disclosed or appropriately masked.

Diff: 3     Type: ES     Page Ref: 362-380

Learning Obj.:  12-1  Identify and describe typical records and transactions in the sales cycle; 12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

12.2   State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

1) As the quality of the enterprise risk management process declines, and the quality of internal controls over all declines

  1. A) risk of fraud decreases.
  2. B) risk of fraud increases.
  3. C) the extent of control testing increases.
  4. D) the extent of substantive testing decreases.

Answer:  B

Diff: 2     Type: MC     Page Ref: 371

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

2) The information systems audit specialist on your audit team has indicated that the general controls over program changes are excellent for all application cycles. What impact does this have upon your audit of sales invoice processing?

  1. A) Generalized audit software should be used to select a sample of sales transactions for control testing.
  2. B) Tests of controls should be omitted; only substantive tests may be conducted.
  3. C) There could be problems with the accuracy of calculations for sales taxes and goods and excise taxes.
  4. D) The auditor can place reliance upon the programs performing sales calculations.

Answer:  D

Diff: 3     Type: MC     Page Ref: 372

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

3) The information systems audit specialist on your audit team has indicated that the general controls over program changes are inadequate for all application cycles. What impact does this have upon your audit of sales invoice processing?

  1. A) The auditor could potentially rely upon only manual controls.
  2. B) Only interdependent controls should be considered for control testing.
  3. C) It is likely that calculations, such as extensions, are performed consistently and accurately throughout the year.
  4. D) Unauthorized access to information recorded in the master files is likely.

Answer:  A

Diff: 3     Type: MC     Page Ref: 372

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

4) One of the reasons that the auditor considers the type of information systems and its functions is to

  1. A) assess whether hardware functioning affects applications.
  2. B) evaluate design effectiveness of internal controls.
  3. C) complete risk assessment by audit assertion for cycles.
  4. D) assess whether programmed controls can be relied upon.

Answer:  D

Diff: 2     Type: MC     Page Ref: 373

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

5) When a company uses purchased software packages for its accounting software, such packages normally do not permit the company to change the software package’s functionality. This means that the auditor will consider

  1. A) access controls as being poor.
  2. B) program change controls as poor.
  3. C) program change controls as excellent.
  4. D) access controls as being excellent.

Answer:  C

Diff: 23     Type: MC     Page Ref: 373

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

6) When there are problems with program change procedures or with access controls the auditor may choose to

  1. A) rely less upon manual controls since control risk has been increased.
  2. B) not rely on programmed or interdependent application controls.
  3. C) reduce control risk, which reduces the level of substantive testing.
  4. D) use an information technology audit specialist to assess programmed application controls.

Answer:  B

Diff: 2     Type: MC     Page Ref: 373

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

7) One of the key internal controls to prevent transactions in the sales and collection cycle to fictitious customers is to

  1. A) have the bank reconciliation done by someone who is independent of the treasury function.
  2. B) account for the integrity of the numerical sequence of sales orders.
  3. C) compare customer numbers entered to the customer master file.
  4. D) include the sales price list of all products in the computer files.

Answer:  C

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

8) To test for recorded sales for which there were no actual shipments, the auditor traces from the

  1. A) bill of lading to the sales journal.
  2. B) sales journal to the shipping documents.
  3. C) sales journal to the accounts receivable subsidiary ledger.
  4. D) bill of lading to the supporting customer order and sales order.

Answer:  B

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

9) Tamra is performing a test of control consisting of looking at the numerical sequence of credit memos issued by the company. Tamra is performing a block test by looking for any missing number in the sequence. This test will provide evidence of

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

Answer:  B

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

10) Which of the following control procedures may prevent the failure to bill customers for some shipments?

  1. A) Each shipment should be supported by a prenumbered sales invoice that is accounted for.
  2. B) Each sales order should be approved by authorized personnel.
  3. C) Sales journal entries should be reconciled to daily sales summaries.
  4. D) Each sales invoice should be supported by a shipping document.

Answer:  A

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

11) An effective procedure to test for unbilled shipments is to trace from the

  1. A) sales history file to the shipping documents.
  2. B) shipping documents to the sales history file .
  3. C) sales history file to the accounts receivable ledger.
  4. D) sales history file to the general ledger sales account.

Answer:  B

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

12) Which of the following procedures would ordinarily be expected to best reveal unrecorded sales at the balance sheet date?

  1. A) Compare shipping documents with sales invoices.
  2. B) Apply gross profit rates to inventory disposed of during the period.
  3. C) Trace payments received subsequent to the balance sheet date.
  4. D) Send accounts receivable confirmation requests.

Answer:  A

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

13) To determine that sales are accurately charged, the unit prices on the duplicate sales invoices are normally compared with

  1. A) the original invoices.
  2. B) the amounts recorded in the sales journal for that transaction.
  3. C) the amounts posted to the customer’s account in the accounts receivable master file.
  4. D) an approved item master file.

Answer:  D

Diff: 2     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

14) Which of the following is an example of a key internal control for an online system that would help ensure that recorded sales are for the amount of goods shipped and are accurately billed and recorded?

  1. A) Shipping documents are matched to invoices.
  2. B) Shipping details are automatically used as the invoicing source.
  3. C) Shipping documents are prenumbered and accounted for.
  4. D) Transactions are summarized daily for posting to the general ledger.

Answer:  B

Diff: 3     Type: MC     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

15) Invoices are prepared using a date equal to the shipping date. This control pertains to which transaction-related audit objective?

  1. A) posting and summarization
  2. B) classification
  3. C) cutoff
  4. D) completeness

Answer:  C

Diff: 3     Type: MC     Page Ref: 375

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

16) After the auditor has identified the key internal controls and weaknesses and assessed control risk, it is appropriate to decide whether

  1. A) substantive tests will be increased sufficiently to justify the cost of performing tests of controls.
  2. B) substantive tests will be reduced sufficiently to justify the cost of performing tests of controls.
  3. C) tests of controls will be increased sufficiently to justify the cost of performing substantive tests.
  4. D) tests of controls will be reduced sufficiently to justify the cost of performing substantive tests.

Answer:  B

Diff: 3     Type: MC     Page Ref: 376

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

17) Certain internal controls satisfy more than one objective. It is desirable to consider

  1. A) each objective separately.
  2. B) the objectives together.
  3. C) the objectives that can be tested.
  4. D) only the controls that satisfy the more than one objective.

Answer:  A

Diff: 2     Type: MC     Page Ref: 377

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

18) For each control on which the auditor plans to rely to reduce assessed control risk, he or she must

  1. A) design one or more tests of controls to verify its effectiveness.
  2. B) report all weaknesses in the management letter.
  3. C) quantitatively determine the effect on sampling error.
  4. D) ensure that the test applies to several different transaction audit objectives.

Answer:  A

Diff: 3     Type: MC     Page Ref: 377

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

19) Which one of the following audit procedures is a dual-purpose test?

  1. A) Conduct analytical review to determine the reasonableness of the bad debt allowance.
  2. B) Examine credit limit changes for authorization.
  3. C) Calculate the accuracy of the accounts receivable aging.
  4. D) Observe error message when incorrect customer number is entered.

Answer:  C

Diff: 3     Type: MC     Page Ref: 377-378

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

20) The auditor traces items from the source documents to the journals in order to satisfy the

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

Answer:  B

Diff: 2     Type: MC     Page Ref: 378-379

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

21) An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to satisfy the audit objective of

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

Answer:  B

Diff: 2     Type: MC     Page Ref: 378

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

22) The auditor traces items from the journals back to the source documents in order to satisfy the

  1. A) occurrence objective.
  2. B) completeness objective.
  3. C) ownership objective.
  4. D) valuation objective.

Answer:  A

Diff: 2     Type: MC     Page Ref: 378-379

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

 

23) It is important that sales be billed and recorded in the journal as soon as possible after

  1. A) the order is received.
  2. B) the order is received and credit is approved.
  3. C) credit is approved and it is verified that there is enough inventory to fill the order.
  4. D) shipment takes place.

Answer:  D

Diff: 2     Type: MC     Page Ref: 380

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

24) It is common to test sales for proper classification as part of testing for

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

Answer:  B

Diff: 2     Type: MC     Page Ref: 380

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

25) What is one of the advantages of converting procedures from a design to a performance format?

  1. A) Obtain audit evidence of better quality
  2. B) Help the auditor select the procedures to be performed
  3. C) Eliminate duplicate procedures
  4. D) Ensure compliance with Canadian Auditing Standards

Answer:  C

Diff: 3     Type: MC     Page Ref: 380

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

26) Which of the following key controls helps ensure that sales transactions are classified to the correct account?

  1. A) Computer checks for gaps in shipping document numbers.
  2. B) Invoices are prepared using prices and terms from the customer master file.
  3. C) Management reviews sales reports regularly for reasonableness.
  4. D) Posting is done automatically to the sales account based upon periodic totals.

Answer:  D

Diff: 3     Type: MC     Page Ref: 380

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

 

27) Outline the key areas that the auditor would review as part of general controls.

Answer:  The key areas that the auditor would review as part of general controls are:

– Types of information systems and their functions, to assess whether programmed controls can be relied upon

– Nature of access controls over sales systems and data

– Program change controls for sales systems

Diff: 3     Type: ES     Page Ref: 373

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

28) A) State the five specific transaction-related audit objectives for sales and describe one common test of controls for each objective.

 

  1. B) Describe three tests of controls commonly used to test the accuracy objective for sales.

 

Answer:

A)

  • Recorded sales are for shipments actually made to nonfictitious customers (occurrence). Trace sales journal entries to copies of sales orders, sales invoices, and shipping documents.
  • Existing sales transactions are recorded (completeness). Trace shipping documents to sales invoices and sales journal entries and accounts receivable master file.
  • Recorded sales are for the amount of goods shipped and are correctly billed and recorded (accuracy). Trace entries in sales journal to sales invoices.
  • Sales are recorded on the correct dates (cutoff). Compare dates of recorded sales transactions with dates on shipping records.
  • Sales transactions are classified to the correct account (classification). Examine documents supporting sales transactions for proper classification.
  • Sales transactions are updated correctly to the customer master file, and the posting to the general ledger summed these transactions correctly: Compare customer mater file totals with general ledger balance on a monthly basis. Investigate any differences.
  1. B) (Note: Answers will vary beyond the three examples below.) Three tests of controls commonly used to test the accuracy objective for sales include:
  • Recompute information on sales invoices (re-foot and re-extend the invoice).
  • Trace entries in sales journal to sales invoices, comparing invoice total with amount recorded in journal.
  • Trace details on sales invoices (description, price per unit, quantity) to shipping documents, approved price lists, and customers’ orders.

Diff: 3     Type: ES     Page Ref: 374-375

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

29) A) Describe each of the six key control activities for sales.

 

  1. B) When assessing planned control risk for sales, the auditor is concerned about proper authorization at three key points. Discuss each of these three points.

 

  1. C) When testing the existence objective for sales, the auditor is concerned with the possibility of three types of misstatements. One type is sales being including in the journal for which no shipment was made. Discuss the other two types of misstatements.

 

Answer:

  1. A) The six key control activities for sales are:
  • Adequate separation of duties. For example, persons responsible for inputting sales and cash receipts transactions should not have access to cash.
  • Proper authorization. Credit should be properly authorized before a sale takes place, goods should be shipped only after proper authorization, and prices should be authorized.
  • Adequate documents and recordkeeping procedures.
  • Prenumbered documents that are accounted for periodically.
  • Mailing monthly statements to customers.
  • Internal verification procedures. An independent person should periodically check the processing and recording of sales transactions.
  1. B) Credit should be properly authorized before a sale takes place; goods should be shipped only after proper authorization; and prices, base terms, freight, and discounts should be properly authorized.
  2. C) The auditor is also concerned with the possibility of (1) shipments being made to nonexistent customers and recorded as sales, and (2) sales being recorded more than once.

Diff: 3     Type: ES     Page Ref: 376, 378

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

30) You are the audit senior responsible for a large photofinishing centre and camera store. The store uses automated cash registers tied to inventory (also known as point of sale devices). The point of sale devices take advantage of automated procedures and controls that can be programmed, to reduce errors and improve controls over completeness of transactions.

 

Required:

Provide examples of interdependent controls that should be used to complement the programmed controls.

Answer:  [Note, see elsewhere in testbank for examples of programmed controls that could be present in cash registers or point of sale devices.]

Error follow up: Any errors (such as rejected transactions or rejected user access attempts) should be recorded by the computer systems and reviewed by a supervisor. The supervisor should ensure that errors are followed up. Exception reports (such as high dollar transactions or negative inventory) should be reviewed by management regularly.

 

Reconciliation: Totals per the point of sale device by each cash receipt type should be reconciled to the cash register drawer daily (i.e. cash, credit card, debit card). Credit card and debit card deposits should be reconciled to the bank statement. Cash should be deposited daily and agreed to the duplicate deposit slip.

 

Bank statements should be reconciled to the balance per general ledger in the cash account.

Diff: 3     Type: ES     Page Ref: 374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

 

31) Office Design Inc. (ODI) has been your audit client for five years. ODI designs and sells office furniture, such as desks, cabinets, and couches used in reception areas. ODI has sales in Canada and the U.S., with five distribution locations, where furniture is available to prospective purchasers to try out before purchasing. These locations are in Toronto, Montreal, Halifax, New York and Chicago. The company uses custom designed software for its order processing and sales, kept current by one of the five information systems personnel.

 

The Vice President Finance is new. Executive management is paid based upon a salary and a bonus based upon the annual net income of ODI. Unfortunately, the accounting staff at head office (Montreal) has been downsized from ten people to six due to a recent slowdown in sales. Your review of the aged accounts receivable trial balance revealed that one third of the accounts have been outstanding for more than one year. ODI’s profits have declined substantially from last year. The line of credit and bank loans are at their maximum, and the company is considering selling its U.S. operations to provide cash flow.

 

Prior year working papers revealed few errors and that you considered management integrity to be good. However, due to segregation issues, you did not rely on the internal controls in the prior year.

 

Required:

 

  1. A) What issues in corporate governance and in the control environment affect your assessment of internal controls for revenue? How does this affect the decision to conduct substantive testing (i.e. exclusion of tests of controls)?

 

  1. B) What is the likely assessment of computer general controls? How does this affect the type of audit testing conducted at ODI?

 

Answer:

  1. A) Senior executives are motivated to overstate revenue as they are remunerated based upon net income (alternatively, they could also understate expenses, such as bad debt expense). This also would motivate them to understate the bad debt allowance, which would increase revenue. Particularly due to the decrease in staff, it would be easier for senior management to override internal controls. This would motivate the auditor to increase substantive testing.

 

Customized programming is more complex and error prone than software packages. Particularly with a small information systems group, it is less likely that there would be controls over program changes, meaning that auditors would need to look for compensating manual controls over revenue and are less likely to be able to rely on automated controls. This takes us back to senior management potential to override such manual controls, again supporting the need for increased substantive testing rather than tests of controls.

 

 

  1. B) With a small information systems group (only five people), it is less likely that there is adequate segregation of duties in key information systems areas. Program change controls are likely difficult to rely upon (see part A) due to the complexity of customized systems rather than packaged systems. Physical access and security is not mentioned, but could be a problem if some information systems support activities are handled by accounting personnel. Finally, documentation of programs and operations tends to be less when there are customized systems and fewer personnel.

 

This would lead the auditor to place limited reliance upon general controls, resulting in the need to conduct increased substantive testing.

[Note: This case is a good example for students to understand why it is still necessary to document internal controls, even though they may decide not to conduct tests of controls. Identification of weaknesses helps the auditor design substantive tests.]

Diff: 3     Type: ES     Page Ref: 370-373

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

 

 

32) Chong Manufacturing Limited (CML) is a small manufacturer that supplies parts to the automotive industry. CML deals primarily with second tier companies, and does not deal with the car manufacturers directly. Last year, CML was required to implement EDI (electronic data interchange), otherwise two of its major customers would have taken their business elsewhere.

 

The installation was provided by Simon’s Computer Company, a local computer store with expertise in EDI. One of CML’s customers, Delta Parts Limited, also sent a purchasing agent to CML to help train staff at CML in the use of EDI and to walk through the first few transactions with CML accounting personnel to ensure that they could use the system effectively.

 

A typical EDI sale is processed as follows:

 

Delta sends a purchase order to CML, which is received via the internet into an EDI in-basket. CML empties the EDI in-basket using its EDI software every hour, and the EDI software edits the purchase order for completeness and obvious errors. If there are no problems, then the purchase order is printed out and used by CML to process the order.

 

Once the order has been processed, CML prepares its shipping documentation and invoice using its normal packaged accounting software. The shipping document and the electronic invoice are transferred to the EDI software and placed in an EDI out-basket. Accounting staff transmit the contents of the EDI out-basket to their customer (e.g. Delta).

 

Once Delta receives the electronic shipping documents and electronic invoices, it will transfer the funds electronically to CML’s bank account to pay for the goods delivered. This means that CML receives payment much faster than when invoices were mailed to customers.

 

Required:

 

  1. A) What is the impact of the new EDI system on the audit engagement?

 

  1. B) List some controls that should be included in the new EDI system.

 

Answer:

  1. A) Since it is a new sub-system, we will need to obtain an understanding of it and document the system so that we can design our audit tests.

 

If the system is complex, we may need to request the assistance of information systems specialist staff on the audit engagement.

It does not appear that there is any transaction data in the new EDI system, but there is likely some master file information, such as customer information and part information. Any information set up in the new system needs to be tested to ensure that it was prepared accurately.

 

It may be necessary to use computer-assisted audit testing if transactions are kept in only electronic format rather than printed (i.e. shipping documents and invoices).

 

If we choose to rely on the edits performed by the EDI system, then we will need to test these edits (e.g. data being accepted in the proper format).

  1. B) Users should require user identification codes and passwords to use the system.

Passwords should be difficult to guess and changed periodically.

 

Users should be limited to the functions that they need to perform their job.

 

The system should have automatic acknowledgements to confirm that transactions have been sent and received.

 

Input edits should be specific to the company, e.g. size of part numbers, looking for missed information, adequate edits on dates.

 

Adequate help screens or other documentation should exist to use the system properly.

 

Staff who use the system should be properly trained.

 

Logs should be used to identify errors or exceptions and printed off regularly.

 

Accounting personnel should follow up on errors and exceptions on a timely basis (e.g. daily).

Diff: 3     Type: ES     Page Ref: 370-374

Learning Obj.:  12-2  State the relationship between overall audit planning risks and risks for sales and collections cycle assertions

12.3   Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

1) The emphasis for the audit of sales return and allowances is often placed on testing the existence of recorded transactions. However, the most important objective to consider is

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

Answer:  D

Diff: 2     Type: MC     Page Ref: 381

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

2) The most difficult type of cash defalcation for the auditor to detect is that which occurs

  1. A) before the cash is recorded.
  2. B) after cash is recorded but before it goes to the bank.
  3. C) out of the balance kept in a cash register.
  4. D) in amounts under $100.

Answer:  A

Diff: 1     Type: MC     Page Ref: 382

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

 

3) Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? The cashier

  1. A) prepares the daily deposit.
  2. B) makes the daily deposit at a local bank.
  3. C) records the receipts to the customer files.
  4. D) endorses the cheques with the company endorsement stamp.

Answer:  C

Diff: 3     Type: MC     Page Ref: 383

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

4) The appropriate test of controls for separation of duties is

  1. A) documentation.
  2. B) confirmation.
  3. C) examination.
  4. D) observation.

Answer:  D

Diff: 2     Type: MC     Page Ref: 383

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

5) Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor?

  1. A) postponing recording of cash receipt entries
  2. B) overstating the accounts receivable control account
  3. C) overstating the accounts receivable subsidiary ledger
  4. D) recording cash receipt entries early

Answer:  A

Diff: 3     Type: MC     Page Ref: 384

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

6) The defalcation process, which postpones entries for the collection of accounts receivable to conceal an existing cash shortage, is referred to as

  1. A) kiting.
  2. B) lapping.
  3. C) computer fraud.
  4. D) financial statement fraud.

Answer:  B

Diff: 1     Type: MC     Page Ref: 384

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

 

7) An audit procedure which compares the name, amount, and dates shown on remittance advices with cash receipts journal entries and with related duplicate deposit slips would be effective in detecting

  1. A) kiting.
  2. B) lapping.
  3. C) illicit write-offs of customers as uncollectible accounts.
  4. D) sales without proper credit authorization.

Answer:  B

Diff: 1     Type: MC     Page Ref: 384

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

8) Which of the following internal control procedures will most likely prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable? Write-offs must be

  1. A) approved by a responsible officer after review of credit department recommendations and supporting evidence.
  2. B) supported by an aging schedule showing that only receivables overdue several months have been written off.
  3. C) approved by the cashier who is in a position to know if the accounts receivable have, in fact, been collected.
  4. D) authorized by company field sales employees who are in a position to determine the financial standing of the customers.

Answer:  A

Diff: 3     Type: MC     Page Ref: 384

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

9) A) State the five specific transaction-related audit objectives for cash receipts and describe one common test of controls for each objective.

 

  1. B) Discuss what is meant by proof of cash receipts and explain its purpose.

 

Answer:

  1. A) The five specific transaction-related audit objectives for sales and one common tests of controls are:
  • Recorded cash receipts are for funds actually received by the company (occurrence). Trace from cash receipts journal to bank statements.
  • Cash received is recorded in the cash receipts journal (completeness). Trace from remittance advices or prelisting to cash receipts journal.
  • Cash receipts are deposited and recorded at the amounts received (accuracy). Prepare a proof of cash receipts.
  • Cash receipts are recorded on the correct dates (cutoff). Compare dates of deposits with dates in the cash receipts journal and prelisting of cash receipts
  • Cash receipts transactions are properly classified (classification). Examine documents supporting cash receipts for proper classification.
  1. B) A proof of cash receipts is an audit procedure in which the total cash receipts recorded in the cash receipts journal for a given period are reconciled with the actual deposits made to the bank during the same period. The purpose of a proof of cash receipts is to determine whether all recorded cash receipts have been deposited in the bank account. It can also identify unrecorded deposits.

Diff: 2     Type: ES     Page Ref: 382-384

Learning Obj.:  12-3  Describe the methodology for designing controls over sales returns and allowances, cash receipts transactions and uncollectable accounts

 

12.4   Illustrate the risk assessment and audit of sales and cash receipts using Hillsburg Hardware Limited to describe the typical audit process through tests of controls

 

1)

  1. A)
  2. B)
  3. C)
  4. D)

Answer:  A

Diff: 2     Type: MC

 

Auditing, 12e (Arens)

Chapter 20   Auditor Reporting

 

20.1   State the requirements for a standard unqualified audit report

 

1) The most common type of audit report contains

  1. A) an adverse opinion.
  2. B) a disclaimer of opinion.
  3. C) a qualified opinion.
  4. D) an unqualified opinion.

Answer:  D

Diff: 1     Type: MC     Page Ref: 596

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

2) According to CAS 700, the standard unqualified report’s title should be

  1. A) Unqualified report of the auditor.
  2. B) Audited financial statements.
  3. C) Auditor’s report.
  4. D) Independent auditor’s report.

Answer:  D

Diff: 2     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

3) Under the Canadian Auditing Standards, the introductory paragraph of the independent auditor’s report indicates that the auditor has audited the balance sheet, the income statement, the cash flow, a summary of accounting policies and notes and

  1. A) the statements of retained earnings.
  2. B) the statement of changes in equity.
  3. C) management’s discussion and analysis letter.
  4. D) the internal controls of the company.

Answer:  B

Diff: 2     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

4) The scope paragraph of the standard unqualified audit report in the auditor responsibility section states that the audit is designed to

  1. A) discover all errors and/or irregularities.
  2. B) discover material errors and/or irregularities.
  3. C) obtain reasonable assurance whether the statements are free of material misstatement.
  4. D) conform to a generally accepted financial reporting framework.

Answer:  C

Diff: 1     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

5) Management has several responsibilities that are important to the auditor. One of these is that management is responsible for

  1. A) internal controls that prevent material misstatements either due to fraud or error.
  2. B) maintaining control of evidence (such as confirmations) until assessed by the auditor.
  3. C) evaluating evidence against acceptable criteria.
  4. D) providing reasonable assurance that the financial statements are fairly stated.

Answer:  A

Diff: 2     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

6) In the scope paragraph of the audit report, the use of the term “reasonable assurance” is intended to indicate that

  1. A) no misstatements exist in the financial statements.
  2. B) no material misstatements exist in the statements.
  3. C) there is some possibility that material misstatements still exist in the financial statements.
  4. D) there is a possibility that immaterial misstatements still exist in the financial statements.

Answer:  C

Diff: 2     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

7) The use of the term “reasonable assurance” is intended to indicate that an audit cannot be expected to

  1. A) completely eliminate the possibility that a material error or fraud exists.
  2. B) consider or search for minor errors.
  3. C) be compliant with the generally accepted accounting principles for every account.
  4. D) provide assurance of no material errors or irregularities to investors who are using the financial statements for investment decisions.

Answer:  A

Diff: 2     Type: MC     Page Ref: 597

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

8) It is management’s responsibility to select the accounting policies that are used in the preparation of the financial statements. What is the auditor’s responsibility with respect to these accounting policies?

  1. A) approve the accounting policies that are used, so that an opinion can be stated on the fairness of the financial statements
  2. B) evaluate the appropriateness of the accounting policies that are used and of the associated estimates made
  3. C) tell management which accounting policies should be selected, so that accurate estimates can be made for year end adjustments
  4. D) recalculate the estimates that are used for the accounting policies (such as bad debt allowance and warranty expenses)

Answer:  B

Diff: 3     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

9) The independent auditor’s opinion explains how much evidence the auditor collects during the independent audit. How much evidence is collected?

  1. A) sufficient and appropriate to provide a basis for the audit opinion
  2. B) sufficient to state that there are no material errors in the financial statements
  3. C) appropriate to be able to evaluate the exact accuracy of the accounting estimates
  4. D) sufficient and appropriate to conclude the financial statements present a true and fair view of the economic events of the organization

Answer:  A

Diff: 2     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

10) The phrase “in our opinion” indicates that

  1. A) the auditor performed the audit on a test basis.
  2. B) the auditor’s judgment can be relied upon.
  3. C) the auditor relied on their knowledge to perform the audit.
  4. D) there may be some information risk associated with the financial statements.

Answer:  D

Diff: 2     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

11) One of the most controversial parts of the auditor’s report is the meaning of the term “presents fairly.” What does the auditor’s opinion mean when these words are used? The

  1. A) values in the financial statements represent the net realizable values of the assets of the entity.
  2. B) financial statements are accurate and provide a true and fair representation of the entity’s current financial position.
  3. C) values in the financial statements represent the value of the entity now, if it were liquidated on an open market.
  4. D) financial statements are fairly presented in accordance with the financial reporting framework described in the opinion paragraph.

Answer:  D

Diff: 2     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

12) Clark Kent is a PA partner at the firm of Kent, Lane and Lang, a limited liability partnership. Kent’s firm has just completed the audit of a client with a March 31, 2012, year end. How should the audit report be signed?

  1. A) Clark Kent, PA
  2. B) Kent, Lane and Lang, LLP
  3. C) Clark Kent, LLP
  4. D) Kent, Lane and Lang, PAs

Answer:  B

Diff: 3     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

13) The appropriate date for the audit report for a public company is the one on which the

  1. A) client’s fiscal year ended.
  2. B) auditor and client entered into a contract.
  3. C) board of directors approved the financial statements.
  4. D) auditor prepares and delivers the report to the client.

Answer:  C

Diff: 1     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

14) The audit report date is important to users because it indicates the last day

  1. A) of the fiscal period.
  2. B) on which the financial statements may be filed with the provincial securities commission.
  3. C) on which users may institute a lawsuit against either client or auditor.
  4. D) of the auditor’s responsibility for the review of significant events that occurred after the date of the financial statements.

Answer:  D

Diff: 1     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

15) If the balance sheet of a company is dated December 31, 2012, the audit report is dated March 6, 2013, and both are released to the public on March 15, 2013, this indicates that the auditor has searched for material unrecorded transactions and events that occurred up to

  1. A) December 31, 2012.
  2. B) March 6, 2013.
  3. C) March 15, 2013.
  4. D) December 31, 2013.

Answer:  B

Diff: 2     Type: MC     Page Ref: 598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

16) Double dating a report is done when

  1. A) the parent company and their subsidiaries have different year ends.
  2. B) the auditor finishes his work later than planned.
  3. C) a material event occurs after the date of the auditor’s report and affects the period that was audited
  4. D) a material event occurs after the date of the auditor’s report and before the date the report is issued.

Answer:  D

Diff: 2     Type: MC     Page Ref: 599

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

17) There are five conditions that must be met before an auditor can issue a standard unqualified report. Discuss each of these five conditions.

Answer:  The five conditions that justify issuing a standard unqualified report are:

  • An audit engagement has been undertaken.
  • The general standard of GAAS has been followed in all respects on the engagement.
  • Sufficient appropriate audit evidence has been accumulated, and the three examination standards have been met.
  • All statements-balance sheet, income statement, statement of retained earnings, and statement of cash flows-are included in the financial statements (along with the notes to the financial statements), and are presented in accordance with an appropriate disclosed basis of accounting, which usually an acceptable financial reporting framework.
  • There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.

Diff: 1     Type: ES     Page Ref: 596

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

 

18) Analyze the “Auditor Responsibility Section” of the standard Independent Auditor’s Report, ie. explain the intended purpose of the sentences in this section.

Answer:  The auditor responsibility paragraph starts with a summary statement that explains the purpose of the audit-the expression of an opinion on the financial statements described in the first sentence. Then, further detail is provided, stating that the auditor followed generally accepted auditing standards during the performance of the audit. It tells the reader what those standards comprise: The audit is designed to obtain reasonable assurance whether the statements are free of material misstatement. The inclusion of the word “material” conveys the meaning that auditors search for significant misstatements, not minor errors that do not affect users’ decisions. The use of the term “reasonable assurance” is intended to indicate that an audit cannot be expected to completely eliminate the possibility that a material error or fraud or other irregularity will exist in the financial statements. In other words, an audit provides a high level of assurance, but not a guarantee.

The remainder briefly describes important aspects of what an audit does and does not include. It starts with the basis of the audit-that is, the auditor’s use of professional judgment in the context of a risk assessment (considering risks of error or fraud) to select audit procedures for the conduct of the audit. It includes assessing internal controls over financial systems that affect the financial statements but does not provide an opinion over those controls (as internal controls can and do change over time).

While the management responsibility paragraph of the report states that management is responsible for the preparation and content of the financial statements, this paragraph explains how the auditor evaluates what management has done. It states that the auditor has the responsibility to evaluate the appropriateness of the accounting policies that are used and of the estimates made, as well as of the overall presentation of those financial statements. The auditor cannot simply accept management’s representations about appropriateness. The final sentence refers to the quality of the evidence collected: sufficient and appropriate-that is, enough high-quality evidence has been obtained to allow the auditor to provide an opinion on the financial statements.

Diff: 3     Type: ES     Page Ref: 597-598

Learning Obj.:  20-1  State the requirements for a standard unqualified audit report

20.2   Describe how the standard audit report is changed to provide additional information to users

 

1) A deviation from the standard unqualified report will cause knowledgeable users of financial statements to recognize that the

  1. A) auditor intends to communicate additional or limiting information.
  2. B) financial statements contain a material error.
  3. C) financial statements contain an error.
  4. D) Canadian Auditing Standards were not followed.

Answer:  A

Diff: 2     Type: MC     Page Ref: 599

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

2) Three of the following conditions would, by themselves, require the auditor to issue a report other than an unqualified report. Which one would permit a standard unqualified report?

  1. A) The financial statements show a significant net loss for each of the last three years, including the current fiscal period.
  2. B) The financial statements have not been prepared in accordance with an acceptable financial reporting framework and are misleading.
  3. C) The auditor is not independent during the fiscal period under audit.
  4. D) The scope of the auditor’s examination has been restricted, although the cause of the restriction was not the client’s fault.

Answer:  A

Diff: 2     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

3) Bianca Jones was engaged to conduct the audit of Smilicor Company, a toy distributor, three months after the year end date. Bianca was unable to conduct an audit of opening inventory, but was able to satisfy herself with respect to the opening balances. She was also able to conduct audit procedures for other opening balances, for example, by observing fixed assets. What type of audit opinion would Smilicor receive?

  1. A) Disclaimer
  2. B) Adverse
  3. C) Qualified
  4. D) Unqualified

Answer:  D

Diff: 2     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

4) The “unqualified report with explanatory paragraph” or the “unqualified report with modified wording”

  1. A) arise as a result of an incomplete audit.
  2. B) arise when the financial statements are not quite “presented fairly.”
  3. C) meet the criteria of a complete audit with satisfactory results but further explanation is required.
  4. D) meet the criteria of a complete audit but with unsatisfactory results.

Answer:  C

Diff: 3     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

5) The ASPE (Accounting Standards for Private Enterprises) financial reporting framework normally requires the auditor to report using the corresponding figures approach. This means that the auditor reports on

  1. A) the current year’s financial statements.
  2. B) both periods under audit, the current and prior year.
  3. C) three years, the current and prior year, and the effects of the prior year.
  4. D) only the ending balances of the general ledger accounts.

Answer:  A

Diff: 2     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

6) Publicly listed organizations and those using IFRS (International Financial Reporting Standards) must have audit reports that use the comparative financial statements approach. This means that the auditor reports on

  1. A) the current year’s financial statements.
  2. B) both periods under audit, the current and prior year.
  3. C) three years, the current and prior year, and the effects of the prior year.
  4. D) only the ending balances of the general ledger accounts.

Answer:  B

Diff: 2     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

 

7) Your client has experienced a major data breach with lawsuits and fines pending of significant and uncertain amounts. These events are disclosed in the client financial statements and clearly explained in the notes. How do these events affect the independent auditors report? The auditor would use

  1. A) a standard unqualified auditor’s report.
  2. B) an emphasis of matter paragraph titled “Data Breach” to highlight the events.
  3. C) an other matters paragraph titled “Data Breach” to highlight the amounts.
  4. D) a qualified audit opinion due to the size of the uncertainty.

Answer:  B

Diff: 3     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

8) Your client has two sets of financial statements. One set is in compliance with IFRS, while the other set is in compliance with local tax legislation, and will be used only with the tax returns. How do these events affect the independent auditors report? The auditor would use

  1. A) an unqualified audit report for both financial statements, with an Emphasis of Matter paragraph that describes to readers the nature of the other set of financial statements.
  2. B) a standard unqualified auditor’s report for both financial statements, labeling the auditor’s report “for IFRS only” and “for tax purposes only.”
  3. C) an unqualified audit report for both financial statements, with an Other Matter paragraph that describes to readers the nature of the other set of financial statements.
  4. D) a qualified audit report would be issued as the client may not have two different sets of financial statements.

Answer:  C

Diff: 3     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

9) Your client is not using either ASPE or IFRS. Instead, it is using current value accounting with no use of historical cost, because your client is in a country with about 50% inflation per year. Local legislation requires that all resident organizations use current value accounting. How do these events affect the independent auditors report? The auditor would

  1. A) issue a standard unqualified auditor’s report.
  2. B) use an Emphasis of Matter paragraph to explain that the financial statements are prepared in accordance with local legislation.
  3. C) use an Other Matter paragraph to explain that the financial statements are prepared in accordance with local legislation.
  4. D) state in the opinion paragraph that the financial statements were prepared in accordance with the local legislation.

Answer:  D

Diff: 3     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

 

10) Your client is a large financial institution in Canada. Canadian regulators require that such financial statements have an audit report that provides an opinion on the consistency of accounting policies. How do these events affect the independent auditors report? The auditor would

  1. A) add an Other Matter paragraph titled Report on Other Legal and Regulatory Requirements.
  2. B) add an Emphasis of Matter paragraph titled Report on Other Legal and Regulatory Requirements.
  3. C) use a standard unqualified auditor’s report.
  4. D) state in the opinion paragraph that the financial statements were prepared in accordance with the legislation for financial institutions.

Answer:  A

Diff: 3     Type: MC     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

11) Beem & Lord, a PA firm, audited the financial statements of Frazer Inc. Since this was a first time audit, Beem & Lord did not audit the comparative financial statements, as this was done by the previous auditor. Beem & Lord should expand their report to include an explanation in

  1. A) the scope paragraph.
  2. B) the management responsibility paragraph.
  3. C) the opinion paragraph.
  4. D) a paragraph following the opinion paragraph.

Answer:  D

Diff: 2     Type: MC     Page Ref: 601

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

12) A company has changed its method of inventory valuation from an unacceptable one to one that complies with ASPE (Accounting Standards for Private Enterprises). The auditor’s report on the financial statements of the year of the change should include

  1. A) no reference to the item assuming that the change has been properly disclosed.
  2. B) a reference to a change in accounting principle in the opinion paragraph.
  3. C) an explanatory paragraph explaining the change.
  4. D) a justification for making the change and the impact of the change on reported net income.

Answer:  A

Diff: 2     Type: MC     Page Ref: 601

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

 

13) PA firm has been auditing Big Manufacturing Company (BMC) for several years. Last year, BMC converted its inventory and purchasing systems to a new system effective December 31, the date of the year end. To their horror, the PA firm discovered at the beginning of the current error that there was a cut-off error in the accounts payable system of $25 million dollars LAST YEAR. Neither the client nor the firm had detected that the purchases of December 31 had been omitted from the old computer system transaction processing and had been recorded only in the new computer system, understating last year’s expenses. Last year’s financial statements have been restated and the error disclosed in the notes to both last year’s and this year’s financial statements. What type of audit opinion will BMC receive this year?

  1. A) Qualified
  2. B) Disclaimer
  3. C) Adverse
  4. D) Unqualified

Answer:  D

Diff: 3     Type: MC     Page Ref: 601

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

14) When a material uncertainty exists, the auditor must

  1. A) disclose it in the audit report.
  2. B) first determine the materiality of the item and whether adequate disclosure is included in the financial statements.
  3. C) issue a disclaimer of opinion.
  4. D) issue a qualified opinion.

Answer:  B

Diff: 2     Type: MC     Page Ref: 602

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

15) ProForce Inc. is facing a large lawsuit from its employees. The contingency is significant and may lead to a going concern issue if ProForce is found guilty. ProForce took the adequate measures, as prescribed by IFRS (International Financial Reporting Standards), to account, disclose and present the contingency in the financial statements. The auditor should

  1. A) add an emphasis-of-matter paragraph after the opinion paragraph.
  2. B) issue a standard unqualified report.
  3. C) issue a qualified report.
  4. D) deny an audit opinion.

Answer:  A

Diff: 2     Type: MC     Page Ref: 602

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

16) Explain four different variations that could occur in unqualified audit reports. For each variation, state how the auditor’s report is affected and provide an example.

Answer:

Purpose of variation How it is accomplished Example of when used
Highlight or emphasize material that is already in the client financial statements or notes Emphasis of Matter paragraph (CAS 706.5[a]) Client has experienced a major data breach with lawsuits and fines pending of significant and uncertain amounts.
Provide information that is not in the client financial statements or notes Other Matter paragraph (CAS 706.5[b]) There are two sets of financial statements, for example one that is in compliance with an acceptable financial reporting framework such as IFRS and another that is in compliance with legislation (such as foreign tax legislation).
The financial statements are in compliance with a legislative framework that is not fair in accordance with a financial reporting framework. State in the opinion paragraph that the financial statements are prepared in accordance with the legislation (CAS 700.36) A country with high inflation requires financial statements fully prepared using current values with no use of historical cost.
Legislation requires reporting on consistency of accounting policies. Add an Other Matter paragraph titled Report on Other Legal and Regulatory Requirements (AuG-48.5 and CAS 700.38) Financial institutions are required to report on consistency of their accounting principles from one year to the next.

Diff: 3     Type: ES     Page Ref: 600

Learning Obj.:  20-2  Describe how the standard audit report is changed to provide additional information to users

 

 

20.3   Describe the difference between an adverse opinion and a disclaimer of opinion

 

1) As a result of management’s refusal to permit the auditor to physically examine inventory, the auditor has not accumulated sufficient evidence to conclude whether financial statements are stated in accordance with ASPE (Accounting Standards for Private Enterprises). The auditor must depart from the unqualified audit report because

  1. A) the financial statements have not been prepared in accordance with GAAP.
  2. B) the scope of the audit has been restricted by circumstances beyond either the client’s or auditor’s control.
  3. C) the auditor has lost independence.
  4. D) the scope of the audit has been restricted by the client.

Answer:  D

Diff: 1     Type: MC     Page Ref: 602-603

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

2) If a misstatement is immaterial relative to the financial statements of the entity for the current period and is not expected to have a material effect in future periods, it is appropriate to issue

  1. A) an unqualified opinion.
  2. B) a qualified opinion.
  3. C) an adverse opinion.
  4. D) a disclaimer of opinion.

Answer:  A

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

3) The auditor’s report of the Huge Mega Company indicates that the financial statement are fairly presented except for the goodwill balance which does not comply with International Financial Reporting Standards. The auditor’s report is

  1. A) unqualified.
  2. B) unqualified with explanatory paragraph.
  3. C) qualified.
  4. D) adverse.

Answer:  C

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

 

4) The auditor’s report of the Samcorp Company indicates that the auditor is unable to form an opinion on whether the financial statements of the company are fairly presented due to scope restrictions and unavailable and incomplete records. The auditor’s report is

  1. A) unqualified.
  2. B) qualified.
  3. C) adverse.
  4. D) disclaimer of opinion.

Answer:  D

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

5) The least severe type of report for disclosing departures from an unqualified report is the

  1. A) adverse opinion.
  2. B) disclaimer of opinion.
  3. C) qualified opinion.
  4. D) report on unaudited financial statements.

Answer:  C

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

6) When the auditor knows that the financial statements may be misleading because they were not prepared in accordance with an acceptable financial reporting framework, he or she must issue

  1. A) a qualified opinion.
  2. B) an adverse opinion.
  3. C) a disclaimer of opinion.
  4. D) a qualified or an adverse opinion, depending on the materiality of the item in question.

Answer:  D

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

7) Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned about the possibility that management is trying to prevent discovery of misstated information. In such cases, which type of report should be issued? A

  1. A) disclaimer of opinion, in all cases.
  2. B) qualification of both scope and opinion, in all cases.
  3. C) disclaimer of opinion, whenever materiality is in question.
  4. D) qualification of both scope and opinion, whenever materiality is in question.

Answer:  C

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

 

8) The auditor would most likely issue a disclaimer of opinion because of

  1. A) the client’s failure to present supplementary information.
  2. B) inadequate disclosure of material information.
  3. C) a client-imposed scope limitation.
  4. D) the qualification of an opinion by the other auditor of a subsidiary where there is a division of responsibility.

Answer:  C

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

9) A misstatement in the financial statements can be considered material if

  1. A) it overshadows the financial statements as a whole.
  2. B) knowledge of the misstatement would affect the decision of a reasonable user of the statements.
  3. C) it affects more than one account on the statements.
  4. D) it affects only one account on the statements.

Answer:  B

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

10) When a misstatement in the financial statements exists but is unlikely to affect the decisions of a reasonable user, it would be appropriate to issue

  1. A) an unqualified opinion.
  2. B) a qualified opinion.
  3. C) a disclaimer of opinion.
  4. D) an adverse opinion.

Answer:  A

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

11) An adverse opinion is issued when the auditor believes

  1. A) some parts of the financial statements are materially misstated or misleading.
  2. B) the financial statements will be found to be misleading or misstated, if an adequate investigation is performed.
  3. C) the overall financial statements are so materially misstated or misleading as a whole that they do not present fairly the financial position or results of operations and changes in financial position.
  4. D) the audit firm is not independent.

Answer:  C

Diff: 1     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

12) Both disclaimers of opinion and adverse opinions are used

  1. A) only when the condition is highly material and pervasive.
  2. B) whether the condition is material or not.
  3. C) regardless of the auditor’s independence.
  4. D) regardless of the client’s choice of accounting method.

Answer:  A

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

13) Mafah Distribution Limited has requested that the audited financial statements be completed by January 5, five days after the December 31 year end. This means that the auditor will be unable to verify subsequent payments on accounts receivable and will be unable to determine whether accounts payable have been set up correctly. What type of audit report should Mafah receive if the auditor is unable to use alternative procedures for these two audit areas?

  1. A) Disclaimer
  2. B) Adverse
  3. C) Qualified
  4. D) Unqualified

Answer:  A

Diff: 3     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

14) The dollar amount of some misstatements cannot be accurately measured. If, for example, the client was unwilling to disclose an existing lawsuit, the materiality question the auditor must evaluate in such a situation is

  1. A) what effect will it have on net income.
  2. B) how will it affect management’s future decisions.
  3. C) does it increase the auditor’s exposure to lawsuits.
  4. D) what effect will it have on statement users.

Answer:  D

Diff: 2     Type: MC     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

15) When a misstatement in the financial statements would affect a user’s decision but the overall statements are still fairly stated, it would be appropriate to issue

  1. A) an unqualified opinion.
  2. B) a qualified opinion.
  3. C) an adverse opinion.
  4. D) a disclaimer of opinion.

Answer:  B

Diff: 1     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

16) The client has presented all required financial statements with the exception of the statement of cash flows. The auditor has completed the audit and is satisfied that everything, with the exception of the missing statement, is presented fairly. As a result, the auditor would likely issue

  1. A) a qualified opinion.
  2. B) an unqualified opinion.
  3. C) a disclaimer of opinion.
  4. D) either an unqualified or qualified opinion.

Answer:  A

Diff: 2     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

17) If inventory is the largest balance on the financial statements, a large misstatement would be so material that the auditor should issue

  1. A) an unqualified opinion.
  2. B) a qualified opinion.
  3. C) an adverse opinion.
  4. D) a disclaimer of opinion.

Answer:  C

Diff: 2     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

18) When determining whether an exception is highly material, the extent to which the exception affects different parts of the financial statements must be considered. This is referred to as

  1. A) materiality.
  2. B) pervasiveness.
  3. C) financial analysis.
  4. D) ratio analysis.

Answer:  B

Diff: 1     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

 

19) Fractal Software Limited has acquired a 100% subsidiary in Malaysia that produces keyboards and other types of computer hardware. Fractal is refusing to consolidate its financial statements, as this would increase the debt to equity ratio to the point that Fractal would violate its debt agreement, although it would benefit the current ratio with a sizeable increase in inventory. Instead, Fractal would like to record the investment in the Malaysian subsidiary at cost. What type of effect does the non-consolidation have upon the financial statements?

  1. A) Material and isolated
  2. B) Material
  3. C) Material and pervasive
  4. D) Immaterial

Answer:  C

Diff: 3     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

20) The primary concern in measuring materiality when a client has failed to follow an acceptable financial reporting framework is usually

  1. A) the total dollar error in the accounts involved, compared with some acceptable base.
  2. B) measurability of the dollar error.
  3. C) the nature of the item in error.
  4. D) whether it can materially affect some future period.

Answer:  A

Diff: 3     Type: MC     Page Ref: 605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

21) The auditor has set materiality at XYZ Company of $50,000 based upon a percentage of net assets. The company currently has a small profit (only $3,500). Which of the following items would the auditor most likely consider to be material and request an account balance adjustment?

  1. A) a misclassification between accounts receivable and accounts payable of $10,000
  2. B) incorrect allocation of a note payable to current rather than long term
  3. C) poor wording in a note to the financial statements, making it a bit difficult to understand
  4. D) an understatement of depreciation expense, which would increase depreciation by $5,000

Answer:  D

Diff: 3     Type: MC     Page Ref: 606

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

 

22) Dussault & Montgomery, the auditors of Greenwich Corp., relied on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of Greenwich. The responsibility for the opinion to issue on the financial statements is the responsibility of

  1. A) Greenwich Corp.
  2. B) Dussault & Montgomery.
  3. C) Groves & Padden.
  4. D) Dussault & Montgomery and Groves & Padden.

Answer:  B

Diff: 3     Type: MC     Page Ref: 608

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

23) When Dussault & Montgomery relied on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of one of their audit client, Dussault & Montgomery should

  1. A) assess Groves & Padden’s professional qualifications.
  2. B) ask Groves & Padden to also sign the auditor’s report.
  3. C) send one of their auditors to Quebec to supervise the work being done by Groves & Padden.
  4. D) issue a qualified opinion for the financial information pertaining to the Quebec subsidiaries.

Answer:  A

Diff: 3     Type: MC     Page Ref: 609

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

24) The primary auditor who relies on a secondary auditor

  1. A) is responsible for any deficiencies in the secondary auditor’s work.
  2. B) will mention the name of the secondary auditor if he or she decides that an unqualified opinion is appropriate.
  3. C) will never mention the name of the secondary auditor in his or her report even if the report is qualified.
  4. D) has no responsibility for checking the work of the secondary auditor.

Answer:  A

Diff: 2     Type: MC     Page Ref: 610

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

 

25) There are two conditions requiring a departure from an unqualified audit report. Discuss each of these conditions and state the appropriate audit report for each condition.

Answer:  The two conditions requiring a departure from an unqualified report are:

  • a scope restriction imposed by the client or by circumstances beyond the auditor’s or client’s control which prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with an acceptable financial reporting framework. In this condition, the auditor would issue either a qualified scope and opinion report, or a disclaimer of opinion.
  • the financial statements were not prepared in accordance with an acceptable financial reporting framework. In this condition, the auditor would issue a qualified opinion if the violation was moderately material, or an adverse opinion if the violation was highly material.

Diff: 2     Type: ES     Page Ref: 602-603

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

26) Discuss how materiality affects audit reporting decisions.

Answer:  When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) highly material or pervasive. For conditions involving an accounting violation, the materiality level of the violation influences whether an unqualified, qualified, or adverse opinion is issued. For conditions involving a scope restriction, the materiality of the restriction influences whether an unqualified report, a qualified scope and opinion report, or a disclaimer of opinion is issued.

Diff: 2     Type: ES     Page Ref: 604-605

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

27) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor’s report that may be necessary, and give reasons. State your assumptions.

 

  1. A) Queen Lake Construction Ltd. uses an aggressive revenue recognition policy under the percentage of completion method for long-term construction contracts. Your review of this year’s contracts indicates that several projects look as if they will be high in revenue for the first two years, and then have negligible earnings for the next three years.

 

  1. B) Maple Manufacturing Limited constructs furniture out of maple wood. The furniture is prized for its durability and craftsmanship. Last year, the company received a letter from a governmental agency advising that it had been found that the factory was located on contaminated land that leached hazardous chemicals into the air. This was a preliminary letter stating that a full investigation into the health effects was underway. Management stated that everything is OK – the investigation was terminated. However, the lawyer refused to sign the legal letter with respect to several lawsuits with respect to employee claims for long term disability due to a nervous disorder that affected employees’ ability to work. Neither the investigation nor the lawsuits are disclosed in the notes to the financial statements.

 

Answer:

  1. A) It is assumed that the amounts involved are material, but can be isolated to specific accounts. If the client is unwilling to recalculate revenue using a less aggressive method so revenue is not so materially overstated, the financial statements are materially misstated (revenue is overstated for the current year), which is a violation. Accordingly, a qualified opinion would be issued, disclosing the amounts involved.
  2. B) The amounts involved cannot be determined, but it is possible that material amounts could be involved. The company has refused to disclose two potential contingencies in the financial statements, so the financial statements are not in accordance with an acceptable financial reporting framework. A qualified opinion or disclaimer would be issued, identifying the lawsuit and environmental contingencies.

Diff: 2     Type: ES     Page Ref: 607

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

28) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor’s report that may be necessary, and give reasons. State your assumptions.

 

  1. A) Rosebud Ltd. is a construction company that builds and repairs greenhouses for nurseries. An architect does the design, and three different small construction companies are used to build the greenhouses. You are concerned that some of the projects that span the April year end may result in material losses, even though income has been reported in the coming year. Management has refused permission for you to enter construction sites, as they feel that the construction sites will be dangerous and they do not want to be exposed to such liability.

 

  1. B) Save our Trees is a charitable organization devoted to maintaining national woodland and green space. Fund raising is handled primarily by means of electronic mail and door to door canvassing by volunteers. Volunteers conducting canvassing provide receipts at the door using prenumbered receipts. Funds raised by email are sent receipts by email.

 

Answer:

  1. A) It is assumed that the amounts are material and can be quantified and/or the reporting of losses on the income statement may have a detrimental effect on any creditor relationships . Management is imposing a scope limitation, so that it would be difficult to determine the actual percentage of completion of projects and assess whether revenue is recorded appropriately. A qualification (scope limitation) is required. If the amounts are so large that they would affect the ability of the company to continue as a going concern, then a disclaimer of opinion should be issued.
  2. B) With both of these fundraising methods, i.e. door to door canvassing and email requests, it is difficult to provide internal controls to ensure that all funds received are deposited and recorded. If the amounts are considered to be material, then a qualification will be issued with respect to completeness of revenue (the auditor cannot conduct field work to determine completeness, so it is a scope limitation). A qualification will be issued, or if the amounts are considered highly material, then a disclaimer of opinion would be issued, although the latter is unlikely. The qualification or disclaimer would be issued if the auditor cannot conduct alternative procedures to satisfy the completeness objective (e.g. testing of prenumbered tax receipts).

Diff: 2     Type: ES     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

29) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor’s report that may be necessary, and give reasons. State your assumptions.

 

  1. A) During 2012, your client was sued by a customer who had a serious car accident as a result of scrap metal that had been dumped in the parking lot. The customer drove over the scrap metal, which was imbedded in the tires of her vehicle. The tires blew, and the car went out of control on a major highway. The amount in dispute is $400,000, with estimated legal bills of about $20,000. The client does not wish to disclose the suit in the financial statements.

 

  1. B) During the current year, your client leased a large amount of equipment. As the lease qualifies as a capital lease, the equipment has been recorded as an asset, with the corresponding liabilities recorded on the financial statements. The implicit interest rate in the lease is seven percent. The annual payments due over the terms of the lease have been disclosed in the notes to the financial statements.

 

Answer:

  1. A) It is assumed that the amount is material, but can be isolated (i.e. it is a specific amount allocated to an individual account). Since the contingency is not disclosed in the financial statements, there is an accounting violation. A qualified audit opinion should be issued. If the possibility of loss is high (perhaps according to a legal letter), and the company is not adequately insured, the loss could lead to a possibility of the company not continuing as a going concern. In that event, the amount now has a pervasive effect, and an adverse opinion is required.
  2. B) The amounts involved have been correctly recorded and adequately disclosed in the financial statements. The auditor would provide an unqualified audit opinion.

Diff: 2     Type: ES     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

30) Your client, Huge Telephone Company (HTC), has encountered troubled times, due to deregulation. There is competition for local telephone business and long distance telephone business. The high speed lines for internet access provided via the telephone network have not been selling as well as expected. A new quirk is that many large cities are going to provide free wireless services by installing wireless transmitters on telephone poles, and is only offering to pay a pittance for the use of the telephone poles. HTC has been able to retain reasonable profits by cutting staff to a bare minimum and outsourcing many services.

However, due to several labour contracts and federal legislation that will increase services, you have doubts about the ability of the company to renew a major bond issue this coming year.

 

Required:

How does the above information affect the audit report?

Answer:  If the company cannot renew the bond issue, what will they do? Do they have time to issue shares or obtain alternative forms of financing? What are management’s plans? These questions would need to be answered before this uncertainty can be addressed.

Then, we would need to find out what is disclosed in the financial statements. Is it clear from the financial statements that the bond issue may not be renewed? Also, is the impact of the non-renewal discussed?

What is the expected impact of the increased competition of HTC’s future ability to continue as a business? Does management have an effective strategy for the future success of HTC?

If there is adequate disclosure, then HTC will receive an unqualified audit report. If not, then there is an accounting violation, and the auditor may issue a qualified or adverse opinion, depending upon the materiality and the potential impact upon the company to continue as a going concern.

Diff: 3     Type: ES     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

 

31) Julia is in the process of auditing the legal liability section of the financial statements. The controller indicated that he did not want her to contact their external lawyers and he is refusing to grant her access to the detail of the legal expense for the year and any legal invoices.

What should Julia do in this situation? Indicate the steps, in the proper order, that should be taken.

Answer:  First, Julia should ask management to remove the scope limitation and allow her to contact external lawyers and provide her with the detail of the legal expense for the year.

If management refuses to remove the scope limitation, Julia should then communicate with the audit committee and the board of directors to inform them of the scope limitation and the potential impact on the audit.

Julia should then evaluate if the restriction to access the legal expense detail and to contact the lawyers is material and pervasive. Given the nature of the legal expenses and future potential liabilities, this is a risky area and the legal liabilities can often be material. Further, if management is preventing the auditor from contacting external lawyers, this could be suspicious.

In this case, the impact is likely to be considered material. Julia could resign from the audit engagement. If Julia cannot resign, then Julia would issue a disclaimer of opinion.

Diff: 3     Type: ES     Page Ref: 604

Learning Obj.:  20-3  Describe the difference between an adverse opinion and a disclaimer of opinion

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