Auditing And Assurance Services An Integrated Approach 13th Edition by Arens – Test Bank

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Auditing And Assurance Services An Integrated Approach 13th Edition by Arens – Test Bank

Chapter 2

 

Multiple-Choice Questions

 

 

1. Which one of the following is not one of the three General Standards?
easy a.      Proper planning and supervision.
a b.      Independence of mental attitude.
  c.       Adequate training and proficiency.
  d.      Due professional care.
   
2. Which one of the following is not a Field Work Standard?
easy a.      Adequate planning and supervision.
b b.      Due professional care.
  c.       Understand the entity and its environment including internal control.
  d.      Sufficient appropriate audit evidence.
   
3. The General Standards stress the importance of:
easy a.      evidence accumulation.
b b.      personal qualities the auditor should possess.
  c.       communicating the auditor’s findings to the reader.
  d.      general supervision of the audit.
   
4.

easy

The generally accepted auditing standard that requires “Adequate technical training and proficiency” is normally interpreted as requiring the auditor to have:
a a.      formal education in auditing and accounting.
  b.      worked for an entity similar to the entity being audited.
  c.       independence in mental attitude
  d.      a graduate degree in a business field.
   
5. (SOX)

 

Members of the Public Company Accounting Oversight Board are appointed and overseen by:
easy a.      the U.S. Congress.
d b.      the American Institute of Certified Public Accountants.
  c.       the Auditing Standards Board.
  d.      the Securities and Exchange Commission.
   
6.

easy

Statements on Auditing Standards provide auditors of privately held companies with ______ guidance regarding the conduct of financial statement audits.
b a.      fairly extensive
  b.      some limited
  c.       practically no
  d.      specific and detailed
   

 

7.

easy

Which of the following statements most accurately captures the intent of the standards of field work?
c a.      Field work standards are primarily concerned with personal attributes necessary during the conduct of the audit.
  b.      Field work standards provide extensive guidance regarding the conduct of an audit.
  c.       Field work standards are primarily directed at the auditor’s planning, understanding of internal control, and evidence accumulation.
  d.      Field work standards are primarily concerned with the conduct of substantive testing as opposed to testing of internal controls.
   
8. (SOX)

easy

Prior to the passage of the Sarbanes-Oxley Act, which of the following was responsible for establishing auditing standards?
c a.      Securities and Exchange Commission
  b.      Public Company Accounting Oversight Board
  c.       Auditing Standards Board
  d.      National Association of Accounting
   
9. (SOX)

medium

Standards issued by the Public Company Accounting Oversight Board must be followed by CPAs who audit:
b a.      both private and public companies.
  b.      public companies only.
  c.       private companies, public companies, and nonprofit entities.
  d.      private companies only.
   
10. Which of the following is the least likely form of business for a CPA firm?
medium a.      General partnership
b b.      General corporation
  c.       Limited liability company
  d.      Limited liability partnership
   
11. The Statements on Auditing Standards issued by the Auditing Standards Board:
medium a.      are interpretations of generally accepted auditing standards.
a b.      are the equivalent of laws for audit practitioners.
  c.       must be followed in all situations.
  d.      are optional guidelines which an auditor may choose to follow or not follow when   conducting an audit.
   
12. An auditor need not abide by a particular auditing standard if the auditor believes that:
medium a.      the issue in question is immaterial in amount.
a b.      more expertise is needed to fulfill the requirement.
  c.       the requirement of the standard has not been addressed by the PCAOB.
  d.      any of the above three are correct.
   
13. (SOX) The Public Company Accounting Oversight Board does not:
medium a.      perform inspections of the quality controls at audit firms that audit public companies.
b b.      establish auditing standards that must be followed by CPAs on all audits.
  c.       oversee auditors of public companies.
  d.      perform any of the above functions.
   
14.

medium

The form that must be completed and filed with the Securities and Exchange Commission whenever a company experiences a significant event that is of interest to public investors is the:
b a.      Form S-1.
  b.      Form 8-K.
  c.       Form 10-K.
  d.      Form 10-Q.
   
15.

medium

The form that must be filed with the Securities and Exchange Commission whenever a company plans to issue new securities to the public is the:
a a.      Form S-1.
  b.      Form 8-K.
  c.       Form 10-K.
  d.      Form 10-Q.
   
16.

medium

The third general standard states that due care is to be exercised in the performance of an audit. This standard is generally interpreted to require:
c a.      objective review of the adequacy of the technical training of firm personnel.
  b.      thorough review of the existing internal control structure.
  c.       critical review of work done at every level of supervision.
  d.      periodic review of a CPA firm’s quality control procedures.
   
17. (SOX)

medium

Assume the Public Company Accounting Oversight Board (PCAOB) identifies a violation during its inspection of a registered accounting firm.
d a.      The PCAOB may not enforce some disciplinary action against the accounting firm.
  b.      The PCAOB may not report the matter to the Securities and Exchange Commission.
  c.       The PCAOB may not report the matter to the appropriate state accountancy board
  d.      The PCAOB may not suspend the license to practice of the CPA guilty of the violation.
   
18.

medium

Which of the following statements best describes the primary purpose of Statements on Auditing Standards?
d a.    They are guides intended to set forth auditing procedures that are applicable to a variety of situations.
  b.    They are procedural outlines that are intended to narrow the areas of inconsistency and divergence of auditor opinion.
  c.     They are authoritative statements, enforced through the Code of Professional Conduct, and are intended to limit the degree of auditor judgment.
  d.    They are interpretations that are intended to clarify the meaning of “generally accepted auditing standards.”
   
19. Statements on Standards for Accounting and Review Services are issued by the:
medium a.      Accounting and Review Services Committee.
a b.      Professional Ethics Executive Committee.
  c.       Securities and Exchange Commission.
  d.      Financial Accounting Standards Board.
   
20. Consulting Standards are issued by the:
medium a.      Accounting and Review Services Committee.
c b.      Securities and Exchange Commission.
  c.       Management Consulting Services Executive Committee.
  d.      Financial Accounting Standards Board.
   
21.

medium

The auditor’s judgment concerning the overall fairness of presentation of financial position, results of operations, and changes in cash flow is applied within the framework of:
d a.      quality control.
  b.      generally accepted auditing standards which include the concept of materiality.
  c.       the auditor’s evaluation of the audited company’s internal control.
  d.      generally accepted accounting principles.
   
22.

medium

A basic objective of a CPA firm is to provide professional services to conform to professional standards. Reasonable assurance of achieving this basic objective is provided through:
c a.      continuing professional education.
  b.      compliance with generally accepted reporting standards.
  c.       a system of quality control.
  d.      a system of peer review.
   
23.

medium

Within the context of quality control, the primary purpose of continuing professional education and training activities is to enable a CPA firm to provide its personnel with:
c a.      technical training that assures proficiency as a valuation expert.
  b.      professional education that is required in order to perform with due professional care.
  c.       knowledge required to fulfill assigned responsibilities.
  d.      knowledge required to perform a peer review.
   
24.

medium

Williams & Co., a member of the Private Companies Practice Section, is to have a “peer review.” The peer review can be performed by:
d a.      a CPA firm selected by Williams & Co.
  b.      a review team selected by the state society.
  c.       internal auditors.
  d.      either a or b.
   
25.

medium

a

Hansen Corporation’s stock is listed on a national stock exchange and registered with the Securities and Exchange Commission. Hansen’s management hires a CPA to perform an independent audit of Hansen’s financial statements. The primary objective of this audit is to provide assurance to the:
  a.      investors in Hansen Corporation’s stock.
  b.      stock exchange.
  c.       Securities and Exchange Commission.
  d.      management of Hansen Corporation.
   
26. Which of the following is not an essential component of quality control?
medium

a

a.      Policies and procedures to ensure that firm personnel are actively engaged in marketing   strategies.
  b.      Policies and procedures to ensure that the work performed by firm personnel meet   applicable professional standards.
  c.       Policies to ensure that personnel maintain their independence in fact and in appearance.
  d.      Policies that ensure that monitoring activities are effectively applied.
   
27. Which of the following is true regarding the AICPA-approved practice monitoring programs?
challenging a.      The Center for Public Company Audit Firms does not offer a peer review program.
c b.      Firms registered with the PCAOB must not enroll in an AICPA-approved practice           monitoring program.
  c.       Public accounting firms must be enrolled in an AICPA-approved practice monitoring           program for members in the firm to be eligible for membership in the AICPA.
  d.      The AICPA peer review program is administered through the SEC.
   
28.

challenging

c

Which of the following statements is true as it relates to limited liability partnerships?

a.      Only senior partners are liable for the partnership’s debts.

b.      Partners have no liability in a limited liability partnership arrangement.

c.       Partners are personally liable for the acts of those under their supervision.

d.      All partners must be AICPA members.

 

29. (SOX)

challenging

If an auditor of a public company cannot find guidance issued by the PCAOB on a particular audit matter, the auditor should generally seek guidance from which of the following sources?
a a.      Statements on Auditing Standards.
  b.      Statements on Standards for Accounting and Review Services.
  c.       Regulations issued by the Securities and Exchange Commission.
  d.      The AICPA Code of Professional Conduct.
   
30. The SEC requirements of greatest interest to CPAs are set forth in the SEC’s:
challenging a.      Regulation S-X and Accounting Series Releases.
a b.      S-1 through S-16 forms.
  c.       Director’s newsletter.
  d.      Forms 8-K, 10-K, and 10-Q.
   
31.

challenging

The AICPA has authority to establish standards and rules in all but which of the following areas?
d a.      Auditing standards applicable to financial statements of private companies.
  b.      Compilation and review standards.
  c.       Professional conduct.
  d.      Auditing standards applicable to financial statements of private and public companies.
   
32.

challenging

Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS) should be looked upon by practitioners as:
c a.      ideals to work towards, but which are not achievable.
  b.      maximum standards that denote excellent work.
  c.       minimum standards of performance that must be achieved on each audit engagement.
  d.      benchmarks to be used on all audits, reviews, and compilations.
   
33.

challenging

Which one of the following is not a requirement for belonging to the Private Companies Practice Section of the American Institute of Certified Public Accountants?
c a.      Adherence to quality control standards.
  b.      Mandatory peer review.
  c.       Partner rotation after a period of ten consecutive years.
  d.      Continuing education.
   
34. Statements on Auditing Standards issued by the AICPA’s Auditing Standards Board are:
challenging

b

a.      part of the generally accepted auditing standards under the AICPA Code of Professional Conduct.
  b.      interpretations of generally accepted auditing standards and departures from such statements must be justified.
  c.       interpretations of generally accepted auditing standards and such standards must be followed in every engagement.
  d.      generally accepted auditing procedures that are not covered by the AICPA Code of Professional Conduct.
   

 

Essay Questions

 

35.

easy

Distinguish between generally accepted auditing standards (GAAS) and generally accepted accounting principles (GAAP). What professional organization establishes GAAS? What professional organization establishes GAAP?

 

  Answer:

Generally accepted auditing standards are general guidelines to help auditors meet their professional responsibilities in the audit of historical financial statements. They are considered to be the minimum standards of performance for auditors to follow and are established by the Auditing Standards Board of the American Institute of Certified Public Accountants for private companies and by the Public Company Accounting Oversight Board for public companies. Generally accepted accounting principles are the guidelines which an entity’s management normally follows when preparing historical financial statements. GAAP is established by the Financial Accounting Standards Board.

 

 

36.

easy

Discuss the relationship between quality control and generally accepted auditing standards.

 

  Answer:

For a CPA firm, quality control encompasses the methods used to make sure that the firm meets its professional responsibilities to clients. Quality control is closely related to, but distinct from, GAAS. A CPA firm must make sure that GAAS are followed on every audit. Quality controls are the procedures used by the CPA firm that help it meet requirements demanded by GAAS on every engagement in a consistent manner.

 

 

37.

easy

Describe the various staff levels and responsibilities of a typical public accounting firm.

 

  Answer:

·         Staff assistant – Staff assistants, or staff accountants, perform most of the detailed audit work.

·         Senior or In-charge auditor – Seniors coordinate and are responsible for the audit field work, including the supervision and review of staff assistants’ work.

·         Manager – Managers assist the senior plan and manage the audit, review the senior’s work, and manages relations with the client. A manager may be responsible for multiple engagements at the same time.

·         Partner – Partners review the overall audit work and they are involved in all significant audit decisions. As owners of the firm, partners are ultimately responsible for conducting the audit and serving the client.

 

38.

medium

Discuss the five elements of quality control. Who establishes the standards for quality control?

 

  Answer:

·         Independence, integrity and objectivity – Personnel on engagement should maintain independence in fact and in appearance, perform all professional responsibilities with integrity and maintain objectivity in performing their professional responsibilities.

·         Personnel management – Policies and procedures should be established to provide the firm with reasonable assurance that all new personnel are qualified to perform their work, work is assigned to personnel who have adequate training, and personnel should participate in continuing professional education.

·         Acceptance and continuation of clients and engagements – Policies and procedures should be established for deciding whether to accept or continue a client relationship. These policies should minimize the risk of associating with a client whose management lacks integrity.

·         Engagement performance – Policies and procedures should exist to ensure that engagement personnel perform work that meets applicable professional standards and the firm’s standards of quality.

·         Monitoring – Policies and procedures should exist to ensure that the other four quality control elements are being effectively applied.

 

Quality control standards are established by the Auditing Standards Board for auditors of private companies and by the Public Company Accounting Oversight Board for auditors of public companies.

 

39.

medium

Describe the six organizational structures available to CPA firms.

 

  Answer:

CPA firms can take one of six organizational forms:

·         Proprietorship. This form is limited to firms with only one owner.

·         General partnership. This form is similar to a proprietorship, except that it applies to multiple owners.

·         General corporation. Unlike a general partnership, shareholders in a general corporation are liable only to the extent of their investment in the corporation.

·         Professional corporation. Professional corporations can have one or more shareholders. Personal liability protection for shareholders in professional corporations varies widely from state to state.

·         Limited liability company. This form combines the most favorable attributes of a general corporation and a general partnership. LLCs are taxed like a general partnership, but its owners have limited personal liability like shareholders of a general corporation.

·         Limited liability partnership. An LLP is structured and taxed like a general partnership. However, the personal liability protection of an LLP is less than that of a general corporation or an LLC, but it is greater than a general partnership. Many accounting firms now operate as LLPs.

 

 

40.

medium

There are ten generally accepted auditing standards, divided into three categories. List, by category, each of these ten standards.

 

  Answer:

General Standards

·         Adequate technical training and proficiency.

·         Independence in mental attitude.

·         Due professional care.

 

Standards of Fieldwork

·         Adequate planning and supervision.

·         Understand the entity and its environment including internal control.

·         Sufficient appropriate audit evidence.

 

Standards of Reporting

·         Whether statements were prepared in accordance with GAAP.

·         Circumstances when GAAP was not consistently followed.

·         Adequacy of informative disclosures.

·         Expression of opinion on financial statements as a whole.

 

 

41.

medium

In the context of auditing, explain what is meant by an independent mental attitude. Discuss how internal auditors can have an independent mental attitude when they are employed by the company they audit.

 

  Answer:

Independent mental attitude refers to a state of mind in which the CPA is totally unbiased with respect to the client and the financial information under audit.

Although internal auditors are employees of the organization for which their audits are performed, internal auditors should be independent of the function being examined and should report their findings to a level high enough in the organization to allow the auditor to be free from influence by the party, or parties, being examined.

 

 

42. (SOX)

medium

The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB). What are the PCAOB’s primary functions? Who performed these functions prior to the PCAOB?

 

  Answer:

The PCAOB has responsibility for providing oversight auditors of public companies, establishing auditing and quality control standards for public company audits and performing inspections of the quality controls at audit firms performing those audits. These functions were formerly the responsibility of the American Institute of Certified Public Accountants.

 

 

 

 

43.

challenging

What are four of the major functions of the AICPA?

 

  Answer:

Major functions of the AICPA include:

·         Establishing standards and rules that practicing CPAs must follow. These standards consist of auditing standards for auditors of private companies, compilation and review standards, other attestation standards, and the Code of Professional Conduct.

·         Research and publication. AICPA publications include the Journal of Accountancy, industry audit guides, periodic updates of the Codification of Statements on Auditing Standards, and the Code of Professional Conduct.

·         Promoting the accounting profession.

·         Developing specialist certifications.

·         Writing and grading the uniform CPA examination.

·         Providing continuing education seminars for its members.

 

 

44.

challenging

Discuss the purpose of the Securities and Exchange Commission and its influence on setting generally accepted accounting principles.

 

  Answer:

The overall purpose of the SEC is to assist in providing investors with reliable information upon which to make investment decisions. As a result of its authority for specifying financial reporting requirements, the SEC has considerable influence in setting generally accepted accounting principles. Although the SEC has taken the position that accounting principles should be set by the profession (FASB), the SEC’s opinion is generally considered in any major change in GAAP proposed by the FASB.

 

 

45.

challenging

The purpose of the AICPA’s CPA Vision Project is to help CPAs make sense of our changing and complex world. The Project has identified core values that CPAs must be aware of in the future. What are the top five core values?

 

  Answer:

·         Continuing education and lifelong learning

·         Competence

·         Integrity

·         Attuned to broad business issues

·         Objectivity

 

 

Other Objective Answer Format Questions

 

46.

easy

b

Membership in the AICPA is restricted to CPAs who are currently practicing as independent auditors.

a.      True

b.      False

 

47.

easy

b

Membership in the AICPA is mandatory for all licensed practicing CPAs.

a.      True

b.      False

 

48.

easy

a

Any public accounting firm can be a member of the AICPA if the firm meets the membership requirements.

a.      True

b.      False

 

49.

easy

b

Statements on Auditing Standards (SASs) are issued by the Public Company Accounting Oversight Board.

a.      True

b.      False

 

50. (SOX)

easy

b

Auditors of public companies should, in the absence of guidance issued by the PCAOB, follow auditing standards issued by the SEC.

a.      True

b.      False

 

51. (SOX)

medium

b

The U.S. Congress has oversight responsibility for the PCAOB.

a.      True

b.      False

 

52.

medium

b

Form 10-K must be filed with the SEC whenever a public company experiences a significant event.

a.      True

b.      False

 

53.

medium

b

In a limited liability partnership, partners are personally liable for liabilities arising from negligent acts of other partners, but not for liabilities arising from acts of other employees.

a.      True

b.      False

 

54.

medium

a

Limited liability companies are structured and taxed like a general partnership, but their owners have limited personal liability similar to that of a general corporation.

a.      True

b.      False

 

55. (SOX)

medium

b

All CPA firms registered with the PCAOB are required to undergo a peer review at least once every two years.

a.      True

b.      False

 

56.

medium

a

Statements on Auditing Standards (SASs) are considered to be interpretations of the ten generally accepted auditing standards.

a.      True

b.      False

 

57. (SOX)

medium

a

Any CPA firm that audits more than 100 public companies is required to have an annual inspection by the PCAOB.

a.      True

b.      False

 

58.

medium

a

The overall purpose of the Securities and Exchange Commission is to assist in providing investors with reliable information upon which to make investment decisions.

a.      True

b.      False

 

59.

medium

a

International Standards on Auditing are issued by the International Auditing Practices Committee.

a.      True

b.      False

 

Chapter 6

 

Multiple-Choice Questions

 

1. The objective of the ordinary audit of financial statements is the expression of an opinion on:
easy a.      the fairness of the financial statements.
a b.      the accuracy of the financial statements.
  c.       the accuracy of the annual report.
  d.      the balance sheet and income statement.
   
2.

easy

If the auditor believes that the financial statements are not fairly stated or is unable to reach an conclusion because of insufficient evidence, the auditor:
c a.      should withdraw from the engagement.
  b.      should request an increase in audit fees so that more resources can be used to conduct the           audit.
  c.       has the responsibility of notifying financial statement users through the auditor’s report.
  d.      should notify regulators of the circumstances.
   
3. Auditors accumulate evidence to:
easy a.      defend themselves in the event of a lawsuit.
d b.      justify the conclusions they have otherwise reached.
  c.       satisfy the requirements of the Securities Acts of 1933 and 1934.
  d.      enable them to reach conclusions about the fairness of the financial statements.
   
4.

easy

The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the:
b a.      board of directors.
  b.      company management.
  c.       financial statement auditor.
  d.      company’s internal audit department.
   
5.

easy

The auditor’s best defense when material misstatements are not uncovered is to have conducted the audit:
a a.      in accordance with auditing standards.
  b.      as effectively as reasonably possible.
  c.       in a timely manner.
  d.      only after an adequate investigation of the management team.
   
6.

easy

If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can:
a Issue an adverse audit report   Issue a qualified audit report
  a.

b.

c.

d.

                Yes

No

Yes

No

Yes

No

No

Yes

   
7.

easy

If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can do all but which of the following?
b a.      Issue an adverse audit report.
  b.      Issue a disclaimer of opinion.
  c.       Withdraw from the engagement.
  d.      Issue a qualified audit report.
   

 

 

8.

easy

Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements?
d a.      The auditor commonly examines a sample, rather than the entire population of           transactions.
  b.      Accounting presentations contain complex estimates which involve uncertainty.
  c.       Fraudulently prepared financial statements are often difficult to detect.
  d.      Auditors believe that reasonable assurance is sufficient in the vast majority of cases.
   
9. (Public)

challenging

In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of:
c a.      GAAP.
  b.      the Sarbanes-Oxley Act.
  c.       the Securities Exchange Act of 1934.
  d.      GAAS.
   
10. Which of the following statements is most correct regarding errors and fraud?
easy a.      An error is unintentional, whereas fraud is intentional.
a b.      Frauds occur more often than errors in financial statements.
  c.       Errors are always fraud and frauds are always errors.
  d.      Auditors have more responsibility for finding fraud than errors.
   
11. (SOX) Which of the following statements is true of a public company’s financial statements?
easy a.      Sarbanes-Oxley requires the CEO only to certify the financial statements.
c b.      Sarbanes-Oxley requires the CFO only to certify the financial statements.
  c.       Sarbanes-Oxley requires the CEO and CFO to certify the financial statements.
  d.      Sarbanes-Oxley neither requires the CEO nor the CFO to certify the financial statements.
   
12. Which of the following is not one of the three categories of assertions?
easy a.      Assertions about classes of transactions and events for the period under audit
b b.      Assertions about financial statements and correspondence to GAAP
  c.       Assertions about account balances at period end
  d.      Assertions about presentation and disclosure
   
13.

easy

If a short-term note payable is included in the accounts payable balance on the financial statement, there is a violation of the:
d a.      completeness assertion.
  b.      existence assertion.
  c.       cutoff assertion.
  d.      classification and understandability assertion.
   
14. Professional skepticism requires auditors to possess a(n) ______ mind.
easy a.      introspective
b b.      questioning
  c.       intelligent
  d.      unbelieving
   
15.

easy

c

The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not ________ are detected.
  a.      important to the financial statements
  b.      statistically significant to the financial statements
  c.       material to the financial statements
  d.      identified by the client
   
 

 

16.

 

 

Fraudulent financial reporting is most likely to be committed by whom?

easy a.      Line employees of the company.
c b.      Outside members of the company’s board of directors.
  c.       Company management.
  d.      The company’s auditors.
   
17. Which of the following would most likely be deemed a direct-effect illegal act?
easy a.      Violation of federal employment laws.
c b.      Violation of federal environmental regulations.
  c.       Violation of federal income tax laws.
  d.      Violation of civil rights laws.
   
18. The concept of reasonable assurance indicates that the auditor is:
easy a.      not an insurer of the correctness of the financial statements.
a b.      not responsible for the fairness of the financial statements.
  c.       responsible only for issuing an opinion on the financial statements.
  d.      responsible for finding all misstatements.
   
19. Tests of details of balances are specific procedures intended to:
easy a.      test for monetary errors in the financial statements.
a b.      prove that the accounts with material balances are classified correctly.
  c.       prove that the trial balance is in balance.
  d.      identify the details of the internal control system.
   
20. Which of the following is the auditor least likely to do when aware of an illegal act?
easy a.      Discuss the matter with the client’s legal counsel.
c b.      Obtain evidence about the potential effect of the illegal act on the financial statements.
  c.       Contact the local law enforcement officials regarding potential criminal wrongdoing.
  d.      Consider the impact of the illegal act on the relationship with the company’s management.
   
21.

medium

c

The auditor gives an audit opinion on the fair presentation of the financial statements and associates his or her name with it when, on the basis of adequate evidence, the auditor concludes that the financial statements are unlikely to mislead:
  a.      investors.
  b.      management.
  c.       a prudent user.
  d.      the reader.
   
22.

medium

The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to:
b a.      the auditor.
  b.      management.
  c.       both management and the auditor equally.
  d.      management for the statements and the auditor for the notes.
   
23. When engaged to audit the financial statements, it is acceptable for the auditor to draft:
medium        
a   The client’s financial statements   The footnotes to the client’s financial statements
  a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
24.

medium

The auditor has considerable responsibility for notifying users as to whether or not the statements are properly stated. This imposes upon the auditor a duty to:
a a.      provide reasonable assurance that material misstatements will be detected.
  b.      be a guarantor of the fairness in the statements.
  c.       be equally responsible with management for the preparation of the financial statements.
  d.      be an insurer of the fairness in the statements.
   
25.

easy

“The auditor should not assume that management is dishonest, but the possibility of dishonesty must be considered.” This is an example of:
b a.      unprofessional behavior.
  b.      an attitude of professional skepticism.
  c.       due diligence.
  d.      a rule in the AICPA’s Code of Professional Conduct.
   
26.

medium

If the auditor were responsible for making certain that all of management’s assertions in the financial statements were absolutely correct:
d a.      bankruptcies could no longer occur.
  b.      bankruptcies would be reduced to a very small number.
  c.       audits would be much easier to complete.
  d.      audits would not be economically feasible.
   
27.

medium

The auditor’s best defense when existing material misstatements in the financial statements are not uncovered in the audit is:
d a.      the audit was conducted in accordance with generally accepted accounting principles.
  b.      the financial statements are the client’s responsibility.
  c.       the client is guilty of contributory negligence.
  d.      the client is guilty of fraudulent misrepresentation.
   
28. Fraudulent financial reporting is often called:
medium a.      management fraud.
a b.      theft of assets.
  c.       defalcation.
  d.      embezzlement.
   
29. Which of the following statements is usually true?
challenging a.      It is easier for the auditor to uncover fraud than errors.
c b.      It is easier for the auditor to uncover indirect-effect illegal acts than fraud.
  c.       The auditor’s responsibility for detecting direct-effect illegal acts is similar to the           responsibility to detect fraud.
  d.      The auditor’s responsibility for detecting indirect-effect illegal acts is similar to the           responsibility to detect fraud.
   
30.

medium

Auditing standards make _____ distinction(s) between the auditor’s responsibilities for searching for errors and fraud.
c a.      little
  b.      a significant
  c.       no
  d.      various
   
31.

medium

In comparing management fraud with employee fraud, the auditor’s risk of failing to discover the fraud is:
b a.      greater for management fraud because managers are inherently more deceptive than           employees.
  b.      greater for management fraud because of management’s ability to override existing           internal controls.
  c.       greater for employee fraud because of the higher crime rate among blue collar workers.
  d.      greater for employee fraud because of the larger number of employees in the organization.
   
32.

medium

Which of the following statements is correct with respect to the auditor’s responsibilities relative to the detection of indirect-effect illegal acts?
a a.      The auditor has no responsibility for searching for indirect-effect illegal acts.
  b.      The auditor has the same responsibility for searching for indirect-effect illegal acts as any           other potential misstatement that may occur.
  c.       Auditors have responsibility for searching for any illegal act, whether direct-effect or           indirect-effect.
  d.      Discovery of indirect-effect illegal acts is usually easier than discovery of fraud.
   
33.

medium

When comparing the auditor’s responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility:
c a.      more on discovering errors than employee fraud.
  b.      more on discovering employee fraud than errors.
  c.       equally on discovering either one.
  d.      on the senior auditor for detecting errors and on the manager for detecting employee fraud.
   
34.

medium

If several employees collude to falsify documents, the chance a normal audit would uncover such acts is:
a a.      very low.
  b.      very high.
  c.       zero.
  d.      none of the above.
   
35.

medium

When planning the audit, if the auditor has no reason to believe that illegal acts exist, the auditor should:
d a.      include audit procedures which have a strong probability of detecting illegal acts.
  b.      still include some audit procedures designed specifically to uncover illegalities.
  c.       ignore the issue.
  d.      make inquiries of management regarding their policies for detecting and preventing illegal           acts and regarding their knowledge of violations, and then rely on normal audit procedures            to detect errors, irregularities, and illegalities.
   
36. When the auditor has reason to believe an illegal act has occurred, the auditor should:
medium a.      inquire of management only at one level below those likely to be involved with the           illegality.
c b.      begin communication with the FASB in accordance with PCAOB regulations.
  c.       consider accumulating additional evidence to determine if there is actually an illegal act.
  d.      withdraw from the engagement.
   
37. When the auditor knows that an illegal act has occurred, the auditor must:
medium a.      report it to the proper governmental authorities.
b b.      consider the effects on the financial statements, including the adequacy of disclosure.
  c.       withdraw from the engagement.
  d.      issue an adverse opinion.
   
38. (Public) If an auditor uncovers an illegal act at a public company, the auditor must notify:
medium a.      local law enforcement officials.
c b.      the Public Company Accounting Oversight Board.
  c.       the Securities and Exchange Commission.
  d.      all of the above.
   
39. Why does the auditor divide the financial statements into smaller segments?
medium a.      Using the cycle approach makes the audit more manageable.
a b.      Most accounts have few relationships with others and so it is more efficient to break the           financial statements into smaller pieces.
  c.       The cycle approach is used because auditing standards require it.
  d.      All of the above are correct.
   
40.

medium

Why does the auditor divide the financial statements into segments around the financial statement cycles?
b a.      Most auditors are trained to audit cycles as opposed to entire financial statements.
  b.      The approach aids in the assignment of tasks to different members of the audit team.
  c.       The cycle approach is required by auditing standards.
  d.      The cycle approach allows the auditor to detect indirect-effect illegal acts.
   
41. The most important general ledger account included in and affecting several cycles is the:
medium a.      cash account.
a b.      inventory account.
  c.       income tax expense and liability accounts.
  d.      retained earnings account.
   
42. Management assertions are:
medium

a

a.      implied or expressed representations about accounts, transactions, and disclosures in the           financial statements.
  b.      stated in the footnotes to the financial statements.
  c.       explicitly expressed representations about the financial statements.
  d.      provided to the auditor in the assertions letter, but are not disclosed on the financial           statements.
   
43. Which of the following statements is true?
medium a.      Audit objectives follow and are closely related to management assertions.
a b.      Management’s assertions follow and are closely related to the audit objectives.
  c.       The auditor’s primary responsibility is to find and disclose fraudulent management           assertions.
  d.      Assertions about presentation and disclosure deal with whether the accounts have been           included in the financial statements at appropriate amounts.
   
44.

medium

Which of the following statements is true regarding the distinction between general audit objectives and specific audit objectives for each account balance?
b a.      The specific audit objectives are applicable to every account balance on the financial           statements.
  b.      The general audit objectives are applicable to every account balance on the financial           statements.
  c.       The general audit objectives are stated in terms tailored to the engagement.
  d.      For any given class of transactions, usually only one audit objective must be met to           conclude the transactions are properly recorded..
   
45. Which of the following statements about the existence and completeness assertions is not true?
medium a.      The existence and completeness assertions emphasize different audit concerns.
c b.      Existence deals with overstatements and completeness deals with understatements.
  c.       Existence deals with understatements and completeness deals with overstatements.
  d.      The completeness assertion deals with unrecorded transactions.
   
46. The occurrence assertion applies to _______.
medium a.      presentation and disclosure matters
b b.      classes of transactions and events during the period
  c.       account balances
  d.      proper classification of income statement accounts
   
47.

medium

Which of the following management assertions is not associated with transaction-related audit objectives?
b a.      Occurrence
  b.      Classification and understandability
  c.       Accuracy
  d.      Completeness
   
48. Which of the following statements is not true?
medium a.      Balance-related audit objectives are applied to account balances.
d b.      Transaction-related audit objectives are applied to classes of transactions.
  c.       Balance-related audit objectives are applied to the ending balance in balance sheet           accounts.
  d.      Balance-related audit objectives are applied to both beginning and ending balances in           balance sheet accounts.
   
49. In testing for cutoff, the objective is to determine:
medium a.      whether all of the current period’s transactions are recorded.
b b.      whether transactions are recorded in the correct accounting period.
  c.       the proper cutoff between capitalizing and expensing expenditures.
  d.      the proper cutoff between disclosing items in footnotes or in account balances.
   
50. The detail tie-in objective is not concerned that the details in the account balance:
medium a.      agree with related subsidiary ledger amounts.
b b.      are properly disclosed in accordance with GAAP.
  c.       foot to the total in the account balance.
  d.      agree with the total in the general ledger.
   
51. The detail tie-in is part of the_______ assertion for account balances.
medium a.      classification
b b.      valuation and allocation
  c.       rights and obligations
  d.      completeness
   
52.

medium

Which of the following is not a proper match of a transaction-related audit objective and management assertion?
a a.      Accuracy and cutoff.
  b.      Classification and classification.
  c.       Posting and summarization with accuracy.
  d.      Occurrence and occurrence.
   
53. Which of the following statements is not correct?
medium a.      There are many ways an auditor can accumulate evidence to meet overall audit objectives.
d b.      Sufficient appropriate evidence must be accumulated to meet the auditor’s professional           responsibility.
  c.       It is appropriate to minimize the cost of accumulating evidence.
  d.      Gathering evidence and minimizing costs are equally important considerations that affect           the approach the auditor selects.
   
54. Two overriding considerations affect the many ways an auditor can accumulate evidence:
medium

a

1.      Sufficient appropriate evidence must be accumulated to meet the auditor’s professional           responsibility.
  2.      Cost of accumulating evidence should be minimized.

In evaluating these considerations:

  a.      the first is more important than the second.
  b.      the second is more important than the first.
  c.       they are equally important.
  d.      it is impossible to prioritize them.
   
55.

medium

b

If the auditor has obtained a reasonable level of assurance about the fair presentation of the financial statements through understanding internal control, assessing control risk, testing controls, and analytical procedures, then the auditor:
  a.      can issue an unqualified opinion.
  b.      can significantly reduce other substantive tests.
  c.       can write the engagement letter.
  d.      needs to perform additional tests of controls so that the assurance level can be increased.
   
56.

medium

d

After the auditor has completed all audit procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on:
  a.      generally accepted auditing standards.
  b.      the AICPA’s Code of Professional Conduct.
  c.       generally accepted accounting principles.
  d.      the auditor’s professional judgment.
   
57. Which of the following combinations is correct?
medium a.      Existence relates to whether the amounts in accounts are understated.
c b.      Occurrence relates to whether balances exist.
  c.       Existence relates to whether amounts included exist.
  d.      Occurrence relates to whether the amounts in accounts occurred in the proper year.
   
58.

medium

If an auditor conducted an audit in accordance with auditing standards, which of the following would the auditor likely detect?
b a.      Unrecorded transactions.
  b.      Incorrect postings of recorded transactions.
  c.       Counterfeit signatures on paid checks.
  d.      Fraud involving collusion.
   
59.

medium

Which of the following statements best describes the auditor’s responsibility with respect to illegal acts that do not have a material effect on the client’s financial statements?
a a.      Generally, the auditor is under no obligation to notify parties other than personnel within the client’s organization.
  b.      Generally, the auditor is under an obligation to inform the PCAOB.
  c.       Generally, the auditor is obligated to disclose the relevant facts in the auditor’s report.
  d.      Generally, the auditor is expected to compel the client to adhere to requirements of the           Foreign Corrupt Practices Act.
   
60.

medium

Which of the following statements best describes the auditor’s responsibility regarding the detection of fraud?
c a.      The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter.
  b.      The auditor must extend auditing procedures to actively search for evidence of fraud in all situations.
  c.       The auditor must extend auditing procedures to actively search for evidence of fraud where the examination indicates that fraud may exist.
  d.      The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued.
   
61. The essence of the attest function is to:
medium a.      assure the consistent application of correct accounting procedures.
b b.      determine whether the client’s financial statements are fairly stated.
  c.       examine individual transactions so that the auditor may certify as to their validity.
  d.      detect collusion and fraud.
   
62.

medium

The primary difference between an audit of the balance sheet and an audit of the income statement is that the audit of the income statement deals with the verification of:
a a.      transactions.
  b.      authorizations.
  c.       costs.
  d.      cutoffs.
   
63.

challenging

The auditor’s evaluation of the likelihood of material employee fraud is normally done initially as a part of:
c a.      tests of controls.
  b.      tests of transactions.
  c.       understanding the entity’s internal control.
  d.      the assessment of whether to accept the audit engagement.
   
64.

challenging

When using the cycle approach to segmenting the audit, the reason for treating capital acquisition and repayment separately from the acquisition of goods and services is that:
c a.      the transactions are related to financing a company rather than to its operations.
  b.      most capital acquisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively.
  c.       both a and b are correct.
  d.      neither a nor b is correct.
   
65. Illegal acts are defined in SAS 54 (AU217) as:
challenging a.      violations of laws or government regulations.
c b.      violations of laws or government regulations other than errors.
  c.       violations of laws or government regulations other than fraud.
  d.      violations of law which would result in the arrest of the perpetrator.
   
66. Most illegal acts affect the financial statements:
challenging a.      directly.
b b.      only indirectly.
  c.       both directly and indirectly.
  d.      materially if direct; immaterially if indirect.
   
67. With respect to the detection of illegal acts, auditing standards state that the auditor provides:
challenging a.      no assurance that they will be detected.
a b.      the same reasonable assurance provided for other items.
  c.       assurance that they will be detected, if material.
  d.      assurance that they will be detected, if highly material.
   
68.

challenging

In describing the cycle approach to segmenting an audit, which of the following statements is not true?
d a.      All general ledger accounts and journals are included at least once.
  b.      Some journals and general ledger accounts are included in more than one cycle.
  c.       The “capital acquisition and repayment” cycle is closely related to the “acquisition of goods and services and payment” cycle.
  d.      The “inventory and warehousing” cycle may be audited at any time during the engagement since it is unrelated to the other cycles.
   
69. Which of the following journals would be included most often in the various audit cycles?
challenging a.      Cash receipts journal.
c b.      Cash disbursements journal.
  c.       General journal.
  d.      Sales journal.
   
70. Transaction cycles begin and end:
challenging a.      at the beginning and end of the fiscal period.
d b.      each start of the annual audit.
  c.       at January 1 and December 31.
  d.      at the origin and final disposition of the company.
   
71.

challenging

After general audit objectives are understood, specific audit objectives for each account balance on the financial statements can be developed. Which of the following statements is true?
a a.      There should be at least one specific objective for each relevant general objective.
  b.      There will be only one specific objective for each relevant general objective.
  c.       There will be many specific objectives developed for each relevant general objective.
  d.      There must be one specific objective for each general objective.
   
72.

challenging

An auditor should recognize that the application of auditing procedures may produce evidence indicating the possibility of errors or fraud and therefore should:
a a.      plan and perform the engagement with an attitude of professional skepticism.
  b.      not rely on internal controls that are designed to prevent or detect errors or fraud.
  c.       design audit tests to detect unrecorded transactions.
  d.      extend the work to audit most recorded transactions and records of an entity.
   

Essay Questions

 

73.

easy

Discuss the differences between errors, frauds, and illegal acts. Give an example of each.

 

  Answer:

The primary difference between errors and frauds is that errors are unintentional misstatements of the financial statements, whereas frauds are intentional misstatements. Illegal acts are violations of laws or government regulations, other than frauds. An example of an error is a mathematical mistake when footing the columns in the sales journal. An example of a fraud is the creation of fictitious accounts receivable. An example of an illegal act is the dumping of toxic waste in violation of the federal environmental protection laws.

 

 

 

 

74.

medium

Discuss the actions an auditor should take when the auditor discovers an illegal act.

 

  Answer:

The auditor should first consider the effects of the illegal act on the financial statements, including the adequacy of disclosures. If the auditor concludes that disclosures are inadequate, the audit report should be modified accordingly. The auditor should also consider the effect of the illegal act on its relationship with management, and management’s trustworthiness. Next, the client’s audit committee or others of equivalent authority should be informed of the illegal act. If the client does not deal with the illegal act in a satisfactory manner, the auditor should consider withdrawing from the engagement. Finally, if the client is publicly held, the auditor may need to report the matter to the SEC.

 

 

75.

medium

There are three broad categories of management assertions. Identify each of these categories.

 

  Answer:

·         Assertions about classes of transactions and events for the period under audit.

·         Assertions about account balances at period end.

·         Assertions about presentation and disclosure.

 

 

76.

medium

Briefly explain each management assertion related to classes of transactions and events for the period under audit.

 

  Answer:

·         Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity.

·         Completeness. All transactions and events that should have been recorded have been recorded.

·         Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately.

·         Classification. Transactions and events have been recorded in the proper accounts.

·         Cutoff. Transactions and events have been recorded in the correct accounting period.

 

 

77.

medium

Briefly explain each management assertion related to account balances at period end.

 

  Answer:

·         Existence. Assets, liabilities, and equity interests exist.

·         Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded.

·         Valuation and allocation. Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded.

·         Rights and obligations. The entity holds or controls the rights to assets, and liabilities are the obligation of the entity.

 

 

 

 

78.

medium

Briefly explain each management assertion related to presentation and disclosure.

 

  Answer:

·         Occurrence and rights and obligations. Disclosed events and transactions have occurred and pertain to the entity.

·         Completeness. All disclosures that should have been included in the financial statements have been included.

·         Accuracy and valuation. Financial and other information are disclosed appropriately and at appropriate amounts.

·         Classification and understandability. Financial and other information is appropriately presented and described and disclosures are clearly expressed.

 

79.

medium

Discuss three reasons why auditors are responsible for “reasonable” but not “absolute” assurance.

 

  Answer:

·         Most audit evidence results from testing a sample of a population. Sampling involves some risk of not uncovering material misstatements.

·         Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. As a result, the auditor has to rely on evidence that is persuasive but not convincing.

·         Fraudulently prepared financial statements are often very difficult for the auditor to detect, especially when there is collusion among management.

 

 

80.

medium

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

 

  Answer:

Management is responsible for adopting appropriate accounting policies, maintaining adequate internal control, and making fair representations in the financial statements. The auditor’s responsibility is to perform an audit designed to provide reasonable assurance of detecting any material misstatements in the financial statements and to express an opinion on those financial statements at the conclusion of the audit.

 

 

81.

medium

In the context of the audit of sales, distinguish between the existence and completeness transaction-related audit objectives. State the effect on the sales account (overstatement or understatement) of a violation of each objective.

 

  Answer:

When testing the existence objective for sales, the auditor’s focus is on whether the sales that have been recorded in the sales journal actually occurred. In contrast, tests of the completeness objective are concerned with determining whether all sales that actually occurred have been recorded in the sales journal. Violations of the existence objective result in overstatements of sales; violations of the completeness objective result in understatements of sales.

 

 

 

 

82.

challenging

Discuss the differences in the auditor’s responsibilities for discovering (1) material errors, (2) material fraud (3) direct-effect illegal acts, and (4) indirect-effect illegal acts.

 

  Answer:

Auditing standards make no distinction between the auditor’s responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor’s responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. The auditor’s responsibility for uncovering direct-effect illegal acts is the same as for errors and fraud. However, the auditor is not required to search for indirect-effect illegal acts unless there is reason to believe they exist.

 

 

83.

challenging

A financial statement audit typically consists of four phases. Identify each of these four phases of an audit and discuss the major activities performed by the auditor in each phase.

 

  Answer:

Phase I: Plan and design an audit approach. In this phase, the auditor obtains an understanding of the client’s entity and its environment. In addition, the auditor obtains an understanding of the client’s internal control and assesses the risk of material misstatement.

Phase II: Perform tests of controls and substantive tests of transactions. In this phase, the auditor tests those internal controls he/she believes may be effective at preventing or detecting misstatements. In addition, the auditor performs substantive tests of transactions to verify the monetary amounts of transactions.

Phase III: Perform analytical procedures and tests of details of balances. In this phase, the auditor performs analytical procedures to assess the overall reasonableness of transactions and balances. In addition, tests of details of balances are performed to test for monetary misstatements in the financial statements.

Phase IV: Complete the audit and issue an audit report. In the last phase of the audit, the information obtained in the previous phases is combined to reach an overall conclusion as to whether the financial statements are fairly presented. An audit report is then issued based on this conclusion.

 

 

84.

challenging

Discuss some precautionary actions an auditor should take when there is a moderate or high risk of management fraud.

 

  Answer:

Some precautionary actions an auditor should take when there is a moderate or high risk of management fraud include:

·         Critically challenging the client’s choice of accounting principles.

·         Assigning more experienced personnel to the engagement.

·         Doing more audit work at year-end instead of at interim dates.

·         Closely supervising assistants and other inexperienced staff.

·         Performing additional or more effective audit procedures.

·         In extreme situations, the auditor should consider withdrawing from the engagement.

 

 

 


Other Objective Answer Format Questions

 

85.

medium

Match seven of the terms (a-k) with the definitions provided below (1-7):

 

  a.      Tests of details of balances
  b.      Tests of controls
  c.       Substantive tests of transactions
  d.      Analytical procedures
  e.       Transaction-related audit objectives
  f.       Management assertions
  g.       Balance-related audit objectives
  h.      Fraud
  i.        Illegal act
  j.       Error
  k.      Management fraud

 

h                   1.       An intentional misstatement of the financial statements.

 

e                   2.       A set of six audit objectives the auditor must meet, including timing, posting and summarization, and accuracy.

 

f                   3.       Implied or expressed representations made by the client about classes of transactions, account balances and disclosures in the financial statements.

 

a                   4.       Audit procedures testing for monetary misstatements to determine whether the balance-related audit objectives have been satisfied for each significant account balance.

 

g                   5.       A set of nine audit objectives the auditor must meet, including completeness, detail tie-in, and rights and obligations.

 

b                   6.       Audit procedures designed to test the effectiveness of control policies and procedures.

 

d                   7.       Use of comparisons and relationships to assess whether account balances or other data appears reasonable.

 

 

86.

challenging

Below are five audit procedures, all of which are tests of transactions associated with the audit of the sales and collection cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested.

 

              Audit Objectives                                                                      Assertions
  A.    Occurrence                                                                    V.    Occurrence
  B.    Completeness                                                               W.   Completeness
  C.    Accuracy                                                                       X.    Accuracy
  D.    Posting and summarization                                       Y.    Classification
  E.    Classification                                                               Z.    Cutoff
  F.    Timing

 

 

 

  1.        Vouch recorded sales from the sales journal to the file of bills of lading.
A                 (1)          .
V                 (2)          .

 

  2.        Compare dates on the bill of lading, sales invoices, and sales journal to test for delays in recording sales transactions.
F                 (1)          .
Z                 (2)          .

 

  3.        Account for the sequence of prenumbered bills of lading and sales invoices.
B                 (1)          .
W                 (2)          .

 

  4.        Trace from a sample of prelistings of cash receipts to the cash receipts journal, testing for names, amounts, and dates.
B, C                 (1)          .
W, X                 (2)          .

 

  5.        Examine customer order forms for credit approval by the credit manager.
A                 (1)          .
V                 (2)          .

 

 

87.

challenging

Below are five audit procedures, all of which are tests of transactions associated with the audit of the acquisition and payment cycle. Also below are the six general transaction-related audit objectives and the five management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested.

 

              Audit Objectives                                                                      Assertions
  A.        Occurrence                                                                                V.            Occurrence
  B.        Completeness                                                                           W.           Completeness
  C.        Accuracy                                                                                   X.            Accuracy
  D.        Posting and summarization                                                   Y.            Classification
  E.        Classification                                                                           Z.             Cutoff
  F.        Timing

 

  1.        Foot the purchases journal and trace the totals to the related general ledger accounts.
D                 (1)          .
X                 (2)          .

 

  2.        Recompute the cash discounts taken by the client.
C                 (1)          .
X                 (2)          .

 

  3.        Compare dates on cancelled checks with the bank cancellation date.
F                 (1)          .
Z                 (2)          .

 

  4.        Trace from a sample of cancelled checks to the cash disbursements journal.
B                 (1)          .
W                 (2)          .

 

 

 

  5.        Examine supporting documentation for a sample of transactions for authorized payee and  amount and to determine services or goods were received.
A                 (1)          .
V                 (2)          .

 

 

88.

challenging

Below are five audit procedures, all of which are tests of balances associated with the audit of accounts receivable. Also below are the eight general balance-related audit objectives and the four management assertions. For each audit procedure, indicate (1) its audit objective, and (2) the management assertion being tested.

 

              Audit Objectives                                                                      Assertions
  A.        Existence                                                                                   V.            Existence
  B.        Completeness                                                                           W.           Completeness
  C.        Accuracy                                                                                   X.            Valuation and allocation
  D.        Classification                                                                           Y.            Rights and obligations
  E.        Cutoff
  F.        Detail tie-in
  G.        Realizable value
  H.       Rights and obligations
   
  1.        Obtain an aged listing of accounts receivable. For a sample of individual customers on the listing, agree the customer’s name, amount, and other information with the corresponding information in the accounts receivable master file.
F                 (1)          .
X                 (2)          .

 

  2.        Examine details of sales for five days before and five days after year-end to determine whether sales have been recorded in the proper period.
E                 (1)          .
X                 (2)          .

 

  3.        Assess the reasonableness of the balance in the allowance for doubtful accounts.
G                 (1)          .
X                 (2)          .

 

  4.        Inquire as to whether any accounts receivable have been factored or sold during the period.
H                 (1)          .
Y                 (2)          .

 

  5.        Inquire as to whether there are any receivables from related parties.
D                 (1)          .
X                 (2)          .

 

 

89.

easy

b

Responsibility for the fair presentation of financial statements rests equally with management and the auditor.

a.        True

b.        False

 

90.

easy

b

Errors are usually more difficult for an auditor to detect than frauds.

a.        True

b.        False

 

 

 

91.

easy

b

Auditors have found that the most efficient way to conduct audits is to focus primarily on testing classes of transactions and performing minimal or no tests of ending account balances.

a.        True

b.        False

 

92.

easy

a

When an auditor has reduced assessed control risk based on tests of controls, he or she may then reduce the extent to which the accuracy of the financial statement information directly related to those controls must be supported through the accumulation of evidence using substantive tests.

a.        True

b.        False

 

93.

easy

b

Tests of details of balances typically involve the use of comparisons and relationships to assess the overall reasonableness of account balances.

a.        True

b.        False

 

94.

easy

a

Other than inquiring of management about policies they have established to prevent illegal acts and whether management knows of any laws or regulations that the company has violated, the auditor should not search for indirect-effect illegal acts unless there is reason to believe they may exist.

a.        True

b.        False

 

95.

easy

a

When an auditor believes that an illegal act may have occurred, the first step he or she should take is to inquire of management at a level above those likely to be involved in the potential illegal act.

a.        True

b.        False

 

96.

medium

b

Audits are expected to provide a higher degree of assurance for the detection of material frauds than is provided for an equally material error.

a.        True

b.        False

 

97.

medium

a

Auditors have a higher degree of responsibility for detecting direct-effect illegal acts than indirect-effect illegal acts.

a.        True

b.        False

 

98.

medium

b

The auditor’s first course of action when an illegal act is uncovered should be to immediately notify the appropriate authorities, including but not limited to the police, and for publicly held companies, the Securities and Exchange Commission.

a.        True

b.        False

 

99.

medium

b

Under the cycle approach to segmenting an audit, transactions recorded in different journals should never be combined with the general ledger balances that result from those transactions.

a.        True

b.        False

 

100.

medium

b

General transaction-related audit objectives vary from audit to audit, depending on the nature and characteristics of the client’s business and industry.

a.        True

b.        False

 

 

 

101.

medium

a

The audit objective of posting and summarization is associated with the management assertion of accuracy.

a.        True

b.        False

 

102.

medium

b

Balance-related audit objectives are usually applied to the ending balance in income statement accounts; transaction-related audit objectives are usually applied to transactions reflected in balance sheet accounts.

a.        True

b.        False

 

103.

medium

a

The transaction-related audit objective of timing is related to the assertion of cutoff.

a.        True

b.        False

 

104.

medium

a

The effect of a violation of the existence transaction-related audit objective for the sales account would be an overstatement of that account.

a.        True

b.        False

 

105.

medium

b

The effect of a violation of the completeness transaction-related audit objective for cash disbursements transactions would be an overstatement of cash disbursements.

a.        True

b.        False

 

106.

medium

b

The transaction-related audit objective that deals with whether recorded transactions have actually occurred is the completeness objective.

a.        True

b.        False

 

107.

medium

a

The general balance-related audit objective that deals with determining that details in the account balance agree with related master file amounts, foot to the total in the account balance, and agree with the total in the general ledger is the detail tie-in objective.

a.        True

b.        False

 

108.

medium

a

The cutoff objective, “transactions near the balance sheet date are recorded in the proper period,” is a balance-related audit objective.

a.        True

b.        False

 

109.

medium

b

For a private company audit, tests of controls are normally performed only on those internal controls the auditor believes have not been operating effectively during the period under audit.

a.        True

b.        False

 

110.

medium

a

An audit generally provides no assurance that indirect-effect illegal acts will be detected.

a.        True

b.        False

 

111.

medium

a

When an auditor believes there is a moderate or high risk of management fraud, the auditor will normally do less audit work at interim dates instead of at year-end.

a.        True

b.        False

 

 

 

112.

challenging

b

An auditor must inform a client’s audit committee of an illegal act discovered during an audit in writing.

a.        True

b.        False

 

113.

challenging

b

The objective of the audit of financial statements by an independent auditor is to verify that the financial statements are free of misstatements and accurately represent the company’s financial position and results of operations.

a.        True

b.        False

 

114.

challenging

a

The auditor’s responsibility for uncovering direct-effect illegal acts is the same as for fraud.

a.        True

b.        False

 

 

Chapter 13

 

Multiple-Choice Questions

 

1.

easy

A listing of all the things which the auditor will do to gather sufficient, competent evidence is the:
b a.      audit strategy.
  b.      audit program.
  c.       audit procedure.
  d.      audit risk model.
   
2.

easy

Shown below (1 through 5) are the five types of tests which auditors use to determine whether financial statements are fairly stated. Which three are substantive tests?
b 1.      procedures to obtain an understanding of internal control
  2.      tests of controls
  3.      tests of transactions
  4.      analytical procedures
  5.      tests of details of balances
  a.      1, 2, and 3.
  b.      3, 4, and 5.
  c.       2, 3, and 5.
  d.      2, 3, and 4.
   
3.

easy

Collectively, procedures performed to obtain an understanding of the entity and its environment, including internal controls, represent the auditor’s:
c a.      audit strategy.
  b.      tests of controls.
  c.       risk assessment procedures.
  d.      tests of transactions.
   
4. For efficiency, tests of controls are frequently done at the same time as:
easy a.      analytical procedures.
c b.      compliance tests.
  c.       tests of transactions.
  d.      tests of details of balances.
   
5.

easy

Which of the following procedures are frequently performed in response to the auditor’s assessment of the risk of material misstatement?
c a.      Ratio analysis
  b.      Tests of controls
  c.       Tests of details of balances
  d.      Risk assessment procedures
   
6. In which stage(s) of an audit are analytical procedures not performed?
easy a.      In the planning stage.
b b.      In the test of controls stage.
  c.       In the completion stage.
  d.      In conjunction with tests of transactions and tests of details of balances.
   
7. Tests of controls may include which of the following types of evidence?
easy  
a   Reperformance   Observation  
  a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
8. The purpose of tests of controls is to provide reasonable assurance that the:
easy a.      accounting treatment of transactions and balances is valid and proper.
b b.      internal control procedures are functioning as intended.
  c.       entity has complied with GAAP disclosure requirements.
  d.      entity has complied with requirements of quality control.
   
9. In the context of an audit of financial statements, substantive tests are audit procedures that:
easy a.      may be eliminated under certain conditions.
c b.      are designed to discover significant subsequent events.
  c.       may be either tests of transactions, tests of balances, or analytical tests.
  d.      will increase proportionately with the auditor’s reliance on internal control.
   
10. Which of the following is not useful for obtaining an understanding of internal controls?
medium a.      Make inquiries of the client’s personnel.
c b.      Examine documents and records.
  c.       Read industry trade magazines.
  d.      Observe client activities and operations.
   
11. A system walkthrough is used to:
medium a.      test balances.
c b.      test details of transactions.
  c.       gain an understanding of internal controls.
  d.      determine acceptance of the client.
   
12. (Public) PCAOB Standard 2 _______ the auditor to perform walkthroughs of significant processes.
medium a.      encourages
b b.      requires
  c.       does not allow
  d.      permits
   
13. The most important consideration in developing the audit plan and audit program is the:
medium a.      client’s size.
d b.      client’s industry.
  c.       audit firm’s available personnel.
  d.      the audit risk model used in its planning form.
   
14. Tests of controls are directed toward the control’s:
medium a.      efficiency.
b b.      effectiveness.
  c.       efficiency and effectiveness.
  d.      cost benefit ratio.
   
15.

medium

When the auditor finds that there are missing controls in an area of the accounting system, the audit program in that area would be modified in such a way as to:
d a.      increase the amount of tests of controls.
  b.      increase the reliance on tests of controls.
  c.       cause the issuance of a qualified or adverse opinion.
  d.      eliminate the need for a test of controls.
   
16.

medium

A procedure designed to test for monetary misstatements directly affecting the correctness of financial statement balances is a:
b a.      test of controls.
  b.      substantive test.
  c.       test of attributes.
  d.      monetary-unit sampling test.
   
17. Which of the following is not appropriate for purposes of testing the effectiveness of controls?
medium a.      Make inquiries of client personnel.
b b.      Evaluate prior experience with the client.
  c.       Observe control-related activities.
  d.      Reperform client procedures.
   
18. Which of the following is not a direct result of performing analytical procedures?
medium a.      Identify areas of potential misstatements.
d b.      Reduce detailed audit tests.
  c.       Understand the client’s business.
  d.      Identify specific errors in the accounts.
   
19.

medium

If no material differences are found using analytical procedures and the auditor concludes that misstatements are not likely to have occurred:
a a.      other tests may be reduced.
  b.      it will be necessary to increase the tests of balances.
  c.       it will not be necessary to perform tests of balances.
  d.      it will be necessary to increase the tests of transactions.
   
20. The primary emphasis in most tests of details of balances is on the:
medium a.      balance sheet accounts.
a b.      revenue accounts.
  c.       cash flow statement accounts.
  d.      expense accounts.
   
21. Analytical procedures are defined in the auditing standards as:
medium a.      compliance tests.
b b.      substantive tests.
  c.       tests of controls.
  d.      helpful procedures not possessing the validity of other tests available to the auditor.
   
22. Tests of transactions are used to determine whether ___________ have been satisfied.
medium a.      compliance test requirements.
c b.      balance coverage requirements.
  c.       transaction-related audit objectives.
  d.      existence assertions
   
23. Which of the following statements is not true?
medium a.      Analytical procedures emphasize the overall reasonableness of transactions and balances.
b b.      Tests of controls are concerned with evaluating whether controls are sufficiently effective to justify reducing control risk and thereby reducing analytical review procedures.
  c.       Substantive tests of transactions emphasize the verification of transactions recorded in the journals and then posted in the general ledger.
  d.      Tests of details of balances emphasize the ending balances in the general ledger.
   
24. Which of the following audit tests is usually the least costly to perform?
medium a.      Analytical procedures.
a b.      Tests of controls.
  c.       Tests of balances.
  d.      Substantive tests of transactions.
   
25. Which of the following audit tests is usually the most costly to perform?
medium a.      Analytical procedures.
c b.      Tests of controls.
  c.       Tests of balances.
  d.      Substantive tests of transactions.
   
26. Analytical procedures must be performed in:
medium a.      the planning and test of control stages.
c b.      conjunction with tests of transactions and tests of details of balances.
  c.       the planning and completion stages.
  d.      the planning, test of control, and completion stages.
   
27. Which of the following tests commonly occur together?
medium a.      Substantive tests of transactions and tests of controls.
a b.      Substantive tests of transactions and obtaining an understanding of internal controls.
  c.       Analytical procedures and tests of controls.
  d.      Tests of controls and tests of details of balances.
   
28. Which of the following relationships between types of tests and audit evidence is not correct?
medium a.      Tests of details and documentation.
c b.      Tests of controls and observation.
  c.       Tests of details and observation.
  d.      Substantive tests of transactions and reperformance
   
29. An increased extent of tests of controls is most likely to occur when:
medium a.      it is a first-year audit.
c b.      the auditor is doing a “fraud audit.”
  c.       controls are effective and the preliminary control risk assessment is low.
  d.      controls are ineffective and the preliminary control risk assessment is high.
   
30. Many auditors perform extensive analytical procedures on audits because:
medium a.      they are required by GAAS.
c b.      they pinpoint errors in accounts.
  c.       they indicate areas of potential risk and misstatement.
  d.      they are required for tests of controls.
   
31. (Public)

medium

Which of the following types of procedures will be performed in an audit of internal control over financial reporting?
c  
    Procedures to obtain an understanding of internal control   Ratio analysis  
  a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
32. Tests of details of balances focus on:
medium a.      beginning of the year balances.
b b.      end of the year balances.
  c.       transaction details for the period under audit.
  d.      accounting cycles.
   
33. Auditors who test manual controls that rely on IT-generated reports must consider:
medium a.      the benefits of relying on IT-generated reports.
c b.      separation of duties related to the IT-generated reports.
  c.       the controls related to the accuracy of the information in the report.
  d.      whether the manual controls are approved by the audit committee..
   
34.

medium

When an auditor believes that analytical procedures indicate a reasonable possibility of misstatement, the auditor usually would:
d  
    Perform additional tests of controls   Decide to modify tests of details of balances  
  a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
35.

medium

If the results of the tests of controls, substantive tests of transactions, and analytical procedures are not consistent with the predictions, tests of details of balances will be:
d a.      eliminated.
  b.      increased.
  c.       unaffected.
  d.      changed.
   
36.

medium

When controls are deemed ineffective and assessed control risk is at the maximum for a private company, there will be ______ emphasis placed on tests of controls.
a a.      no
  b.      relatively little
  c.       moderate
  d.      heavy
   
37. Tests of controls address each of the following questions except:
medium a.      How were the procedures performed?
b b.      Why were the procedures performed?
  c.       Were the necessary procedures performed?
  d.      Who performed the procedures?
   
38. Which of the following audit tests would be regarded as a test of controls?
medium a.      Comparison of the inventory pricing to vendors’ invoices.
b b.      Tests of the signatures on canceled checks to board of directors’ authorizations.
  c.       Tests of the additions to property, plant, and equipment by physical inspections.
  d.      Review of the specific items making up the balance in a given general ledger account.
   
39. (Public)

medium

Which of the following tests form the basis for an auditor’s report on internal control over financial reporting?
c a.      Analytical procedures
  b.      Tests of transactions
  c.       Tests of controls
  d.      Tests of details of balances
   
40.

medium

After finishing the review phase of the study and evaluation of internal control in an audit, the auditor should perform tests of controls on:
a a.      those controls that the auditor wants and plans to rely upon.
  b.      those controls in which material weaknesses were identified.
  c.       those controls that have a material effect upon the financial statement balances.
  d.      a random sample of the controls that were reviewed.
   
41. At what point in the audit are tests of details most appropriately designed?
medium a.      Engagement evaluation.
b b.      Planning.
  c.       Testing.
  d.      Communication of material weaknesses.
   
42. (Public) Which of the following is/are performed in an audit of internal control over financial reporting?
Medium  
b   Procedures to obtain an understanding of internal control    

 

Test of details of balances

   

 

Analytical Procedures

  a. Yes   Yes   No
  b. Yes   No   No
  c. No   Yes   Yes
  d. No   No   Yes
   
43.

medium

The reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily:
b a.      parallel.
  b.      inverse.
  c.       direct.
  d.      equal.
   
44.

medium

Which of the following is ordinarily designed to detect possible material dollar errors on the financial statements?
b a.      Tests of controls.
  b.      Analytical review procedures.
  c.       Computer controls.
  d.      None of the above.
   
45. What type of test is used to obtain more types of evidence than any other?
challenging a.      Substantive tests of transactions.
d b.      Tests of controls.
  c.       Analytical procedures.
  d.      Tests of details.
   
46. Only _______ involve physical examination and confirmation.
challenging a.      tests of controls
c b.      tests of transactions
  c.       tests of balances
  d.      analytical procedures
   
47. Documentation is used in every type of test except ________.
challenging a.      tests of controls
c b.      tests of transactions
  c.       analytical procedures
  d.      tests of details
   
48.

challenging

Which of the following types of evidence is not available when using substantive tests of transactions?
b a.      Documentation.
  b.      Confirmation.
  c.       Inquiries of the client.
  d.      Reperformance.
   
49. An exception in a test of control indicates the _______ of misstatements.
challenging a.      the amount
b b.      the likelihood
  c.       the amount, likelihood, and classification
  d.      the amount and the classification
   
50. Which of the following is not a valid basis for omitting an audit test?
challenging a.      the difficulty and expense involved in testing a particular item.
a b.      the relative risk involved.
  c.       the degree of reliance on the relevant internal controls.
  d.      the relationship between the cost of obtaining evidence and its usefulness.
   
51.

challenging

Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion?
b a.      The audit program.
  b.      The auditor’s judgment.
  c.       Generally accepted auditing standards.
  d.      The auditor’s working papers.
   

Essay Questions

 

52.

easy

Contrast the circumstances in which the auditor would choose not to test controls with those in which he or she would perform tests of controls.

 

  Answer:

If the auditor believes that controls have not been operating effectively during the period under audit, or that it would not be cost-effective to test controls, then he or she would choose not to test controls. In contrast, if the auditor believes that controls have been operating effectively during the period under audit, and that it would be cost-effective to test controls, the auditor will perform tests of controls.

 

 

53.

easy

Three factors the auditor considers when assessing control risk are: the auditor’s belief concerning the effectiveness of internal controls, the results of tests of controls, and the cost-effectiveness of a reduced assessed control risk. Identify the combination of conditions for these three factors that is required before a reduction in substantive testing is permitted.

 

  Answer:

A reduction in substantive testing is permitted when (1) the auditor identifies specific controls he or she believes have been operating effectively during the period under audit, (2) the auditor believes it will be cost-effective to test those controls, and (3) the results of tests of controls indicate that the controls have indeed been operating effectively.

 

 

54.

medium

List each of the five types of audit tests and list at least two types of evidence that may be obtained from each type of test.

 

  Answer:

·         Procedures to obtain an understanding of internal control – documentation, observation, inquiries of the client, and reperformance.

·         Tests of controls – documentation, observation, inquiries of the client, and reperformance.

·         Substantive tests of transactions – documentation, inquiries of the client, and reperformance.

·         Analytical procedures – inquiries of the client and analytical procedures.

·         Tests of details of balances – physical examination, confirmation, documentation, inquires of the client, and reperformance.

 

 

55.

medium

Must auditors always perform tests of controls?
  Answer:

Auditors only need to perform tests of controls in the audit of a private company if they intend to rely on them. Auditors must always perform tests of controls in the audit of a public company.

 

 

 

56.

medium

Describe the five types of audit tests. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk.

 

  Answer:

The five types of audit tests used to determine whether financial statements are fairly stated are: procedures to obtain an understanding of internal control, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Substantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk.

 

 

57.

medium

Consider the audit risk model and the five types of audit tests. Which tests provide evidence pertinent to the various elements of the audit risk model?

 

  Answer:

Evidence can be obtained about control risk via procedures to obtain an understanding of internal controls, tests of controls, and substantive tests of transactions. Evidence can be obtained about planned detection risk via substantive tests of transactions, analytical procedures, and tests of details of balances.

 

 

58.

medium

Discuss the purposes of (1) substantive tests of transactions, (2) tests of controls, and (3) tests of details of balances. Give an example of each.

 

  Answer:

The purpose of substantive tests of transactions is to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions. For example, as part of the auditor’s test of the accuracy objective for sales, the auditor would compare the amount recorded in the sales journal for a sample of sales transactions with the total on the corresponding sales invoices.

The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. For example, the auditor might observe for a month whether statements are mailed to all customers.

The purpose of tests of details of balances is to determine the monetary correctness of the accounts to which they relate. The confirmation of accounts receivable is an example.

 

59.

medium

There are three stages of the audit in which analytical procedures are performed. Identify each of these three stages and, for each stage, discuss the purpose of performing analytical procedures in that stage. Also indicate in which stage(s) analytical procedures are required by current professional auditing standards.

 

  Answer:

Analytical procedures are performed in the audit planning stage to help the auditor decide the other evidence needed to satisfy sufficient competent evidence requirements. Analytical procedures can also be performed as substantive tests in the testing phase of the audit. Analytical procedures are performed in the audit completion phase as a final test of reasonableness. Auditing standards require that analytical procedures be performed in the planning and completion phases of every audit.

 

 

 

 

60.

medium

Discuss the major determinants of the extent of tests of details of balances.

 

  Answer:

Major determinants of the extent of tests of details of balances include: the results of tests of controls, substantive tests of transactions, and analytical procedures; the amount of tolerable misstatement; and the levels of inherent risk and acceptable audit risk.

 

 

61.

challenging

What are the four steps auditors follow when they plan to reduce assessed control risk?
  Answer:

The steps are as follows:

1.       Apply transaction-related audit objectives to the class of transaction being tested.

2.       Identify key controls that should reduce control risk for each transaction-related audit objective.

3.       Develop appropriate tests of controls for all internal controls used to reduce the preliminary assessment of control risk below maximum.

4.       For potential types of misstatements related to each transaction-related audit objectives, design appropriate substantive tests of transactions, considering deficiencies in internal control and expected results of the tests of controls.

 

62.

challenging

Discuss the relationship of each of the following to the extent of planned tests of details of balances: (1) tolerable misstatement, (2) inherent risk, (3) control risk, and (4) acceptable audit risk.

 

  Answer:

Inherent risk and control risk are directly related to the extent of planned tests of details of balances; that is, as inherent risk and/or control risk increase, the extent of planned tests of details of balances also increases. Tolerable misstatement and acceptable audit risk are inversely related to the extent of planned tests of details of balances; that is, as tolerable misstatement and/or acceptable audit risk increase, the extent of planned tests of details of balances decreases.

 

 

63.

challenging

There are seven types of audit evidence: physical examination, confirmation, documentation, observation, inquiries of the client, reperformance, and analytical procedures. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) substantive tests of transactions, (3) analytical procedures, and (4) tests of details of balances.

 

  Answer:

1.       Tests of controls. Documentation, observation, inquiries of the client, reperformance.

2.       Substantive tests of transactions. Documentation, inquiries of the client, reperformance.

3.       Analytical procedures. Inquiries of the client, analytical procedures.

4.       Tests of details of balances. Physical examination, confirmation, documentation, inquiries of the client, reperformance.

 

 

 

 

64.

challenging

Discuss the major activities and procedures performed by the auditor in each of the four phases of an audit.

 

  Answer:

The major activities performed in the planning and design phase (Phase I) are: preplan the engagement; obtain background information about the client; obtain information about the client’s legal obligations; perform preliminary analytical procedures; set materiality, and assess acceptable audit risk and inherent risk; obtain an understanding of internal control, and assess control risk; and develop an overall audit plan and audit program.

Phase II involves tests of controls, substantive tests of transactions, and an assessment of the likelihood of misstatements in the financial statements.

Phase III involves analytical procedures and tests of details of balances.

In Phase IV, the auditor performs the review for contingent liabilities, the review for subsequent events, accumulates final evidence, evaluates results, issues the audit report, and communicates with the client’s audit committee and management.

 

 

 

Other Objective Answer Format Questions

 

65.

easy

a

One difference between procedures used to obtain an understanding of internal control and procedures used to test controls is that tests of controls are more extensive.

a.      True

b.      False

 

66.

easy

b

Tests of controls are generally less expensive to perform than analytical procedures.

a.      True

b.      False

 

67.

easy

a

Tests of controls provide evidence about the potential for misstatements in a client’s accounting system.

a.      True

b.      False

 

68.

easy

b

Auditing standards encourage, but do not require, a written audit program.

a.      True

b.      False

 

69.

easy

b

Substantive tests of transactions are the most expensive type of audit test to perform.

a.      True

b.      False

 

70.

easy

a

An exception in a test of control provides only an indication of the likelihood of monetary misstatements in the financial statements because tests of controls do not reveal whether monetary misstatements have actually occurred.

a.      True

b.      False

 

 

 

71.

easy

b

An exception in a substantive test of transactions provides only an indication of the likelihood of monetary misstatements in the financial statements because substantive tests of transactions do not reveal whether monetary misstatements have actually occurred.

a.      True

b.      False

 

72.

easy

a

Analytical procedures are the least expensive type of audit test.

a.      True

b.      False

 

73.

easy

a

If inherent risk is decreased from medium to low, tests of details of balances can be reduced.

a.      True

b.      False

 

74.

easy

a

When designing an audit program for tests of details of balances, the auditor should make assumptions about inherent risk and control risk, and predictions concerning the outcome of tests of controls, substantive tests of transactions, and analytical procedures.

a.      True

b.      False

 

75.

easy

a

The extent of tests of details of balances can be reduced when transaction-related audit objectives have been satisfied by tests of controls or substantive tests of transactions.

a.      True

b.      False

 

76.

easy

b

Tests of controls and substantive tests of transactions are rarely, if ever, conducted simultaneously on the same transactions.

a.      True

b.      False

 

77.

easy

b

Under normal circumstances, there should be no variation in the audit evidence mix from cycle to cycle for a given audit engagement.

a.      True

b.      False

 

78.

medium

a

Auditing standards recognize that in instances where a significant amount of audit evidence is in electronic form, it may not be possible to reduce detection risk to an acceptable level by performing only substantive tests.

a.          True

b.          False

 

79.

medium

a

When analytical procedures are performed during substantive testing, they are typically more focused and extensive than when performed as part of audit planning.

a.          True

b.          False

 

80.

medium

a

Tests of controls may be performed prior to substantive tests of transactions.

a.      True

b.      False

 

 

 

81.

medium

b

Tests of details of balances focus on beginning and ending of the year balances.

a.      True

b.      False

 

82.

medium

a

If tests of controls reveal that controls are sufficiently effective to justify reducing control risk, the auditor is justified in reducing substantive audit tests.

a.      True

b.      False

 

83.

medium

b

Analytical procedures are the most expensive type of audit test to perform because of the expertise and training required to properly use them.

a.      True

b.      False

 

84. (Public)

medium

b

PCAOB Standard 2 requires auditors to test controls every three years.

a.      True

b.      False

 

85.

medium

b

The auditor must communicate significant deficiencies in internal control only after the entire audit is complete to ensure the auditor has a sufficient understanding of the circumstances surrounding the deficiency.

a.      True

b.      False

 

86.

medium

b

The results of tests of controls and tests of details of balances affect the design of substantive tests of transactions.

a.      True

b.      False

 

87.

medium

b

If the auditor’s preliminary assessment of control risk is decreased from high to medium, tests of controls can be reduced.

a.      True

b.      False

 

88.

medium

b

When testing details of balances, most audit procedures satisfy only one balance-related objective, but more than one audit procedure should be used to test each objective.

a.      True

b.      False

 

89.

medium

b

Substantive tests of transactions and substantive tests of details of balances are often conducted simultaneously.

a.      True

b.      False

 

90.

medium

b

Auditing standards require that tests of controls be performed on every audit engagement.

a.      True

b.      False

 

91. (Public)

challenging

a

In the audit of a public company, computer controls must be tested if they are considered to be key controls for reducing the likelihood of material misstatements in the financial statements.

a.      True

b.      False

 

 

 

92.

challenging

a

Procedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing automated controls.

a.      True

b.      False

 

93.

challenging

a

Analytical procedures are normally designed at the account level, whereas tests of controls and substantive tests of transactions are normally designed at the transaction-related objective level.

a.      True

b.      False

 

94.

challenging

b

Procedures to obtain an understanding of internal control may suffice for tests of controls when the auditor is assessing control risk in a well defined transaction cycle that has not contained material misstatements in prior audits.

a.      True

b.      False

 

95.

challenging

a

Analytical procedures provide fewer types of evidence than any other type of audit test.

a.      True

b.      False

 

Chapter 21

 

Multiple-Choice Questions

 

1.

easy

b

Receipt of ordered materials by the receiving department will generate the completion of a form called the:

a.      bill of lading.

b.      receiving report.

c.       materials requisition.

d.      inventory acquisition summary.

 

2.

easy

c

The audit of ______ is often the most difficult and complex part of an audit.

a.      property, plant and equipment

b.      cash

c.       inventory

d.      prepaid insurance

 

3.

easy

d

Inventory is a complex area to audit for all but which of the following reasons?

a.      Inventory is often in different locations.

b.      There are several acceptable valuation methods and some entities use different methods           for different types of inventory.

c.       Inventory is often the largest account in working capital.

d.      Inventory valuation includes few estimates.

 

4.

easy

b

When labor is a significant part of inventory, verifying the proper accounting of these costs should be tested in the:

a.      inventory and warehousing cycle.

b.      payroll and personnel cycle.

c.       acquisitions and payments cycle.

d.      cash cycle.

 

5.

easy

a

For retail and wholesale businesses, the most important inventory is:

a.      merchandise available for sale.

b.      work-in-process.

c.       raw materials.

d.      inventory held on consignment.

 

6.

easy

b

The audit procedure “observe the client taking a physical inventory count and test the count” is sufficient to determine all of the following except:

a.      whether recorded inventory actually exists.

b.      whether recorded inventory was properly valued by the client.

c.       whether recorded inventory was properly counted by the client.

d.      whether client inventory instruction had properly been followed.

 

7.

easy

d

In most manufacturing companies, the inventory and warehousing cycle begins with the:

a.      receipt of a customer’s order.

b.      completion of production of a customer’s order.

c.       initiation of production of a customer’s order.

d.      acquisition of raw materials for production of an order.

 

8.

easy

c

The audit tests to verify that the client is using an inventory method which is generally accepted and to verify that physical counts were correctly summarized are performed during the audit of the:

a.      acquisition and payments cycle.

b.      payroll and personnel cycle.

c.       inventory and warehousing cycle.

d.      sales and collection cycle.

 

9. Which of the following would be an appropriate initiation of a purchase requisition?
easy  
a   One initiated based on a periodic count of raw materials.   One initiated by stockroom personnel as raw materials are needed.  
  a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
10.

easy

a

Almost all companies need physical controls over their assets to prevent loss. Which of the following is not an example of such a control?

a.      Perpetual inventory master files.

b.      Segregated, limited-access storage areas.

c.       Custody of assets assigned to specific responsible individuals.

d.      Approved prenumbered documents for authorizing movement of inventory.

 

11.

easy

d

Which department within a manufacturing company is often responsible for the review of production and scrap reports?

a.      Purchasing.

b.      Accounts Payable.

c.       Accounting.

d.      Production.

 

12.

easy

b

Handling the receipt of ordered goods is a part of the ________ cycle.

a.      purchasing

b.      acquisition and payment

c.       inventory

d.      inventory and warehousing

 

13.

easy

b

_________ accumulate costs by individual jobs as material is issued into production and labor costs are incurred.

a.      Just-in-time production systems

b.      Job order cost systems

c.       Process cost systems

d.      Manufacturing systems

 

14.

easy

c

There must be a periodic physical count by the client of the inventory items on hand:

a.      only if the client uses the LIFO method.

b.      only if the client uses a lower-of-cost-or-market method.

c.       regardless of the client’s inventory valuation method.

d.      only if the client uses either the LIFO or FIFO method.

 

15.

easy

d

With regard to the physical count of inventory, necessary control procedures include:

a.      proper instructions for the physical count.

b.      independent third-party verification of the counts.

c.       third-party reconciliations of the physical counts with perpetual inventory master files.

d.      counting the inventory only on the year-end date.

   
16.

easy

c

If the auditor concludes that physical controls over inventory are so inadequate that the inventory will be difficult to count, the auditor should ordinarily:

a.      withdraw from the engagement.

b.      issue a qualified audit report.

c.       conduct expanded observation tests of physical inventory.

d.      hire a specialist to assist the auditor.

 

17.

easy

a

From which of the following evidence-gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories?

a.      Observation of physical inventory counts.

b.      Written inventory representations from management.

c.       Confirmation of inventories in a public warehouse.

d.      Auditor’s recomputation of inventory extensions.

 

18.

easy

a

Johnson Co.’s physical count of inventories was lower than the inventory quantities shown in its perpetual records. This situation could be the result of the failure to record:

a.      sales.

b.      sales returns.

c.       purchases.

d.      purchase discounts.

 

19.

easy

d

Which of the following is not a function within the inventory and warehousing cycle?

a.      Process the goods.

b.      Store raw materials.

c.       Ship finished goods.

d.      Process invoices for shipped goods.

 

20.

easy

b

If an auditor were concerned with obtaining evidence about the appropriateness of the value of inventory, which of the following tests would be most appropriate?

a.      Compilation tests.

b.      Price tests.

c.       Confirmation of inventory held by outside parties.

d.      Physical examination of the inventory.

 

21.

easy

b

Which of the following is the best audit procedure for the discovery of damaged merchandise in a client’s ending inventory?

a.      Compare the physical quantities of slow-moving items with corresponding quantities of           the prior year.

b.      Observe merchandise and raw materials during the client’s physical inventory count.

c.       Review the management’s inventory representation letter for accuracy.

d.      Test overall fairness of inventory values by comparing the company’s turnover ratio with           the industry average.

 

22.

medium

c

Which of the following controls would be appropriate regarding the release of materials from a stockroom?

a.        Production employees request materials be delivered to their work areas as they need them.

b.        Stockroom employees deliver materials to work areas throughout the day to maintain acceptable levels of safety stock – no written records are maintained.

c.         Production employees submit approved requisition forms to the stockroom for materials needed.

d.        Production employer in need of materials should personally pick up needed materials from the stockroom.

 

23.

medium

d

Who should maintain the perpetual inventory master files?

a.      Production personnel.

b.      Inventory storeroom personnel.

c.       Inventory receiving personnel.

d.      Accounting department personnel.

 

24.

medium

a

The inventory and warehousing cycle can be thought of as having two separate but closely related systems, one involving the actual physical flow of goods, and the other the:

a.      related costs.

b.      storage of the goods.

c.       internal control over those goods.

d.      prevention of waste, obsolescence, and theft.

 

25.

medium

c

In any company involved in manufacturing, an adequate cost accounting internal control system is necessary to indicate the relative profitability of the various products for management planning and control and to:

a.      determine variances from standards.

b.      determine variances from budgets.

c.       value inventories for financial statement purposes.

d.      value inventories for audit verification.

 

26.

medium

c

Master files, worksheets, and reports that accumulate material, labor, and overhead as the costs are incurred are:

a.      accounting systems.

b.      storeroom documents.

c.       cost accounting records.

d.      finished goods inventory records.

 

27.

medium

b

The main difference between job order and process costing systems is that:

a.      one accumulates costs by materials issued and the other by labor incurred.

b.      one accumulates costs by individual jobs and the other by particular processes.

c.       one emphasizes costs accumulated in completed products and the other emphasizes costs           associated with work-in-process.

d.      one emphasizes costs adding value to the product and the other emphasizes costs incurred           because of waste, scrap, and obsolescence.

 

28.

medium

d

A well-designed computerized system of perpetual inventory master files includes information about the:

a.      units of inventory purchased, sold, and on hand.

b.      unit costs of inventory purchased, sold, and on hand.

c.       units of raw materials, work-in-process, and finished goods.

d.      units and unit costs of inventory purchased, sold, and on hand.

 

29.

medium

a

Which of the following is a significant audit concern related to the transfer of inventory from one location to another?

a.      Recorded transfers occurred.

b.      Transfers were properly transported.

c.       Transfers were properly planned.

d.      Transfers represent efficient movement of assets.

 

30. When may auditors observe the physical inventory count?

 

medium   At an interim date   At year-end  
a a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
31.

medium

d

Which of the following is not an aspect of concern when auditing the cost accounting system?

a.      Unit cost records.

b.      Physical controls over inventory.

c.       Documents and records for transferring inventory.

d.      Safeguarding the raw materials from point of receipt to the storeroom.

 

32.

medium

a

The auditor’s tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods must be restricted to:

a.      observation and inquiry.

b.      documentation and observation.

c.       documentation and confirmation.

d.      documentation and inquiry.

 

33.

medium

a

It is frequently possible to test the physical inventory prior to the balance sheet date when:

a.      there are accurate perpetual inventory master files.

b.      year-end sales are small.

c.       the internal control system is no better at year-end than at an earlier point in time.

d.      the client counts inventory at interim dates.

 

34.

medium

d

Tests of the perpetual inventory master files for the purpose of reducing the tests of physical inventory or changing their timing are done through the use of:

a.      inquiry.

b.      observation.

c.       confirmation.

d.      documentation.

 

35.

medium

c

A major difficulty in the verification of inventory cost records is determining reasonableness of:

a.      direct labor’s hourly rate.

b.      raw materials per unit cost.

c.       cost allocations.

d.      number of direct labor hours applied.

 

36.

medium

d

When auditing the inventory and warehousing cycle, the use of analytical procedures is:

a.      not important for this cycle.

b.      less important than for any other cycle.

c.       more important than for any other cycle.

d.      as important as their use in any other cycle.

 

37.

medium

c

Which one of the following analytical procedures would be most helpful in alerting the auditor to the possibility of obsolete inventory?

a.      Compare gross margin percentage with previous years’.

b.      Compare unit costs of inventory with previous years’.

c.       Compare inventory turnover ratio with previous years’.

d.      Compare current year manufacturing costs with previous years’.

 

38.

medium

a

Which of the following statements is correct regarding the auditor’s responsibility with respect to the year-end inventory procedures of an audit client?

 

c   The auditor is responsible for reconciling the physical count with the perpetual inventory matter files.   The auditor is responsible for taking and compiling the inventory.   The auditor is responsible for observing the physical counting of inventory.  
  a. Yes   No   No
  b. No   No   Yes
  c. Yes   No   Yes
  d. No   Yes   No
   
39.

medium

a

McKesson & Robbins Company is a well-known audit case involving auditor responsibility. What occurred at the McKesson & Robbins Company to change the way in which auditors audit inventory?

a.      The company recorded nonexistent inventory.

b.      The auditor did not perform any audit tests of the inventory.

c.       The auditor and company colluded to overstate inventory balances.

d.      The company counted inventory three months prior to year-end.

 

40.

medium

c

When a physical count of inventory is performed at an interim date, the auditor observes it at that time and tests the perpetual records for transactions:

a.      throughout the year.

b.      which are a representative sample of the period under audit.

c.       from the date of the count to year-end.

d.      from the date of the count to the end of the audit field work.

 

41.

medium

b

When there are no perpetual inventory files and inventory is material:

a.      an audit cannot be performed, so the auditor must issue a disclaimer.

b.      a physical inventory should be taken by the client near year-end.

c.       the auditor will have to perform the inventory count and determine valuation.

d.      the auditor need not observe inventory counts but must do test counts.

 

42. Auditor tests of physical controls over raw materials, work-in-process, and finished goods are performed by:

 

medium   Examination   Observation   Inquiry  
d a. Yes   No   Yes
  b. No   Yes   No
  c. Yes   Yes   No
  d. No   No   Yes
   
43.

medium

d

The most important part of the observation of inventory is to determine whether:

a.      all counts are accurate.

b.      the inventory-takers are qualified.

c.       obsolete inventory has been identified.

d.      the physical count is being taken in accordance with the client’s instructions.

 

44.

medium

d

A useful starting point for becoming familiar with the client’s inventory is for the auditor to:

a.      read the AICPA’s Industry Audit Guide.

b.      review accounting theory covering special problems, such as gas and oil accounting, or           lease-purchase agreements.

c.       read the client’s Accounting Manual.

d.      tour the client’s facility.

 

45.

medium

a

A common inventory observation procedure is to select a random sample of tag numbers and identify the tag with that number attached to the actual inventory item. The audit objective being achieved by this procedure is:

a.      inventory as recorded on tags actually exists (existence).

b.      existing inventory is counted and tagged (completeness).

c.       inventory is counted accurately (accuracy).

d.      inventory is classified correctly (classification).

 

46.

medium

c

If a client intends to count inventory at an interim date, the auditor should expect there to be all of the following except:

a.      controls over the preparation and maintenance of perpetual inventory records.

b.      competent personnel assigned to count the inventory.

c.       third-party inventory counting specialists.

d.      an adequately designed plan to count the inventory.

 

47.

medium

c

A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is:

a.      classification.

b.      cutoff.

c.       realizable value.

d.      rights.

 

48.

medium

d

The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been deleted is associated with the audit objective of:

a.      accuracy.

b.      existence.

c.       detail tie-in.

d.      completeness.

 

49.

medium

d

The test of details of balance procedure which requires the auditor to perform tests of lower-of-cost-or-market, selling price, and obsolescence is an attempt to satisfy the objective of:

a.      existence.

b.      completeness.

c.       accuracy.

d.      realizable value.

 

50.

medium

a

Most of the audit testing of the storage of finished goods as well as the shipment of merchandise takes place during the testing of the:

a.      sales and collection cycle.

b.      payroll and personnel cycle.

c.       acquisitions and payments cycle.

d.      inventory and warehousing cycle.

 

51.

medium

b

The auditor’s main concerns in verifying transfers of inventory do not include whether:

a.      recorded transfers exist.

b.      transfers represent appropriate uses of company resources.

c.       all actual transfers are recorded.

d.      the details of the transfer are accurately recorded.

 

52.

medium

c

After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items:

a.      included in the listing have been counted.

b.      represented by inventory tags actually exist.

c.       represented by inventory tags are included in the listing.

d.      included in the listing are represented by inventory tags.

 

53.

medium

d

Auditors test the quantity of materials charged to work-in-process by tracing these quantities to:

a.      cost ledgers.

b.      perpetual inventory records.

c.       receiving reports.

d.      material requisitions.

 

54.

medium

a

Which of the following situations would most likely require special audit planning?

a.      Inventory consists of precious stones.

b.      Some items of factory and office equipment do not bear identification numbers.

c.       Depreciation methods used on the client’s tax return differ from those used on the books.

d.      Assets costing less than $500 are expensed even though their expected life exceeds one           year.

 

55.

medium

a

For several years, a client’s physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required. Contributing to the inventory problem could be weaknesses in internal control that led to the failure to adjust the accounting records for some:

a.      purchases returned to vendors.

b.      sales returns received.

c.       sales discounts allowed.

d.      cash purchases.

 

56. The physical counting of inventory may be performed at which of the following times?

 

medium   Interim dates   On a cycle basis during the year  
a a. Yes   Yes
  b. No   No
  c. Yes   No
  d. No   Yes
   
57.

medium

c

When an auditor observes that personnel who are responsible for physically counting inventory are not following the inventory instructions, the auditor should:

a.      contact a client’s supervisor in an attempt to correct the problem.

b.      modify the client’s physical inventory instructions.

c.       not discuss the problem with client’s supervisor in order to maintain independence.

d.      assign audit staff to the inventory count.

 

58.

medium

b

The auditor’s objective during an observation of a client’s physical inventory count is to:

a.      discover whether a client has counted a particular inventory item or group of items.

b.      obtain direct knowledge that the inventory exists and has been properly counted.

c.       provide an appraisal of the quality of the merchandise on hand on the day of the physical           count.

d.      allow the auditor to supervise the conduct of the count so as to obtain assurance that           inventory quantities are reasonably accurate.

 

59.

medium

a

The audit of year-end physical inventories should include steps to verify that the client’s purchases and sales cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a:

a.      sale in the current period.

b.      sale in the subsequent period.

c.       purchase in the current period.

d.      purchase return in the subsequent period.

 

60.

medium

b

Which one of the following procedures would not be appropriate for an auditor in discharging his responsibilities concerning the client’s physical inventories?

a.      Confirmation of goods in the hands of public warehouses.

b.      Supervising the taking of the annual physical inventory.

c.       Carrying out physical inventory procedures at an interim date.

d.      Obtaining written representation from the client as to the existence, quality, and dollar           amount of the inventory.

 

61.

medium

d

Pricing manufactured inventory is difficult. Auditors must evaluate the method of allocating manufacturing overhead for all but which of the following?

a.      reasonableness.

b.      computational correctness.

c.       adherence to FASB pronouncement

d.      consistency.

 

62.

medium

c

If the perpetual inventory master files show lower quantities of inventory than the physical count, an explanation of the difference might be unrecorded:

a.      sales.

b.      sales discounts.

c.       purchases.

d.      purchase discounts.

 

63.

easy

b

Which of the following is not a generally recognized inventory method?

a.      FIFO

b.      LOFO

c.       LIFO

d.      Specific identification

 

64.

medium

b

Which of the following control procedures would most likely be used to maintain accurate perpetual inventory records?

a.      Independent storeroom count of goods received.

b.      Periodic independent comparison of records with goods on hand.

c.       Periodic independent reconciliation of control and subsidiary records.

d.      Independent matching of purchase orders, receiving reports, and vendors’ invoices.

 

65.

challenging

c

Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which:

a.      materials are ordered for purchase until the finished product is sold.

b.      the customer’s order is received until the finished product is shipped.

c.       raw materials are requisitioned until the finished product is sent to storage.

d.      raw materials are requisitioned until the finished product is completely manufactured.

 

66.

challenging

d

In valuing inventory, the auditor must consider all but which of the following factors?

a.      The valuation method must be in accordance with GAAP.

b.      The valuation method must be applied on a consistent basis.

c.       The inventory must be valued at the lower of cost or market.

d.      All inventory must be valued using the same valuation method under GAAP.

 

67.

challenging

c

Controls which provide a means of ensuring that the physical counts are properly summarized, priced at the same amount as the unit records, correctly extended and totaled, and included in the general ledger at the proper amount are known as:

a.      standard cost controls.

b.      pricing internal controls.

c.       compilation internal controls.

d.      count quantity internal controls.

 

68.

challenging

c

Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using first-in, first-out (FIFO). If the most recent acquisition of inventory was for 600 units at $10 per unit and the immediately preceding acquisition was for 700 units at $9 per unit, the inventory item is in error and it is:

a.      understated $400.

b.      understated $300.

c.       overstated $400.

d.      overstated $700.

69.

challenging

d

Assume that the client’s valuation of an inventory item is $10 per unit for 1,000 units, using LIFO. If the most recent acquisition of a layer of inventory was for 600 units at $10 per unit and the immediately preceding layer was for 700 units at $9 per unit, the inventory item is in error and it is:

a.      understated $700.

b.      understated $300.

c.       overstated $400.

d.      overstated $700.

 

70.

challenging

c

When an outside specialist has assumed full responsibility for taking the client’s physical inventory, reliance on the specialist’s report is acceptable if:

a.      the auditor’s report contains a reference to the assumption of full responsibility.

b.      the auditor is satisfied through application of appropriate procedures as to the reputation           and competence of the specialist.

c.       the auditor conducted the same audit tests and procedures as would have been applicable if       the client’s employees took the physical inventory.

d.      circumstances made it impracticable or impossible for the auditor either to do the work           personally or observe the work done by the inventory firm.

 

71.

challenging

b

To best ascertain that a company has properly included merchandise that it owns in its ending inventory, the auditor should review and test the:

a.      terms of the open purchase orders.

b.      purchase cutoff procedures.

c.       contractual commitments made by the purchasing department.

d.      purchase invoices received on or around year-end.

 

72.

challenging

a

Hardy Company mass-produces eight different products. The controller who is interested in strengthening internal controls over the accounting for materials used in production would be most likely to implement a(n):

a.      perpetual inventory system.

b.      job order cost accounting system.

c.       economic order quantity system.

d.      separation of duties among production personnel.

 

73.

challenging

d

Which of the following is an internal control weakness for a company whose inventory of supplies consists of a large number of individual items?

a.      The cycle basis is used for physical counts.

b.      Supplies of relatively little value are expensed when purchased.

c.       Perpetual inventory records are maintained only for items of significant value.

d.      The storekeeper is responsible for maintenance of perpetual inventory records.

 

74.

challenging

c

When auditing a public warehouse, which of the following is the most important audit procedure with respect to disclosing unrecorded liabilities?

a.      Observation of inventory.

b.      Review of outstanding receipts.

c.       Inspection of receiving and issuing procedures.

d.      Confirmation of negotiable receipts with holders.

 

Essay Questions

 

75.

easy

What are two factors affecting the complexity of the audit of inventory?
  Answer:

·  Inventory is often the largest account in the working capital.

·  Inventory is often in different locations.

·  Diverse items in inventory are often difficult to value.

·  Inventory valuation is difficult due to the estimates involved.

·  There are several acceptable methods of valuing inventory and some entities use      different methods for different types of inventory.

 

 

76.

easy

The basis for the auditor’s verification of inventory pricing and compilation is the client’s inventory listing. Describe the information that should be included in this listing.

 

  Answer:

The inventory listing should include each inventory item’s description, quantity, unit price, and extended value.

 

 

77.

medium

In pricing inventory, it is necessary to consider whether replacement cost is lower than historical cost.  When applying lower of cost or market tests, what basis should auditors use for each of the following categories of inventory:

·         Raw materials

·         Work-in-process

·         Purchased finished goods

 

  Answer:

·         Raw materials – the most recent cost as found on vendor invoices from the period subsequent to year-end

·         Work-in-process – all manufacturing costs from production records from the period subsequent to year-end

·         Purchased finished goods – the most recent cost as found on vendor invoices from the period subsequent to year-end and the sales value of these goods

 

 

78.

medium

What must auditors do to meet their obligations under professional auditing standards related to the observation of inventory?
  Answer:

·  Be present at the time the client counts their inventory for determining year-end      balances.

·  Observe the client’s counting procedures.

·  Make inquiries of client personnel about their counting procedures.

·  Make their own independent tests of the physical counts.

 

 

79.

medium

Discuss the auditor’s responsibilities for inventory maintained in public warehouses or with other outside custodians.

 

  Answer:

Ordinarily the auditor will confirm inventory held by outside custodians. However, the auditor may perform additional procedures if the amounts involved are significant. These additional procedures may include: an investigation of the custodian’s performance, requesting an independent accountant’s report on the custodian’s control procedures over the custody of goods, and observing the physical count of goods held by the custodian.

80.

medium

Discuss the four aspects of the audit of cost accounting with which the auditor is most concerned.

 

  Answer:

The auditor is most concerned with:

·         Physical controls over inventory.

·         Documents and records for transferring inventory. The auditor’s primary concerns in verifying the transfer of inventory from one location to another are that the recorded transfers exist, the transfers that have actually taken place are recorded, and the quantity, description, and date of all recorded transfers are accurate.

·         Perpetual inventory master files. The adequacy of perpetual inventory master files has a major effect on the timing and extent of the auditor’s physical examination of inventory.

·         Unit cost records.

 

 

81.

medium

Identify three analytical procedures commonly used when auditing accounts in the inventory and warehousing cycle.

 

  Answer:

Common analytical procedures for the inventory and warehousing cycle include:

·         Compare gross margin percentage with previous years’.

·         Compare inventory turnover ratio with previous years’.

·         Compare unit costs of inventory with previous years’.

·         Compare extended inventory value with previous years’.

·         Compare current-year manufacturing costs with previous years’.

 

 

82.

medium

Discuss the methodology for designing tests of details of balances for inventory.

 

  Answer:

The methodology for designing tests of details of balances for inventory is:

1.       Set materiality, and assess acceptable audit risk and inherent risk for the inventory and warehousing cycle.

2.       Assess control risk for several cycles. This risk is assessed for the inventory and warehousing cycle, sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle.

3.       Design and perform tests of controls and substantive tests of transactions for several cycles.

4.       Design and perform analytical procedures for the inventory and warehousing cycle.

5.       Design tests of details of inventory to satisfy balance-related audit objectives. Design sample size, timing of tests, items to select for testing, and audit procedures to be performed.

 

83.

medium

The design of tests of details of balances for inventory is affected by audit results from multiple cycles. Identify the cycles, other than the inventory and warehousing cycle that affect the audit of inventory.

 

  Answer:

Tests of details of balances for inventory are affected by the results of tests of controls and substantive tests of transactions in the sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle, as well as the inventory and warehousing cycle.

 

 

 

 

84.

medium

Discuss the key control procedures relating to the client’s physical count of inventory.

 

  Answer:

The key control procedures relating to the client’s physical count of inventory include proper instructions for the physical count, supervision by responsible personnel, independent internal verification of the counts, independent reconciliations of the physical counts with perpetual inventory master files, and adequate control over count sheets or tags.

 

 

85.

medium

Explain why the audit of work-in-process and finished goods inventory is generally more complex than the audit of purchased inventory.

 

  Answer:

The need to verify the cost of raw materials, direct labor, and manufacturing overhead in pricing work-in-process and finished goods has the effect of making the audit of work-in-process and finished goods inventory more complex than the audit of purchased inventory.

 

 

86.

medium

What types of tests are available to an auditor who wishes to test the physical control over inventory?

 

  Answer:

The auditor may either use observation or inquiry to obtain evidence about the physical           control over inventory.

 

 

87.

challenging

State the six functions that make up the inventory and warehousing cycle and, for each function, identify the related documents and/or records that would be used by a manufacturing company.

 

  Answer:

The six functions are:

·Process purchase orders. Related documents are the purchase requisition and the purchase order.

·Receive raw materials. Related documents are the receiving report and the vendor’s invoice.

·Store raw materials. Related record is the raw materials perpetual inventory master file.

·Process the goods. Related documents and records are the raw materials requisition and the cost accounting records.

·Store finished goods. Related records are the finished goods perpetual inventory master file and the cost accounting records.

·Ship finished goods. Related documents and records are the shipping document, the finished goods perpetual inventory master file, and the cost accounting records.

 

 

 

 

88.

challenging

The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor.

 

  Answer:

The five parts are:

·         Acquire and record raw materials, labor, and overhead. This is tested during the audits of the acquisition and payment cycle, and the payroll and personnel cycle.

·         Internally transfer assets and costs. This is tested in the inventory and warehousing cycle.

·         Ship goods, and record revenue and costs. This is tested during the audit of the sales and collection cycle.

·         Physically observe inventory. This is tested in the inventory and warehousing cycle.

·         Price and compile inventory. This is tested in the inventory and warehousing cycle.

 

 

 

Other Objective Answer Format Questions

 

89.

easy

b

Auditors have been required to perform physical observation tests of inventory since the early 1990s.

a.      True

b.      False

 

90.

easy

b

 

Perpetual inventory records should be maintained by persons have access to inventory.

a.      True

b.      False

 

91.

easy

b

Internal controls over the ship finished goods function in the inventory and warehousing cycle are not normally tested by the auditor as a part of performing tests of controls and substantive tests of transactions in the sales and collection cycle.

a.      True

b.      False

 

92.

easy

b

In the audit of inventory, the auditor and client are jointly responsible for making and recording the count of physical inventory; while the auditor is responsible for drawing conclusions about the adequacy of the physical inventory.

a.      True

b.      False

 

93.

easy

a

The audit procedure “Perform tests of lower-of-cost-or-market, selling price, and obsolescence” provides assurance mainly for the realizable value objective for inventory pricing and compilation.

a.      True

b.      False

94.

easy

b

In process costing systems, costs are accumulated by individual jobs.

a.      True

b.      False

 

95.

easy

a

In job cost systems, costs are accumulated by individual jobs.

a.      True

b.      False

 

96.

easy

b

An approved purchase requisition form authorizes shipment of goods to customers.

a.      True

b.      False

97.

easy

a

The receipt of raw materials is a part of the acquisition and payment cycle.

a.      True

b.      False

 

98.

easy

b

When finished goods are completed, they are usually stored in the packing area.

a.      True

b.      False

 

99.

easy

b

When performing price tests for purchased inventory, the auditor would not be concerned with the most recent vendors’ invoices if the client uses the FIFO valuation method.

a.      True

b.      False

 

100.

easy

a

A comparison of the current year’s inventory turnover ratio with previous years’ may indicate the presence of obsolete inventory.

a.      True

b.      False

 

101.

easy

a

To test for proper sales cutoff, an auditor would obtain the number of the last bill of lading issued during the period under audit and verify that the item shipped had been excluded from the inventory listing.

a.      True

b.      False

 

102.

easy

b

If the perpetual inventory master files show lower quantities of inventory than the physical count, one explanation of the difference might be unrecorded sales.

a.      True

b.      False

 

103.

medium

a

It is acceptable under generally accepted accounting principles for a company to use different valuation methods for different parts of its inventory.

a.      True

b.      False

 

104.

medium

a

Internal controls over the processing of purchase orders function, the receipt of raw materials function, and the storage of raw materials function in the inventory and warehousing cycle are normally tested by the auditor as a part of performing tests of controls and substantive tests of transactions in the acquisition and payment cycle and the payroll and personnel cycle.

a.      True

b.      False

 

105.

medium

a

The major considerations in evaluating the reasonableness of cost allocations are compliance with GAAP and consistency with prior years.

a.      True
b.      False

 

106.

medium

a

 

When verifying the transfer of inventory from one location to another, the audit objectives with which the auditor is primarily concerned are occurrence of recorded transfers, completeness of recorded transfers, and accuracy of recorded transfers.

a.      True

b.      False

 

107.

medium

b

When the client’s perpetual inventory master files are inadequate, the auditor will probably choose to test the physical inventory prior to the balance sheet date.

a.      True

b.      False

 

108.

medium

a

When part of the client’s inventory is in a public warehouse or in the possession of other outside custodians, the auditor does not need to observe a physical count of the inventory if a written confirmation is obtained directly from the inventory custodians.

a.      True

b.      False

 

109.

medium

b

The audit procedure “Foot the inventory listing schedules for raw materials, work-in-process, and finished goods” provides assurance mainly for the accuracy objective for inventory pricing and compilation.

a.      True

b.      False

 

110.

medium

b

The audit procedure “Account for unused tag numbers shown in the auditor’s working papers to make sure no tags have been added” provides assurance mainly for the existence objective for inventory pricing and compilation.

a.      True

b.      False

 

111.

medium

a

When performing audit tests of pricing and compilation for inventory, the client’s perpetual inventory master file may be used in place of vendors’ invoices if controls over the perpetual inventory master file are adequate.

a.      True

b.      False

 

112.

medium

b

Production personnel should ordinarily be responsible for maintaining perpetual inventory records.

a.      True

b.      False

 

113.

medium

a

The extent and timing of an auditor’s physical examination of inventory is significantly influenced by the adequacy of the client’s perpetual inventory records.

a.      True

b.      False

 

114.

challenging

a

While separate perpetual inventory records are normally kept for raw materials and finished goods, most companies do not use perpetuals for work-in-process.

a.      True

b.      False

 

115.

challenging

b

Inherent risk is typically assessed at a moderate level for inventory due to the nature of the asset.

a.      True

b.      False

 

 

 

 

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