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Auditing The Art And Science of Assurance Engagements Canadian 12th Edition By Alvin A. Arens – Test Bank 

 

 

Auditing, 12e (Arens)

Chapter 1   The Demand for an Auditing and Assurance Profession

 

1.1   Identify the components of an audit and explain why there is a demand for audits

 

1) Which of the following illustrates the definition of auditing with respect to the evidence analysis process?

  1. A) accumulation and evaluation of evidence about balance sheet accounts
  2. B) learning about different types of computing technology, such as mainframes
  3. C) writing an operational audit report that is tailored to the client’s situation
  4. D) making sure that the auditor is competent and understands evidence gathering

 

Page Ref: 5

 

 

2) Auditing should be done by a qualified

  1. A) chartered accountant.
  2. B) certified management accountant.
  3. C) competent and independent person.
  4. D) professional accountant.

 

Page Ref: 5

 

 

3) Which of the following illustrates the definition of auditing with respect to the reporting process?

  1. A) accumulation and evaluation of evidence about balance sheet accounts
  2. B) reporting on the degree of correspondence between financial statements and ASPE
  3. C) writing an operational audit report that is tailored to the client’s situation
  4. D) making sure that the auditor is competent and understands evidence gathering

 

Page Ref: 5

 

 

4) In the audit of historical financial statements by PA firms, the criteria used are

  1. A) generally accepted auditing standards.
  2. B) generally accepted accounting principles.
  3. C) regulations of the Canada Revenue Agency.
  4. D) regulations of the provincial securities commissions.

 

Page Ref: 5

 

5) A large PA firm has assessed evidence collected during an engagement. Criteria used to assess the financial statements were International Financial Reporting Standards (IFRS). A high level of assurance was obtained. The type of engagement conducted was a(n)

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

 

Page Ref: 5

 

 

6) The auditor and the entities should agree on the criteria to be used in the audit

  1. A) before the audit starts.
  2. B) after the audit planning has been done.
  3. C) as they progress with the audit as they can determine which criteria is more suitable.
  4. D) at the end of the audit.

 

Page Ref: 5

 

 

7) George had a conversation with the accounting personnel and documented information about how the accounting systems function. He has also placed copies of accounting forms in his files. George is performing which task?

  1. A) accounting procedures
  2. B) evidence gathering
  3. C) tax audit
  4. D) audit report preparation

 

Page Ref: 5

 

 

8) One of the reasons that an auditor must be competent is to be able to

  1. A) understand the engagement risks and the criteria used by the client.
  2. B) explain how the bookkeeping should be done to his staff.
  3. C) record the transactions properly for the underlying records.
  4. D) capture the information properly in the computer files.

 

Page Ref: 6

 

 

 

9) One of the reasons that an auditor must be competent is to be able to

  1. A) select the type and amount of evidence to accumulate.
  2. B) explain how the bookkeeping should be done to his staff.
  3. C) record the transactions properly for the underlying records.
  4. D) capture the information properly in the computer files.

 

Page Ref: 6

 

10) It is important for the auditor to be independent because

  1. A) the auditor would not charge a fair rate to the client.
  2. B) the auditor might not be as knowledgeable of the subject matter and the criteria.
  3. C) this will prevent bias in accumulating and evaluating evidence.
  4. D) the Canadian Tax Authorities require that the auditor be independent.

 

Page Ref: 6

 

 

11) Because an external auditor is paid a fee by a client company, he or she

  1. A) is absolutely independent and may conduct an audit.
  2. B) may be sufficiently independent to conduct an audit.
  3. C) is never considered to be independent.
  4. D) must receive approval of the relevant provincial securities commission before conducting an audit.

 

Page Ref: 6

 

 

12) The independent auditor’s report is the

  1. A) communication of the result of the audit to the users.
  2. B) set of audited financial statements.
  3. C) invoice of the auditor detailing the work they have performed.
  4. D) report presented to management about the possible improvements.

 

Page Ref: 6

 

 

 

13) In the audit of an individual’s tax return, the auditor should demonstrate competence in the use of

  1. A) external databases that contain economic statistics.
  2. B) standard personal and corporate tax preparation software.
  3. C) the Income Tax Act and accompanying regulations.
  4. D) database management software for the use of client based research.

 

Page Ref: 6

 

 

14) In the audit of an individual’s tax return, the criteria used would be

  1. A) an accounting framework.
  2. B) the Income Tax Act.
  3. C) the client’s policies for taxable income.
  4. D) the auditor’s judgment.

 

Page Ref: 6

 

15) In the audit of a corporate tax return, the report provided by the Canada Revenue Agency auditor would describe

  1. A) an opinion on the likelihood of tax return error.
  2. B) the likely accounting errors that could contribute to tax errors.
  3. C) management issues with respect to accurately reporting taxes.
  4. D) corporate income tax overages or income tax under payments.

 

Page Ref: 6

 

 

16) Joe is recording sales transactions in the accounting system so that they can be summarized in a logical manner for the purpose of providing financial information for decision-making. Joe is performing

  1. A) accounting.
  2. B) auditing.
  3. C) review.
  4. D) management consulting.

 

Page Ref: 7

 

 

 

17) Which of the following is an example of accounting rather than auditing?

  1. A) gathering evidence about the quality of accounts receivable
  2. B) entering sales transactions into the sales order system
  3. C) reviewing sales invoices to see if they have been calculated correctly
  4. D) comparing bank deposit documents to the recorded cash received

 

Page Ref: 7

 

 

18) In “auditing” accounting data, the concern is with

  1. A) determining whether recorded information properly reflects the economic events that occurred during the accounting period.
  2. B) determining if fraud has occurred.
  3. C) determining if taxable income has been calculated correctly.
  4. D) analyzing the financial information to be sure that it complies with government requirements.

 

Page Ref: 7

 

 

19) Which of the following is an example of auditing rather than accounting?

  1. A) recording purchase amounts in the expense accounts
  2. B) posting the daily sales totals to the general ledger
  3. C) recording cash received in the customer account files
  4. D) evaluating whether accounts receivable are collectible

 

Page Ref: 7

 

20) An accountant records information. When conducting an audit, the auditor must possess

  1. A) an ability to interpret generally accepted accounting frameworks.
  2. B) an education beyond the bachelor’s degree.
  3. C) an ability to classify transactions by type.
  4. D) an ability to organize and summarize economic events.

 

Page Ref: 8

 

 

 

21) How does a financial statement audit affect a bank manager’s decision in providing loans to a corporate client?

  1. A) Information risk could be reduced, so the bank manager may lower the interest rate charged.
  2. B) The bank manager will lower the risk-free interest rate that applies to the corporation.
  3. C) The business risk for the client will be reduced, so the borrowing costs will decline.
  4. D) The business risk for the client will be increased, so the borrowing costs will be lowered.

 

Page Ref: 8

 

 

22) What is the most appropriate method for an organization to lower information risk related to its financial statements? To have

  1. A) good bookkeeping work completed on the accounts.
  2. B) a high quality software package keep track of information.
  3. C) an independent financial statement audit conducted.
  4. D) an independent operational audit conducted on effectiveness.

 

Page Ref: 8

 

 

23) Discuss the differences and similarities between the roles of accountants and auditors. What additional expertise must an auditor possess beyond that of an accountant?

24) Frederic is an account manager at a large Canadian bank. Frederic has to decide if the bank will make a loan to Frost Corp, a snow removal company. Further, Frederic has to decide how much they will lend to Frost and at what rate.

 

Assuming that Frederic makes the loan, what factors will he use to decide the rate of interest? What factors are impacted by auditing and how?

1.2   Link the nature of assurance services to examples of actual services provided

 

1) The No-Name Advertising Rating Agency conducts independent surveys to determine the sources of purchases by consumers (e.g. newspaper ad, magazine ad, television ad). This information is then used by those media (i.e. newspapers, magazines, and television broadcasters) to indicate to purchasers of advertising the breadth of coverage that they have. For example, Small Local Newspaper can say that 10% of the purchasers of soap products made their decisions based upon their ads. This helps in selling advertising. What type of service is No-Name providing?

  1. A) Assurance
  2. B) Attest
  3. C) Review
  4. D) Compilation

 

 

2) Which of the following is an example of an attestation engagement?

  1. A) Accounting and bookkeeping services for the accounts
  2. B) An audit of internal controls over financial reporting
  3. C) Preparation of the annual financial statements, with notes
  4. D) Completion of provincial and federal tax returns

 

Page Ref: 9

 

3) For how many years will assurance engagements be required by individuals or organizations?

  1. A) usually only when organizations obtain debt or other loans
  2. B) for five years from the start of an organization until debt is retired
  3. C) only when historical such as financial information needs to be audited
  4. D) on an ongoing basis, as organizations and society’s needs evolve

 

4) What impact is the presence of factors such as real-time information (such as via the Internet) expected to have upon the demand for assurance services? Demand is expected to

  1. A) decline, due to the lack of adequate resources.
  2. B) grow, due to the increase in large corporations.
  3. C) grow, due to the need for forward-looking information.
  4. D) decline, as small businesses use the Internet more.

 

Page Ref: 10

 

 

5) A major type of assurance service performed by large public accounting firms is

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

 

Page Ref: 10

 

 

6) In Canada, publicly traded companies are

  1. A) required to have audits.
  2. B) strongly encouraged to have audits.
  3. C) not required to have an audit if they have a review.
  4. D) not required to have an audit.

 

Page Ref: 10

 

 

7) A shareholder of a public Canadian firm can have access to the audited financial statements

  1. A) on the internet.
  2. B) by calling the accounting department of the company.
  3. C) requesting a copy from the auditors.
  4. D) if he holds more than 1% of the shares of the company.

 

Page Ref: 10

 

 

8) What type of information is available from www.sedar.com (System for Electronic Document Analysis and Retrieval)? Documents such as

  1. A) minutes of shareholders and directors meetings.
  2. B) transaction reports from major credit card companies.
  3. C) annual reports and management discussion and analysis.
  4. D) listings of all of the shareholders on record.

 

Page Ref: 10-11

 

 

9) A reason for a not-for-profit organization to be audited is

  1. A) complying with the laws requiring them to be audited.
  2. B) meeting requirements of lenders or funding sources.
  3. C) having a professional accountant perform their bookkeeping.
  4. D) ensuring that their financial statement do not contain errors.

 

Page Ref: 11

 

 

10) Which of the following services provides a moderate level of assurance about the client’s financial statements?

  1. A) Forecasts and projections
  2. B) Compliance
  3. C) Review
  4. D) Audit

 

Page Ref: 12

 

 

11) Which of the following is an advantage of a review engagement as compared to an audit engagement? For the review engagement

  1. A) information risk is reduced more than for an audit.
  2. B) the documentation to be provided by the client is greater.
  3. C) the financial statements assessed will have more detail.
  4. D) it requires considerably less work, so is less costly.

 

Page Ref: 12

 

 

 

12) The Sarbanes-Oxley Act requires the auditor to attest to the

  1. A) accuracy of the financial statements.
  2. B) efficiency of the internal controls in financial reporting.
  3. C) effectiveness of internal controls.
  4. D) compliance of the company with the generally accepted accounting framework.

 

Page Ref: 12

 

13) The reasoning behind the requirements of the Sarbanes Oxley Act’s section 404 (attestation on internal control over financial reporting) is that

  1. A) effective controls result in greater profits to organizations, reducing business failures.
  2. B) effective controls reduce the likelihood of future misstatements in the financial statements.
  3. C) better internal controls can be implemented at lower cost, improving product quality.
  4. D) automated controls improve customer service, resulting in higher product sales.

 

Page Ref: 12

 

 

14) There is an increasing demand for assurance about computer controls surrounding financial information transacted electronically and the security of the information related to the transaction. This is in large part due to

  1. A) the increasing presence of internet sales in many businesses.
  2. B) the use of computer assisted auditing tools.
  3. C) the many transactions and information shared online and in real time by companies.
  4. D) client’s uncertainty about the proper functioning of their computer system.

 

Page Ref: 12

 

 

15) The purpose of a WebTrust service is to assure the user that

  1. A) criteria related to business practices, transaction integrity, and information processes have been met.
  2. B) information systems are reliable in areas such as security, data integrity, and program quality.
  3. C) controls over information systems implemented by the company are used consistently and reliably.
  4. D) there will not be any unauthorized access to the web site or other systems used by the client organization.

 

Page Ref: 12

 

 

 

16) Which of the following services results in the placement of an electronic seal affixed to the web site?

  1. A) review engagement
  2. B) internal controls assessment
  3. C) SysTrust
  4. D) WebTrust

 

Page Ref: 12

 

17) PA is attempting to sell a service to his clients that will provide assurance on information systems reliability. PA is attempting to sell a(n)

  1. A) WebTrust service.
  2. B) compilation service.
  3. C) SysTrust service.
  4. D) audit engagement.

 

Page Ref: 12

 

 

18) Which of the following services provides no assurance about the client’s financial statements?

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

 

Page Ref: 13

 

 

19) Herbert Zora is having financial statements prepared by his PA to accompany his tax return. His primary concern is cost. Of the following, the lowest cost engagement that the PA can perform for Zora’s financial statements is

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

 

Page Ref: 13

 

 

 

20) When a compilation engagement is performed, the report attached is called a

  1. A) Compilation Report.
  2. B) Notice to Reader.
  3. C) No Assurance Report.
  4. D) Auditor’s Report.

 

Page Ref: 13

 

 

21) Blader Ng. Inc. has recently placed into production new air-cleaning systems in their smoke-stacks to meet clean-air quality regulations. PA has been engaged to assess air quality and compare results to legislated requirements. What type of audit or engagement is PA conducting?

  1. A) financial statement
  2. B) compliance
  3. C) operational
  4. D) review

 

Page Ref: 14

 

22) Big Bank requires, as part of its loan agreement, that only accounts receivable less than 60 days old be used as collateral. An auditor has been engaged to provide assurance that the accounts receivable on the list provided to the bank are indeed less than 60 days old. What type of engagement is the auditor conducting?

  1. A) financial statement
  2. B) compliance
  3. C) operational
  4. D) review

 

Page Ref: 14

 

 

23) A review of any part of an organization’s procedures and methods for the purpose of evaluating efficiency and effectiveness is classified as a(n)

  1. A) audit of financial statements.
  2. B) compliance audit.
  3. C) operational audit.
  4. D) production audit.

 

Page Ref: 14

 

 

 

24) Which one of the following is more difficult to evaluate objectively?

  1. A) efficiency and effectiveness of operations
  2. B) compliance with government regulations
  3. C) presentation of financial statements in accordance with a generally accepted accounting framework
  4. D) internal controls in use at a small company.

 

Page Ref: 14

 

 

25) A typical objective of an operational audit is for the auditor to

  1. A) determine whether the financial statements fairly present the entity’s operations.
  2. B) evaluate the feasibility of attaining the entity’s operational objectives.
  3. C) evaluate the effectiveness of an internal process.
  4. D) report on the entity’s relative success in attaining profit maximization.

 

Page Ref: 14

 

 

26) Which of the following audits can be regarded as being solely “compliance” audits?

  1. A) Canada Revenue Agency’s examinations of the returns of taxpayers
  2. B) the Auditor General’s evaluation of the computer operations of governmental units
  3. C) an internal auditor’s review of his employer’s payroll authorization procedures
  4. D) a public accounting firm’s audit of the local school district

 

Page Ref: 14

 

27) Which of the following is an example of a financial statement audit?

  1. A) determining whether ABC’s financial statements overall do not violate any debt covenants
  2. B) determining whether ABC’s overall financial statements are stated in conformity with IFRS
  3. C) evaluating the effectiveness and efficiency of internal controls used to create account balance
  4. D) evaluating the effectiveness and efficiency of internal controls used to record transactions

 

Page Ref: 14

 

 

 

28) What is the primary difference between internal and external auditors? The

  1. A) methodology used to conduct financial statement audits.
  2. B) level of competence required.
  3. C) parties to whom the auditor is responsible.
  4. D) level of objectivity required.

 

Page Ref: 15

 

 

29) Why might the decisions about materiality and risks be different for the internal auditor than for the external auditor when conducting an audit of a system?

  1. A) the auditors are applying different skills during the conduct of the audit
  2. B) external auditors have different expectations with respect to quality control
  3. C) internal auditors will focus only on the potential for dollar errors internally
  4. D) external users may have different needs than management

 

Page Ref: 15

 

30) To do an audit, it is necessary to have information in a verifiable form and some criteria by which the auditor can evaluate the information.

 

Required:

 

  1. A) What information and criteria would a public accounting firm use when auditing a company’s financial statements?

 

  1. B) What information and criteria would a Canada Revenue Agency auditor use when auditing that same company’s tax return?

 

  1. C) What information and criteria would an internal auditor use when performing an operational audit to evaluate whether the company’s computerized payroll processing system is operating efficiently and effectively?

 

 

31) Two types of services provided by public accounting firms are audits and reviews. Discuss the similarities and differences between these two types of services. Which type provides the most assurance?

32) Mega Manufacturing Company (Mega) is thinking about acquiring Localized Small Producer Inc. (LSP), a small manufacturing company that produces related products. Mega has examined the financial statements of LSP, which show only a small profit in the last five years. Management of LSP has taken reasonable salaries, and cost of goods sold is higher than the industry average for LSP. Mega believes that it will be able to introduce operational efficiencies at LSP, improving the profitability of the small company, if acquired.

 

Required:

 

  1. A) What type of engagement should be conducted to assess the operational efficiencies of LSP? Justify your response.

 

  1. B) Who should be engaged to conduct the engagement?

 

  1. C) What major problems might the auditors encounter when conducting the audit and writing the report?

 

33) Jordan set up a nonprofit corporation several years ago to provide scholarships to poor youth in his community. From a small start, Scholarships Get up and Go Foundation now has assets of over $5 million, and provides about ten university scholarships every year. Jordan is proud of the new doctors, dentists and other health care practitioners that his Foundation has funded.

Jordan is thinking of starting another foundation in an old building that he has purchased. It would be a youth drop in centre, with music lessons, art facilities, basketball facilities in a gym, with linkages to local high schools so that there could be a homework club to encourage good grades.

 

Required:

 

  1. A) Why should Jordan have the financial statements of both of these foundations audited?

 

  1. B) Who would be the users of the financial statements of the foundations?

 

  1. C) What other types of services could PAs provide to Jordan and the foundations?

 

34) You, PA, have been asked to prepare the year-end financial statements of your sister. Betty is a photographer, and is the sole shareholder of a small company called Best Weddings Ltd. She photographs weddings, graduations and schools, earning about $75,000 per year. Betty has said that she only needs the financial statements for her tax returns, and would like you to prepare the tax returns too.

 

Required:

 

  1. A) Would you be able to prepare the financial statements for your sister? Why or why not?

 

  1. B) If yes, what type of report would you prepare to accompany the financial statements?

 

  1. C) Would you be able to prepare the tax returns for your sister? Why or why not?

 

1.3   Explore the different types of accountants and what they do

 

1) Who is responsible for developing financial statement audit and assurance standards in Canada?

  1. A) AASB (Auditing and Assurance Standards Board)
  2. B) Standards staff at the CICA (Canadian Institute of Chartered Accountants)
  3. C) National accounting bodies such as CGA Canada
  4. D) The accounting firms who conduct financial statement audits

 

Page Ref: 15

 

2) Which of the following organizations establishes ethical standards and standards for the practice of Internal Auditing?

  1. A) (ISACA) Information Systems Audit and Control Association
  2. B) (IIA) Institute of Internal Auditors
  3. C) (SMAC) Society of Management Accountants of Canada
  4. D) (CICA) Canadian Institute of Chartered Accountants

 

Page Ref: 53

 

 

3) Auditors General are responsible for auditing which types of organizations?

  1. A) Public companies with shares issued to investors
  2. B) Private companies that have loans outstanding to banks or other creditors
  3. C) Ministries, departments, agencies, and crown corporations
  4. D) Any organization that submits tax returns to the tax authorities

 

Page Ref: 17

 

 

4) The extent and the scope of the audits conducted by Auditors General are determined by

  1. A) legislation in the Auditor General’s jurisdiction.
  2. B) audit partner planning audit program development.
  3. C) the Auditor General and his/her staff.
  4. D) the financial statement auditors of the client.

 

5) To operate effectively, an internal auditor must be independent of the

  1. A) line functions of the organizations.
  2. B) entity that is being audited.
  3. C) employer-employee relationship which exists for other employees in the organization.
  4. D) outsourcing organizations used.

 

Page Ref: 18

 

 

6) The internal audit group typically reports directly to the

  1. A) board of directors.
  2. B) management of the company.
  3. C) external auditor
  4. D) audit committee.

 

Page Ref: 18

 

7) We discuss four types of auditors: public accountants, government auditors, Canada Revenue Agency auditors and internal auditors. Briefly describe the work and responsibilities of each type.

 

 

8)

[Note: If this question is used as part of an examination question, Figure 1-1. Audit of a Tax Return will need to be included as part of the examination.]

 

Use your knowledge of the definition of auditing and Figure 1-1. Audit of a Tax Return, to explain how an auditor would conduct a privacy audit.

 

 

Auditing, 12e (Arens)

Chapter 2   The Public Accounting Profession

 

2.1   Describe the various organizational structures of public accounting firms

 

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

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

 

Page Ref: 27

 

 

2) National accounting firms in 2012 are those with

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

 

Page Ref: 27

 

 

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

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

 

Page Ref: 27

 

 

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

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

 

Page Ref: 28

 

 

 

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

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

 

Page Ref: 28

 

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

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

 

Page Ref: 28

 

 

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

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

 

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

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

 

Page Ref: 29

 

 

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

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

 

Page Ref: 30

 

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

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

 

Page Ref: 30

 

 

4) The reason for adopting the CASs is to

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

 

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

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

 

Page Ref: 30-31

 

 

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

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

 

Page Ref: 32

 

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

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

 

Page Ref: 32

 

 

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

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

 

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

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

 

Page Ref: 32

 

 

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

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

 

Page Ref: 32

 

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

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

 

Page Ref: 32

 

 

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

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

 

Page Ref: 32

 

 

 

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

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

 

Page Ref: 32

 

 

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

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

 

Page Ref: 33

 

 

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

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

 

Page Ref: 33

 

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

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

 

Page Ref: 34

 

 

 

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

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

 

Page Ref: 34

 

 

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

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

 

Page Ref: 34

 

 

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

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

 

Page Ref: 34

 

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

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

 

Page Ref: 34

 

 

 

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

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

 

Page Ref: 34

 

 

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

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

 

Page Ref: 34-35

 

 

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

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

 

Page Ref: 35

 

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

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

 

Page Ref: 35

 

 

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

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

 

Page Ref: 35

 

 

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

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

 

Page Ref: 35

 

 

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

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

 

Page Ref: 35

 

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

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

 

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

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

 

Page Ref: 37

 

 

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

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

 

Page Ref: 37

 

 

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

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

 

Page Ref: 37

 

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

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

2.3   Examine the characteristics of quality control for financial statement audits

 

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

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

 

Page Ref: 38

 

 

2) CPAB’s purpose is to

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

 

Page Ref: 38

 

 

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

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

 

Page Ref: 38

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

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

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

 

Page Ref: 39

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

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

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

 

Page Ref: 39

 

 

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

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

 

Page Ref: 39

 

 

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

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

 

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

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

 

Page Ref: 40

 

 

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

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

 

Page Ref: 40

 

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

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

 

Page Ref: 40

 

 

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

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

 

 

 

23) Securities regulations in Canada are the responsibility of

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

 

Page Ref: 41

 

 

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

Answer:

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

Page Ref: 37-38

 

 

 

Auditing, 12e (Arens)

Chapter 3   Professional Relationships: The Role of Ethics and Independence

 

3.1   Describe ethics and their relevance

 

1) Ethical behaviour is considered to be a cornerstone for trust in everyday life as well as in business practices. Ethics are

  1. A) beliefs that we have about our own behaviour.
  2. B) a set of moral principles or values.
  3. C) rules in society that help us to do the right thing.
  4. D) laws that govern how businesses should behave.

 

Page Ref: 48

 

 

2) Ethical dilemmas occur when

  1. A) you know what you want to do but the rules say otherwise.
  2. B) businesses disregard the laws and engage in illegal behaviour.
  3. C) a person chooses to act in his/her own interest.
  4. D) a choice must be taken about appropriate behaviour.

 

Page Ref: 49

 

 

3) A public accountant would be facing an ethical dilemma when deciding whether or not to

  1. A) overlook a material overstatement of revenues to maintain a good client relationship.
  2. B) overlook a non material error in the financial statements.
  3. C) accept an invitation from the client to go golfing in order to maintain a good client relationship.
  4. D) participate in a charitable activity organized by the client.

 

Page Ref: 49-50

 

 

4) Formal frameworks have been developed to help people resolve ethical dilemmas. After obtaining the relevant facts and identifying the ethical issues from the facts, what is the next step in the six-step ethical framework?

  1. A) Decide on the appropriate action to be taken in resolving the ethical dilemma.
  2. B) Identify the likely consequences of actions that will be taken.
  3. C) Determine who is affected by the outcome of the dilemma and how they are affected.
  4. D) Identify the alternatives available to the person who must resolve the dilemma.

 

5) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer, and is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach, and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices. The first step of the GVV approach includes

  1. A) identifying the stakeholders, what is at stake for them, and how to connect with them.
  2. B) identifying the values underpinning the different positions in the conflict and the possibilities for action.
  3. C) considering Frank’s personal and professional purpose and choices in this situation.
  4. D) development and practice of a powerful response that Frank can use with his boss.

 

Page Ref: 50

 

 

6) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer, and is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach, and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices. After identifying and clarifying the ethical issue, what should Frank do next?

  1. A) identify the stakeholders, what is at stake for them, and how to connect with them
  2. B) identify the values underpinning the different positions in the conflict and the possibilities for action
  3. C) consider his personal and professional purpose and choices in this situation
  4. D) develop and practice a powerful response that he can use with his boss

 

Page Ref: 50

 

 

7) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer, and is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach, and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices. After considering his personal and professional purpose and choices, what should Frank do next?

  1. A) identify the stakeholders, what is at stake for them, and how to connect with them
  2. B) identify the values underpinning the different positions in the conflict and the possibilities for action
  3. C) practice what he is going to say, with help from a mentor or coach
  4. D) develop a powerful response that he can use with his boss, using external research or resources

 

8) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer, and is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach, and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices Frank has identified who is affected, what is at stake for them, and how to connect with them. What is his next step, using the GVV analysis framework?

  1. A) list the values underpinning the different positions in the conflict
  2. B) consider his personal and professional purpose and choice in this situation
  3. C) practice what he is going to say, with help from a mentor or coach
  4. D) craft a useful, powerful response that he could use, taking into account multiple options

 

Page Ref: 50

 

 

9) Frank has discovered that his employer is part of a group of banks that is manipulating interest rates. He would like to stop this practice at his employer, and is not sure how best to talk to his boss. He has heard of the GVV (Giving Voice to Values) approach, and thinks he may be able to use it successfully because his company has recently implemented new initiatives to empower employees to speak of improvements to business practices. Frank has crafted a useful, powerful response that he could use, taking into account multiple options. He has conducted research to make him more informed on the issue, and has consulted a friend who is expert in this area. What should is the next thing he should do before talking to his boss?

  1. A) review the values underpinning the different positions in the value conflict
  2. B) further develop and practice his response (scripting) and get help (coaching)
  3. C) review the different possibilities for action to make sure that he has considered enough
  4. D) check his stakeholder analysis to make sure that it is thorough and complete

 

10) Describe an ethical dilemma that an auditor or an accountant might face in his or her business career, then illustrate how the auditor or accountant might use the six-step approach presented in Chapter 3 to resolve that dilemma. Be specific.

lthough students’ answers will vary depending on the dilemma, their answer should list the following six steps, along with a discussion of how each step relates to their particular dilemma:

  1. Obtain the relevant facts. Students should list the key facts from their dilemma.
  2. Identify the ethical issues from the facts. Students should identify the key ethical issue(s) in their dilemma.
  3. Determine who is affected by the outcome of the dilemma and how each person or group is affected. Students should identify who is involved and how each party is affected by the dilemma.
  4. Identify the alternatives available to the person who must resolve the dilemma. Students should list the alternatives available to the auditor or accountant.
  5. Identify the likely consequence of each alternative. Students should identify both the short- and long-term effects of each alternative.
  6. Decide on the appropriate action.

Note: Students could be asked to use the 5-step GVV approach instead, discussed on pages 50 to 52.

Page Ref: 50

 

3.2   Explain how PAs are different from other professionals

 

1) Society has attached a special meaning to the term professional. A professional is

  1. A) someone who has passed a qualifying exam to enter the job market.
  2. B) any person who receives pay for the services performed.
  3. C) a person who is expected to conduct himself or herself at a higher level than the requirements of society’s laws or regulations.
  4. D) someone who has both an education in the trade and on-the-job experience received under an experienced supervisor.

 

Page Ref: 52

 

 

2) The underlying reason for a high level of professional conduct, such as exemplified in a code of conduct, for any profession is

  1. A) the need for public confidence in the quality of service of the profession.
  2. B) that it provides a safeguard to keep unscrupulous people out.
  3. C) that it is required by federal legislation.
  4. D) that it allows licensing agencies to have a yardstick to measure deficient performance.

 

Page Ref: 53

 

 

 

3) It is not practical for users to evaluate the quality of the performance of most professional services because of their

  1. A) complexity.
  2. B) legal standing.
  3. C) veracity.
  4. D) salaries and working conditions.

 

Page Ref: 53

 

 

4) Financial statement users cannot be expected to evaluate audit performance because they will not have the time or the competence to do so. In such a situation, how is public confidence in the quality of professional services enhanced? When there are

  1. A) only business majors hired to work as auditing students with public accounting firms.
  2. B) adequate controls at the public accounting firm to limit the amount of overtime worked.
  3. C) high standards of performance and conduct on the part of all practitioners.
  4. D) strict rules about the type of work that employees should complete on a daily basis.

 

Page Ref: 53

 

5) The need to implement philosophies and practices commonly referred to as “improved business practices” comes from

  1. A) increased competition resulting in public accounting firms being concerned about keeping clients and maintaining a reasonable profit.
  2. B) a CAS pronouncement.
  3. C) a GAAP pronouncement.
  4. D) a need to increase profitability on assurance type mandates.

 

Page Ref: 53

 

 

6) In a code of conduct, the advantage of general statements of ideal conduct, as opposed to specific rules of behaviour, is

  1. A) the emphasis on positive activities that encourage a high level of performance.
  2. B) the ability to enforce the ideals.
  3. C) the enforceability of minimum behaviour and performance standards.
  4. D) the tendency to define the rules as maximum rather than minimum standards.

 

Page Ref: 54-55

 

 

 

7) PAs are members of a professional association that can impose sanctions for violations of the professional code of conduct. What is an example of a severe penalty that can be imposed by a professional association?

  1. A) Publication of information about the offence in a newsletter
  2. B) Requirement of the completion of training courses
  3. C) Requirement to have another peer review conducted within one year
  4. D) Expulsion from the professional association

 

Page Ref: 55, 66

 

 

8) The disadvantage of general statements in codes of professional conduct is

  1. A) the emphasis on positive activities.
  2. B) that they identify ideal conduct.
  3. C) the difficulty of enforcing general ideals without minimum standards of behaviour.
  4. D) that there are too many to remember.

 

Page Ref: 55

 

 

9) A code of professional conduct typically includes principles, rules of conduct, and interpretations or examples. What is the purpose of the principles?

  1. A) state what a practitioner must do for each audit engagement conducted
  2. B) provide discussions of the rules of conduct and how they relate to practical situations
  3. C) provide minimum standards of ethical conduct stated specifically
  4. D) provide ideal standards of ethical conduct stated in philosophical terms

 

Page Ref: 56

 

10) Which portions of the code of professional conduct are enforceable?

  1. A) Principles and rules
  2. B) The rules of conduct
  3. C) Interpretations
  4. D) Rules and interpretations

 

Page Ref: 56-57

 

 

 

11) One difference between auditors and other professionals is that most professionals

  1. A) need not be concerned about maintaining independence.
  2. B) don’t have requirements for continuing education beyond university.
  3. C) don’t have to pass a rigorous examination.
  4. D) aren’t expected to act in the public interest.

 

Page Ref: 57

 

 

12) Generally, all of the rules of professional conduct for CAs apply to

  1. A) students in public practice.
  2. B) students and members.
  3. C) all members.
  4. D) members in public practice.

 

Page Ref: 57

 

 

13) As a member of a professional accounting association, when considering the applicability of the rules of professional conduct, a PA would be responsible for compliance by

  1. A) themselves only.
  2. B) their partners in the practice and themselves.
  3. C) their employees.
  4. D) themselves, their employees, and partners.

 

Page Ref: 57

 

14) Discuss the ways the accounting profession and society encourage public accountants to conduct themselves in a professional manner; i.e., the factors that influence the ethical conduct of audit practitioners.

15) Identify and describe each of the three parts to the Code of Professional Conduct. Also discuss which parts are officially enforceable and which are not.

16) Each of the following situations involves a possible violation of the independence requirements of the provincial institutes’ Rules of Professional Conduct. For each situation, (1) decide whether the Rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the Rules.

 

  1. A) Mike Lednicky, public accountant, is a partner in the Oshawa office of Arthur & Thompson, public accountants. Mike’s brother is employed as an inventory warehouse supervisor (an audit-sensitive position) by Sweeny Appliances, a publicly-held company in Manitoba. Sweeny Appliances is one of Arthur & Thompson’s audit clients. Neither Mike nor the Oshawa office of Arthur & Thompson is involved in the audit of Sweeny Appliances.

Violation? Yes No

Explanation:

 

  1. B) The accounting firm of Finke & Hersley, public accountants, provides bookkeeping and tax services for Hendershot Corporation. Finke & Hersley also performs the annual audit of Hendershot Corporation.

Violation? Yes No

Explanation:

 

  1. C) Brent Shaw, public accountant, is the auditor of Cafe Eccel. A couple of weeks ago, Cafe Eccel’s management expressed an intention to commence litigation against Brent, alleging he was negligent in last year’s audit. Brent believes there is a strong possibility that management will proceed with the litigation. However, Cafe Eccel has not fired Brent as its auditor, and he is now working on the current year’s audit of Cafe Eccel.

Violation? Yes No

Explanation:

 

  1. D) Melissa Barry, public accountant, is the auditor of Audio Video Inc. Audio Video has not paid Melissa’s audit fee for the past two years. Melissa is working on the current year’s audit of Audio Video.

Violation? Yes No

Explanation:

 

17) Each of the following situations involves a possible violation of the provincial institutes’ Rules of Professional Conduct. For each situation (1) decide whether or not the rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the rules.

 

  1. A) Carla is the CFO of Xenon Company. Carla was very happy after her husband Dwayne, a partner at a large PA firm was assigned as the new auditor of the company. Carla is confident that this will be helpful to Xenon since Dwayne already knows so much about the business.

Violation? Yes No

Explanation:

 

  1. B) Jeremy accepted a summer internship at a PA firm. Jeremy’s parents own 0.1% of Raven Inc, a large public company in Austria. Raven Inc. is a client of the Austrian branch of the PA firm. Jeremy reported this to the partner of his office.

Violation? Yes No

Explanation:

 

  1. C) Ken Burns is a partner at Burns and Fields LLP, a PA firm. Ken was approached by a friend who asked him to invest in Safran Group Inc., a growing high tech company. The proposal would be for Ken to invest $650,000 to obtain 1% of the company. Ken decided to go ahead with the investment because Safran is a client from their Seattle office and he has never provided any services to Safran Inc. Ken indicates that he will ensure that he does not work on the audit of Safran.

Violation? Yes No

Explanation:

 

  1. D) Sintron Inc. is a payroll processing company. Over the past 5 years, Clarkson Coppers LLP, a PA firm, has outsourced its payroll processing and other human resources tasks to Sintron. Clarkson Coopers LLP is happy to outsource more functions to Sintron as Sintron has asked Clarkson for additional consulting services with regards to system implementation and application of new accounting policies.

Violation? Yes No

Explanation:

 

 

18) Raul, PA, received a call from his friend Cristobal Franco. He needed an audit urgently, because the bank might call his loan for his computer store CF Ltd. Since Cristobal had been his high school friend and they still played soccer together every two weeks, Raul agreed. Raul and Cristobal had a quick meeting, where Raul fixed the audit fee at $10,000. Cristobal stressed the importance of an unqualified opinion for the bank.

Raul sent two available junior staff to CF’s offices. The junior staff were experienced in review engagements, and had been working for Raul for about six months. The two staff had a quick look around the store, noting the documents strewn everywhere. The accounting staff came in and chatted briefly after their smoke break. They were about a month behind on recording transactions, because Cristobal had laid off one sales person. The accounting staff also helped out with providing sales quotes and Cristobal did all of the technical work.

At the end of the day, the junior staff were each given a $250 gift certificate to be used in the computer store. This was great, because CF also sold MP3 players and supplies such as CDs and DVDs.

At dinner that night, the junior staff told their family that it would probably be a great idea to hold off on any computer supplies or equipment purchases that they needed, since CF would likely hold a sale in the next month or two to improve cash flow.

Required:

Identify and discuss the violations in the rules of conduct with respect to CF.

19) You are having lunch with a former employee of your firm, a friend of yours. Gino had been laid off last year when he had failed to pass his professional examinations for the third year in a row. Gino told you that he managed to obtain a CMA designation in the past year, and has started his public practice.

He has been circulating flyers and electronic email announcements with fixed rates: $400 for a compilation engagement, $1,000 for a review, and $5,000 for an audit where revenues are less than $1 million, $15,000 for an audit for a client with revenues up to $5 million. He already has clients to keep him busy for the next three months. He even has some feelers for clients that he personally handled while he was working for your firm – there were a lot of contacts developed during the five years that he was working there! To help attract some of the larger clients, he is considering not charging any fee for the first ten hours spent on tax-related services.

Gino ended the conversation by asking you if you would like to join him in his new firm, because at this rate he’ll need a second person real soon!

Required:

Identify the violations in the professional rules of conduct and explain why they are violations.

 

 

3.3   Examine the threats to independence and explain how the threats can be mitigated

 

1) “Independence” in auditing means

  1. A) remaining aloof from the client.
  2. B) not being financially dependent on the client.
  3. C) impartiality in performing professional services.
  4. D) being an advocate for the client.

 

Page Ref: 58

 

 

2) When public accountants are able to maintain an independent attitude in fulfilling their responsibility, it is referred to as independence in

  1. A) fact.
  2. B) appearance.
  3. C) conduct.
  4. D) total.

 

Page Ref: 58

 

3) When the users of financial statements have confidence in the independence of the public accountant, it is referred to as independence in

  1. A) fact.
  2. B) appearance.
  3. C) conduct.
  4. D) total.

 

Page Ref: 58

 

 

4) When should a PA assess the five threats to independence with respect to an audit engagement?

  1. A) When deciding to accept a client or whether to continue an existing engagement
  2. B) After signing the engagement letter and before commencing field work
  3. C) After the completion of this year’s audit, before starting the next engagement
  4. D) After a discussion with the Board of Directors

 

Page Ref: 58

 

 

5) Which of the following situations would be an example of a self-interest threat that would prevent a PA from auditing the client?

  1. A) The PA’s uncle owns the business that the PA is auditing.
  2. B) For the last two years, the client could not pay their fees, so the PA created a loan agreement covering the fees, with the client paying 10% interest on the fees.
  3. C) The PA has a small bank loan at normal business interest rates with the bank that his firm is auditing.
  4. D) The PA has purchased a used car from one of the employees of the client.

 

Page Ref: 58-59

 

 

6) Which of the following situations best describes an advocacy threat? PA has been hired to

  1. A) consult with the corporate controller and the bank manager about the conditions for financing a loan.
  2. B) manage the accounting department for three weeks while the corporate controller is on vacation.
  3. C) complete the personal tax returns of all executive management.
  4. D) prepare the year end journal entries for a subsidiary company.

 

Page Ref: 58-59

 

7) Which of the following situations would be an example a of self-review threat? Prior to commencing the audit engagement, PA has completed

  1. A) personal and corporate tax returns.
  2. B) audit of a company where the client owns a minority interest.
  3. C) purchase price allocation calculation for a company that the client purchased during the year.
  4. D) audit of the non-for profit organization of the client.

 

Page Ref: 58-59

 

 

8) Why does a self-review threat pose a problem when conducting an audit engagement?

  1. A) The audit can be conducted more efficiently.
  2. B) You are auditing your own work, and may not detect inadequacies.
  3. C) The audit is more expensive, as you have to provide clear documentation.
  4. D) The auditor may not have the expertise to complete the special work.

 

Page Ref: 58-59

 

 

9) According to the profession’s ethical standards, an auditor would be considered independent in which of the following instances? The

  1. A) auditor’s chequing account, which is fully insured by CDIC, is held at a client financial institution.
  2. B) client comprises 75% of the auditor’s fees.
  3. C) auditor does not have enough employees to meet the client’s reporting deadline.
  4. D) client owes the auditor fees for two consecutive annual audits.

 

Page Ref: 58-59

 

 

10) Which of the following situations best describes a familiarity threat?

  1. A) Design and implementation of a new payroll system
  2. B) Preparation and entry of bookkeeping transactions
  3. C) Completion of corporate transactions for subsidiary companies
  4. D) PA has been working with this client for ten years, first as a manager, now as a partner

 

11) A familiarity threat at an audit engagement occurs when

  1. A) the member has a financial interest in the client.
  2. B) it is difficult to behave with professional skepticism.
  3. C) PA promotes the client’s position to third parties.
  4. D) the member discloses financial information about the client.

 

Page Ref: 59

 

12) Which of the following is the best example of an intimidation threat? Management

  1. A) has decided to sue you because the audit fee was twice as high as they expected.
  2. B) has changed auditors of all of its subsidiary companies as they can get the audit done for a lower cost.
  3. C) threatens to change auditors if you do not let them overstate accounts receivable by $100,000 (the bad debt allowance is too low).
  4. D) threatens to resign from the company if the board of directors does not give them a 15% raise.

 

Page Ref: 59

 

 

13) An intimidation threat occurs when

  1. A) it is difficult to believe the actions of management because there is a suspicion of irregular activity with respect to the recording of transaction activity.
  2. B) the auditor suspects that fraud has occurred at the middle management level of the organization.
  3. C) the auditor has been working on a client engagement for many years and has trouble believing that management would deceive the auditors.
  4. D) a client threatens the firm or its staff with respect to the content of the financial statements or with respect to the conduct of the audit.

 

Page Ref: 59

 

 

14) If a PA firm provided corporate finance services to a company during the year, which of the following engagements could the PA firm accept to provide to the same company?

  1. A) Non-assurance services
  2. B) Audit of listed entity
  3. C) Audit of non-listed entity
  4. D) Other assurance engagement

 

Page Ref: 60

 

 

15) Some independence rules apply to all assurance engagements, while others apply only to a listed entity. For the purposes of assessing the independence rules, a listed entity is defined as

  1. A) an organization with share capital exceeding $10 million that has public accountability.
  2. B) an entity whose debt or shares is listed on a stock exchange, with market capitalization and total assets greater than $10 million.
  3. C) any organization that has shares or debt listed on a stock exchange.
  4. D) an organization that has shares or debt listed on a stock exchange, and that has redeemed shares.

 

Page Ref: 60

 

16) Where an independence threat occurs, it may be that only the person affected needs to be removed from the engagement. In this case, other members of the firm can complete the engagement. An example of a situation where only the student or member would be excluded from the engagement is where PA

  1. A) has a significant financial interest in the client, such that influence could be exerted.
  2. B) used to be a controller at the client, but now works for the PA firm.
  3. C) owns ten percent of the shares of the client.
  4. D) is a board member of the client with signing authority for cheques.

 

Page Ref: 60

 

 

17) At a small practice where the bulk of the work is accounting, bookkeeping, and review engagements, what is an important procedure that should be followed by the PA to help ensure independence?

  1. A) Management should be trained in accounting principles so that they can adequately assess the PAs work.
  2. B) All transactions should be prepared and processed by client personnel.
  3. C) Transactions and journal entries should be discussed with and approved by the client.
  4. D) The accountant should avoid doing bookkeeping for review engagements, and restrict this to compilation engagements only.

 

Page Ref: 61

 

 

 

18) To ensure that employees remain independent, an audit firm should

  1. A) ask employees to sign a form confirming that they do not have an investment in a company that they are auditing.
  2. B) prohibit an employee from the Toronto office to have an investment in a company audited by the Hong Kong branch of the PA firm.
  3. C) include a section in the code of conduct indicating that the employees should not invite their client to dinner.
  4. D) refuse an audit mandate where the cousin of a staff member works in the marketing department.

 

Page Ref: 61

 

 

19) For listed clients, the audit committee should approve both the appointment of the auditor and

  1. A) all services that the PA firm provides to the client.
  2. B) an engagement that might affect the appearance of independence, such as design of control systems.
  3. C) any services that are provided for senior management.
  4. D) the material that is included in the management letter by the PA firm.

 

Page Ref: 62

 

20) In which of the following circumstances would a public accountant be bound by ethics to refrain from disclosing any confidential information obtained during the course of a professional engagement?

  1. A) The public accountant is issued a subpoena that orders the public accountant to present confidential information.
  2. B) A major shareholder of a client company seeks accounting information from the public accountant after management declined to disclose the requested information.
  3. C) Confidential client information is made available as part of a practice inspection of the public accountant’s practice.
  4. D) An inquiry by a disciplinary body of a provincial institute requests confidential client information.

 

Page Ref: 63

 

 

 

21) The confidential relationship will be violated if, without the client’s permission, the public accountant provides working papers about a client to

  1. A) a court of law which subpoenas them.
  2. B) the relevant provincial institute as part of a practice inspection.
  3. C) another public accounting firm which has just purchased the public accountant’s entire practice.
  4. D) an investigative or disciplinary body of the relevant provincial institute which is conducting a review of the public accountant’s practice.

 

Page Ref: 63

 

 

22) The rules of accounting bodies in Canada require their members to behave in the best interest of the profession and the public. Identify the situation where the accountant is acting in the best interest of the profession. An accountant

  1. A) reports a fellow accountant after noticing that the accountant helped a client with tax evasion.
  2. B) openly criticizes a fellow accountant’s competencies after having lost a bid for a new client.
  3. C) brags about his competence and professional title, and encourages clients to invest in a new venture he is starting.
  4. D) refuses to cooperate with the new auditor after having lost a client.

 

Page Ref: 63

 

 

23) The provincial institutes’ Rules of Professional Conduct state, in part, that a public accountant should maintain integrity and due care. Integrity in the Rules refers to a public accountant’s

  1. A) ability to maintain an impartial attitude on all matters that come under the public accountant’s review.
  2. B) ability to distinguish independently between accounting practices that are acceptable and those that are not.
  3. C) ability to be unyielding in all matters dealing with auditing procedures.
  4. D) reputation for honesty and fair dealing.

 

Page Ref: 64

 

 

24) What should a PA do if approached by a client where he and his firm lack or do not have access to the technical knowledge required to complete the audit?

  1. A) Subcontract the audit to another firm
  2. B) Indicate that they can do a review engagement, not an audit
  3. C) Decline the new audit engagement
  4. D) Conduct the engagement, but prepare a qualified audit report

 

Page Ref: 64

 

 

25) How is use of an applicable accounting framework enforced via legislation?

  1. A) The Canada Business Corporations Act and many provincial incorporating acts require that financial statements be prepared in accordance with the CICA Handbook.
  2. B) PAs who do not prepare financial statements in accordance with such frameworks are expelled from their professional association.
  3. C) Tax authorities may sue corporations who do not prepare their financial statements in accordance with such frameworks.
  4. D) Financial executives may be sued if the financial statements prepared by their company are not in conformance with such frameworks.

 

Page Ref: 65

 

 

26) Which one of the following forms of advertisement would violate solicitation rules? PA

  1. A) placed an advertisement in a newspaper indicating the opening of a new office.
  2. B) conducted a cold-calling campaign where companies were asked if they would like to change PA firms.
  3. C) placed a media advertisement listing the different types of expertise available at the firm’s major office locations.
  4. D) conducted a survey asking companies about the types of services that are provided by their accounting firms.

 

Page Ref: 65

 

 

 

27) Which one of the following situations is a violation of the professional rules of conduct? PA

  1. A) looked the other way when he noticed that one of his firm’s accounting staff accepted money from client management.
  2. B) resigned so that he could accept a position on the Board of Directors at a major client.
  3. C) prepared personal and corporate tax returns for a client and all of its executive officers.
  4. D) placed an advertisement in the local paper indicating that she conducted audit engagements for five major insurance companies.

 

Page Ref: 65

 

28) For which of the following engagements is a contingent fee permitted?

  1. A) An audit engagement of a large listed corporation
  2. B) A tax consulting assignment assessing the excise tax payment processes
  3. C) A review engagement of a small manufacturing corporation
  4. D) An assurance engagement of leasehold payments for a rental agreement

 

Page Ref: 66

 

 

29) PA has been asked to accept the audit engagement of BarneyBlues Corporation. PA sent a letter to the predecessor auditor asking whether there was any reason why he should not accept the engagement. Assuming that the prior year audit went smoothly, what would be an appropriate response by the predecessor auditor?

  1. A) Provide a brief statement that there is no reason of which he or she is aware that would prevent accepting the engagement.
  2. B) Send a copy of the entire working paper file to PA.
  3. C) Telephone PA and say that PA should not take the engagement because the fee charged was too large.
  4. D) Send a copy of the tax returns and tax assessments to PA.

 

Page Ref: 66

 

 

 

30) The Rules of Professional Conduct require a successor auditor to communicate with the previous auditor. The primary concern in this communication is

  1. A) to acquire information which will help the successor auditor determine whether the client management has integrity.
  2. B) to learn about the client by examining the predecessor’s working papers.
  3. C) to enable the successor to perform a more efficient audit.
  4. D) to save the successor auditor time and money in gathering data.

 

Page Ref: 66

 

 

31) Many PAs prepare tax returns for individuals and for corporations. Under what circumstances is liability insurance required to cover the preparation of tax returns? When

  1. A) the PA is a member of a professional accounting association.
  2. B) any number of tax returns are prepared, including no charge tax returns.
  3. C) fees are being charged and more than a handful of returns are being prepared.
  4. D) the bulk of the PA’s income comes from preparing tax returns.

 

32) Each of the following situations involves a possible violation of the provincial institutes’ Rules of Professional Conduct. For each situation, (1) decide whether or not the Rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the Rules.

 

  1. A) Johnny Line has a successful dentistry practice in Calgary. Johnny has recommended one of his patients to Leslie King, public accountant. To show gratitude for the referral, Leslie has agreed to pay Johnny 5% of the fee for audit services rendered by Leslie to Johnny’s patient. Leslie discloses the payment agreement to her new client.

Violation? Yes No

Explanation:

 

  1. B) The accounting firm of Bayer & Peng, public accountants, is negotiating a fee with a new audit client. They agree the client will pay $75,000 if Bayer & Peng issues a clean, unqualified opinion, $50,000 if a qualified opinion is issued, $40,000 if an adverse opinion is issued, and $10,000 if a denial of opinion is issued.

Violation? Yes No

Explanation:

 

  1. C) Don Smith, public accountant, takes part in the audit of Shaw Corporation. Don is not a partner or a manager in the public accounting firm, and does not own any stock in Shaw Corporation. Don’s five year-old daughter, Betty Lou, received one share of Shaw Corporation’s common stock for her fifth birthday. The stock was a gift from Betty Lou’s grandmother. Betty Lou treasures that share of stock and is absolutely unwilling to part with it.

Violation? Yes No

Explanation:

 

  1. D) On August 5, 2012, Page Dane, public accountant, issued the audit report on Borhut Corporation’s June 30, 2012 financial statements. On August 30, 2012, Borhut paid Page’s audit fee with stock rather than cash. Page sold the stock on September 15, 2012, two months prior to the beginning of the planning phase for the audit of the June 30, 2013, financial statements.

Violation? Yes No

Explanation:

 

33) You are the senior in charge of the accounts receivable section of the audit of a large clothing manufacturer downtown in the clothing district. The client sells to local clothing stores as well as to other retailers in the province.

Accounts receivables seem to be deteriorating, with many more accounts in the over 90 days column than in the past. You sent out twenty accounts receivable confirmations, but only six were returned. Of these six, only three confirmed the balance as in agreement with the client, while the others indicated that they kept their records on an open item basis (rather than a balance forward basis) and were unable to respond to the confirmation request. When you looked at the prior year’s file, it seemed that the same thing had happened last year.

When you phoned the supervisor in charge of the audit engagement, she told you to not bother with follow up, as the engagement was already over budget and costs need to be kept down. You were concerned that you would be unable to state a conclusion with respect to the fairness of the accounts receivable balance and she was really angry with you, saying that she would have to sign off for you then.

Required:

Discuss the ethical and quality issues raised by this audit engagement.

 

 

34) Kimora is a senior manager at a public accounting firm. Kimora was assigned to the audit of Toble Corp. Upon arriving at the client, Kimora met with the controller, Brad, who was a classmate in college, 20 years ago. She had not been in contact with Brad since college, but they realized that they still had many friends in common. Brad invited Kimora to go to the company box to watch a hockey game and catch up.

Discuss the issue of independence between Kimora and Toble Corp.

35) Xiao, PA, is the audior of Minkle Credit Union, a medium-sized credit union. Xiao has prepared a management letter with several serious control weaknesses. Management agrees with the facts, but does not want to present the letter with the weaknesses to the audit committee or the board of directors. Management has implied that they will request a change of auditors if your firm presents the management letter to the board.

Required: Discuss the actions that Xiao should take. Justify your response.

 

Auditing, 12e (Arens)

Chapter 4   Legal Liability

 

4.1   Explain how sources of legal liability are related to a distinction between business failure and audit failure

 

1) While performing services for their clients, professionals have always had a duty to provide a level of care which is

  1. A) reasonable.
  2. B) greater than average.
  3. C) superior.
  4. D) guaranteed to be free from error.

 

Page Ref: 74

 

 

2) In rare cases, auditors have been held liable for criminal acts. A criminal conviction against an auditor can result only when it is demonstrated that the auditor

  1. A) was negligent.
  2. B) was grossly negligent.
  3. C) intended to deceive or harm others.
  4. D) caused a financial loss to an innocent third party.

 

Page Ref: 75

 

 

3) What situation represents a fiduciary duty?

  1. A) A professional accountant acts as a director of an organization.
  2. B) A professional accountant performs an audit.
  3. C) The owner of a private company prepares financial statements.
  4. D) A professional accountant performs a non-assurance engagement.

 

4) Canadian PAs are required to have controls in place to identify and track suspicious transactions and comply with the reporting requirements of the Proceeds of Crime and Terrorist Financing Act. This Act requires PAs to report to FINTRAC any

  1. A) cash payment of $10,000 or more.
  2. B) cash payment of $100,000 or more.
  3. C) transaction of $1,000 or more from clients suspected of being terrorists.
  4. D) cash payment to a related party.

 

Page Ref: 75

 

5) A bank sues an auditor after having lost a significant amount of money from a loan granted to a client based on the financial statements that contained a material error. The source of the legal liability is

  1. A) known third party liability.
  2. B) client liability.
  3. C) liability under provincial securities law.
  4. D) criminal liability.

 

Page Ref: 77

 

 

6) Amin is distraught. There is a big box stereo store that opened just down the block from his independent stereo and music business six months ago, and he is unable to continue operating his business. Only eight months ago, you issued an unqualified audit opinion on his financial statements, which showed the financial results of a well run, profitable store. Amin’s business is experiencing

  1. A) customer expectation gap.
  2. B) audit failure.
  3. C) fiduciary duty.
  4. D) business failure.

 

7) When the auditor issues an erroneous opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards, it results in

  1. A) business failure.
  2. B) audit failure.
  3. C) audit risk.
  4. D) business risk.

 

Page Ref: 77

 

 

8) An example of an audit failure is that the

  1. A) auditor issues an erroneous audit opinion as the result of a failure to comply with the requirements of GAAS.
  2. B) audit opinion is qualified.
  3. C) company files for bankruptcy less than 12 months after receiving an unqualified opinion.
  4. D) auditor issues an erroneous audit opinion as the result of an undiscovered fraud that took place in the period being audited.

 

Page Ref: 77

 

9) Conflict between financial statement users and auditors often arises because of the

  1. A) high cost of performing an audit.
  2. B) extremely technical vocabulary which the auditor uses in the report.
  3. C) placement of the auditor’s report in the back of the client’s annual report where it is hard to locate.
  4. D) expectation gap.

 

10) For each of the following independent situations, state whether the PA would be considered to have a fiduciary duty. Justify your response.

 

  1. A) Juan is conducting a review engagement for the fifth year for Mini Market Greenwood Limited.

 

  1. B) Lisa is working as a temporary controller at Middle Manufacturing Co. while the controller recovers from surgery.

 

  1. C) Mark is managing the assets of a ten year old buy whose parents were killed in a car accident. Mark has signing authority on cheques and makes investment decisions.

 

 

 

11) There are four major sources of auditor’s legal liability. Briefly summarize the four sources.

 

12) PA has been recently appointed auditor of Foible Ltd., a company that sells high cost knickknacks to third world countries. To facilitate the rapid preparation of the financial statements, management had the physical inventory counted in October, rather than at the December year end. During the inventory count, PA noticed that several of the boxes were labelled with receiving documents from a competitor. PA was told that the new warehouse supervisor worked part time at the competitor, and must have picked up the wrong boxes.

Several employees have sued Foible Ltd. for wrongful dismissal, claiming that they were promised a job that would last at least one year, with low cost accommodations as well. They are suing for the balance of the year’s wages and claiming that they were brought into the country under false pretenses. These employees are all from an eastern European country. The law firm has responded in the legal letter that this suit is without merit.

During the year Foible obtained legal services from a firm in which the Chairman of the Board of the company is a partner. Fees and disbursements for these services for the year was $125,000, a material amount.

During the audit, employees often spoke in a foreign language among themselves before responding to PA, then one employee would respond after some often heated discussion.

Subsequent to the year end, the warehouse supervisor was arrested on criminal charges of theft, and Foible charged with selling stolen goods. PA was charged as an accomplice to money laundering, as all of the management for Foible were members of a criminal group laundering money from eastern Europe.

Required:

Discuss the actions that PA could have taken during the engagement to prevent these charges.

4.2   Explain why the accountant does not have the right of privilege communication

 

1) If the public accountant negligently failed to properly prepare and file a client’s tax return, the public accountant can be held liable for

  1. A) the penalties which the client owes Canada Customs and Revenue Agency.
  2. B) the penalties and interest which the client owes.
  3. C) the penalties and interest, plus the tax preparation fee which the public accountant charged.
  4. D) the penalties and interest, the tax preparation fee, and the amount of tax which was underpaid.

 

Page Ref: 79

 

2) Most of the major lawsuits against public accounting firms have dealt with

  1. A) audited or unaudited financial statements.
  2. B) disputes over income tax preparation services.
  3. C) disputes arising in the performance of management consulting services contracts.
  4. D) unaudited financial statements.

 

Page Ref: 79

 

 

3) There is agreement within the auditing profession and the courts that the auditor is

  1. A) not a guarantor or insurer of financial statements.
  2. B) a guarantor but not an insurer of the statements.
  3. C) an insurer but not a guarantor of the statements.
  4. D) both a guarantor and an insurer of the financial statements.

 

Page Ref: 79

 

 

4) The standard of due care to which the auditor is expected to be held is referred to as the

  1. A) prudent person concept.
  2. B) common law doctrine.
  3. C) due care concept.
  4. D) reckless regard doctrine.

 

5) An individual PA sets up his or her own business as a sole practitioner. With additional practitioners, a common structure is a partnership. Why would a large firm set up its organizational structure as a limited liability partnership (LLP)? If the audit was conducted in accordance with GAAS

  1. A) partners not on the engagement would not be liable on their personal assets.
  2. B) improved quality control practices can be initiated using technical personnel.
  3. C) more formal reporting requirements are in place to federal tax authorities.
  4. D) partners are liable for only a limited portion of their personal assets when sued.

 

Page Ref: 79

 

 

6) During the audit engagement, the primary auditor may rely on other individuals, such as specialists, other auditors and internal auditors (secondary auditors). The primary way to defend the auditor against negligence should such other individuals conduct poor quality work is whether the

  1. A) other individuals were professionals with recognized credentials.
  2. B) primary auditor conducted sufficient quality control work with respect to the secondary auditor.
  3. C) secondary auditor had ever been sued before.
  4. D) the appropriate level of materiality had been used during the conduct of the engagement.

 

Page Ref: 80

 

7) The PA is having a discussion with his client about the outcome of several lawsuits that are presently in progress. The client has requested that the comments during the discussion be removed from the audit file. The client would like the only documentation in the audit file to be the legal letter from the client, and brief comments with respect to the auditor’s judgments with respect to the quality of disclosure in the financial statements. The client is concerned that

  1. A) only high quality audit working papers be included in the working paper files.
  2. B) auditors may breach confidentiality and disclose information about the client.
  3. C) the auditor’s working paper files may be subpoenaed by the courts.
  4. D) the audit firm does not have adequate quality control procedures.

 

8) An auditor would be found negligent if he/she

  1. A) relied on a report from management without considering management integrity.
  2. B) relied on a report that contained errors that had been concealed by management.
  3. C) did not consider the expenses from a division due to management intentionally withholding that information.
  4. D) failed to discover a payroll fraud by testing a statistical sample of transactions in the salary expense account.

 

Page Ref: 81

 

 

9) A bank sues the auditor after making a loan to Klaxxon, a company that went bankrupt. The bank indicates that they relied on the year-end financial statements of Klaxxon to make the lending decision. The bank analyst indicates that the audit opinion was unqualified so he assumed that Klaxxon was a going concern. The auditor defends himself by referring to a note disclosure in the financial statements about the company’s economic dependence on one buyer, Dexters Corp. Dexters Corp had experienced some significant financial trouble for the past year and went bankrupt 3 months after the financial statements of Klaxxon were released. The PA’s liability is likely

  1. A) contributory negligence.
  2. B) fraud.
  3. C) breach of contract.
  4. D) gross negligence.

 

Page Ref: 81

 

 

10) An example of a breach of contract would be

  1. A) a bank’s claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan.
  2. B) an auditor’s refusal to return a client’s records until the client paid last year’s audit fees.
  3. C) a public accounting firm’s failure to deliver a tax return on the agreed-upon date because the firm had a backlog of other work which was more lucrative.
  4. D) an auditor’s failure to complete the audit by the agreed-upon date because the client’s financial records had been destroyed.

 

Page Ref: 81

 

 

11) Laws that have been passed through federal or provincial governments are

  1. A) statutory law.
  2. B) judicial law.
  3. C) criminal law.
  4. D) common law.

 

Page Ref: 81

 

 

12) The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing is called

  1. A) separate and proportionate liability.
  2. B) joint and several liability.
  3. C) shared liability.
  4. D) unitary liability.

 

Page Ref: 81

 

 

13) The assessment against a defendant of that portion of the damage caused by the defendant’s negligence is called

  1. A) separate and proportionate liability.
  2. B) joint and several liability.
  3. C) shared liability.
  4. D) unitary liability.

 

Page Ref: 81

 

 

14) Small Town Lumberyard Limited (STLL) needed an additional loan from its bank to finance its operations. To make its financial statements look better, the company overstated its inventory and overstated its accounts payable. The auditors did not detect this deliberate misstatement because they conducted limited tests of inventory and did not confirm accounts payable. Other auditors agreed that the procedures conducted during this audit were inadequate. The auditors of STLL would likely be considered to be

  1. A) guilty of fraud.
  2. B) negligent.
  3. C) contributorily negligent with STLL.
  4. D) guilty of constructive fraud.

 

Page Ref: 82

 

 

15) The principal issue to be resolved in cases involving alleged negligence is usually

  1. A) the amount of the damages suffered by the plaintiff.
  2. B) whether to impose punitive damages on the defendant.
  3. C) the level of care required to be exercised.
  4. D) whether the defendant was involved in fraud.

 

Page Ref: 82

 

16) In the auditing environment, failure to meet generally accepted auditing standards is often

  1. A) an accepted practice.
  2. B) a suggestion of negligence.
  3. C) strong evidence of negligence.
  4. D) tantamount to criminal behaviour.

 

Page Ref: 82

 

 

17) Most accounting and auditing professionals agree that when an audit has failed to uncover material misstatements, and the wrong type of audit opinion is issued, the audit firm

  1. A) has failed to follow generally accepted auditing standards (GAAS).
  2. B) deserves to lose the lawsuit.
  3. C) should be asked to defend the quality of the audit.
  4. D) should not be held responsible for the financial loss suffered by others.

 

Page Ref: 83

 

 

18) A common way for a public accounting firm to demonstrate its defence of a lack of duty to perform is by use of a(n)

  1. A) engagement letter.
  2. B) letter of representation.
  3. C) confirmation letter.
  4. D) expert witness.

 

19) PA was engaged by Microcomputer Distributor Limited (MDL) to conduct a review engagement. The financial statements are used primarily by the shareholders, management, and by the bank. Recently, an employee was fired for stealing computer parts, primarily chips and boards that could easily be placed in a pocket. MDL is suing PA because they believed that audit procedures, such as counting inventory, would have detected this fraud. What is PA’s best defence?

  1. A) absence of causal connection
  2. B) lack of negligence
  3. C) contributory negligence
  4. D) lack of duty to perform

 

Page Ref: 83

 

20) Joan talked to the owners of Fancy Clothing Limited before investing. She obtained a copy of their financial statements and saw that profits were low, even considering the fact that the owners did not take any money for themselves in the current year. However, she decided to invest in the company because she believed her superior knowledge of the clothing industry would turn the business around, resulting in enough profits for all owners. Unfortunately, this did not occur and the company went bankrupt. Joan is suing the auditors because she relied upon the financial statements during her investment decision. What is the auditor’s best defence?

  1. A) absence of misstatement
  2. B) contributory negligence
  3. C) non-negligent performance
  4. D) duty of care

 

Page Ref: 83

 

 

21) Fabio recently sold his restaurant for $650,000, the value of the net assets as reported on the balance sheet. After the sale, Fabio realized that he could’ve sold the restaurant for as much as $950,000 as the fair value of the assets was $300,000 higher than what was reported on the balance sheet. Fabio is suing the auditors for his loss. The auditor’s best defence is

  1. A) absence of a misstatement.
  2. B) lack of duty.
  3. C) no damages.
  4. D) absence of causal connection.

 

22) According to the CICA Handbook, the auditor’s responsibility for failure to detect fraud arises

  1. A) when such failure clearly results from failure to comply with generally accepted auditing standards.
  2. B) whenever the amounts involved are material.
  3. C) only when the examination was specifically designed to detect fraud.
  4. D) only when such failure clearly results from negligence so gross as to sustain an inference of fraud on the part of the auditor.

 

Page Ref: 84

 

23) Winston Chang, PA conducted the audit of Manra Manufacturing Ltd., a small company that produces a variety of machined parts for the automotive and computer industry. The audit showed that the company produced a small profit after paying the owners of the company a high salary. Manra was purchased by a competitor, Cheblay. Cheblay had hoped to produce efficiencies by combining the two companies and was unable to do so. Cheblay sued Chang because it relied upon the financial statements when purchasing the company’s shares, claiming that the machines, which were about fifteen years old, had been overvalued. The machines were recorded at cost, which was below net realizable value. What is the auditor’s best defence?

  1. A) contributory negligence
  2. B) absence of negligence
  3. C) duty of care
  4. D) absence of liability

 

Page Ref: 84

 

 

24) The King Surety Company wrote a general fidelity bond covering defalcations by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17,200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson’s auditors, Lynch & Merritt, public accountants. Which of the following would be Lynch & Merritt’s best defence?

  1. A) King is not in privity of contract.
  2. B) The shortages were the result of clever forgeries and collusive fraud which would not be detected by an examination made in accordance with generally accepted auditing standards.
  3. C) Lynch & Merritt were not guilty either of negligence or fraud.
  4. D) Lynch & Merritt were not aware of the King-Wilson surety relationship.

 

25) In connection with the examination of financial statements, an auditor could be responsible for failure to detect a material fraud if

  1. A) statistical sampling techniques were not used on the audit engagement.
  2. B) the auditor planned the work in a hasty and ineffective manner.
  3. C) accountants performing important parts of the work failed to discover a close relationship between the treasurer and the cashier.
  4. D) the fraud was perpetrated by one client employee, who circumvented the existing internal controls.

 

Page Ref: 84

 

26) To succeed in an action against the auditor, the client must be able to show that

  1. A) the auditor was grossly negligent.
  2. B) the auditor was fraudulent.
  3. C) there is a close causal connection between the auditor’s breach of the standard of due care and the damages suffered by the client.
  4. D) there was a written contract.

 

Page Ref: 84

 

 

27) The court ruled that Jones did not rely on the financial statements in his decision to purchase shares of Manumite Limited. Instead, Jones relied upon his discussions with the owners and with financial analysts. This result illustrates

  1. A) absence of negligence.
  2. B) lack of privity.
  3. C) contributory negligence.
  4. D) absence of causal connection.

 

28) A client is suing a PA firm claiming that they are responsible for the losses suffered from a fraud in the payroll department that was not uncovered during the year end testing done by the auditor. The auditors did indicate to management that controls over payroll calculations and payments were weak as there was improper segregation of duties. The auditor’s best defence is

  1. A) contributory negligence.
  2. B) absence of negligence.
  3. C) absence of causal connection.
  4. D) no damages.

 

Page Ref: 84

 

29) A) List the four items which a defendant must prove in an action for negligence against a public accountant.

 

  1. B) Describe each of the six defences a public accounting firm can normally use when facing legal claims by clients.

 

  1. C) Discuss what is meant by the term “expectation gap.”

 

30) A) What are the different business organization structures that an accountant may use? What are the advantages of these structures?

 

  1. B) What is the difference between auditors and lawyers with respect to privileged information?

 

31) You are the auditor of Jehello Incorporated, a public company with a December year end. Your firm has audited Jehello for the past three years. The following issues were documented in the working paper files for the prior year audit:

∙ The company had incurred expenditures of $400,000 related to the development of a new music format for electronic media. The large majority of the costs were related to development of software, hardware, and presentation of the results to customers who participated in focus groups. Management had been optimistic that the new sound system would work well, even though focus group results had been poor. These costs had been fully capitalized.

∙ About 40% of the company’s revenues were from one customer. That contract had been due for renewal on May 15, ten days after the audit report had been issued. Documents on file indicated that the customer seemed likely to renew the contract, although quality control disputes were escalating. On May 14, Jehello was informed that the contract would not be renewed.

Jehello has defaulted on its bank loans and the bank is suing you, saying that the financial statements presented last year were false and misleading.

Required:

  1. A) Which defences should the auditor use?
  2. B) Do you believe that the auditor will lose the suit? Why or why not?

 

32) Your firm has been the auditor of Chappello Design and Construction Limited for several years. During the current year, a consultant on staff at your firm assisted Chappello in the selection and implementation of a new computer system. The audit staff were not involved in this process.

The new system was an enterprise wide system that was to be implemented without modification using the direct cut-over approach (the old system was discontinued and the new one continued the next day). Unfortunately, staff had extreme difficulty using the system, and discontinued it after two months. During that time, Chappello was unable to document and bill its work for progress billings, and borrowed heavily to continue to pay its employees while work continued. The company reverted to its old system and claims that it has lost several hundreds of thousands of dollars in revenues as it was unable to issue quotes and bids on new contracts.

Chappello has sued your firm for negligence with respect to the implementation of the computer system.

Required:

Which defences should the firm use? Support your answer with reasons.

33) Musical Productions Limited has had declining sales as more and more media are being presented online rather than on CD or DVD. It diversified its business by moving into backup systems, but are still having trouble boosting income.

The audit team was led by Theresa Sanford, who obtained her CA last year. Theresa had two assistants, Marv and Uhta, who did the work in the accounts receivable and inventory area. Theresa felt that they did not require supervision, as they had been with the firm for two years, and were expected to do well on their professional exams this year. Marv found that the accounts receivable had many old accounts, and customers were tough to get hold of. Accordingly, he decided to accept management’s representations with respect to the balances. Similarly, Uhta noted that there were still many CDs in inventory that had been there for over three years. Management insisted on recording these at cost. Uhta accepted managements’ valuation.

Two months after the audit report was issued, Musical Productions Limited went bankrupt. It was found that many accounts receivable were for fictitious customers, and the receiver was only able to obtain five cents on the dollar for the inventory, which was sold as scrap.

The bank is suing the auditors to recover its bank loan, which had been renegotiated based upon the results of the financial statements.

Required:

Will the bank be successful in its suit? Why or why not?

4.3   Describe the groups of individuals or organizations, in addition to the client, who can sue the auditor

 

1) An investor suing an auditor for not discovering that the financial statements of a company are materially misstated is an example of

  1. A) criminal liability.
  2. B) fiduciary duty.
  3. C) third party liability.
  4. D) liability to client under common law.

 

Page Ref: 85

 

2) The leading precedent-setting case in third-party liability was a 1931 U.S. case, Ultramares v. Touche. What is the key aspect of this case?

  1. A) to succeed, claimants must be foreseebale users of the audited financial statements that are part of the claim process
  2. B) ordinary negligence is insufficient for liability to third parties because of lack of privity of contract
  3. C) the auditor must have actual knowledge of the users of the financial statements to establish privity
  4. D) there is no general auditor liability to shareholders, since the loss of equity was suffered by the company

 

Page Ref: 85

 

 

3) The Ultramares doctrine is that ordinary negligence is insufficient for liability of auditors to third parties because of the lack of privity of contract between the third party and the auditor. What type of behaviour on the part of an auditor would result in liability to more general third parties according to this doctrine?

  1. A) conducting an audit engagement when a review engagement had been contracted
  2. B) completing work in accordance with a contract that was signed with the client
  3. C) deliberate misstatement of the financial statements by management remaining undetected
  4. D) fraud or constructive fraud with respect to the working papers

 

4) Which of the following lawsuits resulted in a decision that shareholders could not sue the auditors for the loss in the value of their shares?

  1. A) Haig V. Bamford et al (1976)
  2. B) Hercules Management Ltd. V. Ernst & Young (1997)
  3. C) Ultramers Corporation V. Touche (1931)
  4. D) United States V. Anderson (2002)

 

Page Ref: 85-86

 

 

5) What rights do secondary investors (i.e. those who purchase shares after an initial offering) have to sue an auditor?

  1. A) since they are third-party claimants, they would be part of a limited class of known users
  2. B) they could claim contributory negligence, since they had prior information of company results
  3. C) they can sue under provincial legislation without the need to prove reliance
  4. D) since there is absence of causal connection, they would not be able to sue the auditors

 

Page Ref: 86

 

6) In third party suits, when there is a misstatement in the financial statements, which of the auditor’s defences usually means non-reliance on the financial statements by the user?

  1. A) lack of duty
  2. B) non-negligent performance
  3. C) contributory negligence
  4. D) absence of causal connections

 

Page Ref: 86

 

 

7) Pierre, a CA, was convicted of stealing money from his clients and for deliberately preparing personal tax returns that were false. In addition, Pierre will likely

  1. A) need to take additional training courses to upgrade his tax skills.
  2. B) need to defend himself to prove non-negligent performance.
  3. C) be charged with misconduct by his professional institute (or ordre).
  4. D) have lack of privity with the federal and provincial tax authorities.

 

8) The Sarbanes-Oxley Act of 2002 made it a felony to

  1. A) destroy or create documents to impede a federal investigation.
  2. B) have internal control weaknesses.
  3. C) have a significant internal control weakness.
  4. D) engage in transactions with related parties.

 

Page Ref: 87

 

 

9) In the case of Enron, Andersen was ultimately convicted on the count of

  1. A) obstruction of justice for altering a memo.
  2. B) obstruction of justice for shredding documents relating to the audit of Enron.
  3. C) failing to discover the fraud.
  4. D) refusing to testify in court against their client.

 

Page Ref: 88

 

10) Enron and Equity Funding are companies that suffered from large frauds by corporate management. One important lesson with respect to such cases is that

  1. A) when a company does really well financially it is important to suspect that such results are always inflated.
  2. B) an investigation of the integrity of management is an important part of deciding upon the extent of audit work.
  3. C) securities and exchange commissions expect auditors to be perfect in their assessment of management.
  4. D) partners and staff should cooperate in preparing working papers that prove the accuracy of the financial statements.

 

Page Ref: 88

 

 

11) Individuals who accept fees (or property), should they know or be willfully blind to the fact that the property was obtained illegally can be charged with money laundering, a criminal offence. Which of the following techniques will help a PA prevent such charges?

  1. A) ensure that the financial statements are in accordance with an acceptable reporting framework
  2. B) require that clients carefully document the sources of their funds.
  3. C) carefully assess management integrity.
  4. D) obtain a detailed letter of representation from management confirming the sources of their funds.

 

Page Ref: 88

 

 

12) Bigland and Betton, PAs, is being sued by a bank for potential negligence during an audit engagement which was completed over five years ago. Which one of the following actions during that audit engagement will help ensure that the suit is fairly assessed?

  1. A) good quality documentation
  2. B) honest management at the client
  3. C) low employee turnover
  4. D) good employee memory of events

 

Page Ref: 88

 

13) One of the lessons learnt from accounting scandals such as Enron is that generally accepted accounting principles (now under an acceptable financial reporting framework) cannot be relied upon exclusively in deciding whether financial statements are fairly presented. Why is this the case?

4.4   List the actions that individual accountants and the profession can undertake to mitigate the risks of legal liability

 

1) There are a number of things that the CICA, representing the profession as a whole, can do to reduce the practitioner’s exposure to lawsuits. One of them is to

  1. A) sanction members for improper conduct and performance.
  2. B) deal only with clients possessing integrity.
  3. C) hire qualified auditors and train and supervise them.
  4. D) perform quality audits.

 

Page Ref: 89

 

 

2) Danford, PA, is setting up his accounting firm as a sole practitioner. Which of the following is an important way that Danford can reduce legal liability with respect to the work completed by his office?

  1. A) participate in the standard setting process for audit engagements
  2. B) find out when his practice is due for practice inspection
  3. C) hire only qualified personnel and train them well
  4. D) sanction other PAs who engage in improper conduct

 

Page Ref: 89

 

3) There are a number of things that the practising auditor can do to reduce the liability in lawsuits. One of them is to

  1. A) lobby for changes in laws.
  2. B) carry adequate insurance.
  3. C) establish peer review requirements.
  4. D) revise auditing standards to meet the changing needs of society.

 

4) A) Describe some of the steps the CICA and the accounting profession as a whole can and are taking to reduce the practitioner’s exposure to lawsuits.

  1. B) Describe some of the steps individual practising auditors can take to minimize their legal liability.

5) Sandra is a new partner at a PA firm. Sandra recently signed a new contract with Gretchen Fabrics to become its auditor. In the process of accepting the client and planning the first year’s audit, Sandra did the following:

– Sandra contacted the previous auditor to enquire if there were any reasons not to accept the audit of this client. Unfortunately, the previous auditor was on vacation and did not respond to Sandra before she accepted the client.

– Upon his return, the previous auditor did communicate with Sandra and indicated that the client had aggressive expense deferral policies that they disagreed on. Sandra asked to review the working papers of the previous auditor with regards to these expenses and found them to be right below the materiality threshold.

– Gretchen Fabrics imports most of its fabrics and has two production facilities in Asia. The company therefore has a complex tax structure and many import duties. Since this is not the area of expertise of Sandra, she asked another auditing firm to provide the required audit procedures for the international taxes and duties expense. When selecting the other audit firm, Sandra researched the firm on the internet. She also ensured that they had their professional designation and enquired with the CICA and provincial association if the firm had any complaints or litigation outstanding for malpractice.

– Since the bidding process took time, Sandra had to start the audit almost right after learning she had the winning bid. She did not prepare an engagement letter before starting the work. She does not see this as being a problem since waiting until the audit has begun will provide her with a better idea of what work has to be done and what the engagement letter should include.

Required:

Identify the good and bad steps that Sandra has undertaken in reducing her exposure to legal liability.

– Sandra should have conducted a thorough risk assessment of both management and the industry before accepting the audit.

Page Ref: 89-90

 

4.5   Identify the actions that accountants should take to determine which legislation has an impact on their work

 

1) How do quality control processes for the financial statement audit process incorporate consideration of legislation that affects the client?

  1. A) requiring second partner review of all working partners that relate to legislative matters
  2. B) provide auditors with copies of legislation that affects their client
  3. C) train all auditors in legislation details that could affect all clients
  4. D) include in audit checklists questions that address relevant new legislation

 

Page Ref: 91

 

Auditing, 12e (Arens)

Chapter 5   Audit Responsibilities and Objectives

 

5.1   Describe the objective of conducting an audit of financial statements

 

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

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

 

Page Ref: 102

 

 

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

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

 

Page Ref: 102

 

 

3) The reason auditors accumulate evidence is to

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

 

Page Ref: 102

 

 

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

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

 

Page Ref: 102

 

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

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

 

Page Ref: 102

 

 

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

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

 

Page Ref: 103

 

 

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

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

 

Page Ref: 103

 

 

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

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

 

Page Ref: 104

 

 

 

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

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

 

Page Ref: 105

 

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

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

 

Page Ref: 105

 

 

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

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

 

Page Ref: 105

 

 

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

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

 

Page Ref: 105

 

 

 

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

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

 

Page Ref: 105

 

 

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

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

 

Page Ref: 105

 

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

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

 

Page Ref: 107

 

 

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

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

 

Page Ref: 107

 

 

 

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

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

 

Page Ref: 107

 

 

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

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

 

Page Ref: 107

 

 

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

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

 

Page Ref: 107

 

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

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

 

Page Ref: 108

 

 

 

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

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

 

Page Ref: 108

 

 

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

 

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

Required:

 

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

 

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

 

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

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

Required:

 

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

 

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

 

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

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

Required:

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

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

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

Required:

Explain how this situation might affect the audit process.

 

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

 

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

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

 

Page Ref: 108-109

 

 

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

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

 

Page Ref: 110

 

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

 

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

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

 

Page Ref: 116

 

 

2) Analytical procedures are those that

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

 

Page Ref: 116

 

 

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

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

 

Page Ref: 117

 

 

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

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

 

Page Ref: 117

 

 

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

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

 

Page Ref: 118

 

 

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

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

Required:

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

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

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

Required:

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

 

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

Required:

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

5.4   Show how transactions underlying financial statements are divided into cycles

 

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

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

 

Page Ref: 118

 

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

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

 

Page Ref: 118

 

 

3) Transaction cycles begin and end at

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

 

Page Ref: 122

 

 

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

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

 

Page Ref: 123

 

 

 

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

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

 

Page Ref: 123-124

 

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

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

Required:

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

5.5   Describe management assertions about financial information

 

1) Management assertions are

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

 

Page Ref: 125

 

2) Management assertions are

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

 

Page Ref: 125

 

 

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

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

 

Page Ref: 126

 

 

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

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

 

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

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

 

Page Ref: 126

 

 

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

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

 

Page Ref: 127

 

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

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

 

Page Ref: 128

 

 

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

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

 

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

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

 

Page Ref: 128

 

 

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

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

 

Page Ref: 130

 

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

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

 

Page Ref: 130

 

 

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

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

 

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

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

 

Page Ref: 130

 

 

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

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

 

Page Ref: 130

 

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

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

 

Page Ref: 131

 

 

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

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

 

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

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

 

Page Ref: 131

 

 

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

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

 

Page Ref: 131

 

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

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

 

Page Ref: 131

 

 

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

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

 

Page Ref: 131

 

 

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

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

 

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

 

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

related? (Y/N)

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

 

 

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

Required:

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

 

 

Auditing, 12e (Arens)

Chapter 6   Client Risk Profile and Documentation

 

6.1   Explain the importance of an adequate audit planning process

 

1) An effective audit is one that

  1. A) reduces the audit risk to the targeted level.
  2. B) ensures that there are no errors contained in the financial statements.
  3. C) does not contain errors of a dollar amount higher than 5% of the net income of the company.
  4. D) is completed on time and within budget.

 

Page Ref: 156

 

 

2) When the auditor has properly planned and performed the audit to reduce risk to an acceptably low level that is consistent with the objective of the audit, this means that the auditor has conducted enough work to

  1. A) reduce inherent risks to an acceptable level.
  2. B) increase detection risk to a satisfactory level.
  3. C) detect errors in internal controls so that control risk can be set higher.
  4. D) detect material misstatements to the targeted level of assurance.

 

Page Ref: 156

 

 

3) The audit plan includes the nature, timing and extent of audit procedures for the purposes of risk assessment, including those that are linked to the individual audit assertions, as well as any other audit procedures that are considered necessary. At what point in the audit process is the audit plan finalized? When

  1. A) the auditor has finished documenting internal controls.
  2. B) the client risk profile has been completed.
  3. C) risk assessments are complete.
  4. D) inherent risk information has been gathered.

 

Page Ref: 157

 

 

4) An important reason for adequately planning the audit engagement is to

  1. A) help decide whether the engagement should be accepted.
  2. B) enable the auditor to obtain sufficient appropriate audit evidence.
  3. C) properly design the contents of the engagement letter.
  4. D) keep audit risk as low as possible.

 

5) A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the

  1. A) inherent risk.
  2. B) audit risk.
  3. C) statistical risk.
  4. D) financial risk.

 

Page Ref: 157

 

 

6) One of the purposes of developing a client risk profile is to assist the auditor in

  1. A) developing the pertinent audit procedures for tests of internal controls.
  2. B) assessing the client’s business risk.
  3. C) locating related parties that need to be disclosed.
  4. D) deciding whether fraud or illegal acts have taken place.

 

Page Ref: 157

 

 

7) A thorough understanding of the client’s business and industry and knowledge about the company’s operations are essential for doing an adequate audit. Why do auditors need greater knowledge about major customers and suppliers and related risks?

  1. A) information technology connects these organizations, so that they affect each other
  2. B) information technology provides rapid information about organizations
  3. C) there is increased importance of human capital and other intangible assets
  4. D) joint ventures and strategic alliances affect client business risks

 

Page Ref: 157

 

 

8) Risks associated with specific industries may affect the auditor’s assessment of client business risk and acceptable audit risk, and even influence client acceptance decisions. Which of the following business would be the most risky for the auditor to accept as a new client? A client that

  1. A) is a small manufacturer of metal and plastic parts, with steady profits, in business for 15 years.
  2. B) is developing a computer game, expected to be ready in three years, and has no other products.
  3. C) has fifteen retail outlets in the clothing industry, with mid-range pricing, appealing to a large population sector.
  4. D) consists of a partnership of ten lawyers, operating out of three different cities in one province.

 

9) It is important for the auditor to obtain a good understanding of the industry of the client to develop a client risk profile. If the auditor is looking at a client in the fashion clothing industry, a risk specific to the industry would be

  1. A) the high risk of poor governance and management oversight.
  2. B) the high risk of defective products.
  3. C) the high risk of obsolescence of their inventory.
  4. D) the volatility in the stock market with regards to common stock.

 

Page Ref: 159

 

 

10) An important reason for auditors to obtain a good knowledge of a client’s industry is that

  1. A) payroll processing functions could differ from client to client.
  2. B) control risks will vary from zero to 100% and can be better assessed in context.
  3. C) detection risk must be set in accordance with the needs of the industry as well as of the individual client.
  4. D) organizations like city governments have unique accounting requirements that could be complex.

 

Page Ref: 159

 

 

11) How is lack of understanding of a client’s knowledge and industry linked to the auditor’s business risk?

  1. A) sales and collection processes need to be carefully documented so that the auditor can assess the value of accounts receivable
  2. B) failure to fully understand the nature of the client’s transactions could result in litigation should the client fail
  3. C) the auditor may not be adequately trained to understand the nature of the client’s business, conducting a poor quality audit
  4. D) there may not be sufficient expertise assigned to the audit engagement, resulting in a lack of understanding of complex issues

 

Page Ref: 159

 

 

12) There are many types of analytical procedures that the auditor can conduct during the planning stage of the financial statement audit. What is the purpose of calculating key ratios for the client’s business and comparing them with industry averages?

  1. A) understand the client’s industry and business
  2. B) assess going concern
  3. C) indicate possible misstatements
  4. D) reduce detailed tests

 

Page Ref: 160

 

13) In order to assess if a company is a going concern, the auditor can calculate which of the following ratios during the audit planning and compare with previous years and successful companies in the industry?

  1. A) debt to equity ratio
  2. B) accounts receivable turnover ratio
  3. C) percent of interest expense to sales
  4. D) inventory turnover ratio

 

Page Ref: 160

 

 

14) There are many types of analytical procedures that the auditor can conduct during the planning stage of the financial statement audit. What is the purpose of comparing the gross margin with those of prior years, looking for large fluctuations?

  1. A) understand the client’s industry and business
  2. B) assess going concern
  3. C) indicate possible misstatements
  4. D) reduce detailed tests

 

Page Ref: 160

 

 

15) There are many types of analytical procedures that the auditor can conduct during the planning stage of the financial statement audit. What is the purpose of comparing prepaid expenses and related expense accounts with those of prior years?

  1. A) understand the client’s industry and business
  2. B) assess going concern
  3. C) indicate possible misstatements
  4. D) reduce tests of controls

 

Page Ref: 160

 

 

16) The existence of advanced automated systems affects the audit process. Which of the following characteristics is an indicator of the presence of an advanced automated information system?

  1. A) custom-designed operational or strategic information systems
  2. B) use of packaged software to process sales both locally and across Canada
  3. C) use of customer relationship management systems to manage sales information
  4. D) numerically-controlled equipment used in the manufacturing process

 

17) The existence of advanced automated systems affects the audit process. Which of the following characteristics is an indicator of the presence of an advanced automated information system?

  1. A) use of data communications (such as the Internet) to transfer transaction data
  2. B) use of packaged software to process sales both locally and across Canada
  3. C) use of customer relationship management systems to manage sales information
  4. D) numerically-controlled equipment used in the manufacturing process

 

Page Ref: 160

 

18) The existence of advanced automated systems affects the audit process. Which of the following characteristics is an indicator of the presence of an advanced automated information system?

  1. A) electronic data interchange systems for purchase orders, sales invoices and payments
  2. B) use of packaged software to process sales both locally and across Canada
  3. C) use of customer relationship management systems to manage sales information
  4. D) numerically-controlled equipment used in the manufacturing process

 

Page Ref: 161

 

 

19) Mario, the owner of Clayton’s ice cream, is giving Steve, the manager of the audit, a private tour of the production facilities. By doing the tour, Steve will

  1. A) be better able to identify control risks.
  2. B) understand the client’s business and operations better.
  3. C) be able to gather audit evidence on operational efficiencies.
  4. D) Steve should not be taking a tour alone with the owner as this could compromise his independence.

 

Page Ref: 161

 

 

20) Simon owns a clothing store, Simonello. Simonello recently purchased a material amount fabrics from Simonique Inc., a textile company also owned by Simon. With regards to this transaction, the auditors should

  1. A) request a confirmation from Simonique that the transaction took place.
  2. B) inspect the textile received in the warehouse to ensure that the amount sent equals the amount ordered.
  3. C) qualify the audit report as this puts into question management’s integrity.
  4. D) verify that the business relationship is disclosed in the financial statements.

 

Page Ref: 161

 

 

 

21) Jibbery Company has numerous transactions with related parties. For example, it has borrowed money from shareholders, purchases raw materials from a subsidiary company, and sells finished goods to its parent company. Which of the following describes one of the impacts upon risk assessment of these transactions?

  1. A) inherent risk would be set as low
  2. B) inherent risk would be set as high
  3. C) control risk would be set as low
  4. D) audit risk would be decreased

 

Page Ref: 161

 

22) Brandon is working on the audit of Michum Inc. In accordance with CAS 550 (related parties), Brandon had obtained a management confirmation of all related-party transactions. When auditing the purchasing cycle of Michum, Brandon found that the company had purchased over $500,000 of merchandise from Elite Crust Inc., a company that is owned by the CEO’s brother. The $500,000 purchase is a material amount and it was not included in the confirmation provided by Michum. Brandon should

  1. A) inform the audit committee.
  2. B) qualify the audit report.
  3. C) discuss this issue with the management of Michum.
  4. D) reduce materiality to increase the likelihood of discovering other undisclosed related party transactions.

 

Page Ref: 161-162

 

 

23) Michum Inc. has related parties with a company owned by the CEO’s brother that comprise about $500,000. There are also related party transactions with the owner (about $250) and with two of the officers ($750 and $1,000) respectively. Which related parties should be identified and included in audit documentation?

  1. A) those with material transactions only
  2. B) those that had transactions in the current year only
  3. C) all related parties
  4. D) only those that could lead to a conflict of interest

 

24) An effective board of directors helps ensure that the company takes only appropriate risks. The audit committee can

  1. A) reduce the likelihood of fraud and financial statement errors through oversight of the entity level controls.
  2. B) reduce the likelihood of financial statement errors by helping management of the company with complex financial reporting issues.
  3. C) reduce the likelihood of financial statement errors by helping management in the preparation of the financial statements and related notes.
  4. D) reduce the likelihood of overly aggressive accounting through oversight of financial reporting.

 

Page Ref: 162

 

 

25) The auditor will obtain a copy of the client’s articles of incorporation (if applicable) and retain a copy in the permanent file. Important information in the articles of incorporation includes

  1. A) the interest rates currently being paid for bonds that have been issued.
  2. B) voting rights of each class of shares issued by the company.
  3. C) which shares have been redeemed by the company in the current year.
  4. D) the interest rates that are being received on long term notes invested.

 

Page Ref: 162

 

26) Which of the following would you expect to find in a corporation’s bylaws? The

  1. A) kinds and amounts of capital stock authorized.
  2. B) date of incorporation.
  3. C) rules and procedures adopted by the shareholders of the corporation.
  4. D) types of business activities that the corporation is authorized to conduct.

 

Page Ref: 163

 

 

27) A code of ethics is an important document for organizational conduct. In response to the Sarbanes-Oxley Act in the U.S., the SEC requires which of the following actions for organizations that have not adopted a code of ethics?

  1. A) explanation of why it has not done so
  2. B) disclosure of actions undertaken to prevent and detect fraud
  3. C) disclosure of all related parties in management and discussion documents
  4. D) a cost-benefit analysis for immediate implementation of one

 

Page Ref: 163

28) Which of the following is an important purpose of an organizational code of ethics and the associated processes to ensure adherence?

  1. A) make sure that there are no fraudulent or illegal transactions at the company
  2. B) train employees in acceptable conduct at the organization
  3. C) keep unethical employees from acting out unacceptable behaviour
  4. D) provide a powerful signal of acceptable organizational conduct

 

Page Ref: 163

 

 

29) The official record of the meetings of the board of directors and shareholders is contained in the corporate

  1. A) bylaws.
  2. B) charter.
  3. C) minutes.
  4. D) license.

 

Page Ref: 163

 

 

30) When reading the corporate minutes, the auditor extracted the approved annual salary for the President, the Chief Executive Officer and other senior executives. What audit step would the auditor likely conduct with this information?

  1. A) trace the payroll amount to each individual officer’s payroll record
  2. B) check that the payroll has been recorded into the correct bank account
  3. C) verify that payroll cheques have two signatures for all large amounts
  4. D) ensure that all overtime is approved and adequately documented

 

Page Ref: 163

 

31) When reading the corporate minutes, the auditor obtained information regarding the loans that were authorized for borrowing. What audit step would the auditor likely conduct with this information?

  1. A) trace the authorized amounts to the bank statements
  2. B) verify that notes payable have been recorded
  3. C) calculate interest payable as of the end of the year
  4. D) contact a credit rating agency to determine the rating of the lender

 

32) Frontenac Construction, your audit client, is a construction company. In the initial planning phase of the audit, you identified that it has many contracts with severe non-performance clauses if any of the current constructions are not completed on the dates set in the contracts over the next three years. As the auditor, you would set the inherent risk for sales and penalties as

  1. A) high.
  2. B) moderate.
  3. C) low.
  4. D) cannot be determined until more procedures are performed.

 

Page Ref: 164

 

 

33) It is important that the policies, procedures and key decisions of senior management, board of directors and audit committee be considered when developing a client risk profile because

  1. A) they have a pervasive effect on the company.
  2. B) they influence the most important decisions for the company.
  3. C) it is required by accounting and auditing standards.
  4. D) they have the effect of increasing client business risks.

 

Page Ref: 164

 

 

34) In addition to direct impacts upon the financial statements, the auditor also needs to consider indirect effects. An assessment of client objectives and strategies can reveal issues that could lower income or cause contingent liabilities. Which of the following could cause lost sales, increases in warranty expenses and product liability claims?

  1. A) poor product quality
  2. B) excessive advertising
  3. C) ineffective projections
  4. D) inaccurate budgets

 

Page Ref: 164

 

35) Organizations with a good control environment are able to document their positive “tone at the top” with a clear code of ethics. How would the auditor include the presence of such a code of ethics in the risk assessment process?

  1. A) increase inherent risks associated with violations of laws and regulations
  2. B) lower inherent risks associated with violations of laws and regulations
  3. C) increase control risks associated with violations of laws and regulations
  4. D) lower control risks associated with violations of laws and regulations

 

36) A client’s performance measurement system includes key performance indicators that management uses to

  1. A) measure its profitability.
  2. B) compare its performance with prior periods.
  3. C) prepare the financial statements.
  4. D) measure progress toward its objectives.

 

Page Ref: 164

 

 

37) If the client has set unreasonable objectives or if the performance measurement system encourages aggressive accounting, the auditor will

  1. A) increase inherent risk of financial statement misstatements.
  2. B) lower inherent risk of financial statement misstatements.
  3. C) increase control risk of financial statement misstatements.
  4. D) lower control risk of financial statement misstatements.

 

Page Ref: 165

 

 

38) If management and salespeople are compensated on the basis of achieving high sales targets, there is increased incentive to record sales before they have been earned. In such a situation, the auditor will increase the extent of testing for which of the following transaction-related audit objectives for sales?

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

 

Page Ref: 165

 

39) Your client, Macilbink Ltd., manufactures calendars, books and magazines. The printing presses that they use are only three years old, yet new technology has been developed that would result in cuts in ink and electricity costs by over 20%, while simplifying the set up process (the new equipment can read in PDF files directly), making lower production runs more feasible. Macilbink Ltd. is facing lowered demand for its products, and will need to change direction or innovate to stay in business. The effect of the new printing technology has resulted in the following risk assessment changes by Macilbink Ltd.’s auditors:

  1. A) decrease control risk
  2. B) increase control risk
  3. C) decrease client business risk
  4. D) increase client business risk

 

Page Ref: 165

 

 

40) Vanovo Ltd. is a company that has purchased several companies in the retail sector. Recently, Vanovo Ltd. purchased both a coffee and donut chain that also owned bakeries and a submarine sandwich chain. Unfortunately, the planned synergies between these two retail chains did not arise. What effect would this have on the financial statements of Vanovo Ltd., the parent company?

  1. A) the financial statements will be incorrectly calculated, and should be checked
  2. B) the fixed assets and goodwill recorded at acquisition could be impaired
  3. C) risk of material misstatement for payroll expenses will increase
  4. D) costs of goods sold will likely be overstated for both of the new chains

 

Page Ref: 165

 

 

41) The Sarbanes-Oxley Act requires management to certify that it has informed the auditor and audit committee of any

  1. A) related party transactions.
  2. B) significant deficiencies in business practices.
  3. C) significant deficiencies in internal controls.
  4. D) specific business or industry risk.

 

Page Ref: 166

 

 

42) The Canadian Auditing Standards state the the auditor must develop an audit plan. List and explain the components that must be included in the auditor’s plan.

 

43) What is the purpose of developing a client risk profile? List the steps involved in developing a client risk profile.

 

 

44) Black Rock Limited is a marble and tile outlet that has a large outdoor area as well as an indoor showroom for a variety of rock, tile and marble. It is July and your firm has just been appointed auditors for the September year end audit. The previous firm of auditors had conducted review engagements. The company’s bank has asked for audited financial statements for the current year end.

Required:

  1. A) What is the purpose of obtaining knowledge of the client’s industry and business environment? Identify at least three procedures that you could undertake in this area.
  2. B) What is the purpose of obtaining knowledge of the client’s business? Identify at least three procedures that you could undertake in this area.

 

45) Knowledge of the client’s industry and external environment can be obtained in different ways. Discuss some of the ways that this knowledge can be obtained.

 

46) Juniper Berry is a private company, operating in the fruits and vegetable industry, located in the Niagara region. In its main St-Catharines plant, it receives the picked berries and proceeds to sort, package and also make some related products such as jams, cookies and pies. Your firm has recently been hired as the auditor of Juniper Berry. The partner in charge of the audit has asked you to write a memo explaining why it is important to gain understanding of the business operations and processes of Juniper Berry and also to list some suggested procedures to be performed in the process of understanding the business operations and processes.

 

To assist you with your memo, the partner provided you with some notes he took at a recent meeting with the management of Juniper Berry.

 

Juniper Berry (JB) sells and manufactures a wide range of products. From fresh to frozen berries, to jam, cookies and pies. Fresh and Frozen berries make up most of the revenues of JB.

– JB sells mostly to grocery stores directly. Its frozen berries however are packaged with the Mondo Grocers logo as they have an exclusive contract to sell all of their frozen berry production to Mondo.

– In 2011, JB installed a high tech scale system where the berries received from the various farms are weighed when they are delivered and the amount to be paid to the farmer is calculated and recorded immediately. The system automatically records the inventory and the central system also issues an electronic payment for the amount calculated by the scale. JB is proud to be technologically advanced as it allowed the company to cut some jobs and be more cost efficient.

– Given that most of the packaging and processing of berries into derived products is automated, capital assets represent a significant portion of the balance sheet and also required JB to obtain large bank loan in 2011 when the plant upgrade took place.

 

47) Your preliminary discussion with European Real Estate Management (EREM) Corporation indicated that the company was owned by three Swedish individuals who sold limited liability partnerships of shopping malls, office buildings and large residential apartment buildings to European investors. Often, a single shopping mall was broken up into several limited liability partnerships to make the ownership pieces small enough to sell easily.

In some cases, these partnership units were sold to European companies, who diversified and bought units in several buildings. Other units were purchased by individuals. If a property looked particularly promising, the owners of EREM occasionally purchased units or advised their wives and family members to purchase units.

Required:

Explain why it is important for the auditor to identify related party transactions. Why are related party transactions a high risk area for the EREM audit?

 

48) A) One step in the planning phase of an audit is to obtain information about the client’s legal obligations. Identify the types of legal documents and records that auditors examine to obtain this information.

 

  1. B) Discuss the audit-relevant information contained in each of these three types of documents that an auditor should be aware of early in the audit.

 

49) White Top Telephones is the largest telephone distributor in the province, distributing wired and wireless phones, as well as cellular phones. Management always seems to be in a rush, and difficult to approach. Unfortunately, this attitude has permeated down to all of the staff, and everyone seems to be hurrying about, doing what needs to be done. Sometimes, it seems as if they don’t even have time for the customers, moving on to the next task.

Yet everything seems to get done. The company’s web site has a lengthy privacy policy statement indicating that customers are number one, and that all data are kept secure.

Required:

Explain the importance of the control environment and corporate governance structure. During what phases of the risk assessment and planning process would the control environment and corporate governance structure be documented and assessed?

 

6.2   Describe the type of evidence that the auditor collects when developing the client risk profile and assessing client business risk

 

1) During discussion and inquiry with management, the auditor determined that the company has started a new line of business, requiring a substantial investment in manufacturing equipment. The company has also implemented wireless scanning for its warehouse and inventory. Which of the following techniques will the auditor likely use to corroborate these statements?

  1. A) further inquiry of the accounting personnel
  2. B) inspection of recent sales invoices for types of sales
  3. C) use of analytical procedures, comparing last year to this year
  4. D) observation during the plant tour

 

Page Ref: 166

 

2) Anna performed a trend analysis of accounts receivable (AR) balances and computed the days to collect AR ratio. When she compared the results of her analysis with the industry averages, she found the results were unusually low compared to the industry norm. Anna can conclude that

  1. A) the accounts receivable balance is wrong.
  2. B) the accounts receivable has an increased risk of misstatement.
  3. C) the integrity of the company’s management is questionable.
  4. D) she will not be able to rely on internal controls for accounts receivable for audit purposes.

 

6.3   Determine what working papers the auditor retains to document the financial statement audit

 

1) During the course of an audit engagement an auditor prepares and accumulates audit working papers. The primary purpose of the audit working papers is to

  1. A) aid the auditor in adequately planning the work.
  2. B) provide a point of reference for future audit engagements.
  3. C) support the underlying concepts included in the preparation of the basic financial statements.
  4. D) support the auditor’s report.

 

Page Ref: 168

 

 

2) The working papers are

  1. A) the property of client.
  2. B) prepared by the client’s internal auditors.
  3. C) the primary means of documenting that an adequate audit was conducted in accordance with GAAS.
  4. D) used primarily as a basis for the partners to review and reward the work of the managers, seniors, and staff.

 

Page Ref: 168

 

 

3) The new Canadian Auditing Standards require the auditor to complete the audit working papers within how many days of the audit report date?

  1. A) 45
  2. B) 60
  3. C) 90
  4. D) 183

 

Page Ref: 168

 

4) The audit working papers serve as a record of the evidence accumulated and the results of the audit tests. This helps to demonstrate that the audit was

  1. A) properly kept confidential; information was held secure.
  2. B) completed using Canadian generally accepted accounting principles.
  3. C) organized effectively with no mistakes in calculations.
  4. D) conducted in accordance with Canadian generally accepted auditing standards.

 

Page Ref: 168

 

 

5) The working papers contain data useful for evaluating the adequacy of the audit scope and the fairness of the financial statements. This data helps the auditor to conclude whether

  1. A) control risks were accurately identified and tested.
  2. B) inherent risks were set as low as possible.
  3. C) an unqualified audit report can be issued.
  4. D) the current files properly contain copies of client contracts and agreements.

 

Page Ref: 168

 

 

6) The audit of Simcoe Transports Inc. was completed three months ago so the PA firm proceeded to the file archive stage in accordance with Canadian Audit Standards. If the audit firm receives additional information related to the audit but the information does not affect the audit conclusions, the information should be

  1. A) disregarded as it the file archive was already done.
  2. B) added to the audit file in the section to which it pertains.
  3. C) separately identified and added at the front of the audit file.
  4. D) added to the audit file and request that the reviewing partner reviews the new information.

 

Page Ref: 169

 

 

7) With the use of electronic working papers, each team member should have a unique access identification code and a password to access the working papers. Once a working paper is completed, what type of access should the staff auditor who prepared the working paper file have?

  1. A) edit capability
  2. B) update for current information
  3. C) read only
  4. D) change based upon review

 

8) In addition to including on each working paper the name of the client, the period covered, the date of preparation and an index code, each working paper should clearly include

  1. A) the name of the preparer and a description of the contents.
  2. B) symbols used and a reconciliation to the general ledger balance.
  3. C) audit working paper steps that were completed.
  4. D) the nature of the transaction-based risk that is being audited.

 

Page Ref: 171

 

 

9) To facilitate the working paper preparation process, defaults can be established to automatically insert client name, period covered, and preparer. This can best be done using

  1. A) the junior staff assigned to the engagement.
  2. B) an old-fashioned rubber stamp on each printed page.
  3. C) cut and paste from word processing or spreadsheet software.
  4. D) automated working paper software.

 

Page Ref: 171

 

 

10) Renaldo compared shipping reports to sales documents, checking to see that the sales invoice date matched the shipping date, and that quantities invoiced matched quantities shipped. On his working paper, he said that he vouched invoices. What else should his working paper include with respect to the audit procedure conducted?

  1. A) details of tests conducted, with results
  2. B) results of analytical review procedures on the aging of accounts receivable
  3. C) employee number and wage rate of the employees he spoke to
  4. D) a statement that the information will be held confidential

 

Page Ref: 171

 

 

11) Each working paper should include enough information to fulfill the objectives for which it was designed. For example, if a working paper is designed to list the detail and show the verification of support of a balance sheet account such as prepaid insurance, it is essential that the detail on the working paper

  1. A) reconcile the change in costs from last year to this year.
  2. B) use analytical review to consider the reasonableness of the account.
  3. C) reconcile with the associated general ledger account.
  4. D) use observation to identify controls in place over the transactions.

 

Page Ref: 171

 

12) The working papers prepared during the engagement are the property of the

  1. A) auditor, but do not include the working papers prepared by the client for the auditor.
  2. B) auditor, even including those prepared by the client for the auditor.
  3. C) client, who will provide copies to the auditor.
  4. D) auditor and client jointly.

 

Page Ref: 171

 

 

13) Ordinarily, the working papers can be provided to someone else only with the express permission of the client. This is the case even if the papers are

  1. A) subpoenaed by a court.
  2. B) used as a part of a provincial institute practice inspection.
  3. C) requested as evidence in a provincial institute disciplinary hearing.
  4. D) transferred as a result of a public accountant selling his/her practice to another public accounting firm.

 

Page Ref: 172

 

 

14) Identify the characteristics that working papers should have. For each characteristic, briefly explain why it is important.

 

15) At the first day of work at a PA firm, staff are given their own laptop computer for use in working with clients and other data.

Required:

  1. A) What is the typical structure of client working paper files?
  2. B) How is client data protected from unauthorized change?

 

 

Auditing, 12e (Arens)

Chapter 7   Materiality and Risk

 

7.1   State the components of the audit risk model and describe the process used to assess audit risk

 

1) Risk in auditing means that the auditor accepts some level of uncertainty in performing the audit function. An effective auditor will

  1. A) take any means available to reduce the risk to the lowest possible level.
  2. B) set the risk level between 5% and 10%.
  3. C) perform the audit procedures first and quantitatively set the risk level before forming an opinion and writing the report.
  4. D) recognize that risks exist and deal with those risks in an appropriate manner.

 

Page Ref: 182

 

 

2) If the auditor assessed the detection risk as high, the extent of evidence the auditor plans to accumulate is

  1. A) low.
  2. B) high.
  3. C) medium.
  4. D) need more information to conclude.

 

Page Ref: 182, 185

 

 

3) As the effectiveness of internal control increases, what happens to control risk? It

  1. A) stays the same.
  2. B) increases.
  3. C) changes based upon the audit procedures conducted.
  4. D) decreases.

 

 

 

4) The audit risk model is used primarily

  1. A) for planning purposes in determining how much evidence to accumulate.
  2. B) while doing tests of controls.
  3. C) to determine the type of opinion to express.
  4. D) to evaluate the evidence which has been gathered.

 

Page Ref: 184

 

5) Audit risk is a measure of

  1. A) the auditor’s assessment of the likelihood that a material misstatement might occur in the first place.
  2. B) the probability that the financial statements contain errors.
  3. C) how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed.
  4. D) the probability that errors in the financial statements that were not detected by the internal controls of the firm are not detected by the auditor.

 

Page Ref: 184

 

 

6) PA has set audit risk at 2% and determined that inherent risk is 60%. What is the level of targeted audit assurance?

  1. A) 2%
  2. B) 40%
  3. C) 98%
  4. D) 60%

 

Page Ref: 184

 

 

7) How much control does the auditor have over inherent risk? The auditor

  1. A) adjusts the controls that are considered – high levels of control.
  2. B) considers inherent risk for the business as a whole – some control.
  3. C) assesses the factors that make up inherent risk – no control.
  4. D) calculates inherent risk values as a residual – no control.

 

Page Ref: 185

 

 

 

8) What is the role of internal controls during the assessment of inherent risk?

  1. A) Internal controls are considered separately, so they are ignored during the assessment of inherent risk.
  2. B) As the quality of internal controls increases, inherent risk decreases.
  3. C) As the quality of internal controls improves, inherent risk increases.
  4. D) There is a direct relationship between the quality of internal controls and inherent risk.

 

Page Ref: 185

 

9) In addition to representing an assessment of whether a client’s internal control is effective for preventing or detecting misstatements, control risk also represents the

  1. A) reliability of management in preventing or detecting fraud.
  2. B) auditor’s intention to rely on internal controls.
  3. C) likelihood that the auditor will detect illegal acts.
  4. D) possibility of collusion occurring between two employees.

 

Page Ref: 185

 

 

10) Using the audit risk model, audit risk describes targeted assurance, while control risk and inherent risk are assessed based upon a variety of factors. Of the components of the audit risk model, which is most likely to be set to 100%?

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

 

Page Ref: 185

 

 

11) Assessing design effectiveness and conducting tests of controls are required when the auditor

  1. A) chooses to set control risk below 100 percent and relies on the controls.
  2. B) chooses to set control risk below 100 percent even it there is no reliance placed on controls.
  3. C) is planning the audit.
  4. D) should always test the design effectiveness.

 

Page Ref: 185

 

 

 

12) The risk that an auditor’s procedures will lead to the conclusion that a material error does not exist in an account balance when, in fact, such error does exist is referred to as

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

 

Page Ref: 185

 

13) If audit risk is increased, what happens to detection risk? It

  1. A) stays the same.
  2. B) increases.
  3. C) changes based upon the audit procedures conducted.
  4. D) decreases.

 

Page Ref: 185

 

 

14) If detection risk is reduced, the amount of evidence the auditor accumulates will

  1. A) increase.
  2. B) decrease.
  3. C) remain unchanged.
  4. D) be indeterminate.

 

Page Ref: 185

 

 

15) An inherent risk (IR) of 40% and a control risk (CR) of 60% affect detection risk and planned evidence differently than an

  1. A) IR of 60% and CR of 40%.
  2. B) IR of 100% and CR of 24%.
  3. C) IR of 80% and CR of 30%.
  4. D) IR of 70% and CR of 30%.

 

Page Ref: 186

 

 

 

16) The auditor set audit risk at 5%, inherent risk at 100%, and control risk at 50%, and determined a detection risk of 10%. If control risk had been 80%, detection risk would be about

  1. A) 16%.
  2. B) 10%.
  3. C) 6%.
  4. D) 5%.

 

Page Ref: 186

 

 

17) All other factors held constant, if the auditor decreases audit risk then

  1. A) there will be less documentation in the audit file.
  2. B) total audit evidence and audit costs will increase.
  3. C) it will also be necessary to decrease either control risk or inherent risk.
  4. D) less supervision will be required of the audit team.

 

Page Ref: 186

 

18) When inherent risk is assessed as higher (i.e. more material errors are likely to exist) and control risk is assessed the same from one year to the next, what is the likely effect on detection risk? Detection risk will

  1. A) increase.
  2. B) decrease.
  3. C) stay the same.
  4. D) need less documentation.

 

Page Ref: 186

 

 

19) If from last year to the current year’s audit, inherent risk has stayed constant, but control risk is higher (it is more likely that controls do not detect material errors), what is the likely effect on detection risk? Detection risk will

  1. A) increase.
  2. B) decrease.
  3. C) stay the same.
  4. D) need less documentation.

 

Page Ref: 186

 

 

 

20) With respect to clients, business risk increases when conditions, events, circumstances or inactions

  1. A) adversely affect the entity’s ability to achieve its objectives.
  2. B) cause employees to not do their job properly.
  3. C) result in the company continuing profitable operations.
  4. D) result in an assessment of poor internal controls.

 

Page Ref: 186

 

 

21) A PA firm can experience high levels of business risk if the audit firm

  1. A) does a poor job on preparing client risk profiles.
  2. B) pays its employees wages that are not in line with the market.
  3. C) has clients that do not pay their bills, or experiences significant litigation.
  4. D) has a generous vacation policy for its staff.

 

Page Ref: 186

 

22) When external users place heavy reliance on the financial statements it is appropriate that

  1. A) audit risk be increased.
  2. B) inherent risk be decreased.
  3. C) inherent risk be increased.
  4. D) audit risk be decreased.

 

Page Ref: 187

 

 

23) PA recently finished the audit of a family-owned business. Now, she is working on a large client with about 50 times the assets and 30 times total revenue. For the larger client, PA will likely have

  1. A) no effect on the audit risk model.
  2. B) higher control risk.
  3. C) higher audit risk.
  4. D) lower audit risk.

 

Page Ref: 187

 

 

 

24) PA is working on the audit of a publicly held corporation. At what level will the auditor likely set audit risk?

  1. A) low
  2. B) medium
  3. C) high
  4. D) very high

 

Page Ref: 187

 

 

25) PA is comparing the liabilities section of ABC Ltd. from last year to this year. Last year, ABC Ltd. had large loans due to major shareholders and officers and to one bank. This year, the debt has been reorganized, so there are now two different banks used for loans. Instead of having debt to shareholders and officers, the company now owes notes to 25 different foreign investors, who are entitled to convert the debt to shares if interest is not paid or if principal instalments are not paid on time. For this year’s audit, how will the change in debt structure affect the audit risk model?

  1. A) no effect on the audit risk model
  2. B) higher control risk
  3. C) lower audit risk
  4. D) higher audit risk

 

Page Ref: 187

 

26) Which one of the following would be a signal as to possible problems with management integrity?

  1. A) reliance on debt rather than equity for financing permanent assets
  2. B) rotation of holidays in the supervisory area over a period of months
  3. C) rapidly declining profits or increasing losses over a period of years
  4. D) frequent disagreements with regulators and the Canada Revenue Agency

 

27) A) Explain how auditors use the audit risk model when planning an audit.

 

  1. B) Describe the audit risk model and each of its components.

 

28) Discuss three factors that affect client business risk, and therefore audit risk.

usiness risk and audit risk are affected by:

  • The degree to which external users will rely on the statements. For large, publicly-held clients, client business risk is greater, and audit risk will be less, than for small, privately held clients.
  • The likelihood that a client will have financial difficulties after the audit report is issued. Client business risk is greater, and audit risk will be lower, when the client is experiencing financial difficulties.
  • The auditor’s evaluation of management’s integrity. Client business risk is greater, and audit risk will be lower, when the client’s management has questionable integrity.

Page Ref: 187-190

 

 

29) Below are four situations that involve the audit risk model as it is used for planning audit evidence requirements in the audit of inventory. For each situation, calculate planned detection risk.

 

SITUATION

 1  2  3  4
Audit risk  1%  10%  10%  5%
Inherent risk  100%  100%  50%  20%
Control risk  100%  100%  40%  30%
Detection risk  ________  ________  ________  ________

 

30) In practice, auditors rarely assign numerical probabilities to inherent risk, control risk, or audit risk. It is more common to assess these risks as high, medium, or low. For each of the four situations below, fill in the blanks for detection risk and the amount of evidence you would plan to gather (“planned evidence”) using the terms high, medium, or low.

 

SITUATION

 1  2  3  4
Audit risk  Low  Low  High  High
Inherent risk  High  Low  Low  Low
Control risk  High  Low  Medium  Low
Detection risk  ________  ________  ________  ________
Planned

evidence

 ________  ________  ________  ________

 

31) Your firm has been appointed as the auditor of Bush Mining Inc. (BMI), a company that runs small mining operations in remote areas of northern Canada, primarily in surface mines. You have been assigned the job of audit senior for BMI.

BMI’s operations are subject to provincial and federal laws and regulations. These laws and regulations have become stricter in recent years and some of BMI’s older mines may be in violation of environmental laws.

 

Surface mining produces tailings (toxic wastes that are dangerous to animal and plant life). These tailings are either further processed and buried or retained in tailings ponds. BMI is required to restore the mining property to a safe condition after a mine is exhausted. BMI has programs in place to monitor and control pollutants that are released to the air and to local waterways.

 

Required:

 

  1. A) What factors would affect the client business risk of BMI? Based upon your assessment of BMI’s client business risk, would you adjust audit risk? Why or why not?

 

  1. B) What is your preliminary assessment of audit risk? Justify your answer.

 

32) Mugsy Brights Limited (MBL) is a private company in Winnipeg that sells mugs, jars and bottles in a variety of colours, sizes and materials. MBL is owned by four equal owners since inception. The owners have different skills – creative design, marketing, finance and information systems. The company attributes much of its success to the use of materials that can be easily shipped without breaking, and unique designs that appeal to a variety of buyers, particularly commercial buyers who purchase for restaurants, or for businesses who choose to advertise their business by giving away or selling regular or travel mugs.

 

The owners meet formally every month, and have informal meetings two or three times per week to discuss particular clients or new approaches. About a quarter of the sales are via the company’s secure web site, while the remainder are by telephone or purchase order. MBL works with distributors of kitchenware, selling wholesale to hundreds of outlets in Canada. Most of these sales are done via the telephone, although a salesperson does spend some time in major cities across the country visiting some of the large customers, helping with shelf layout and marketing to the ultimate consumers for larger distributors. These efforts have resulted in gradually increasing market share for the company.

 

All sales are recorded in the accounting software package used by the company. The accounting manager reports directly to one of the owners, and there are two other employees in the accounting department. Password controls are used to limit functions that are accessible by employees. For example, only the controller can implement wage rate increases or product price increases (which are reviewed and approved by the owner responsible for marketing). Two owners are required to sign cheques, and do so with source documents attached. Similarly, two owners are required to approve new employees.

 

All manufacturing is outsourced to local producers who work with different materials. For example, a different supplier handles steel mugs versus plastics or glass. Ceramics is rarely used as it is quite breakable, whereas some forms of glass are very durable. MBL does not hold any inventory, as manufacturing is all done to order. However, as there have been some collection problems from customers, the company has had to go to the maximum of its line of credit, and has no additional borrowing capacity available. It is waiting for the results of the audited financial statements to approach the bank for an increase in its line of credit.

 

Internet sales are prepared (via credit card), while sales to distributors are net thirty. The company has an April year end.

 

 

Following are extracts from the annual financial statements:

 

2012 2011 2010
Cash $99,000 $110,000 $124,000
Accounts receivable $320,000 $220,000 $150,000
Fixed assets (net) $15,000 $20,000 $25,000
Accounts payable $270,000 $180,000 $150,000
Bank indebtedness $100,000 $25,000 $0
Share capital $200,000 $200,000 $200,000
Revenue $625,310 $538,120 $507,380
Cost of sales $406,452 $333,634 $304,428
Administration expenses $89,000 $57,000 $58,000
Sales expenses $31,266 $21,525 $20,295
Amortization $5,000 $5,000 $5,000

 

Required:

  1. A) What audit risk would you assign to the company? Why? [Tip: Do some calculations and consider client business risk.]
  2. B) Calculate preliminary materiality. Justify your decision of materiality base and choice of materiality.

7.2   Describe the factors the auditor considers when assessing inherent risk

 

1) An important role of inherent risk assessment during the audit process is the need to

  1. A) document the quality of the disaster recovery plan.
  2. B) attempt to predict where misstatements are most and least likely in the financial statement segments.
  3. C) train the audit staff to assess the integrity of management.
  4. D) increase the level of analytical review.

 

Page Ref: 190

 

 

2) Which of the following describes the components of the audit risk model that are used to describe the risk of material misstatement (RMM)?

  1. A) AR / DR
  2. B) IR × CR
  3. C) IR × DR
  4. D) CR × DR

 

Page Ref: 190

 

 

3) The inherent risk of programming errors (and thus processing errors for the affected application systems) increases when

  1. A) programs are customized by an external software house.
  2. B) the company uses an internet-based applications service provider.
  3. C) standard software packages are used for processing transactions.
  4. D) programs are customized by an understaffed information system group.

 

Page Ref: 191

 

 

4) The inherent risks of programming errors with resulting data loss increases when

  1. A) packaged software is used that has to be updated every year.
  2. B) complex configurations such as ERP at multiple locations are used.
  3. C) functional systems are used (such as separate systems for sales and payroll).
  4. D) sequential file systems are used rather than database management systems.

 

Page Ref: 191

 

 

5) The inherent risks of data compromise (such as privacy violations) or data loss increase when

  1. A) documents are sent by regular mail to confirm contract details.
  2. B) information is encrypted using public key technology.
  3. C) organizations use web sites to process sales transactions.
  4. D) packaged software is used to process sales transactions.

 

Page Ref: 191

 

 

6) Use of electronic funds transfers (such as electronic data interchange and online banking) has which of the following effects on the audit risk model?

  1. A) decreases control risks associated with cash
  2. B) increases control risks associated with cash
  3. C) decreases inherent risks associated with cash
  4. D) increases inherent risks associated with cash

 

Page Ref: 191

 

 

7) You generally consider your audit client’s management to be honest. However, they do have a bias towards wanting to understate their income to lower income taxes. How would this bias be implemented in the audit risk model?

  1. A) reduce audit risk and reduce inherent risk
  2. B) increase audit risk and reduce inherent risk
  3. C) reduce audit risk and increase inherent risk
  4. D) increase audit risk and increase inherent risk

 

Page Ref: 191

 

 

8) Senior management of Mega Corp. is entitled to receive large bonuses if they achieve earnings targets. What is the effect of this on the risks associated with recording of revenue? It increases

  1. A) inherent risks associated with revenue cutoff and existence assertions.
  2. B) inherent risks associated with revenue cutoff and completeness assertions.
  3. C) control risks associated with revenue cutoff and existence assertions.
  4. D) control risks associated with revenue cutoff and completeness assertions.

 

Page Ref: 191

 

 

 

9) PA is auditing a client where the accounts receivable are in worse shape than last year: many accounts are significantly overdue. How would this fact be dealt with in the audit risk model?

  1. A) increase inherent risk for accounts receivable
  2. B) decrease inherent risk for accounts receivable
  3. C) increase control risk for accounts receivable
  4. D) decrease control risk for accounts receivable

 

Page Ref: 191

 

10) If inherent risk is considered at the assertion level, why does the nature of the client’s business affect inherent risk?

  1. A) Certain accounts, such as inventory, are affected by the nature of the client’s business.
  2. B) If the client has really basic manufacturing processes, inherent risk is low.
  3. C) When there is a risk of technological obsolescence, a specialist must be used during the engagement.
  4. D) Accounts such as cash, notes and mortgages payable vary depending upon the type of business.

 

Page Ref: 192

 

 

11) If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, then that information is considered to be

  1. A) significant.
  2. B) insignificant.
  3. C) material.
  4. D) relevant.

 

Page Ref: 192

 

 

12) CAS 320 (Materiality in planning and performing an audit) defines materiality in terms of three key concepts. The first and second concepts are that a material misstatement should be considered in the context of knowledgeable users and the effect on decision making and that material is relative to circumstances surrounding the decision and nature of the information. The third concept is

  1. A) that the auditor should consider users of financial statements as a group.
  2. B) that the auditor should consider users of financial statements individually.
  3. C) that the users should be informed and approve of the materiality used by the auditor.
  4. D) that the auditor should be conservative in setting the materiality level.

 

Page Ref: 192

 

 

13) GreenGrow Limited is a local landscaping company that does household and commercial landscaping. Primarily, it helps businesses select plants and manage the plants. It also has regular maintenance contracts such as watering, weeding, and mowing. In the winter, it has some contracts for managing the indoor plants of shopping malls, and does snow clearing to help boost that low income season.

 

Joey, the majority shareholder of GreenGrow is ecstatic. He has managed to come in as the low bidder for a new type of contract. He bid on the construction of a track for the track and field area of a local university. A piece of land on the north end of the university is being cleared and GreenGrow will be leveling the land and placing a bed of crushed stone for the track. Joey has just the right person to be in charge. Jack has previous experience working as an assistant on a road crew and knows how to use the surveying equipment needed to keep the track level. This is a big contract, and will increase revenues by one third!

 

Required:

Assess inherent risk for revenue for GreenGrow Limited.

 

14) Big Box Distribution Company has an in-house information systems department of 50 people. The company generally does its own programming, although some software was acquired as a software package.

 

In addition, a software package was purchased for customer relationship management, which will be modified by the programming staff.

 

Procedures for implementing programs vary by department. All major changes are approved by the Management Information Systems steering committee. The committee is also given a list of the maintenance changes that are planned in the coming year. Some departments request that the data processing department handle testing, while other users are rather picky and want to do their own testing.

 

Requirements are generally prepared in writing, although small maintenance changes may be handled verbally.

 

Required:

Assess inherent risk associated with program changes at Big Box.

7.3   Examine how materiality is used to assess the amount of work conducted during an audit engagement

 

1) Silka is in the process of performing an audit. During the audit, Silka decided to change materiality. A valid reason for this would be

  1. A) a new user of the financial statements was identified.
  2. B) a fraud was discovered in the accounts payable section.
  3. C) materiality required the auditors to perform too many tests.
  4. D) too many errors were found during testing.

 

Page Ref: 192

 

2) Which of the following types of misstatements has the highest level of certainty?

  1. A) identified misstatements
  2. B) likely misstatements
  3. C) likely aggregate misstatements
  4. D) further possible misstatements

 

Page Ref: 193

 

 

3) Further possible misstatement considers

  1. A) possible presence of management fraud.
  2. B) possible lack of knowledge of the audit team.
  3. C) imprecision in the sampling process.
  4. D) imprecision in the audit procedures.

 

Page Ref: 193

 

 

4) The first step in applying materiality is

  1. A) estimating the misstatement in a segment, for each functional cycle.
  2. B) setting a judgment about materiality for the financial statements as a whole.
  3. C) estimating the combined effects of errors.
  4. D) comparing the error estimate with the materiality levels.

 

5) If the auditor sets a low dollar amount as materiality,

  1. A) more evidence is required than for a high amount.
  2. B) less evidence is required than for a high amount.
  3. C) the same amount of evidence is required as for a high dollar amount.
  4. D) it has no effect on the amount of evidence required.

 

Page Ref: 194

 

 

6) Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Normally, the most important base for deciding what is material, because it is regarded as a critical item of current period information for users, is

  1. A) total assets.
  2. B) net income.
  3. C) net working capital.
  4. D) net income before taxes.

 

Page Ref: 195

 

7) The auditors have decided upon a materiality level of $100,000 for their audit of ABC Manufacturing. Which one of the following errors would be considered more important by the auditors? An

  1. A) error in accounts receivable cut-off of $50,000.
  2. B) overstatement of accounts payable by $15,000.
  3. C) error in allocation between accounts receivable and accounts payable by $75,000.
  4. D) illegal payment of $15,000.

 

Page Ref: 195

 

 

8) The materiality for Holloy Company is $75,000. There are carryforward misstatements of $25,000 from the previous year. Current year anticipated misstatements are $15,000, with anticipated corrections of $10,000. What is the performance materiality?

  1. A) $45,000
  2. B) $50,000
  3. C) $55,000
  4. D) $90,000

 

9) Materiality should be adjusted for the effect of net anticipated misstatements to determine performance materiality available for

  1. A) identified misstatements.
  2. B) likely misstatements.
  3. C) unanticipated misstatements.
  4. D) further possible misstatements.

 

Page Ref: 197

 

 

10) When an auditor allocates materiality to segments, then the materiality amount for different accounts under audit will

  1. A) potentially differ from each other.
  2. B) require the same level of unanticipated misstatements.
  3. C) require the same amount of audit work.
  4. D) be the same for each account audited.

 

Page Ref: 198

 

11) The purpose of allocating planning materiality to balance sheet accounts is to

  1. A) assess the appropriate evidence to accumulate for each account on the balance sheet.
  2. B) assess the appropriate evidence to accumulate for each account on both the balance sheet and income statement.
  3. C) reduce the amount of procedures done in the course of the audit.
  4. D) increase the possibility that fraud or illegal activities would be detected by audit procedures.

 

Page Ref: 198

 

 

12) If an auditor were to calculate an estimate of the errors by direct projection from the sample to the population, and found $7,000 of net overstatement errors in a sample of $100,000 out of a total population of $900,000, the estimate of errors in the population is

  1. A) $6,300.
  2. B) $778.
  3. C) $63,000.
  4. D) $77,778.

 

13) A) Discuss each of the six steps in applying materiality in an audit, and identify the audit phase(s) in which each step is performed.

 

  1. B) Discuss the three main factors that affect an auditor’s preliminary judgment about materiality.

 

14) Lauralye Leasing Limited (LLL) provides lease financing to companies and individuals for equipment other than automobiles. Leases on commercial signs make up 50% of total leases, computer and telecommunications equipment are 30% and restaurant equipment makes up most of the remainder. LLL’s customers arrange to buy new equipment from equipment dealers, then contact LLL to arrange lease financing.

 

LLL was founded over thirty years ago by Laura and Al Ye. It is now run by Mr. and Mrs. Ye’s daughter, Betsy, who is the President of LLL. LLL owns a small building downtown, where the offices of the business are located. Unused office space is rented out to other commercial tenants.

Betsy was a classmate of yours at York University, and you have kept loosely in touch over the years. This year, she moved the audit to your firm (a local firm with five partners), deciding that the firm her parents had hired many years ago did not really understand her business’ needs.

 

LLL has a small loan that is used to cover blips in working capital. The company has two salespeople. Most loans are received from stores throughout the city, with whom LLL has standing agreements. If customers require financing, they fill in an application at the store, which is faxed to LLL for approval. LLL will reply within two business days.

 

The company has been profitable for many years. There are no extraordinary items in the current year’s financial statements.

 

Selected financial information is as follows:

 

Current assets                   $9,910,000

Long term assets             $46,500,000

Short term liabilities        $30,700,000

Shareholders’ equity        $25,710,000

Revenue                          $10,200,000

Expenses                           $5,600,000

Income before tax             $4,600,000

(and before bonus)

 

Required:

  1. A) Which base would you use to calculate materiality? Why?
  2. B) Calculate materiality. Choose a specific number, and explain why you chose that amount.

 

  1. B) The range applied to net income is 5% to 10%, which would result in a materiality range of $230,000 to $460,000. The company is a private company, with the shareholders and the bank as users. Due to the few users, we would likely go towards the larger end of this range, i.e. $460,000.

Page Ref: 195

 

 

7.4   Relate the components of the audit risk model to the amount of evidence that should be collected during an audit

 

1) When a different extent of evidence is needed for the various cycles, the difference is caused by

  1. A) errors in the client’s accounting system.
  2. B) the client’s need to achieve an unqualified opinion.
  3. C) the auditor’s need to follow GAAS.
  4. D) the auditor’s expectations of errors and assessment of internal control.

 

Page Ref: 201

 

 

2) Audit risk is ordinarily set by the auditor during planning and

  1. A) held constant for each major cycle and account.
  2. B) held constant for each major cycle but varies by account.
  3. C) varies by each major cycle and by each account.
  4. D) varies by each major cycle but is constant by account.

 

Page Ref: 201

 

 

3) Because control risk and inherent risk vary from cycle to cycle, account to account, or objective to objective,

  1. A) audit risk must also change.
  2. B) planned detection risk and required audit evidence will also vary.
  3. C) planned detection risk will vary but audit evidence will remain constant.
  4. D) planned detection risk will remain constant but audit evidence will vary.

 

Page Ref: 202

 

 

4) When the auditor has the same level of willingness to risk that material errors will exist after the audit is finished for all five cycles,

  1. A) the same amount of evidence will be gathered for each cycle.
  2. B) a different extent of evidence is needed for various cycles.
  3. C) he/she has not followed generally accepted auditing standards.
  4. D) the level for each cycle must be no more than 2% so that the entire audit does not exceed 10%.

 

Page Ref: 202

 

 

5) The audit risk model is

  1. A) a planning, testing, and evaluation model.
  2. B) useful in planning but of limited value in evaluating results.
  3. C) useful in evaluating results but of limited use in planning.
  4. D) useful when performing the tests of balances, but of little value in either the planning or evaluation stages.

 

 

Auditing, 12e (Arens)

Chapter 8   Audit Evidence

 

8.1   Describe five evidence decisions made during the audit process

 

1) CAS 330, the auditor’s response to assessed risks, explains that the auditor needs to link completed audit work to the assessed risks at the assertion level and

  1. A) document the conclusions and results of the audit procedures.
  2. B) perform substantive procedures in areas where there is a high risk of fraud.
  3. C) have the reviewing partner sign off on the assessed risk.
  4. D) ensure that they test the entire population for areas that are considered to have a high risk of errors.

 

Page Ref: 216

 

 

2) “The detailed instructions for the collection of a particular type of audit evidence” that is to be obtained at some time during the audit is the definition of a(n)

  1. A) sampling plan.
  2. B) audit procedure.
  3. C) audit plan.
  4. D) audit program.

 

Page Ref: 217

 

 

3) How frequently does the auditor make a decision with respect to the sample size to be selected?

  1. A) once for the entire audit
  2. B) for each transaction cycle
  3. C) once for each type of audit procedure
  4. D) for each audit procedure

 

Page Ref: 217

 

 

4) Those procedures specifically outlined in an audit program are primarily designed to

  1. A) prevent litigation.
  2. B) detect errors or irregularities.
  3. C) test internal controls.
  4. D) collect evidence.

 

Page Ref: 218

 

 

5) “The detailed instructions for the entire collection of evidence for an audit area” is the definition of a(n)

  1. A) sampling plan.
  2. B) audit procedures.
  3. C) audit plan.
  4. D) audit program.

 

Page Ref: 218

 

 

6) In determining the quantity and quality of evidence to gather, the auditor will be satisfied when the evidence is

  1. A) irrefutable.
  2. B) conclusive.
  3. C) highly persuasive.
  4. D) sufficiently convincing.

 

Page Ref: 218

 

 

7) Audit evidence is generally considered sufficient when

  1. A) it is appropriate.
  2. B) there is enough of it to afford a reasonable basis for an opinion on financial statements.
  3. C) it has the qualities of being relevant, objective, and free from known bias.
  4. D) it has been obtained by random selection.

 

Page Ref: 218

 

 

8) The decision of how many items to test must be made by the auditor for each audit procedure. The sample size for any given procedure

  1. A) will be the same if the same level of assurance is required.
  2. B) must cover the entire period under audit.
  3. C) is focused on high dollar items only.
  4. D) is likely to vary from audit to audit.

 

Page Ref: 218

 

 

9) The two most important factors that determine the appropriate sample size in audits are

  1. A) the auditor’s expectation of errors and the effectiveness of the client’s internal controls.
  2. B) the auditor’s expectation of errors and materiality.
  3. C) the effectiveness of the client’s internal controls and materiality.
  4. D) materiality and the type of audit procedure to be applied to the population.

 

Page Ref: 218

 

10) Which of the following characteristics of samples would make the sample more sufficient? Samples that contain

  1. A) at least one of each type of transaction that is in the population, and have a high number of sample items.
  2. B) items with a high likelihood of error and have large dollar values, as well as being representative of the population.
  3. C) multiple items from different layers of the population (strata), as well as all items that are above the materiality threshold.
  4. D) items that have a high likelihood of error, as well as being related to the audit assertions that are being tested.

 

Page Ref: 218

 

 

11) Evidence is generally considered appropriate when

  1. A) it has the qualities of being relevant, objective, and free from known bias.
  2. B) there is enough of it to afford a reasonable basis for an opinion on financial statements.
  3. C) it has been obtained by random selection.
  4. D) it consists of written statements made by managers of the enterprise under audit.

 

Page Ref: 218-221

 

 

12) To improve the appropriateness of audit evidence, the auditor should

  1. A) make sure to select a larger sample size for the items being tested.
  2. B) add additional population items into the sample, improving sample variety.
  3. C) select audit procedures that improve the reliability of the evidence.
  4. D) select a smaller sample size that is statistically valid.

 

Page Ref: 218

 

 

13) The auditor is tracing from the duplicate sales invoices to related shipping documents with respect to the occurrence transaction-related audit objective. This type of evidence is

  1. A) independent.
  2. B) relevant.
  3. C) timely.
  4. D) related to external documentation.

 

Page Ref: 219

 

 

 

14) Which of the following audit techniques would the auditor use to test the completeness of sales (i.e. test whether shipments have been billed to customers)?

  1. A) trace shipping documents to duplicate sales invoices
  2. B) trace duplicate sales invoices to shipping documents
  3. C) match data file versions of sales invoices to paper records
  4. D) look at subsequent payments after the year end for payments for outstanding invoices

 

Page Ref: 219

 

15) Which of the following types of evidence is most appropriate in the audit of fixed assets?

  1. A) recalculation of the amortization schedule provided by the client
  2. B) auditor inspection of recently acquired fixed assets
  3. C) reperformance of the posting of depreciation expenses to the general ledger
  4. D) analytical review to assess the reasonableness of depreciation expense

 

Page Ref: 220

 

 

16) Which of the following types of evidence would be considered most reliable in the audit of accounts payable?

  1. A) review of internal budgets for the period under audit
  2. B) inquiry of management with respect to recent purchases
  3. C) inspection of client purchase orders
  4. D) inspection of supplier invoices

 

Page Ref: 220

 

 

17) Last year, the client’s internal controls were weak. This year, the internal controls are stronger. This means that information recorded on internal documentation is

  1. A) more timely.
  2. B) less reliable.
  3. C) more reliable.
  4. D) less timely.

 

Page Ref: 220

 

 

 

18) Evidence can be obtained from others, or provided by the auditor, who has good knowledge of each industry but is not an expert. Which of the following types of evidence is considered to be most reliable?

  1. A) examination of diamond inventory by the auditor
  2. B) external confirmations from individual owners of condominium units
  3. C) examination of oil and gas reserves by the auditor
  4. D) external confirmations from financial institutions

 

Page Ref: 220

 

19) Gina is performing the audit of the payables section of Reno Inc. She wants to confirm the payables from an independent source. Which of the following sources would represent an independent provider?

  1. A) Confirm an interco payable with the CEO of the US branch of Reno Inc.
  2. B) Confirm the account payable with Clarkson Corp. The CFO of Clarkson is the wife of the controller of Reno.
  3. C) Confirm the line of credit balance with Citizen Bank. Reno does all its banking with Citizen and it also has a long-term loan there.
  4. D) Confirm the account payable to Suco Inc. The CEO of Reno owns 30% of the outstanding shares of Suco.

 

Page Ref: 220

 

 

20) Which of the following is the best example of objective evidence?

  1. A) a letter written by a client’s lawyer discussing the likely outcome of outstanding lawsuits
  2. B) the physical count of securities and cash by the auditor
  3. C) inquiries of the credit manager about the collectability of noncurrent accounts receivable
  4. D) observation of cobwebs on some inventory bins

 

Page Ref: 220-221

 

 

21) Which of the following is an example of subjective evidence?

  1. A) a positive confirmation of an account receivable
  2. B) a bank confirmation
  3. C) inquiries of the credit manager about the collectability of noncurrent accounts receivable
  4. D) the physical count of securities and cash

 

Page Ref: 220

 

 

 

22) Evidence is usually more persuasive for balance sheet accounts when it is obtained

  1. A) from various times periods throughout the client’s year.
  2. B) only from transactions occurring on the balance sheet date.
  3. C) as close to the balance sheet date as possible.
  4. D) from the time period when transactions in that account were most numerous during the fiscal period.

 

Page Ref: 221

 

 

23) For income statement accounts, evidence is more persuasive if there is a sample from

  1. A) the entire period under audit.
  2. B) the period closest to the end of the fiscal period.
  3. C) at least three months of the fiscal year.
  4. D) December, since this would include large holiday sales.

 

Page Ref: 221

 

24) Inspection of assets is not a sufficient form of evidence when the auditor wants to determine the

  1. A) existence of the asset.
  2. B) quantity and description of the asset.
  3. C) condition or quality of the asset.
  4. D) ownership of the asset.

 

Page Ref: 223

 

 

 

25) The auditor’s decisions regarding evidence accumulation can be broken into five subdecisions. One decision relates to determining the nature of the audit procedure to be used to collect the evidence; i.e., “which audit procedures to use.” Identify and discuss the remaining four audit evidence decisions that the auditor makes.

 

 

26) Identify and explain the three determinants of the persuasiveness of evidence.

27) There are six factors that affect the reliability of audit evidence. One factor is the independence of the provider; i.e., evidence obtained from a source outside the client company is more reliable than that obtained within. Identify and discuss the remaining five factors that affect the appropriateness of evidence.

 

 

8.2   List and explain the seven general methods of evidence collection

 

1) Observation is an important audit technique where the auditor can use sight, hearing, touch, and smell. Observation needs to be used together with other audit techniques because

  1. A) employees will often perform their procedures consistently over time.
  2. B) it is a high cost technique that is rarely used by auditors.
  3. C) it is a point in time technique limited to the time of the observation.
  4. D) auditors may not accurately observe and interpret what is happening.

 

Page Ref: 224

 

 

2) Confirmations from outside organizations such as banks and law firms are

  1. A) a highly regarded and often-used type of evidence.
  2. B) expensive and rarely used during the audit.
  3. C) difficult to obtain and infrequently required.
  4. D) internal documents that provide low quality evidence.

 

Page Ref: 224

 

 

 

3) Mary is entering a fictitious transaction in the sales data entry system to see if the system will reject the order for a client that is already exceeding its credit limit. Mary is using

  1. A) observation.
  2. B) analytical procedures.
  3. C) test data.
  4. D) generalized audit software.

 

Page Ref: 226

 

4) Reperformance is often conducted using computer-assisted audit techniques. The most effective use of generalized audit software for reperformance would be to

  1. A) recalculate a whole class of transactions, helping to quantify dollar errors.
  2. B) determine on a test basis whether posting and summarization is performed accurately.
  3. C) confirm whether evidence has been recorded for the entire period under audit.
  4. D) select a sample of transactions for recalculation.

 

Page Ref: 226

 

 

5) An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of

  1. A) tests of details of balances.
  2. B) procedures to obtain an understanding of internal controls.
  3. C) specialized audit programs.
  4. D) analytical procedures.

 

Page Ref: 226

 

 

6) “Use of comparisons and relationships to determine whether account balances or other data appear reasonable” is a definition of

  1. A) auditing.
  2. B) tests of balances.
  3. C) tests of controls.
  4. D) analytical procedures.

 

Page Ref: 226

 

 

 

7) Although considerable evidence is obtained from the client through inquiry, it usually cannot be regarded as conclusive because

  1. A) the client may not have sufficient knowledge to answer the question.
  2. B) it is not from an independent source and may be biased.
  3. C) there is a risk that the auditor will misinterpret what the client said.
  4. D) the client cannot be trusted to provide persuasive information.

 

Page Ref: 227

 

 

8) Inquiry is a valuable technique during the planning phase of the audit because it

  1. A) involves the rechecking of controls to ensure that they are conducted accurately.
  2. B) is a type of audit evidence that provides a very high level of assurance.
  3. C) is conclusive evidence from an independent source.
  4. D) helps obtain information about how procedures and internal controls operate.

 

Page Ref: 227

 

9) An example of an internal document is

  1. A) a cancelled cheque.
  2. B) a bank statement.
  3. C) a bill of lading for purchases.
  4. D) employees’ time reports.

 

Page Ref: 227

 

 

10) An example of an external document is

  1. A) a cancelled cheque.
  2. B) employees’ time reports.
  3. C) inventory receiving reports.
  4. D) the minutes of the Board of Directors’ meetings.

 

Page Ref: 227

 

 

11) A document which the auditor receives from the client, but which was prepared by someone outside the client’s organization, is a(n)

  1. A) external confirmation.
  2. B) copy of sales invoice.
  3. C) copy of bank note payable.
  4. D) inventory receiving report.

 

Page Ref: 227

 

 

12) When comparing the reliability of external versus internal documents, the external documents are generally considered

  1. A) more reliable.
  2. B) less reliable.
  3. C) equally reliable.
  4. D) unreliable.

 

Page Ref: 227

 

 

13) When the auditor examines the client’s documents and records to support recorded transactions or amounts, it is commonly referred to as

  1. A) inquiry.
  2. B) confirmation.
  3. C) vouching.
  4. D) physical examination.

 

Page Ref: 228

 

14) An example of vouching would be to trace from

  1. A) receiving reports to the acquisitions journal.
  2. B) the acquisitions journal to supporting vendors’ invoices.
  3. C) duplicate bank deposit slips to the cash receipts journal.
  4. D) cancelled cheques to the cash disbursement journal.

 

Page Ref: 228

 

 

 

15) Identify and define the seven methods of audit evidence collection. Which two types of evidence are the most expensive? Which three types of evidence are the least expensive? Which type of evidence would be most persuasive when testing the existence objective for long-term assets?

16) A) Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable?

  1. B) Below are 10 documents typically examined by auditors. Classify each document as either internal or external.

 

Type of

Document

Documents
1. Cancelled cheques for payments of  accounts payable.
2. Payroll time cards.
3. Duplicate sales invoices.
4. Vendor’s invoices.
5. Bank statements.
6. Minutes of the board of directors’ meetings.
7. Signed lease agreements.
8. Notes receivable
9. Subsidiary accounts receivable records.
10. Customer payment remittance advices.

 

17) Below are 12 audit procedures. Classify each procedure according to the following types of audit evidence: (1) inspection, (2) external confirmation, (3) recalculation, (4) observation, (5) inquiry of the client, (6) reperformance, and (7) analytical procedure.

 

Type of

Evidence

Audit Procedures
1. Watch client employees count inventory to determine whether company procedures are being followed.
2. Count inventory items and record the amount in the audit working papers.
3. Stand by the payroll time clock to determine whether any employee “punches in” more than one time.
4. Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of gross margin relative to the preceding year.
5. Obtain information about the client’s internal controls by asking questions of client personnel.
6. Trace totals from the cash disbursements journal to the general ledger.
7. Examine a piece of equipment to make sure a recent purchase of equipment was actually received and is in operation.
8. Review the total of repairs and maintenance for each month to determine whether any month’s total was unusually large.
9. The auditor computes the debt covenant based on the financial information to ensure that the client’s calculation was performed correctly.
10. Re-foot entries in the sales journal to determine whether they were correctly totalled by the client.
11. Make a surprise count of petty cash to verify that the amount of the petty cash fund is intact.
12. Obtain a written statement from the client’s bank stating the client’s year-end balance on deposit.

 

18) Following are examples of evidence that could be collected during an audit of financial statements.

  1. Duplicate copies of sales invoices.
  2. Inspection of new $100,000 cutting machine.
  3. Bank confirmation.

4 Remittance advices.

  1. Vendor’s invoices.
  2. Standard letter from lawyer to auditor.
  3. Auditor inventory count sheets.
  4. Shipping documents.
  5. Payroll cheques.
  6. Long-term debt agreements review notes.
  7. Auditor interest expense calculation worksheet.
  8. Observation by auditor of computer error message (invalid supplier number).
  9. Gross margin calculation.
  10. Interview notes from interview with credit manager.

Required:

Classify each type of evidence as to its reliability (1 – high, 2 – moderate, 3 – low). Justify your classification.

19) An auditor is conducting the audit of the financial statements of a retail department store. The auditor is aware that he must obtain sufficient appropriate evidence with respect to various audit assertions associated with management assertions and thus with material financial statement amounts.

The following is a list of specific audit procedures the accountant plans to perform:

  1. Send negative external confirmation requests to a large sample of the store’s customers with balances due on account at year end.
  2. Perform test counts of goods on hand during the company’s normal physical inventory taking, one month prior to the year end.
  3. Examine receiving reports dated prior to the year end which have not been matched to vendor’s invoices.
  4. Review paid invoices and supporting documents for amounts classified as repair and maintenance expense for large or unusual items.
  5. Examine audited financial statements of several foreign companies in which the client owns shares, and which are being held as temporary investments.

Required:

For each of the five audit procedures listed, describe only the PRIMARY management assertion being tested, the PRIMARY audit assertion being tested, and the quality of evidence (high, medium, low) obtained, explaining WHY the evidence is the quality level you specify.

 

 

20) The following are audit procedures in the sales and collection cycle.

  1. Inspect a sample of shipping documents to determine if each has a sales invoice number included on it.
  2. Discuss with the sales manager whether any sales allowances have been granted after the balance sheet date that may apply to the current period.
  3. Add the columns on the aged trial balance and compare the total with the general ledger.
  4. Observe whether the controller makes an independent comparison of the total in the general ledger with the trial balance of accounts receivable.
  5. For the month of May, count the approximate number of shipping documents filed in the shipping department, and compare the total with the number of sales invoices in the sales journal.
  6. Compare the date on a sample of shipping documents throughout the year with related duplicate sales invoices and the accounts receivable master file.
  7. Examine a sample of customer orders and see if each has a credit authorization.
  8. Send letters directly to former customers whose accounts have been written off as uncollectible to determine if any have actually been paid.
  9. Examine the master file of accounts receivable to see if each has an indication of “C” for a regular customer, “N” for interest-bearing receivables, and “R” for related parties.
  10. Compare the date on a sample of shipping documents a few days before and after the balance sheet date with related sales journal transactions.

Required:

For each procedure, identify the type of evidence being used. For each procedure, identify either the transaction-related audit objective(s) being met or the balance-related audit objective(s) being met.

 

 

8.3   Discuss methods used to choose the types of evidence to collect

 

1) Which one of the following forms of evidence would be least persuasive in forming the auditor’s opinion?

  1. A) the auditor’s count of marketable securities
  2. B) correspondence with a stockbroker regarding the quantity of client’s investments held in street name by the broker
  3. C) minutes of the board of directors authorizing the purchase of stock as an investment
  4. D) responses to auditor’s questions by the president and controller regarding the investments account

 

Page Ref: 230

 

 

2) Audit evidence can come in different forms with different degrees of persuasiveness. Which of the following is the least persuasive type of evidence?

  1. A) bank statement obtained from the client
  2. B) computations made by the auditor
  3. C) prenumbered client sales invoices
  4. D) vendor’s invoice

 

Page Ref: 230

 

 

3) Which one of the following forms of evidence would be least reliable?

  1. A) monthly bank statement
  2. B) positive confirmation of customer’s balance
  3. C) a letter from client’s lawyer stating that there are no known lawsuits pending against client
  4. D) client’s file copy of a purchase requisition

 

Page Ref: 230

 

 

4) Most auditors prefer to replace external confirmation with analytical procedures whenever possible because the

  1. A) analytical procedures are more reliable.
  2. B) external confirmations are more expensive.
  3. C) analytical procedures are more persuasive.
  4. D) tests of details are more difficult to interpret.

 

Page Ref: 230

 

 

5) The Bank of New Haven relies heavily on computers to calculate the settlements of amounts due to other banks. Given that the process is highly automated, the auditor would not be able to obtain sufficient evidence with substantive procedures. The auditors of the Bank of New Haven should

  1. A) design and perform tests of controls.
  2. B) qualify the opinion for the section on settlements.
  3. C) hire a specialist to give an opinion on the proper functioning of the system.
  4. D) perform a walkthrough of the system.

 

Page Ref: 232

 

 

 

6) For each of the following audit procedures, state and describe the type of audit evidence, state the audit assertion that it applies to, and describe the reliability of the evidence (with reasons).

 

  1. A) Watch staff scan products and enter cash received.

 

  1. B) Reconcile daily cash drawer receipts (cash, debit card sales, credit card sales) with daily sales for one week.

 

  1. C) Calculate daily gross profit and gross profit by product line.

 

  1. D) Account for a sequence of sales documents.

 

 

 

8.4   Define analytical procedures and state when they are used during the audit process

 

1) When an auditor calculates the gross margin as a percent of sales and compares it with previous periods, this type of evidence is called

  1. A) physical examination.
  2. B) analytical procedures.
  3. C) observation.
  4. D) enquiries of client.

 

Page Ref: 232

 

 

2) When a higher than normal ratio of long-term debt to net worth is coupled with a lower than average ratio of profits to total assets, the company

  1. A) is highly successful.
  2. B) is comparable with industry standards.
  3. C) has a high risk of financial failure.
  4. D) has a liquidity problem.

 

Page Ref: 234

 

 

 

3) An aspect of analytical procedures is referred to as “attention-directing” when it highlights

  1. A) errors.
  2. B) irregularities.
  3. C) areas of improvement.
  4. D) areas that need more detailed procedures.

 

Page Ref: 234

 

4) For some audit objectives and in some circumstances, analytical procedures may be the most effective procedure to apply. The objectives that most likely would benefit from the use of analytical review with respect to the allowance for uncollectible accounts would be

  1. A) validity of sales transactions recorded for individual customer accounts.
  2. B) classification and completeness of transactions, accuracy of judgments and estimates.
  3. C) collectability of individual customer account balances.
  4. D) allocation of transactions to the proper accounting period.

 

Page Ref: 234

 

 

5) During final review of working papers and financial statements, possible oversights in the audit can be identified by

  1. A) the partner’s knowledge of the client’s business combined with effective analytical procedures.
  2. B) conducting a closing interview with management of the client.
  3. C) conducting a meeting with the audit team.
  4. D) review the minutes from the board meetings.

 

Page Ref: 234

 

 

6) An important benefit of industry comparisons is as

  1. A) an aid to understanding the client’s performance.
  2. B) an indicator of errors.
  3. C) an indicator of irregularities.
  4. D) a least-cost indicator for audit procedures.

 

Page Ref: 236

 

 

 

7) If most companies in the industry use FIFO inventory valuation and straight-line depreciation, and the audit client uses LIFO and double-declining balance, comparisons of client and industry data

  1. A) will be a meaningful highlight of the result of these differences in accounting methods.
  2. B) will enable the auditor to spot errors but not irregularities.
  3. C) will enable the auditor to spot irregularities but not errors.
  4. D) may not be meaningful, affecting the comparability of data.

 

Page Ref: 236

 

 

8) When the current year’s unaudited trial balance amounts are compared to the prior year’s audited trial balance amounts,

  1. A) errors are identified.
  2. B) discrepancies are discovered.
  3. C) irregularities become apparent.
  4. D) significant changes in balances are highlighted.

 

Page Ref: 236

 

9) A common comparison occurs when the auditor calculates the expected balance and compares it with the actual balance. The auditor’s expected account balance may be determined by

  1. A) using industry standards.
  2. B) using credit bureau reports.
  3. C) relating it to some other balance sheet or income statement account or accounts.
  4. D) inquiry of the client.

 

Page Ref: 239

 

 

10) The most common statistical technique for analytical procedures is

  1. A) analysis of variance.
  2. B) bell-curve analysis.
  3. C) time-series analysis.
  4. D) regression analysis.

 

Page Ref: 240

 

 

 

11) A major benefit of computerized analytical procedures is the

  1. A) ease of doing the calculations.
  2. B) ease of updating the calculations.
  3. C) ease of correcting math calculations.
  4. D) ability to push the work down to lower levels of the audit staff to do the analysis.

 

12) A) There are four important purposes of analytical procedures. Identify each of these four purposes and, for each purpose, give a specific example of an analytical procedure that an auditor might perform.

 

  1. B) Identify each of the five major types of analytical procedures and give an example of each.

 

  1. C) One purpose of performing analytical procedures in the planning phase of an audit is to assess the client’s financial condition. Explain how the assessment of a client’s financial condition can affect the auditor’s decisions concerning evidence accumulation in later phases of the audit.

 

 

Auditing, 12e (Arens)

Chapter 9   Internal Controls and Control Risk

 

9.1   State the three primary objectives of effective internal control

 

1) A system of internal control consists of policies and procedures designed to provide management with

  1. A) reasonable assurance that the company achieves its objectives.
  2. B) assurance that fraud will be prevented.
  3. C) reasonable assurance that fraud will be detected.
  4. D) assurance that the firm’s resources will be used in the optimal way.

 

Page Ref: 254

 

 

2) Management’s objectives with respect to internal control include

  1. A) having reasonable assurance that the financial statements are in accordance with IFRS or ASPE.
  2. B) ensuring that all policies and procedures are clearly documented to reduce employee training costs.
  3. C) preventing fraud and illegal activities at all costs.
  4. D) providing reasonable assurance that the goals and objectives important to the entity have been met.

 

Page Ref: 254

 

 

3) Management safeguards assets by

  1. A) having the internal auditors conduct periodic counts of physical assets.
  2. B) controlling access and by comparison of physical items to records.
  3. C) requiring the external auditors to do surprise audits.
  4. D) having management sign a management representation letter.

 

Page Ref: 255

 

 

4) Carrie is the manager of the Bay Street Pharmacy. Carrie is considering implementing a security tag system to reduce the losses related to stolen goods at their store. The system Carrie is looking at currently costs $60,000 and is expected to be effective for 5 years. In order to justify the implementation of the security tag system, average theft per year should be at least

  1. A) $1,000.
  2. B) $12,000.
  3. C) $60,000.
  4. D) theft should be prevented at all costs.

 

5) Which one of the following controls would be of concern to management, but not to the auditor? Controls over the

  1. A) collection of accounts receivable amounts.
  2. B) entry of payroll wage rates into the computer systems.
  3. C) distribution of promotional information to present and potential clients.
  4. D) cost of inventory items as recorded in the perpetual inventory system.

 

Page Ref: 256

 

 

6) To comply with the second examination standard, the auditor need not be concerned with all areas of internal control that apply to management. The auditor’s primary concerns are with the system’s ability to

  1. A) maintain reliable control systems pertaining to financial transactions.
  2. B) promote efficiency and encourage adherence to policy.
  3. C) prevent and detect financial statement fraud and error.
  4. D) provide reliable data and safeguard assets.

 

Page Ref: 256

 

 

7) The accuracy of the results of the accounting system (account balances) is heavily dependent upon the

  1. A) knowledge and skills of the auditor.
  2. B) adequacy of the entity level controls.
  3. C) accuracy of the inputs and processing (transactions).
  4. D) training provided to the personnel.

 

Page Ref: 257

 

 

8) The auditor may identify some risks that cannot be effectively tested by substantive tests alone, for example, when there are paperless transactions (perhaps using EDI – electronic data interchange). Then the auditor is required, to address those risks, to

  1. A) assess the design effectiveness of relevant controls, and test them
  2. B) obtain an understanding of the controls and test them if reliance is intended
  3. C) obtain an understanding of the controls and assess their design effectiveness
  4. D) test the controls that address the paperless aspects of the transactions

 

9) Internal controls can never be regarded as completely effective. Even if systems personnel could design an ideal system, its effectiveness depends on the

  1. A) adequacy of the computer system.
  2. B) proper implementation by management.
  3. C) ability of the internal audit staff to maintain it.
  4. D) competency and dependability of the people using it.

 

Page Ref: 258

 

10) It is important for the public accountant to consider the competence of the audit clients’ employees because their competence bears directly and importantly upon the

  1. A) cost/benefit relationship of internal controls.
  2. B) achievement of the objectives of the system of internal control.
  3. C) comparison of recorded accountability with assets.
  4. D) timing of the tests to be performed.

 

Page Ref: 258

 

 

11) Which of the following best describes the inherent limitations that should be recognized by an auditor when considering the potential effectiveness of an accounting system?

  1. A) Procedures whose effectiveness depends on segregation of duties can be circumvented by collusion.
  2. B) The competence and integrity of client personnel provides an environment conducive to accounting control and provides assurance that effective control will be achieved.
  3. C) Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against irregularities perpetrated by management.
  4. D) The benefits expected to be derived from effective accounting system usually do not exceed the costs of such control.

 

Page Ref: 258

 

 

12) An act of two or more employees to work together to misstate records is called

  1. A) malfeasance.
  2. B) collusion.
  3. C) defalcation.
  4. D) felony.

 

13) Three conditions for fraud are referred to as the “fraud triangle.” One of the sides of this triangle is incentives or pressures. The other two sides are

  1. A) opportunities, a desire to meet debt repayment obligations.
  2. B) opportunities, attitudes or rationalizations.
  3. C) attitudes or rationalizations, the need to maintain stock prices.
  4. D) the need to maintain stock prices and meet debt repayment obligations.

 

Page Ref: 259

 

14) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of a management “incentives or pressures” risk factor?

  1. A) Customer demand for a new product line was significantly less than expected.
  2. B) Management and the auditors disagree upon how to value a large contract in progress.
  3. C) There is only one board member who understands financial statements, and she has suffered a heart attack.
  4. D) There has been significant turnover in the accounting department in the last year.

 

Page Ref: 259

 

 

15) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of a management “opportunities” risk factor?

  1. A) The company has lost a major account and income is falling.
  2. B) Two major competitors have gone bankrupt as margins decline in the industry.
  3. C) The chief executive officer owns forty percent of the outstanding share capital.
  4. D) New accounting standards provide three different methods for valuing financial instruments.

 

Page Ref: 259

 

 

16) Which of the following is a factor that relates to “incentives or pressures” to commit fraudulent financial reporting?

  1. A) Significant accounting estimates involving subjective judgments
  2. B) Excessive pressure for management to meet debt covenant requirements
  3. C) Management’s practice of making overly achievable forecasts
  4. D) High turnover of accounting, internal audit and information technology staff

 

Page Ref: 259

 

 

 

17) Which of the following is a factor that relates to “attitudes or rationalization” to commit fraudulent financial reporting?

  1. A) Significant accounting estimates involving subjective judgments
  2. B) Excessive pressure for management to meet debt repayment requirements
  3. C) Management’s practice of making overly aggressive forecasts
  4. D) High turnover of accounting, internal audit and information technology staff

 

Page Ref: 259

 

18) A) Describe the three broad objectives of management when designing an effective system of internal control.

  1. B) Describe the aspect of internal control with which auditors are primarily concerned with for a financial statement audit.

 

 

 

19) A) Describe the three basic concepts (assumptions) underlying the study of internal control and assessment of control risk.

  1. B) Describe the inherent limitations of internal control.

 

20) Joan is the owner of a small manufacturing company. In prior years, your firm has conducted a review engagement of the company. However, this year, Joan obtained a loan from the federal business development bank, and is required to have an audit of her financial statements. When you started asking about controls and procedures at the company, Joan got pretty upset.

 

“All you need to be concerned about is the numbers! Why are you asking all of these questions? It takes too much time away from my staff to answer these questions! Just check the numbers and let us get on with our work!”

 

You calmed her down a bit, and reminded her about the general discussion that occurred with the engagement letter. You invited her for coffee to briefly explain the following items:

  1. Why auditors are concerned about internal controls
  2. Why auditors are required to be concerned about internal controls
  3. What you need to do to understand internal controls
  4. What you will do once you have documented your understanding of internal controls

 

Required:

Explain what you would say to Joan.

 

21) You, PA, have been assigned as in charge auditor of a long-time audit client of your firm, Mikla Tool Inc. (MTI). MTI is owned by George Mikla, an experienced machinist. George established the business over 20 years ago, and it has grown into a $10 million a year business, with an excellent reputation for high quality machined parts. MTI has regular clients in the automobile parts sector and in the health care sector. The company has recently begun producing parts for environmentally friendly products, such as recycling containers. This is due to the business’ versatility in dealing with a variety of metals as well as plastics using both manually controlled and machine controlled (computerized) equipment. The following description is based upon your review of prior files, and planning discussions with personnel at MTI.

 

Equipment suppliers have helped MTI develop efficient operations, by providing sample programs for standard operations and by providing training to employees. One of the suppliers unfortunately sent sample programs that had been infected by a virus. George’s daughter, Tiffany, had to cleanse the servers and each of the machines using her copy of the anti-virus software. When contacted, the supplier did not know that the software was infected, and apologized profusely!

 

The company’s four CAD/CAM terminals and printers are connected to the company’s central local area network. The local area network is maintained by Toni Lee, the owner of a computer shop conveniently located three blocks away. All computer equipment, software and supplies are now purchased from Mr. Lee, who is responsible for attaching and maintaining equipment, upgrading software, and maintaining user profiles on the network. To reduce the amount of Mr. Lee’s work as network administrator, he has set up passwords by function.

 

There is one user identification code (userid) and password for accounting (shared by Tiffany, George and the accounting clerk, Isabel). The plant supervisors share another userid that is used for production control and to initiate the timekeeping system every morning. A separate userid and password allowing for only enquiry into the job costing system has also been set up, and can be used by all employees.

 

A standard routine has been set up to back up the accounting systems. Either Tiffany or the accounting clerk inserts one of seven tape cartridges into the system at the end of the day (they are labelled with the day of the week), so that the company has a full set of accounting

backups for the week. Tiffany keeps these in her office. These are particularly important, since during the last office move, two years ago, the original software for the accounting system was misplaced.

 

The network has two central servers, eleven user stations, and five printers. The user stations are set up as follows: four CAD/CAM, two time keeping, two production planning and control, two accounting and one for George.

 

A good working relationship is extremely important for satisfying some of the company’s larger customers. MTI has paid for computer equipment for each of the supervisors, so that they have fully functioning computers at home. If a rush job requires weekend work, then these senior personnel can work at home to get the necessary quoting or design work completed. Since the ‘at home’ systems are identical to the office systems Mr. Lee simply copied across the MTI systems to the home computers. Files can be easily taken home and then brought back to the office using thumb drives. It is understood that when times are slower, a day off can be taken to compensate for this weekend work.

 

It is almost ten years ago that Tiffany arranged for the implementation of the network, and the purchase of the standard integrated accounting packages (general ledger, order entry/accounts receivable, purchases/payable and payroll), and for the purchase of the job costing and time keeping systems. A variety of reports are printed daily, weekly, or monthly from the job costing system which are used for monitoring employee hours, the status of the jobs, the costs accumulated for particular jobs, and the work in progress inventory.

 

The weekly report of hours from the job costing system is approved by the production supervisors, and is used as an input source for hours worked into the payroll system. The accounting clerk enters the hours into the accounting system, so that weekly payroll cheques and reports can be produced. The accounting clerk handles most data entry.

 

Tiffany is really pleased with their accounting clerk, Isabel, who has been with the company for three years. She insists that fate had a hand in getting Isabel working for MTI. Isabel had been ‘pounding the pavement,’ having recently immigrated, and had no Canadian business experience. Her accounting skills were rudimentary, but she quickly learned the accounting software, and has reorganized the filing systems. Tiffany considers her as indispensable. When Isabel goes on holiday, many things just don’t get done! Tiffany can do the payroll in a pinch, but accounts payable and cash disbursements are always done by Isabel. If she’s away, suppliers are simply told to wait, or Tiffany issues a manual cheque for recording later. Isabel is very good at clearing queries from suppliers, and ensuring that new suppliers are set up properly. The purchasing supervisor and his staff rely on Isabel, for she checks the account allocation of purchases and makes any necessary corrections.

 

Tiffany or George are signing officers, although Tiffany realizes that she checks supporting materials more thoroughly than George, who usually just queries Isabel verbally about larger purchases.

 

In the past, MTI’s audit has been entirely substantive. However, your partner has decided that with MTI’s growth, it is time for the company to consider adding additional internal controls. Accordingly, he has asked you to draft a management letter, to be addressed to George and Tiffany.

 

Required:

 

  1. A) Prepare a draft management letter, clearly identifying the weaknesses (W), impact or implications of the weaknesses (I), and recommendations for improvement (R).

[The following is a theory question that does not require examples from the case, although examples could be used.]

 

  1. B) Explain how the control environment and general IT (information technology) controls are related. Describe the impact of the control environment and of general IT controls upon different types of application controls and upon the audit process.

 

 

 

 

9.2   Explain the five components of the COSO internal control framework and relate these to the audit process

 

1) The essence of an effectively controlled organization lies in the

  1. A) effectiveness of its auditor.
  2. B) effectiveness of its internal auditor.
  3. C) attitude of its employees.
  4. D) attitude of its management.

 

Page Ref: 262

 

2) The control environment consists of actions, policies and procedures that

  1. A) reflect the overall attitudes of top management, the directors and the owners of an entity about control and its importance.
  2. B) govern access to particular applications, such as how employees use passwords to change master file payroll rates.
  3. C) are recorded on the web site, for example, access policies to data.
  4. D) help implement the ethical attitudes at the organization, such as a computer usage policy.

 

3) The board of directors is essential for effective corporate governance because it has ultimate responsibility to

  1. A) make sure management implements proper internal control and financial reporting processes.
  2. B) assist management in the preparation of the financial statements.
  3. C) test internal controls and ensure they are working properly.
  4. D) provide a report to the auditor confirming that internal controls are working properly.

 

Page Ref: 263

 

 

4) To help with corporate governance and a positive “tone at the top,” the board of directors and its committees, such as the audit committee, should

  1. A) rubber stamp the financial statements once per year.
  2. B) consist of all members of executive management.
  3. C) follow the policies and procedures approved by management.
  4. D) take an active role in overseeing the company.

 

Page Ref: 264

 

 

5) A well-designed organizational structure at an entity

  1. A) has operations and programming personnel tasks combined.
  2. B) clearly defines authority and responsibility assignments.
  3. C) requires that wage rates are recorded and tracked by the human resources department.
  4. D) has the internal audit department report to the Chief Financial Officer.

 

Page Ref: 264

 

6) The methods that management uses to supervise the entity’s activities are called

  1. A) personnel practices.
  2. B) management control methods.
  3. C) methods of assigning authority and responsibility.
  4. D) management’s operating style.

 

7) External auditor Mary Smith may not rely on the work of internal auditor Ray Jones unless

  1. A) Jones is certified (CA, CGA or CMA).
  2. B) Jones is independent of the client.
  3. C) Jones is supervised by Smith.
  4. D) Smith obtains evidence that supports the competence, integrity, and objectivity of Jones.

 

Page Ref: 265

 

 

8) The first step for management in the risk assessment process is to identify factors that may increase risk, for example failure to meet prior objectives. Then, management will

  1. A) assess the likelihood of the risk occurring.
  2. B) make sure that procedures are developed to eliminate the risk.
  3. C) estimate the significance of that risk.
  4. D) develop specific actions to reduce the risk to an acceptable level.

 

Page Ref: 265

 

 

9) Management assesses risks as a part of designing and operating internal controls to minimize fraud and errors. Auditors assess risks to

  1. A) decide the evidence needed in the audit.
  2. B) fully implement the audit risk model.
  3. C) enable them to assess the completeness of internal controls.
  4. D) make sure that the company will continue to operate over the next year.

 

Page Ref: 267

 

10) FiddleWare Limited uses purchased packaged application software to handle the processing of its transactions. An important control that management should implement with respect to information systems is the

  1. A) use of a formal systems development methodology.
  2. B) evaluation of potential new systems against organizational objectives.
  3. C) use of appropriate checkpoints and milestones during development.
  4. D) tracking of routine program maintenance changes.

 

11) An example of general computer control systems that provide reasonable assurance of authorization of application systems is

  1. A) operations and information systems support.
  2. B) systems, acquisition, development and maintenance controls.
  3. C) organization and management controls.
  4. D) application system control procedures.

 

Page Ref: 268

 

 

12) Which of the following duties would indicate a weakness in internal controls? The

  1. A) accounting function is under the controller.
  2. B) custodianship of cash is the responsibility of the treasurer’s function.
  3. C) internal auditor reports to the board of directors.
  4. D) custodianship of buildings and equipment is the responsibility of the controller’s function.

 

Page Ref: 269

 

 

13) The operational responsibility and the recording of transactions are normally kept separate

  1. A) to centralize activities in order to be more cost efficient.
  2. B) to ensure unbiased information is recorded.
  3. C) because operational personnel rarely has the necessary accounting skills to record transactions.
  4. D) to avoid confusion of responsibilities and duplication of efforts.

 

Page Ref: 269

 

14) Why is it important to separate systems development (or acquisition) and program maintenance activities from accounting?

  1. A) Accounting personnel have the expertise to evaluate program changes that have been implemented.
  2. B) Custody of media is important to help ensure ongoing operations.
  3. C) This allows accounting to reconcile transaction totals to transaction details.
  4. D) Lack of separation could result in unauthorized changes to programs and systems.

 

Page Ref: 269

 

 

 

15) Which one of the following is an example of a general authorization?

  1. A) The highest credit limit allowed for accounts receivable is $50,000.
  2. B) ABC Company has a credit limit of $25,000.
  3. C) Each supervisory wage rate must be approved by the executive manager.
  4. D) Grocery supervisors approve each transaction reversal over five dollars.

 

Page Ref: 270

 

 

16) Which one of the following is an example of a specific authorization?

  1. A) The computer systems automatically reorder inventory when quantities fall below the economic order quantity.
  2. B) The highest credit limit allowed for accounts receivable customers is $100,000.
  3. C) Each sales transaction that exceeds the credit limit of a customer must be approved by the controller.
  4. D) Grocery sales clerks may approve returns of goods less than ten dollars in value.

 

Page Ref: 270

 

 

17) The chart of accounts is an important control because it provides the framework for determining the information presented to management and other financial statement users. What type of errors is the chart of accounts helpful in preventing? It helps prevent errors of

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

 

Page Ref: 271

 

18) An important type of protective measure for safeguarding assets and records is

  1. A) adequate segregation of duties among personnel.
  2. B) proper authorization of transactions.
  3. C) the use of physical precautions.
  4. D) adequate documentation.

 

Page Ref: 271

 

 

 

19) An essential characteristic of the persons performing internal check procedures is

  1. A) independence from the original data preparer.
  2. B) a thorough knowledge of accounting.
  3. C) an analytical and inquisitive mind.
  4. D) competence in data entry skills.

 

Page Ref: 272

 

 

20) A major control available in a small company, which might not be feasible in a large company, is

  1. A) a wider segregation of duties.
  2. B) use of sequentially numbered documents.
  3. C) fewer transactions to process.
  4. D) the owner-manager’s personal interest and close relationship with the personnel.

 

Page Ref: 273

 

 

21) Effective internal control in a small company that has an insufficient number of employees to permit proper division of responsibilities can best be enhanced by

  1. A) employment of temporary personnel to aid in the segregation of duties.
  2. B) direct participation by the owner of the business in the record-keeping activities of the business.
  3. C) engaging a public accountant to perform monthly “write-up” work.
  4. D) delegation of full, clear-cut responsibility to each employee for the functions assigned to each.

 

22) A) The COSO internal control framework consists of five components. Describe each of these components.

 

  1. B) Custody of assets and reconciliation should be separated to contribute to strong internal control. List the general categories of activities that should be separated.

 

23) A) Discuss what is meant by the term “control environment” and identify four control environment subcomponents that the auditor should consider.

 

  1. B) List the steps that management follows in assessing risks relevant to the preparation of financial statements in conformity with an applicable financial reporting framework.

 

  1. C) How does the auditor obtain knowledge about management’s risk assessment process?

 

  1. D) Explain how management’s risk assessment process differs from the auditor’s risk assessment process.

 

  1. E) What is the relationship between management’s risk assessment process and audit evidence?

 

  1. E) There is an inverse relationship: if management effectively assesses and responds to risks, the auditor will typically accumulate less evidence than when management fails to identify or respond to significant risks.

Page Ref: 262-267

 

 

24) A) List the three types of general computer control systems.

 

  1. B) Adequate segregation of duties is an important control procedure. Describe the specific functions that should be separated for segregation of duties to prevent both intentional and unintentional misstatements that are of significance to auditors.

 

  1. C) Adequate documents and records are important for effective internal control. Five principles dictate the proper design and use of documents and records. One principle is that documents and records should be prenumbered consecutively to facilitate control over missing documents, and to aid in locating documents when they are needed at a later date. Discuss each of the other four principles of adequate documents and records.

 

25) Dimple Leather is a chain of retail stores that sells leather clothing and accessories across Canada. Each store has point of sale equipment that is linked to a local server. At night, local accounting information is transmitted to the head office computer and any updates to prices or other adjustments are transferred to the local office.

Required:

Define the control environment. List the components of the control environment. For each component, provide an example of a control that might exist at Dimple Leather.

efinition: The control environment consists of the actions, policies and procedures that reflect the overall attitudes of top management, the directors, and the owners of an entity about control and its importance to the entity.

26) Porterville, Ontario, is the home of the largest leather tanning operation in Canada. Hides from various animals are stretched and treated, then cut into shapes for shipment to wholesalers.

 

Computer assisted operations are important in maintaining temperature, humidity, and proper mix proportions in chemical solutions used for the tanning process. Computer assistance has helped improve the quality of the tanning process, as well as provide a safer environment for employees. Computer operations and backup is supported by the warehouse manager, Joe.

 

Individual hides are tagged with a bar code and tracked for quality control purposes. The HomeTown Tanning Company uses a centralized microcomputer based system for its manufacturing and accounting operations. The two owners of the company are active in the business, and approve all new hardware and software acquisitions.

 

The controller is responsible for network upgrades as well as maintaining passwords and user identification codes on the network. Accounting transactions are entered by accounting staff, although the controller has the ability to review and correct transactions.

 

Required:

List the six categories of functions that need to be separated from each other. Does HomeTown Tanning have these functions separated? For any functions that are not separated, indicate the potential impact upon controls and upon the audit.

 

  1. Separation of authorization from control over assets: Yes. Controller and owners are responsible for authorization, while the warehouse manager has custody of assets.

Page Ref: 268-270

 

 

9.3   Define information technology governance. Describe the attributes of good IT governance

 

1) Jenny is the information technology support manager at CMH. Jenny is considered to be a super-user at CMH since she can circumvent normal controls. In order to address the risk of super-users, management should

  1. A) remove the super-user.
  2. B) establish effective compensating controls.
  3. C) update the background check on the super-user on a yearly basis.
  4. D) ensure that the super-user is familiar with the code of conduct of the company.

 

Page Ref: 276

Learning Obj.:   9-3  Define information technology governance. Describe the attributes of good IT governance

 

2) Bravo Design had IMB consulting design a custom software to record the job costs and sales in progress. What acquisition process did Bravo design follow?

  1. A) In-house development
  2. B) Systems acquisition
  3. C) Turnkey software development
  4. D) Outsourcing

 

Page Ref: 278

Learning Obj.:   9-3  Define information technology governance. Describe the attributes of good IT governance

 

9.4   Describe what the auditor does to obtain an understanding of internal controls

 

1) When the auditor attempts to determine the operation of the accounting system by tracing one or a few transactions through the accounting system, this is referred to as

  1. A) tracing.
  2. B) vouching.
  3. C) tests of controls.
  4. D) a walk-through.

 

Page Ref: 282

 

2) Once an understanding of internal controls is obtained that is sufficient for audit planning, then the auditor must first assess

  1. A) whether a lower level of control risk could be supported.
  2. B) whether the financial statements are auditable.
  3. C) the level of control risk supported by the understanding obtained.
  4. D) the level of control risk to use.

 

Page Ref: 282

 

3) Control risk is a measure of the auditor’s expectation that internal controls will

  1. A) prevent material misstatements from occurring.
  2. B) detect and correct material misstatements.
  3. C) either prevent material misstatements or detect and correct them.
  4. D) neither prevent material misstatements nor detect and correct them.

 

Page Ref: 283

 

4) When planning the audit, the auditor’s decision on the appropriate assessed level of control risk to use is

  1. A) an economic issue, trading off the costs of testing controls against the cost of testing balances.
  2. B) calculated by using the audit risk model.
  3. C) calculated by using a standard formula.
  4. D) determined by using actuarial tables.

 

Page Ref: 283

 

5) The procedures to test effectiveness of control policies and procedures in support of a reduced assessed control risk are called

  1. A) tests of details of balances.
  2. B) tests of controls.
  3. C) analytical procedures.
  4. D) a walk-through.

 

Page Ref: 284

6) Narratives, flowcharts, and internal control questionnaires are three commonly used methods of

  1. A) documenting the auditor’s understanding of internal controls.
  2. B) testing internal controls.
  3. C) designing the audit manual and procedures.
  4. D) documenting the auditor’s understanding of client’s organizational structure.

 

Page Ref: 286

 

7) Paul is in the process of performing procedures to obtain the necessary understanding of the client’s internal controls. As part of this process, Paul received from the client completed narratives, flowcharts and internal control questionnaires. Paul can use this information from the client

  1. A) if the entity level controls and tone at the top were found to be effective.
  2. B) if there has not been any significant change in the internal controls since the prior year.
  3. C) as long as any subsequent reliance on controls is adequately substantiated with testing.
  4. D) since it was prepared by management who are unbiased.

 

Page Ref: 287

 

8) When a compensating control exists, a weakness in the system

  1. A) is no longer a concern because the potential for misstatement has been sufficiently reduced.
  2. B) is reduced but not removed; therefore, it is still of concern to the auditor.
  3. C) could cause a material loss, so it must be tested using substantive procedures.
  4. D) is magnified and must be removed from the sampling process and examined in its entirety.

 

Page Ref: 289

 

 

9) When the auditor identifies opportunities for the client to make operational improvements in the internal control system, it will be communicated to the client’s audit committee in the

  1. A) management letter.
  2. B) reportable conditions letter.
  3. C) engagement letter.
  4. D) audit report.

 

Page Ref: 292

10) A secondary objective of the auditor’s study and evaluation of internal control is that the study and evaluation provide

  1. A) a basis for constructive suggestions concerning improvements in internal control.
  2. B) a basis for reliance on the accounting system.
  3. C) an assurance that the records and documents have been maintained in accordance with existing company policies and procedures.
  4. D) an indication that management and employees are trustworthy.

 

Page Ref: 292-293

 

11) Each key control that the auditor intends to rely on must be supported by sufficient

  1. A) tests of details of balances.
  2. B) tests of controls.
  3. C) analytical review procedures.
  4. D) reperformance procedures.

 

Page Ref: 294

 

12) A procedure that would most likely be used by an auditor in performing tests of control procedures that involve segregation of functions and that leave no transaction trail is

  1. A) inspection.
  2. B) observation.
  3. C) reperformance.
  4. D) reconciliation.

 

Page Ref: 294

 

13) Ideally, tests of controls should be applied to controls

  1. A) at the balance sheet date.
  2. B) at each quarterly interim period.
  3. C) for the entire period under audit.
  4. D) at the beginning of the fiscal period.

 

Page Ref: 295

 

14) After considering a client’s internal controls, an auditor has concluded that it is well designed and is functioning as intended. Under these circumstances, the auditor would most likely

  1. A) perform tests of controls to the extent outlined in the audit program.
  2. B) determine the control procedures that should prevent or detect errors and irregularities.
  3. C) use a combined audit approach that includes tests of controls and substantive tests.
  4. D) determine whether transactions are recorded to permit preparation of financial statements in accordance with generally accepted accounting principles.

 

Page Ref: 296

15) A) Step one in the auditor’s study and evaluation of internal control is obtain understanding of internal control for audit planning purposes. List each of the remaining steps.

 

  1. B) Once the auditor has an understanding of internal control, two assessments are made. List each assessment that must be made prior to testing controls.

 

  1. C) Describe five common procedures an auditor can use to obtain an understanding of internal control design.

 

16) You have just finished documenting your understanding of cycle controls at an audit engagement.

 

Required:

 

  1. A) Explain how you will identify the controls that will be tested.

 

  1. B) What process will you follow for weakness in internal controls?

 

9.5   Identify important risks and controls in small businesses

 

1)

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

 

 

Auditing, 12e (Arens)

Chapter 10   Audit Strategy and Audit Program

 

10.1   Explain what an audit strategy is

 

1) A planned approach to the conduct of audit testing, taking into account assessed risks, is called an

  1. A) audit approach.
  2. B) audit plan.
  3. C) audit program.
  4. D) audit strategy.

 

Page Ref: 308

 

 

2) Audit risk is assessed at which level of the audit?

  1. A) account
  2. B) cycle
  3. C) transaction-related audit objective
  4. D) overall audit

 

Page Ref: 309

 

 

3) Materiality is used to help decide the scope of testing, help determine the sample size and to help

  1. A) develop the audit report.
  2. B) decide which analytical review calculations to use.
  3. C) evaluate the results of testing.
  4. D) conduct understanding of business tests.

 

Page Ref: 311

 

 

4) Risks of fraud are assessed at which level(s) of the audit?

  1. A) overall audit, transaction-related audit objectives
  2. B) balance-related audit objectives only
  3. C) overall audit, cycle and account
  4. D) cycle, account and transaction-related audit objectives

 

Page Ref: 311-312

 

 

 

5) Which of the following areas is considered to have a high risk of fraud in the retail industry?

  1. A) point-of-sale sales
  2. B) customer refunds
  3. C) credit sales
  4. D) completeness of payroll

 

Page Ref: 312

 

6) CAS 240 requires which of the following to be considered a significant risk?

  1. A) revenue recognition
  2. B) inventory valuation
  3. C) accounts receivable valuation
  4. D) calculation of income taxes

 

Page Ref: 312

 

 

7) A substantive procedure is used to

  1. A) assess the likelihood of material misstatement in the financial statements.
  2. B) obtain an understanding of internal controls.
  3. C) analyze the account balance to see if there are potential errors.
  4. D) quantify the amount of potential error in an account or transaction stream.

 

Page Ref: 312

 

 

8) A procedure designed to test for dollar errors or irregularities directly affecting the correctness of financial statement balances is a

  1. A) substantive test.
  2. B) analytical test.
  3. C) test of controls.
  4. D) definition of dollar-unit sampling.

 

Page Ref: 312

 

 

9) When the auditor has determined that there is a significant risk of misstatement for a particular assertion (for example, completeness of revenue), what type of audit testing does CAS 330 require?

  1. A) tests of risk assessment
  2. B) tests of understanding of internal control
  3. C) control tests
  4. D) substantive tests

 

Page Ref: 312

 

10) The auditor of ABC Ltd. has concluded that there are significant risks of misstatement of revenue at the company, with potential overstatement of revenue. Which of the following audit tests should the auditor conduct to address this significant risk?

  1. A) control tests of authorization, to ensure that credit limits for sales are all approved by the sales manager
  2. B) analytical review of sales, comparing sales trends over the last five years by division and to the industry
  3. C) examination of sales after the year end to quantify potential cut-off errors (income from the subsequent period included in the current year)
  4. D) risk assessment procedures, looking carefully at inherent risks associated with the handling of cash in the sales cycle

 

Page Ref: 312

 

 

11) When the auditor assesses the likelihood of material misstatement in the financial statements, the auditor will use

  1. A) risk assessment procedures.
  2. B) procedures to obtain an understanding.
  3. C) tests of control.
  4. D) assessment of design effectiveness of controls.

 

Page Ref: 312

 

 

12) An example of an audit procedure that relates to the auditor’s understanding of internal control is

  1. A) reperform the counting of physical inventory.
  2. B) inspect documents and records.
  3. C) recalculate the depreciation expenses.
  4. D) trace all legal expenses to supporting invoices.

 

Page Ref: 313

 

 

13) An example of an audit procedure that relates to the auditor’s understanding of internal control is

  1. A) count petty cash at all locations.
  2. B) use test data to verify functioning of data entry controls.
  3. C) observe entity activities and operations.
  4. D) trace all large fixed asset purchases to supporting invoices.

 

Page Ref: 313

 

 

14) The purpose of tests of controls is to provide reasonable assurance that the

  1. A) accounting treatment of transactions and balances is valid and proper.
  2. B) accounting control procedures are operating effectively.
  3. C) entity has complied with disclosure requirements of generally accepted accounting framework.
  4. D) entity has complied with requirements of quality control.

 

Page Ref: 313

 

 

15) Eleonar is inspecting a sample of “Code of Conduct acknowledgement forms” that must be signed by all employees to indicate that they have read and understood the company’s code of conduct. Eleonar is ensuring that they have been signed by the employee. Eleonar is performing

  1. A) a test of controls.
  2. B) an analytical procedure.
  3. C) a substantive procedure.
  4. D) a procedure to obtain an understanding of internal controls.

 

Page Ref: 313

 

 

16) The auditor selects several transactions in each functional area and traces them through the entire accounting system, paying special attention to evidence about whether or not the control features are in operation. This is an example of a

  1. A) sequence test.
  2. B) test of controls.
  3. C) substantive test.
  4. D) functional test.

 

Page Ref: 313

 

 

17) The auditor would like to design a test of control to test the following key control: “there is a separation of duties between billing, recording sales, and handling of cash receipts.” Which of the following typical tests of controls would be suitable?

  1. A) match the amounts billed to the amounts recorded
  2. B) verify that sales have been recorded in the proper period
  3. C) trace cash receipts to the duplicate bank deposit slips
  4. D) inquire about the duties of the accounting personnel

 

Page Ref: 314

 

 

18) The auditor would like to design a test of control to test the following key control: “shipping documents are issued in numerical order by the computer and are accounted for weekly.” Which of the following typical tests of controls would be suitable?

  1. A) trace sales documents issued to the sales journal and trace the daily total to the general ledger
  2. B) ask the shipping department about the process that they use to issue shipping documents, paying particular attention to continuity of numerical sequence
  3. C) use computer assisted audit testing to determine whether there are any numbers in the sequence missing (gap detection)
  4. D) match shipments to the associated sales invoice

 

Page Ref: 314

 

 

19) The auditor would like to design a test of control to test the following key control: “unit selling prices are obtained from the price list master file of approved prices.” Which of the following typical tests of controls would be suitable?

  1. A) compare prices used on sales invoices to the authorized customer purchase order
  2. B) review change to price file throughout the year for proper authorizations and trace prices to copy of sales invoice
  3. C) use analytical review to compare total sales last year to total sales this year
  4. D) discuss the process used to authorize sales prices with the sales manager and the controller

 

Page Ref: 314

 

 

20) The auditor would like to design a test of control to test the following key control: “statements are mailed to all customers each month.” Which of the following typical tests of controls would be suitable?

  1. A) inquire about who is responsible for mailing the statements
  2. B) find out whether customers pay by statement or by invoice
  3. C) reconcile subsequent payments to particular invoices
  4. D) match remittance advices from customers to customer statements

 

Page Ref: 314

 

 

21) If no material fluctuations are found using analytical procedures and the auditor concludes that differences should not have occurred,

  1. A) it will be necessary to increase the tests of details of balances.
  2. B) other tests may be reduced.
  3. C) it will be necessary to increase the tests of controls.
  4. D) it will not be necessary to perform tests of details of balances.

 

Page Ref: 315

 

 

22) Donna sees a large variation in the gross margin percentage as a result of analytical procedures she performed. This means that

  1. A) Donna should perform more tests.
  2. B) the financial statements contain an error.
  3. C) Donna cannot rely on the company’s internal controls.
  4. D) Donna should document this difference.

 

Page Ref: 315

 

 

23) Which of the following is an example of a substantive test that could be used for the audit of the accuracy of sales prices?

  1. A) inspect sales price master authorization forms for the presence of an approval signature
  2. B) observe that the point-of-sale system automatically pulls sales prices from the master file
  3. C) inquire about the process that is used to update sales prices in the sales price master file
  4. D) calculate the gross margin for each product that is sold by the company

 

Page Ref: 318

 

 

24) The auditor has decided that there is a risk of material misstatement with respect to sales revenue. Which of the following audit tests should the auditor use to quantify the potential error?

  1. A) discuss the process used to assign credit limits with the sales manager and the controller
  2. B) send external confirmations to customers with accounts receivable balances
  3. C) determine whether all sales tested have a supporting customer purchase order
  4. D) determine whether all sales tested have a matching bill of lading

 

Page Ref: 315

 

 

25) The auditor has completed analyzing the results of tests of details of the accounts receivable ending balance. Errors totaling $25,000 were found. These exceptions are

  1. A) indications that the credit limit is being incorrectly applied.
  2. B) probably cut-off errors that can be explained.
  3. C) an indication of potential errors in the ending balance.
  4. D) financial statement misstatements.

 

Page Ref: 316

 

 

 

26) In the context of an audit of financial statements, substantive tests are audit procedures that

  1. A) may be eliminated under certain conditions.
  2. B) are designed to discover significant subsequent events.
  3. C) may be either direct tests of financial balances, or analytical tests.
  4. D) will increase proportionately with the auditor’s reliance on internal control.

 

Page Ref: 316

 

27) Performance of tests of controls provide evidence in support of the specific controls that contribute to the auditor’s assessed control risk (where it is reduced below 100%). Also, when dual-purpose tests are used, evidence is also obtained in support of

  1. A) the nature of illegal acts that occurred.
  2. B) the quantitative effects of fraud risks.
  3. C) statistical ratios to assist analytical review.
  4. D) monetary correctness of transactions.

 

Page Ref: 316

 

 

28) The auditor verifies the summarizing, accuracy, and posting of entries by performing

  1. A) analytical procedures.
  2. B) tests of controls.
  3. C) dual-purpose tests.
  4. D) procedures to gain an understanding of internal control.

 

Page Ref: 316

 

 

 

29) A) Describe the five types of audit tests used to determine whether financial statements are fairly stated. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk.

 

  1. B) There are several types of audit procedures that relate to the auditor’s understanding of internal control. One type of procedure is “Update and evaluate the auditor’s previous experience with the entity.” Identify the five additional types of procedures related to understanding internal control, and four types of procedures that are used to test controls.

 

 

30) Discuss the purposes of tests of controls and tests of details of balances. Give an example of each.

 

31) Greenvale Construction Limited was started by four brothers who lived in the Toronto area. Over time, the brothers have moved to different parts of the country. They decided it was a good idea to keep the company, and organize their work as separate divisions as part of the same company. There are now three divisions, one for each of the brothers who are actively involved in construction. The fourth brother, Ted, is responsible for accounting and record keeping. Ted went back to school and completed an accounting designation, and now has three employees in the accounting area.

 

Each of the brothers has moved on to specialize in a different kind of construction work. In Toronto, it is mainly new home construction. In Edmonton, the work is primarily renovations of large homes and small commercial enterprises, while in Halifax, the work is completely commercial on mid-to-large projects. All of the brothers prefer to subcontract their work rather than hiring full time construction employees, although some of the subcontract relationships have lasted over fifteen years now.

Required:

Explain what you would do to document your understanding of internal control for Greenvale. Identify potential risk areas where you would need to focus additional attention.

 

 

 

32) Samru has been assigned the sales cycle as part of an audit team. He will be evaluating several key controls in the sales cycle and conducting tests of detail for accounts receivable.

 

Samru has been told to look at 15 customers with respect to the credit limit approval process (a test of control). Then, he has been told to use dual purpose tests for the rest of his testing.

 

Required:

Explain the relationship between tests of controls, dual purpose tests and tests of details.

33) You are a senior at a PA firm and this is your junior’s first day. He would like you to explain to him what are the different types of audit tests that should be performed over the course of an audit to obtain sufficient and appropriate audit evidence. Further, please indicate to which component of audit risk the type of test is linked.

 

34) Restaurant Products Company (RPC) has been an audit client of your firm for many years. RPC has a March 31 fiscal year end. The company is a successful distributor of restaurant and food industry products, such as trays, weigh scales, dishes, cooking implements. The company sells to businesses only (i.e. not to end consumers), with clients ranging from small restaurants to large food service chains and hotels. The company does have a perpetual inventory system, but the current inventory system relies upon accurate data entry of receipts, shipments and inventory adjustments from paper documents.

RPC is looking to improve inventory management and maintain costs in the face of rising competition and growth. Accordingly, it is implementing RFID (radio frequency identification) technology for its inventory in January 2012. RFID chips will be placed on warehouse shelf locations, boxes of products, and on large cost individual products. At the same time the company will implement a wireless mesh system throughout the warehouse, with wireless tracking of product movement. Effective January 31, 2012 a new inventory management system is being implemented to facilitate better decision making and access to online realtime inventory data. The new inventory management system will include a new database that will include internal records of inventory on hand, receipts and shipments of inventory, purchase order details, and payment details.

Required:

 

  1. For each phase of the financial statement audit process, describe the phase, and explain how the audit process is affected or changed due to the implementation of the new database management system.

 

  1. What is the impact of the implementation of RFID on the financial statement audit process?

[Note that these points must be different from those raised in Part A above.]

 

 

10.2   Explain why determining evidence mix is a dynamic process

 

1) Which of the following audit tests is usually the most costly to perform?

  1. A) analytical procedures
  2. B) tests of controls
  3. C) tests of details of balances
  4. D) procedures to obtain an understanding of internal control

 

Page Ref: 318

 

 

2) When considering the relationships between types of audit tests and evidence, which of the following procedures are used for both obtaining an understanding of internal control and for conducting tests of controls?

  1. A) inspection, recalculation, observation, inquiry, and reperformance
  2. B) inspection, recalculation, external confirmation, and reperformance
  3. C) recalculation, observation, inquiry, analytical procedures and reperformance
  4. D) analytical procedures, inspection, recalculation and reperformance

 

Page Ref: 317-318

 

 

3) When considering the relationships between types of audit tests and evidence, which of the following procedures is used only for tests of details of balances?

  1. A) inspection
  2. B) recalculation
  3. C) reperformance
  4. D) external confirmation

 

Page Ref: 317

 

 

4) When considering the relationships between types of audit tests and evidence, which of the following procedures is suitable for use for all types of audit tests (procedures to obtain an understanding of internal control, tests of controls, analytical procedures, and tests of details of balances)?

  1. A) inspection
  2. B) observation
  3. C) inquiries of the client
  4. D) recalculation

 

Page Ref: 317

 

 

5) After finishing the procedures to obtain an understanding of internal control in an audit engagement, the auditor should perform tests of controls on

  1. A) those controls that the auditor plans to rely upon.
  2. B) those controls in which material weaknesses were identified.
  3. C) those controls that have a material effect upon the financial statement balances.
  4. D) a random sample of the controls that were reviewed.

 

Page Ref: 318

 

 

6) Control risk has been assessed at 100% for your client. What audit approach will you follow?

  1. A) combined approach.
  2. B) substantive approach.
  3. C) reliance on analytical review and tests of controls.
  4. D) reliance on tests of controls and tests of details.

 

Page Ref: 318

 

 

7) PA has designed an audit approach where she places maximum possible reliance on controls. This means that she will be

  1. A) conducting only tests of controls.
  2. B) using analytical review and tests of controls.
  3. C) following a combined audit approach.
  4. D) setting control risk at 100%.

 

Page Ref: 318

 

 

 

8) Which of the following audit tests is usually the least costly to perform?

  1. A) analytical procedures
  2. B) tests of controls
  3. C) tests of balances
  4. D) confirmations

 

Page Ref: 318

 

9) The auditor has conducted tests of controls of the write off of accounts receivable and found two exceptions. These exceptions are

  1. A) an indication of the likelihood of errors or fraud and other irregularities.
  2. B) confirmation that controls are not functioning as designed throughout the year.
  3. C) information about the quantity of the dollar error in accounts receivable.
  4. D) indications that employee training is required in the accounting area.

 

Page Ref: 319

 

 

10) Symco Inc has a policy that all cash disbursements of $2,000 or more must be approved by the treasurer. While performing a test of controls on a sample of disbursements, Craig discovered that the assistant controller had authorized a cash disbursement of $3,500 while the treasurer was on vacation. This control deviation is significant only if

  1. A) it is determined that the assistant controller is not qualified to approve cash disbursements of this size.
  2. B) it occurred with sufficient frequency to cause the auditor to believe there may be material dollar misstatements in the statements.
  3. C) the amount of the deviation identified is larger than the planning materiality.
  4. D) the amount of the deviation identified is larger than the planning materiality and no compensating control exists.

 

Page Ref: 319

 

 

11) If the auditor is not using tests of control, then

  1. A) tests of detail must be used.
  2. B) analytical procedures must be used.
  3. C) tests of design of internal controls must at least be used.
  4. D) the auditor will have to qualify the audit opinion.

 

Page Ref: 319

 

 

 

12) When the auditor identifies an area of the accounting system with missing controls (i.e., a weakness or deviation), this would lead to a modification of the audit program in that area that would

  1. A) increase the amount of tests of controls.
  2. B) increase the reliance on tests of controls.
  3. C) cause the issuance of a qualified or adverse opinion.
  4. D) eliminate the need for a test of controls.

 

Page Ref: 319

 

13) The auditor is deciding upon audit procedures to be used in the audit for a particular cycle (i.e. what combination of the four types of tests are needed to obtain sufficient appropriate audit evidence). This type of decision is called

  1. A) audit risk.
  2. B) audit strategy.
  3. C) evidence mix.
  4. D) detection risk.

 

Page Ref: 320

 

 

14) There will be heavy emphasis on tests of controls when

  1. A) controls are ineffective and assessed control risk is high.
  2. B) controls are effective and assessed control risk is low.
  3. C) the auditor is doing a “fraud audit.”
  4. D) it is a first-year audit.

 

Page Ref: 322

 

 

15) PA is conducting the audit of Middi Furniture Company, a medium-sized company with few effective controls and significant inherent risks. Management has decided that it is not cost-effective to implement better internal controls. What audit strategy will PA likely select for this client?

  1. A) combined audit approach for all transaction cycles and accounts
  2. B) substantive audit approach for all transaction cycles and accounts
  3. C) combined audit approach for all cycles except cash and inventory
  4. D) substantive audit approach for all cycles except sales and payroll

 

Page Ref: 322

 

 

 

16) The highest cost audit will be incurred when the auditor expects that the internal control system would

  1. A) be effective, but the auditor found extensive control test deviations.
  2. B) have few effective controls, but client’s personnel were well-trained and knowledgeable.
  3. C) be very sophisticated, and the tests of controls confirmed this.
  4. D) have few effective controls, and tests of balances found many errors.

 

Page Ref: 322

 

 

17) The audit program for most audits is designed in three parts. Those parts are

  1. A) risk assessment procedures, tests of controls, and tests of details.
  2. B) risk assessment procedures, analytical procedures, and tests of details.
  3. C) obtaining an understanding of internal controls, analytical procedures, and tests of details.
  4. D) tests of controls, analytical procedures, and tests of details of balances.

 

Type: MC

 

18) A) There are seven types of audit evidence: inspection, observation, inquiries of the client, external confirmation, recalculation, reperformance, 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) analytical procedures, and (3) tests of details of balances.

 

  1. B) 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.

 

  1. C) Types of audit tests include tests of controls, analytical procedures, and tests of details of balances. Please rank the preceding three types of tests from least costly to most costly.

 

19) You are conducting the audit of a medium-sized company that has a chief accountant and three employees. Segregation of duties is excellent, with jobs allocated to provide maximum levels of controls. Segregation is supported by accounting software with user identification and password that limits functions to the appropriate job.

 

Required:

 

  1. A) What type of audit approach would you recommend? Why?

 

  1. B) How would your answer change if the accounting department was organized on a job sharing basis so that all employees did some of every task to keep the work more interesting? Why?

 

 

20) “This is really confusing! I’ve sat in on three audit planning meetings so far, and each one has gone differently. I’ve been responsible for the sales section each time. Sure the risks are all different, but in the first one I’m supposed to do flowcharts and detailed narrative for the sales systems, in the second one I’m supposed to use the firm’s computerized system to answer detailed questions, and in the last one the partner only wants a brief description of the system in narrative form – no more than one page, he said.”

 

Required:

Explain why it may be necessary to do different types of documentation to support an understanding of internal controls, in the context of risks and evidence mix.

 

 

10.3   Describe the methodology for designing tests of controls and tests of details in the audit program

 

1) Which of the following ultimately determines the specific audit procedures necessary to provide an auditor with a reasonable basis for the expression of an opinion?

  1. A) the audit program
  2. B) the auditor’s professional judgment
  3. C) generally accepted auditing standards
  4. D) the auditor’s working papers

 

Page Ref: 324

 

2) After completing tests of key controls, the auditor should review the results and consider whether

  1. A) the planned degree of reliance on internal controls is justified.
  2. B) the audit evidence obtained from the study of internal controls can provide a reasonable basis for an opinion.
  3. C) further study of internal controls is likely to justify any restriction of tests of details of balances.
  4. D) sufficient knowledge has been obtained about the entity’s entire internal control structure.

 

Page Ref: 323

 

 

3) Analytical procedures are mandatory during which phases of the audit?

  1. A) tests of controls and tests of details
  2. B) planning and final evaluation
  3. C) planning and tests of details
  4. D) tests of details and final evaluation

 

Page Ref: 324

 

 

4) Choosing the appropriate analytical procedures requires the auditor to use

  1. A) the standards developed by the auditor’s firm.
  2. B) automated working paper software.
  3. C) computer assisted audit techniques.
  4. D) professional judgment.

 

Page Ref: 324

 

 

5) When does the auditor normally conduct tests of controls?

  1. A) prior to the completion of the tests of details
  2. B) after the completion of all analytical review
  3. C) prior to the preparation of the client risk analysis
  4. D) prior to the finalization of the audit risk model

 

Page Ref: 324

 

6) Last year the materiality for the client was $590,000. This year it is $400,000. All things being equal, how will the change in materiality affect the extent of tests of details?

  1. A) increase
  2. B) decrease
  3. C) no effect as the tests of controls will be increased
  4. D) no effect as the tests of controls will be decreased

 

Page Ref: 325

 

 

7) Julianne is performing an analysis of the bad debt expense as a percentage of total sales. When performing the analytical procedure, it is important that Julianne

  1. A) can rely on the internal controls of the accounts receivable process.
  2. B) has an expectation of the result that should be obtained.
  3. C) has concluded that the accounts receivable balance is free from material misstatement.
  4. D) has requested permission from the client.

 

Page Ref: 325

 

 

8) Tests of details are designed based upon planned results of analytical review and planned results of tests of controls. Should the planned results differ materially from the actual results of analytical review and tests of controls then

  1. A) audit risk will be revised.
  2. B) the planned audit program will require revision.
  3. C) inherent risk will be revised.
  4. D) tests of controls will not be considered for overall risk assessment processes.

 

Page Ref: 326

 

 

 

9) Cimco Forest is a client of your PA firm that has requested that the audit of its financial statements be completed 25 days after its year end. Given the time constraint, the auditor

  1. A) should not accept Cimco as a client.
  2. B) should increase the size of the audit team.
  3. C) can perform audit procedures at an interim date and roll forward the interim balances to year end.
  4. D) should change the audit program to include more tests of controls and less tests of details as they are more time consuming.

 

Page Ref: 326

 

10) A standard audit program can dramatically increase

  1. A) audit efficiency.
  2. B) quality of audit evidence.
  3. C) communication between the audit team.
  4. D) the amount of work that can be delegated to more junior staff members.

 

11) Jane is a sole practitioner operating out of a local office. She is part of a regional group of firms, and occasionally does a small audit, with the assistance of one staff person. Using automated working paper software, she runs a standard set of analytical review calculations for each audit, then puts them in the working paper file. She does not look at the analytical review process again.

 

Since most of her audit clients have no internal controls, she then calculates materiality, and conducts a substantive audit. She prefers to do more substantive testing rather than having to do all kinds of work with internal controls.

 

Required:

What is wrong with Jane’s audit approach?

 

 

10.4   Describe the impact on the audit process of a client conversion to IFRS

 

1)

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

 

 

Auditing, 12e (Arens)

Chapter 11   Audit Sampling Concepts

 

11.1   Define sampling. Decide when an auditor would use statistical rather than nonstatistical sampling

 

1) CAS 530 has a very specific definition of sampling. Assuming that each item (described as a sampling unit) in the populations below could be selected as part of the sample, which of the following illustrates the other part of the CAS 530 definition of sampling?

  1. A) looking at 50 sales invoices from the current population of 100,000
  2. B) recalculating interest calculations for notes payable
  3. C) estimating the gross profit by product for all company products
  4. D) inspecting all legal invoices for potential contingent liabilities

 

Page Ref: 337

 

 

2) A sample in which the characteristics of the sample are the same as those of the population is a(n)

  1. A) random sample.
  2. B) variables sample.
  3. C) attribute sample.
  4. D) representative sample.

 

Page Ref: 338

 

 

3) Assume that the client’s internal controls require a clerk to attach a shipping document to every duplicate sales invoice. But this procedure is not followed exactly 3 percent of the time. If the auditor selects a sample of 200 duplicate sales invoices, which of the following sample results is most representative of the population?

  1. A) three shipping documents are missing
  2. B) six shipping documents are missing
  3. C) five shipping document are missing
  4. D) there were no shipping documents missing

 

Page Ref: 338

 

 

 

4) Nonsampling errors occur when audit tests do not uncover existing exceptions in the

  1. A) population.
  2. B) sample.
  3. C) planning stage.
  4. D) financial statements.

 

Page Ref: 338

 

5) One of the causes of nonsampling error is

  1. A) the use of inappropriate or ineffective audit procedures.
  2. B) failure to draw a random sample.
  3. C) failure to draw a representative sample.
  4. D) the use of attribute sampling instead of variables sampling.

 

Page Ref: 338

 

 

6) One of the ways to eliminate nonsampling risk is through

  1. A) proper supervision and instruction of the client’s employees.
  2. B) proper supervision and instruction of the audit team.
  3. C) the use of attribute sampling rather than variables sampling.
  4. D) controls which ensure that the sample drawn is random and representative.

 

Page Ref: 338

 

 

7) Sampling risk (sampling error) is an inherent part of sampling that results from

  1. A) inappropriate audit procedures.
  2. B) failure to recognize exceptions.
  3. C) testing less than the entire population.
  4. D) weaknesses in the client’s internal control system.

 

Page Ref: 338

 

 

 

8) One of the ways to reduce sampling risk is to

  1. A) use an appropriate method of selecting sample items from the population.
  2. B) carefully design the audit procedures to be used.
  3. C) provide proper supervision and instruction of the audit team.
  4. D) use variables sampling rather than attribute sampling.

 

Page Ref: 339

 

 

9) One of the purposes of using statistical sampling is to quantify sampling risk. For which of the following audit tests would sampling risk be zero? The auditor

  1. A) used monetary unit sampling to select a sample of payroll payments.
  2. B) used attribute sampling to select a sample of shipping documents.
  3. C) sent empty (zero balance) external confirmations to suppliers with large dollar balances.
  4. D) sent external confirmations to all financial institutions used by the client.

 

Page Ref: 339

 

10) Carrie found an error in the sample she tested from the population of accounts receivable that was over 90 days old.  The error found by Carrie should be extrapolated to the population of

  1. A) all past due accounts receivable.
  2. B) accounts receivable over 90 days.
  3. C) all accounts receivable.
  4. D) current accounts receivable.

 

Page Ref: 339

 

 

11) An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods

  1. A) afford greater assurance and clarity than a nonstatistical sample of equal size.
  2. B) provide an objective basis for quantitatively evaluating sample risks.
  3. C) can more easily convert the sample into a dual-purpose test useful for substantive testing.
  4. D) eliminate the need to use judgment in determining appropriate sample sizes.

 

Page Ref: 339

 

 

 

12) The auditing standards indicate that

  1. A) it is preferable to use statistical sampling instead of non-statistical sampling.
  2. B) it is preferable to use non-statistical sampling instead of statistical sampling.
  3. C) it is equally acceptable to use either statistical or non-statistical sampling.
  4. D) non-statistical sampling should only be used if statistical sampling is too costly to use.

 

Page Ref: 340

 

 

13) An example of judgmental sampling is

  1. A) block sampling.
  2. B) simple random sample selection.
  3. C) systematic sample selection.
  4. D) proportionate-to-size sample selection.

 

Page Ref: 340

 

14) The auditor has decided to audit all accounts receivable amounts that are over 120 days old and over $5,000. What type of sample selection method is the auditor using?

  1. A) haphazard
  2. B) systematic
  3. C) directed
  4. D) block

 

Page Ref: 340

 

 

15) The auditor has selected a sequence of 200 payroll cheques to verify the numerical continuity of the cheque numbers. What type of sampling is the auditor doing?

  1. A) haphazard
  2. B) systematic
  3. C) directed
  4. D) block

 

Page Ref: 341

 

 

 

16) A common use of block testing is testing

  1. A) cut-off.
  2. B) existense.
  3. C) authorization.
  4. D) valuation.

 

Page Ref: 341

 

 

17) When the auditor goes through a population and selects items for the sample without regard to their size, source, or other distinguishing characteristics, it is called

  1. A) block selection.
  2. B) haphazard selection.
  3. C) systematic selection.
  4. D) statistical selection.

 

Page Ref: 342

 

18) Which of the following statements is a valid criticism of the use of non-statistical sampling methods?

  1. A) Many audit tests, such as footing of journals, must be performed outside a statistical sampling context.
  2. B) The cost of performing random selection or testing often exceeds the benefits.
  3. C) Nonstatistical sampling does not differ substantially from statistical sampling methods.
  4. D) The difficulty of remaining unbiased in the selection of items.

 

Page Ref: 342

 

 

19) The auditor wants to trace credits from the accounts receivable transaction history files to the duplicate bank deposit slips and other authorized sources as a test for fictitious credits in the data files. Which of the following sampling methods would be the least costly to use in this situation?

  1. A) simple random
  2. B) block
  3. C) systematic
  4. D) probability proportionate-to-size

 

Page Ref: 342

 

 

 

20) An underlying feature of the random-based selection of items is that each

  1. A) stratum of the population be given equal representation in the sample.
  2. B) each item in the population must be randomly ordered.
  3. C) each item in the population should have an equal opportunity to be selected.
  4. D) each item must be systematically selected using replacement.

 

Page Ref: 342

 

21) A) Discuss what is meant by “sampling risk.”

 

  1. B) Discuss what is meant by “nonsampling risk.”

 

  1. C) Discuss two causes of nonsampling risk. Also discuss ways the auditor can control nonsampling risk.

 

  1. D) Discuss two ways the auditor can control sampling risk.

 

22) A) Describe the differences between statistical and nonstatistical sampling in terms of (1) the sample selection methods used, and (2) measurement (quantification) of sampling risk.

 

  1. B) Describe each of the three types of sample selection methods commonly associated with nonstatistical audit sampling.

 

  1. C) Directed sample selection is the selection of each item in the sample based on some judgment criteria established by the auditor. Describe three commonly used criteria.

 

23) Kyle is performing a test of detail using a non-statistical sample.

 

  1. A) Can Kyle formally measure sampling error?

 

  1. B) What should Kyle consider in determining the sampling error?

 

 

11.2   Explain the three different ways that an auditor can select a statistical sample

 

1) When statistical sampling is used, the sample selected must be a probabilistic one. In addition, the auditor should

  1. A) use the haphazard selection method to make sure that the sample is properly selected.
  2. B) use appropriate statistical evaluation methods of non-sampling risk computations.
  3. C) request the client to review the sample and approve all items that are selected.
  4. D) use appropriate statistical evaluation methods of sampling risk computations.

 

Page Ref: 340

 

 

2) When the auditor intends to evaluate a sample statistically, the only acceptable selection method is

  1. A) probabilistic selection.
  2. B) judgmental selection.
  3. C) haphazard selection.
  4. D) block selection.

 

3) When does the auditor use simple random sampling?

  1. A) when the auditor has a particular judgmental criteria that is used to select the sample
  2. B) where the auditor wants numbers in sequence and would like to select the sample rapidly
  3. C) for testing of cut-off after the year end with respect to accounts payable
  4. D) for populations where each item is considered to have the same characteristics for audit purposes

 

Page Ref: 342

 

 

4) The process which requires the calculation of an interval and then selects the items based on the size of the interval is

  1. A) statistical sampling.
  2. B) random selection.
  3. C) systematic selection.
  4. D) computerized selection.

 

Page Ref: 343

 

 

5) In systematic selection, population size is divided by the number of sample items desired in order to determine the

  1. A) interval.
  2. B) tolerable exception rate.
  3. C) computed upper exception rate.
  4. D) mean.

 

Page Ref: 343

 

6) When systematic sample selection is used, the first item is selected randomly and all other items are selected automatically.  If the characteristic of interest is not distributed randomly in the population, the systematic selection creates the possibility of

  1. A) bias.
  2. B) abnormal frequency distribution.
  3. C) judgmental intervention in the process.
  4. D) selecting mostly larger dollar items.

 

7) In performing a review of his client’s cash disbursements, a public accountant uses systematic sampling with a random start. The primary disadvantage of systematic sampling is that population items

  1. A) must be reordered in a systematic pattern before the sample can be drawn.
  2. B) may occur in a systematic pattern, thus negating the randomness of the sample.
  3. C) may occur twice in the sample.
  4. D) must be replaced in the population after sampling to permit valid statistical inference.

 

Page Ref: 343

 

 

8) A method of sampling in which all the items in the population are divided into two or more subpopulations is

  1. A) variables sampling.
  2. B) attribute sampling.
  3. C) stratified sampling.
  4. D) divisible sampling.

 

Page Ref: 344

 

 

9) When the auditor would like to improve the efficiency of the audit by focusing work on transactions that may be more subject to material error in a particular area of the population, the auditor will use

  1. A) block testing.
  2. B) haphazard sample selection.
  3. C) random sample selection.
  4. D) stratified sample selection.

 

Page Ref: 344

 

 

10) Which of the following best describes what the auditor means by the exception rate in the attribute sampling plan? The

  1. A) number of errors that can reasonably be expected to be found in a population.
  2. B) frequency with which a certain characteristic occurs within a population.
  3. C) degree of confidence that the sample is representative of the population.
  4. D) dollar range within which the true population total can be expected to fall.

 

Page Ref: 344

 

 

11) A statistical method used to estimate the proportion of items in a population containing a characteristic of interest is

  1. A) population-proportional-to-size sampling.
  2. B) attribute sampling.
  3. C) variables sampling.
  4. D) estimation sampling.

 

Page Ref: 344

 

 

12) A public accountant examining inventory may appropriately apply sampling for attributes in order to estimate the

  1. A) average price of inventory items.
  2. B) percentage of slow-moving inventory items.
  3. C) dollar value of inventory.
  4. D) physical quantity of inventory items.

 

Page Ref: 344

 

 

13) The occurrence rate or exception rate for attribute sampling is defined as the

  1. A) exception rate that the auditor will permit in the population and still be willing to use the assessed control risk.
  2. B) risk that the auditor is willing to take of accepting a balance as correct when the true misstatement in the balance is greater than materiality.
  3. C) exception rate that the auditor expects to find in the population before testing begins.
  4. D) ratio of the items containing a specific attribute to the total number of population items.

 

Page Ref: 344

 

 

14) If an auditor would like to estimate how many sales invoices have errors (such as no required order number showing or authorization for customers exceeding their credit limit) , the auditor would likely use

  1. A) random sampling with replacement.
  2. B) sampling for attributes.
  3. C) sampling for variables.
  4. D) stratified random sampling.

 

Page Ref: 344

 

 

 

15) The auditor is going to select a sample to find out whether any potentially fraudulent transactions have been processed. The auditor should use what type of sampling?

  1. A) attribute sampling
  2. B) discovery sampling
  3. C) monetary unit sampling
  4. D) variable estimation sampling

 

Page Ref: 344

 

16) The auditor is going to select a sample of accounts receivable to circulate external confirmations, and then estimate the total dollar value of the accounts receivable balance. The auditor should use what type of sampling?

  1. A) attribute sampling
  2. B) discovery sampling
  3. C) monetary unit sampling
  4. D) variable estimation sampling

 

Page Ref: 344

 

 

17) The most common method used for performing statistical tests of controls is

  1. A) variables sampling.
  2. B) attribute sampling.
  3. C) judgment sampling.
  4. D) random selection of samples.

 

Page Ref: 345

 

 

18) Attribute sampling would be an appropriate method to use on which one of the following procedures in an audit program?

  1. A) Review sales transactions for large and unreasonable amounts.
  2. B) Observe whether the duties of the accounts receivable clerk are separate from handling cash.
  3. C) Examine a sample of duplicate sales invoices for credit approval by the credit manager.
  4. D) Review the aged schedule of accounts receivable to determine if amounts receivable from officers are included.

 

Page Ref: 348

 

 

19) A) Describe three types of sample selection methods commonly associated with statistical audit sampling.

 

  1. B) Explain the difference between sampling with replacement and without replacement. Which method is more common in audit practice?

 

  1. C) Describe the steps involved in systematic sampling.

 

20) You have recently been hired as an audit trainee with an internal audit department. Your first assignment will be to select the sample for a test of new capital assets acquired over the last two years. Your review of the internal audit files indicates that the last time this work was done the sample to be tested was selected on a judgmental nonstatistical basis.

However, based on your university/college audit course, you believe the work offers good potential for the use of statistical sampling techniques. You know that you will have to be able to explain and justify your opinion to the internal audit manager.

 

Required:

Both statistical sampling as well as nonstatistical or judgmental sampling have advantages and disadvantages. Briefly state two advantages and two disadvantages of statistical sampling and one advantage and one disadvantage of nonstatistical sampling.

 

11.3   Describe the 14 steps in planning and selecting a sample, performing the tests, and evaluating the sample

 

1) The overall objectives of the audit test must be stated in terms of the

  1. A) anticipated results.
  2. B) transaction cycle being tested.
  3. C) risks addressed and the transaction cycle being tested.
  4. D) risk addressed and the anticipated results.

 

Page Ref: 347

 

2) As part of the audit program for the audit of sales, the auditor will “review sales transactions for large and unusual amounts.” Which of the following types of sampling would be suitable for this audit procedure?

  1. A) systematic
  2. B) attribute
  3. C) block
  4. D) directed

 

Page Ref: 347

 

 

3) During the audit of the fixed asset section, the auditor decided to inspect source documents supporting all fixed asset additions exceeding $3,000. This type of audit procedure is called a

  1. A) census of the strata over $3,000
  2. B) analytical review
  3. C) attribute sample
  4. D) monetary unit sample

 

Page Ref: 348

 

 

4) As part of the audit of sales, the auditor has used attribute sampling to select a sample of sales invoices. The auditor has examined the duplicate sales invoice to determine whether it was approved for credit. Which of the following would be termed the “attribute?” The

  1. A) sales invoice number
  2. B) approval initials
  3. C) name of the person who approves credit
  4. D) absence of an authorization

 

Page Ref: 348

 

 

5) As part of the audit of sales, the auditor has used attribute sampling to select a sample of sales invoices. The auditor has examined the duplicate sales invoice to determine whether it was approved for credit. Which of the following would be termed the “exception?” The

  1. A) sales invoice number.
  2. B) approval initials.
  3. C) name of the person who approves credit.
  4. D) absence of an authorization.

 

Page Ref: 348

 

6) As part of the audit of sales, the auditor has used attribute sampling to select a sample of sales invoices. The auditor has examined the duplicate sales invoice to determine whether it was approved for credit. The client has a December year end. In October, the auditor conducted the interim audit and drew a sample of 40 items that covered the period from January to September. In order to be able to generalize to the sales population, the auditor should also

  1. A) select sample items from the rest of the year.
  2. B) increase the sample size in proportion to the total population size.
  3. C) use statistical methods to calculate sampling risk.
  4. D) use statistical methods to calculate non-sampling risk.

 

Page Ref: 349

 

 

7) To ensure that all the population items will be properly subjected to the sample selection process, the auditor should

  1. A) use a random number generator for sample selection.
  2. B) use monetary unit sample selection methods.
  3. C) document the range of document numbers in use by the client.
  4. D) test the population for completeness.

 

8) The exception rate the auditor will permit in the population and still be willing to use the assessed level of control risk is called the

  1. A) tolerable exception rate.
  2. B) estimated population exception rate.
  3. C) acceptable risk of overreliance.
  4. D) sample exception rate.

 

Page Ref: 349

 

 

9) Establishing the tolerable exception rate (TER) requires

  1. A) statistical frequency probability tables.
  2. B) random number tables.
  3. C) a computer program.
  4. D) professional judgment.

 

Page Ref: 349

 

10) The tolerable exception rate (TER) has a significant effect on sample size. The relationship of TER to sample size is

  1. A) direct (larger TER = larger sample).
  2. B) inverse (larger TER = smaller sample).
  3. C) variable (sometimes larger, sometimes smaller).
  4. D) not determinable.

 

Page Ref: 349

 

 

11) In statistical terms, acceptable risk of assessing control risk too low (ARACR) corresponds with

  1. A) sampling risk.
  2. B) inherent risk.
  3. C) control risk.
  4. D) nonsampling risk.

 

Page Ref: 350

 

 

 

12) The acceptable risk of incorrect acceptance (ARIA) has a significant effect on sample size. The relationship of ARIA to sample size is

  1. A) direct (larger ARIA = larger sample).
  2. B) inverse (larger ARIA = smaller sample).
  3. C) variable (sometimes larger, sometimes smaller).
  4. D) not determinable.

 

Page Ref: 350

 

 

13) In attribute sampling, an advance estimate of the expected population exception rate is necessary to plan the appropriate sample size. The relationship of expected population exception rate (EPER) to sample size is

  1. A) direct (small EPER = small sample).
  2. B) inverse (small EPER = large sample).
  3. C) a variable (sometimes small, sometimes large) dependent on other factors present.
  4. D) indeterminate.

 

Page Ref: 351

 

14) If all other factors specified in a sampling plan remain constant, changing the estimated population exception rate (EPER) from 2% to 4% would cause the required sample size to

  1. A) increase.
  2. B) remain the same.
  3. C) decrease.
  4. D) become indeterminate.

 

Page Ref: 351

 

 

15) The sample exception rate equals the number of

  1. A) exceptions in the population divided by the sample size.
  2. B) items in the population multiplied by the number of exceptions in the sample.
  3. C) exceptions in the sample divided by the sample size.
  4. D) exceptions in the population divided by the population size.

 

Page Ref: 352

 

 

 

16) Helen found that the expense reports were not properly approved while the senior accounts payable clerk was on vacation in July.  Helen decided to perform a test of control on the authorization of expense reports for all the months except for July which she will test substantively.  Helen is allowed to do this because

  1. A) the authorized expense reports for July are not material.
  2. B) it would not be cost beneficial to test the entire population substantively.
  3. C) the authorizations for the month of July are not representative of the population as a whole.
  4. D) compensating controls exist in the payroll reconciliation process.

 

Page Ref: 353

 

 

17) The final step in the evaluation of the audit results is the decision to

  1. A) determine the acceptability of the population.
  2. B) determine sampling error and calculate the estimated total population error.
  3. C) analyze exceptions or misstatements.
  4. D) determine the error in each sample.

 

Page Ref: 354

 

18) An increase in the sample size has the effect of decreasing the sampling error if the

  1. A) actual sample exception rate increases.
  2. B) actual sample exception rate does not increase.
  3. C) number of exceptions in the sample does not increase.
  4. D) number of exceptions in the sample increases.

 

Page Ref: 354

 

 

19) An auditor who uses statistical sampling for attributes in testing internal controls should increase the assessed level of control risk when the

  1. A) sample rate of exceptions is less than the expected rate of exception used in planning the sample.
  2. B) tolerable exception rate less the allowance for sampling risk exceeds the sample rate of deviation.
  3. C) sample rate of exceptions plus the allowance for sampling risk exceeds the tolerable exception rate.
  4. D) sample rate of exceptions plus the allowance for sampling risk equals the tolerable exception rate.

 

Page Ref: 354

 

20) There are 14 steps to audit sampling, divided into four sections: plan the sample, select the sample, perform the audit procedures, and evaluate the results. Discuss each of the steps that comprise the “plan the sample” section for attribute sampling.

21) You are working on the testing of internal controls over price changes in the inventory system. You completed the controls testing to determine whether all price changes were approved by the senior accountant, by reference to master file change forms.

 

In order to place reliance on this control, your audit supervisor has decided that the error rate in the population should be less than 1%. When you calculated your sample size, you used a confidence level of 90% and predicted an error rate in the population of less than one percent. Based on these decisions, you examined 150 inventory price master file change forms.

 

In your testing, you uncovered two deviations. Based on these results, you calculate that the actual error rate in the population could be as high as 2.33 %.

 

Required:

 

  1. A) What actions are available to you regarding your planned reliance on the master file change controls?

 

  1. B) What are the advantages and disadvantages of each action?

 

  1. C) How would you decide which action to take?

 

 

 

22) You have just been given the approval to conduct statistical sampling for the audit of capital assets acquisitions. Previously, this work was completed using a judgmental sample.

 

Required:

Explain the key areas where decisions need to be made when conducting audit work using a statistical sample.

 

23) You are analyzing the exceptions that arose after your control testing of credit limit approvals. There were four exceptions where credit had not been approved. One was for a customer that was subsequently placed on C.O.D. (cash on delivery), and three occurred while the business was in the middle of its busy season, processing three times more transactions than most other times of the year. The company’s busy season normally lasts about two months.

 

Required:

 

  1. A) What is an anomaly?

 

  1. B) Are any of the exceptions that you found anomalous? Why or why not?

 

  1. C) Provide an example of a credit approval testing exception that would be anomalous.

 

 

 

Auditing, 12e (Arens)

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

 

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

 

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

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

 

Page Ref: 362

 

 

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

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

 

Page Ref: 363

 

 

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

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

 

Page Ref: 363

 

 

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

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

 

Page Ref: 363

 

 

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

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

 

Page Ref: 363

 

 

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

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

 

Page Ref: 365

 

 

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

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

 

Page Ref: 365

 

 

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

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

 

Page Ref: 366

 

 

 

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

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

 

Page Ref: 366

 

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

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

 

Page Ref: 366

 

 

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

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

 

Page Ref: 366, 368

 

 

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

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

 

Page Ref: 367

 

 

 

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

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

 

Page Ref: 367

 

 

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

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

 

Page Ref: 367

 

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

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

 

Page Ref: 367

 

 

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

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

 

Page Ref: 368

 

 

 

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

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

 

Page Ref: 368

 

 

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

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

 

Page Ref: 368

 

 

19) Most companies recognize sales when

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

 

Page Ref: 368

 

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

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

 

Page Ref: 369

 

 

 

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

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

 

Page Ref: 369

 

 

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

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

 

Page Ref: 370

 

 

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

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

 

Page Ref: 370

 

 

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

 

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

 

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

 

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

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

 

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

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

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

Sales

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

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

Web-Site Security

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

Collection and Reconciliation

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

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

Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust revenues reported by Gonzo.
27) You have just been assigned to manage the audit for a new large client of your firm, Cheap Music Downloads Inc. (CMD). CMD is a subsidiary of a client of your firm that manufactures audio and video equipment for international distribution. CMD has been in operation for two years, when its custom information systems were established.

 

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

 

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

 

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

 

Required:

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

(i) State the control

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

(or state the purpose of the control)

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

 

 

 

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

 

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

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

 

Page Ref: 371

 

 

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

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

 

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

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

 

Page Ref: 372

 

 

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

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

 

Page Ref: 373

 

 

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

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

 

Diff: 23     Page Ref: 373

 

 

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

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

 

Page Ref: 373

 

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

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

 

Page Ref: 374

 

 

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

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

 

Page Ref: 374

 

 

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

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

 

Page Ref: 374

 

 

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

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

 

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

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

 

Page Ref: 374

 

 

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

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

 

Page Ref: 374

 

 

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

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

 

Page Ref: 374

 

 

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

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

 

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

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

 

Page Ref: 375

 

 

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

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

 

Page Ref: 376

 

 

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

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

 

Page Ref: 377

 

 

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

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

 

Page Ref: 377

 

 

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

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

 

Page Ref: 377-378

 

 

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

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

 

Page Ref: 378-379

 

 

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

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

 

Page Ref: 378

 

 

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

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

 

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

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

 

Page Ref: 380

 

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

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

 

Page Ref: 380

 

 

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

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

 

Page Ref: 380

 

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Required:

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

 

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

 

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

 

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

 

Required:

 

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

 

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

 

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

 

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

 

A typical EDI sale is processed as follows:

 

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

 

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

 

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

 

Required:

 

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

 

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

 

 

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

 

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

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

 

Page Ref: 381

 

 

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

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

 

Page Ref: 382

 

 

 

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

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

 

Page Ref: 383

 

 

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

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

 

Page Ref: 383

 

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

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

 

Page Ref: 384

 

 

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

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

 

Page Ref: 384

 

 

 

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

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

 

Page Ref: 384

 

 

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

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

 

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

 

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

 

 

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

 

1)

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

 

 

Auditing, 12e (Arens)

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

 

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

 

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

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

 

Page Ref: 410

 

 

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

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

 

Page Ref: 412

 

 

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

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

 

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

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

 

Page Ref: 412

 

 

5) Audit risk is assessed for

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

 

Page Ref: 413

 

 

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

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

 

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

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

 

Page Ref: 414

 

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

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

 

Page Ref: 414

 

 

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

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

 

Page Ref: 414

 

 

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

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

 

Page Ref: 414

 

 

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

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

 

Page Ref: 415

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

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

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

 

Page Ref: 415

 

 

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

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

Required:

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

 

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

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

Page Ref: 413-415

 

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

 

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

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

 

Page Ref: 415

 

 

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

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

 

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

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

 

Page Ref: 416

 

 

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

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

 

Page Ref: 416

 

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

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

 

Page Ref: 417

 

 

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

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

 

Page Ref: 417

 

 

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

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

 

Page Ref: 418

 

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

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

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

 

ANALYTICAL PROCEDURE

 

POSSIBLE MISSTATEMENT

 

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

 

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

 

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

Page Ref: 415-418

 

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

 

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

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

 

Page Ref: 418

 

 

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

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

 

Page Ref: 418, 420

 

 

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

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

 

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

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

 

Page Ref: 420

 

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

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

 

Page Ref: 420

 

 

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

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

 

Page Ref: 420

 

 

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

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

 

Page Ref: 421

 

 

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

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

 

Page Ref: 421

 

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

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

 

Page Ref: 422

 

 

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

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

 

Page Ref: 422

 

 

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

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

 

Page Ref: 422

 

 

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

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

 

Page Ref: 422

 

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

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

 

Page Ref: 422

 

 

14) Trade accounts receivable should exclude

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

 

Page Ref: 423

 

 

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

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

 

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

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

 

Page Ref: 423

 

 

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

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

 

Page Ref: 423

 

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

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

 

Page Ref: 423

 

 

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

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

 

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

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

 

Page Ref: 424

 

 

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

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

 

Page Ref: 425

 

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

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

 

Page Ref: 425

 

 

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

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

 

Page Ref: 425

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

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

 

Page Ref: 426

 

 

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

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

 

Page Ref: 426

 

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

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

 

Page Ref: 425-426

 

 

 

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

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

 

Page Ref: 426

 

 

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

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

 

Page Ref: 426

 

 

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

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

 

Page Ref: 427-428

 

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

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

 

Page Ref: 428

 

 

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

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

 

Page Ref: 428

 

 

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

 

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

 

Clients & Credit Limits

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

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

 

Allowance for Doubtful Accounts

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

2012                2011

 

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

Allowance for doubtful accounts      212,150           207,660

Sales                                              25,640,000      24,630,000

 

Required:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Description of field contents

Type of account (personal, corporate)            Customer account number

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

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

Current month’s charges                                 Current month’s payments

Total Outstanding Balance                             Aged balance over 30 days

Aged balance over 60 days                             Aged balance over 90 days

Aged balance over 120 days                           Year account opened

Year last active                                               Total purchases this year to date

Total returns this year to date                         Number of months active

Total purchases last year                                 Number of months active last year

 

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

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

 

Required:

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

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

 

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

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

 

Page Ref: 437

 

 

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

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

 

Page Ref: 438

 

 

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

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

 

Page Ref: 442

 

Auditing, 12e (Arens)

Chapter 14   Audit of Cash Balances

 

14.1   Identify the different types of cash accounts

 

1) The general cash account is considered significant in almost all audits

  1. A) where the ending balance is material.
  2. B) where either the beginning or ending balance is material.
  3. C) even when the ending balance is immaterial.
  4. D) except those of not-for-profit organizations.

 

Page Ref: 451

 

 

2) From an audit perspective, an imprest bank account at a client can

  1. A) require less time for the audit of general cash.
  2. B) increase audit risk.
  3. C) result in an increase in control risk.
  4. D) improve client internal controls.

 

Page Ref: 452

 

 

3) A branch bank account is helpful for

  1. A) limiting the impact of a fraud.
  2. B) improving internal controls.
  3. C) empowering the different branches of the company.
  4. D) building public relations in local communities.

 

Page Ref: 452

 

 

4) When are short-term investments that are readily converted to cash included in the cash account in the financial statements?

  1. A) If they are held in local currencies (i.e. Canadian dollars)
  2. B) When there is little risk of change in value
  3. C) When they are under the control of the treasury department
  4. D) If interest has been paid up to the year end date

 

5) There is a greater risk of defalcation for cash than for other types of assets because

  1. A) it is easier to steal.
  2. B) most other assets must be converted to cash to make them usable.
  3. C) companies usually have weak internal controls surrounding cash.
  4. D) most employees have access to cash.

 

Page Ref: 452

 

6) During the audit of cash, the focus of the audit is to

  1. A) do substantive tests of payments for supplies.
  2. B) conduct control tests of sales transactions.
  3. C) verify the bank reconciliation.
  4. D) conduct control tests over payments.

 

Page Ref: 453

 

 

7) A significant part of the total audit, that relates to cash , is the audit of

  1. A) physical inventory on hand using an inventory count.
  2. B) assessment of the accounting policies in use.
  3. C) substantive testing of the ending accounts payable balance.
  4. D) sales and collections, payables payments and payroll payments.

 

Page Ref: 453

 

 

8) Certain types of misstatements that affect cash may be detected in the audit of tests of controls. Which of the following misstatements would be detected in the audit of the sales and collection cycle?

  1. A) A defalcation of cash hidden by an unauthorized write off of a bad debt
  2. B) Accidental duplicate payment of a vendor’s invoice
  3. C) Payment for raw materials that were not received
  4. D) Payment to an employee at an incorrect wage rate

 

9) Certain types of misstatements that affect cash may be detected in the audit of tests of controls. Which of the following misstatements would be detected in the audit of the acquisition and payment cycle?

  1. A) Failure to bill a customer for goods shipped
  2. B) Billing a customer at the incorrect price
  3. C) Improper reimbursement of an officers’ personal expenses
  4. D) Paying an employee at the incorrect wage rate

 

Page Ref: 453

 

 

10) Which of the following misstatements in the payroll cycle could be detected during the audit of payroll transactions (but would not be discovered as part of the audit of the bank reconciliation)?

  1. A) failure to include outstanding payroll cheques on the outstanding cheque list
  2. B) overpayment of Receiver General payments received after the year end but recorded as cash receipts in the current year
  3. C) unclaimed payroll cheques recorded as a deposit near the end of the year, but reconciled as deposits in transit
  4. D) payment to fictitious employees that had been set up by the payroll supervisor

 

Page Ref: 454

 

11) Which one of the following misstatements could be detected as part of the tests of a bank reconciliation?

  1. A) Payment of interest to a related party at an incorrect rate
  2. B) Exclusion of mortgage interest receivable from the balance sheet
  3. C) Deposits recorded as cash receipts at the end of year, but included as outstanding deposits (deposits in transit)
  4. D) A defalcation of cash by interception of collections before they are recorded

 

Page Ref: 454

 

 

12) The auditor has determined exchange rates used by the client to present cash in foreign currencies and has recalculated the amounts. Which audit assertion is associated with this audit procedure?

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

 

13) A) Describe each of the major types of cash accounts maintained by business entities.

 

  1. B) Discuss the advantages of using an imprest bank account for payroll transactions.

 

14) A) “Failure to bill a customer” is an example of an error that results in the failure to receive cash, but would not be discovered as part of the audit of the bank reconciliation. State three other examples of errors or irregularities that result in the improper payment of, or failure to receive, cash, but would not be discovered during the audit of the bank reconciliation. How are these types of misstatements normally uncovered in the audit?

 

  1. B) State three examples of errors or irregularities that normally would be uncovered during the audit of the bank reconciliation.

 

15) A) Distinguish between (i) risks of error, (ii) risks of fraud, and (iii) risks of inadequate presentation or disclosure of financial information.

  1. B) For each of the three types of risks described in (A), provide three examples of major risks of error or fraud in the cash cycle.

 

 

14.2   Link the audit of cash to corporate governance and control processes

 

1) Toasted Tomato is a restaurant in Ottawa. You walk by this restaurant frequently and noticed it is usually empty. When you came in to do the audit, you were surprised to see that they had a large cash balance and high sales. Toasted Tomato might

  1. A) have a going concern issue.
  2. B) be engaging in money laundering.
  3. C) have lower business risk than initially anticipated.
  4. D) have weak internal controls.

 

Page Ref: 454

 

 

2) Sandra is analyzing the cash cycle of her audit client. Which of the following indicator could lead to a liquidity problem?

  1. A) Obsolete inventory
  2. B) High level of inventory
  3. C) Inventory on consignment
  4. D) Backordered inventory

 

Page Ref: 454

 

3) Which of the following statements best describes the position of cash on the balance sheet at most organizations that utilize effective cash management practices? It is usually

  1. A) immaterial.
  2. B) highly material.
  3. C) dispersed among many different accounts.
  4. D) affected by many different capital asset accounts.

 

Page Ref: 455

 

 

4) Because cash is the most desirable asset for people to steal, it has a higher

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

 

5) Which of the following is an essential internal control in the cash cycle?

  1. A) Use of two signatures on payroll cheques and payables cheques
  2. B) Independent receipt of the bank statement from the bank
  3. C) Careful accounting of the continuity of cheques returned from the bank
  4. D) Independent preparation of bank reconciliations

 

Page Ref: 455

 

 

6) Which of the following situations would indicate a susceptibility at the client to the potential of fraud that pertains to theft of cash?

  1. A) lack of segregation of duties between the handling of cash and the recording of cash
  2. B) cash disbursements cheques requiring only one authorizing signature
  3. C) payroll rates being approved by the corporate controller
  4. D) customer master file changes being handled by the controller’s executive assistant

 

Page Ref: 456

 

 

7) What is an important benefit of independent preparation of bank reconciliations?

  1. A) An opportunity to independently check that cheques have two signatures
  2. B) The client being able to check that the bank is processing transactions correctly
  3. C) The ability to internally verify cash receipts and disbursements transactions
  4. D) The best time to carefully serially account for cheques issued

 

Page Ref: 456

 

8) What is the best way to prevent potential alteration, deletion or addition of cancelled cheques, duplicate deposit slips or other documents provided with the bank statement? Have the

  1. A) bank statements provided unopened to an independent reconciler.
  2. B) person responsible for recording cash receipts does the bank reconciliation.
  3. C) signing officer(s) review the bank reconciliation.
  4. D) bank statements are provided to the accounts payable supervisor.

 

9) Which of the following is a common analytical procedure that may detect misstatements in cash?

  1. A) Calculation of inventory turnover and gross profit
  2. B) Review of amounts included in the earnings per share calculations
  3. C) Comparison of outstanding cheques and deposits in transit with the prior year bank reconciliation
  4. D) Comparison of gross sales on a month by month basis with the prior year

 

Page Ref: 456

 

 

10) Bank reconciliations are normally verified on a 100-percent basis. Testing the reasonableness of the cash balance is therefore

  1. A) less important than for most other audit areas.
  2. B) more important than for other audit areas.
  3. C) equally important than for other audit areas.
  4. D) less important than for the audit of other assets, but more important than the audit of liabilities.

 

Page Ref: 456

 

 

11) Jane works for Middle Co. She is responsible for opening the mail, and preparing the bank deposit for cheques received, which she then gives to the owner. After the owner has deposited the cash, he gives Jane the stamped bank deposit slip, which she uses to record the cash received in the accounts receivable records. How does this allocation of responsibilities affect the audit process? The auditor should

  1. A) increase control testing with respect to the accuracy assertion.
  2. B) do substantive tests (compare the deposit slip to the accounts receivable records).
  3. C) consider the possibility of material fraud.
  4. D) increase control testing with respect to the completeness assertion.

 

Page Ref: 456

 

12) The starting point for the verification of the balance in the general bank account is to obtain

  1. A) the client’s December bank statement and reconcile it.
  2. B) a bank reconciliation from the client.
  3. C) a cutoff bank statement directly from the bank.
  4. D) the client’s cash account balance from the general ledger.

 

13) In an effort to satisfy the completeness objective, the auditor could perform which of the following test of details of balance procedures?

  1. A) Trace the book balance on the reconciliation to the general ledger.
  2. B) Trace outstanding cheques to subsequent period bank statements.
  3. C) Obtain and test a cut-off bank statement.
  4. D) Review financial statements to make sure that material savings accounts and certificates of deposit are disclosed separately.

 

Page Ref: 459

 

 

14) Which of the following audit tests pertains to the accuracy assertion?

  1. A) prepare proof of cash
  2. B) test a cut-off bank statement
  3. C) examine minutes and loan agreements
  4. D) read the notes to the financial statements

 

Page Ref: 459

 

 

15) The test of balances procedure that requires the auditor to trace the unadjusted book balance on the reconciliation to the general ledger is an attempt to satisfy the audit objective of

  1. A) detail tie-in.
  2. B) existence.
  3. C) completeness.
  4. D) accuracy.

 

Page Ref: 459

 

 

16) The audit procedure which requires the auditor to record the last cheque number used on the last day of the year and subsequently trace to the outstanding cheques and the cash disbursements journal is performed to satisfy the audit objective of

  1. A) detail tie-in.
  2. B) existence.
  3. C) completeness.
  4. D) allocation.

 

Page Ref: 459

 

 

17) During his examination of a January 19, 2013 cutoff bank statement, an auditor noticed that the majority of cheques listed as outstanding at December 31, 2012 had not cleared the bank. This would indicate

  1. A) a high probability of lapping.
  2. B) a high probability of kiting.
  3. C) that the cash disbursements journal had been held open past December 31, 2012.
  4. D) that the cash disbursements journal had been closed prior to December 31, 2012.

 

Page Ref: 459

 

 

18) The auditor has examined the financial statements, particularly the cash flow statement, and the notes to the financial statements to determine that all relevant information is presented clearly. Which audit assertion is associated with this audit test?

  1. A) classification
  2. B) allocation
  3. C) understandability
  4. D) valuation

 

Page Ref: 459

 

 

19) After the bank confirmation has been received by the auditor, the auditor should

  1. A) recalculate the bank reconciliation in its entirety.
  2. B) verify that cash cutoff was correct for that bank account.
  3. C) trace the general ledger cash account balance to the amount confirmed.
  4. D) trace the bank reconciliation cash amount to the amount confirmed.

 

Page Ref: 459

 

 

20) A partial-period bank statement and the related cancelled cheques, duplicate deposit slips, and other documents included in bank statements, mailed by the bank directly to the public accounting firm’s office, is called a

  1. A) four-column proof of cash.
  2. B) bank statement.
  3. C) cutoff bank statement.
  4. D) short-period bank statement.

 

Page Ref: 461

 

 

21) The reason for testing the client’s bank reconciliation is to verify whether the client’s recorded bank balance is the same amount as the actual cash in the bank, except for deposits in transit, cheques outstanding, and other reconciling items. The information needed to complete the tests of the reconciliation are provided by the

  1. A) journals and ledgers of client for the year under audit.
  2. B) cutoff bank statement.
  3. C) journals and ledgers of client for the subsequent year.
  4. D) cancelled cheques for the year under audit.

 

Page Ref: 461

 

 

22) An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily in order to

  1. A) verify the cash balance reported on the bank confirmation inquiry form.
  2. B) verify reconciling items on the client’s bank reconciliation.
  3. C) detect lapping.
  4. D) detect kiting.

 

Page Ref: 461

 

 

23) If the auditor does not obtain a cut-off statement directly from the bank for testing, an alternative procedure that the auditor can use is to

  1. A) account for a continuity of cheques that covers the year end.
  2. B) reconcile cash paid to the cash disbursements journal for the last month of the year.
  3. C) reconcile cash received to the cash receipts journal for the last month of the year.
  4. D) prove the bank statement for the period after the year end.

 

Page Ref: 461

 

 

24) After testing the bank reconciliation and inspecting the cut-off bank statement received from the bank, the auditor has determined that there are two outstanding cheques from the list on the bank reconciliation that have still not cleared the bank. The auditor’s next step should be to

  1. A) trace the details of the two cheques to the cash disbursements journal.
  2. B) trace the details of the two cheques to their associated expense accounts.
  3. C) reperform the calculations in the bank reconciliation.
  4. D) compare the total of the bank reconciliation to the bank confirmation.

 

Page Ref: 461

 

 

25) You are the auditor of Brody Grass Inc. The CEO expressed a concern that the audit fees for the year were very high. You then explained that this is largely due to poor internal controls in the cash and transaction cycle and that the audit fees could decrease if better controls were in place.

 

Provide 5 examples of general cash account controls that Brody Grass Inc. could implement.

 

26) A) Discuss the methodology for designing tests of details of balances for cash in the bank.

 

  1. B) An effective monthly bank reconciliation by client personnel includes nine procedures. List these nine bank reconciliation procedures.

 

  1. C) Discuss two analytical procedures commonly performed during the audit of the cash account.

 

27) A) Explain what is meant by a cutoff bank statement and discuss the purpose of the cutoff bank statement in the audit of cash.

 

  1. B) Explain the purpose of testing the client’s bank reconciliation and discuss the major audit procedures involved.

 

28) Following are situations that an auditor might find by means of tests of controls or tests of details of cash balances for a company with a December year end.

 

  1. A) The accountant did not record or deposit a cash receipt for $50,000 that was received on December 28. Cash is prelisted by the receptionist.

 

  1. B) Cheques prepared up to January 6 were dated December 31 and recorded in the cash disbursements journal.

 

  1. C) A cheque was issued for office supplies that were never received by the client.

 

Required:

List a substantive audit procedure that could uncover each of the preceding situations.

 

29) Serena is the assistant controller of Opus Inc. As a result of a recent expansion the controller has been very busy and delegated the signing authority of the cheques to Serena. Further, due to the cash accountant leaving on maternity leave, Serena was asked to perform the bank reconciliation until they found someone to replace the cash accountant.

Serena is a qualified accountant and has been able to handle all of these additional tasks. However, she asked her boss for a raise to compensate her for the additional responsibilities that she currently has. Her boss indicated that this was only temporary and the company could not afford a raise for now.

 

Serena created a vendor in the system with her home address. She has been paying this vendor $2,000 for the past 3 months as a means of compensating herself. This theft has yet to be discovered by Opus.

 

Required:

 

  1. A) What internal controls are missing to enable the theft to occur?

 

  1. B) What audit procedures might detect the theft?

 

 

14.3   Identify the additional audit procedures conducted when there is suspicion of fraud

 

1) A major consideration in the audit of the general cash balance is the possibility of fraud. The auditor must extend his or her procedures in the audit of year-end cash to determine the possibility of a material fraud when there are

  1. A) large cash balances at the end of the year.
  2. B) large cash receipts and disbursements during the year.
  3. C) no imprest accounts used for payroll.
  4. D) material internal control weaknesses.

 

Page Ref: 462

 

2) What is the purpose of an extended test of the bank reconciliation? To

  1. A) verify whether all transactions included in the journals for the last month of the year were correctly allocated to the bank reconciliation.
  2. B) compensate for material weaknesses in internal control with respect to segregation of duties.
  3. C) increase detection risk for the audit of cash.
  4. D) verify whether specific transactions that flowed through the cash account were correctly recorded.

 

Page Ref: 462

 

 

3) Under what circumstances would an auditor prepare a proof of cash? When

  1. A) the client has material internal control weaknesses in cash.
  2. B) control risk is set at minimum.
  3. C) inherent risk in cash is considered to be low.
  4. D) an enterprise resource system is in use for processing of cash transactions.

 

Page Ref: 463

 

 

4) A four-column proof of cash can be performed for

  1. A) one or more interim months.
  2. B) the entire year.
  3. C) the last month of the year.
  4. D) any specified time period for which bank statements are available and which the auditor chooses to designate.

 

Page Ref: 463

 

 

5) The auditor uses a proof of cash to determine whether

  1. A) internal controls over cash have been functioning effectively in the period under audit.
  2. B) all recorded cash receipts were deposited and whether all recorded cash disbursements were paid by the bank.
  3. C) accounts receivable was properly recorded and whether cash receipts transactions were properly recorded.
  4. D) accounts payable was properly recorded and whether cash disbursement transactions were properly recorded.

 

Page Ref: 463

 

 

6) What type of audit test is a proof of cash?

  1. A) Test of control
  2. B) Test of details
  3. C) Dual-purpose
  4. D) Analytical review

 

Page Ref: 463

 

7) The process of transferring money from one bank account to another and improperly recording the transaction in both accounts is called

  1. A) lapping.
  2. B) embezzling.
  3. C) kiting.
  4. D) a scam.

 

Page Ref: 465

 

 

8) Testing to ensure that bank transfers are recorded in both the receiving and disbursing banks helps to detect evidence

  1. A) that would reduce inherent risk to a minimum.
  2. B) associated with an attempt to conceal a theft of cash.
  3. C) that increases reliability with respect to the accuracy of the transfer schedule.
  4. D) that would warrant decreasing control risk to a minimum.

 

Page Ref: 465

 

 

 

9) On a bank transfer schedule, if a cash disbursement was recorded in the current fiscal year, and the receipt in the subsequent fiscal year, this might be

  1. A) the best way to record this type of transaction.
  2. B) an indication of increased inherent risk with respect to cash.
  3. C) an attempt to cover a cash shortage.
  4. D) an indication of an error in recording information by the bank.

 

Page Ref: 465

 

 

10) On the last day of the fiscal year, the cash disbursements clerk drew a company cheque on bank A and deposited the cheque in the company account in bank B to cover a previous theft of cash. The disbursement had not been recorded. The auditor will best detect this form of kiting by

  1. A) comparing the detail of cash receipts as shown by the cash receipts records with the detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year-end.
  2. B) preparing from the cash disbursements book a summary of bank transfers for one week prior to and subsequent to year-end.
  3. C) examining the composition of deposits in both bank A and B subsequent to year-end.
  4. D) examining paid cheques returned with the bank statement of the next account period after year-end.

 

Page Ref: 465

 

11) Disbursements on the bank transfer schedule should be correctly included in or excluded from year-end bank reconciliations as outstanding cheques. Understating outstanding cheques on the bank reconciliation indicates

  1. A) the possibility of kiting.
  2. B) a cut-off error in the bank account.
  3. C) an understatement of the bank balance.
  4. D) an increase in inherent risks associated with cash.

 

12) What audit objective is associated with the comparison of disbursement and receipt information on a bank transfer schedule to the cash disbursements and cash receipts journals?

  1. A) Accuracy
  2. B) Classification
  3. C) Occurrence
  4. D) Completeness

 

Page Ref: 465

 

 

13) In addition to the possibility of kiting, inaccurate handling of bank transfers could result in

  1. A) a misclassification between cash and accounts receivable.
  2. B) an incorrect balance in the accounts receivable account.
  3. C) a misclassification between cash and accounts payable.
  4. D) an incorrect balance in the bank loan account.

 

Page Ref: 466

 

 

14) A) Many auditors prove the subsequent period bank statement if a cutoff statement is not received directly from the bank. Discuss the purpose of proving the subsequent period statement, and explain the audit procedures performed during the proof of cash.

 

  1. B) Discuss the circumstances in which an auditor would prepare a proof of cash.

 

15) A) Explain what is meant by kiting and discuss how it is performed.

 

  1. B) Discuss how an auditor can test for kiting.

 

14.4   Explain how an audit of the payroll cash account differs from the audit of the general cash account

 

1) When examining the bank reconciliation for the imprest payroll account, it is normal for the only reconciling item to be

  1. A) outstanding cheques.
  2. B) direct deposits from customers.
  3. C) outstanding deposits.
  4. D) corrections to payroll amounts.

 

Page Ref: 466

 

 

2) Electronic data interchange (EDI) represents the electronic transfer of

  1. A) funds.
  2. B) business documents.
  3. C) data between accounting systems of the company’s entities.
  4. D) information between the bank and the company.

 

Page Ref: 467

 

3) Stella is auditing the electronic receipts and payments. The extent of her audit work conducted on the bank reconciliation will

  1. A) be less extensive than if the company did not engage in electronic receipts and payments.
  2. B) be more extensive than if the company did not engage in electronic receipts and payments.
  3. C) depend on the assessed quality of internal controls.
  4. D) be significantly diminished if Stella can determine that the receipts and payments come from a reputable bank with proper internal controls.

 

Page Ref: 468

 

 

4) The most important internal control for petty cash is

  1. A) the use of an imprest fund that is the responsibility of one individual.
  2. B) keeping it in a safe or locked drawer.
  3. C) keeping the amount of cash to a minimum.
  4. D) accessibility so that cheques won’t have to be written for small amounts.

 

5) Petty cash tests can ordinarily be performed at any time during the year, but as a matter of convenience they are typically done

  1. A) on the balance sheet date.
  2. B) near the end of the field work.
  3. C) at the same time as the observation of inventory, since both auditor and client must be present at that time.
  4. D) on any interim date.

 

Page Ref: 469

 

 

6) Outline the audit procedures that would be performed when testing electronic receipts and payments.

Answer:  Procedures would include:

  • Agreeing electronic payments to an authorized schedule of such payments by date, payee account number and amount.
  • Reviewing the authorized schedule of payments and controls over its preparation.
  • Tracing deposits to the client’s POS (point-of-sale) system records.

Page Ref: 468

 

Auditing, 12e (Arens)

Chapter 15   Audit of the Human Resources and Payroll Cycle

 

15.1   Explain the importance of the human resources and payroll cycle

 

1) The human resources and payroll cycle is the transaction cycle that begins with

  1. A) processing the payment to the employees.
  2. B) the creation of the employee profile in the payroll master file.
  3. C) the employee performing work for the company.
  4. D) hiring of personnel.

 

Page Ref: 477

 

 

2) Payroll and personnel costs at ABC Manufacturing are a major expense. This means that improper allocation or misclassification of labour costs could result in

  1. A) a material misstatement of net income.
  2. B) a net effect that is negligible when costing inventory.
  3. C) quality control problems with respect to the production of finished products.
  4. D) incorrect payment of payroll to employees.

 

Page Ref: 477

 

 

3) Which of the following describes the class of transactions associated with payroll?

  1. A) Posting costs of purchasing inventory
  2. B) Payment of employee services
  3. C) Payment of withholding taxes and benefits
  4. D) Write-off of damaged inventory dropped by employees

 

Page Ref: 478

 

 

4) In most audits, the amounts of the balance sheet accounts related to payroll are

  1. A) large and require substantial effort to audit.
  2. B) small compared with the transactions.
  3. C) large on the liability side but small on the asset side.
  4. D) significantly larger than the related accounts on the income statement.

 

5) In auditing the imprest payroll account, which of the following procedures will take the least amount of auditor time?

  1. A) tests of controls
  2. B) risk analysis and obtaining an understanding of controls
  3. C) analytical procedures
  4. D) tests of details of balances

 

Page Ref: 478

 

6) If there is an error in wage rates, such errors can typically escalate into material amounts. What characteristic of the human resources and payroll cycle causes this?

  1. A) many repeated transactions
  2. B) the presence of independent verification
  3. C) the use of outsourcing organizations for payroll
  4. D) an error in the starting cheque number in a cheque run

 

Page Ref: 479

 

 

7) The human resources department would likely provide which of the following internal controls for the human resources and payroll cycle?

  1. A) recalculation of net pay for every pay
  2. B) independent verification of wage rate
  3. C) account for the continuity of employee numbers
  4. D) account for the continuity of payroll check numbers

 

Page Ref: 480

 

 

8) Which of the following is an example of semi-permanent information that would be included in personnel records?

  1. A) gross pay for the monthly pay issued in September
  2. B) met pay for the weekly pay issued in the first week of October
  3. C) category of job the person is employed in
  4. D) income tax deducted for the current pay

 

9) The most important control in the payroll cycle is clear, properly documentation of the employee’s job responsibilities and wages by the appropriate level of authority. This control is associated with which audit objective?

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

 

Page Ref: 480, 486

; 15-2  List typical audit tests of controls by assertion

 

10) Which of the following best describes proper internal control over payroll? The

  1. A) preparation of the payroll must be under the control of the personnel department.
  2. B) confidentiality of employee payroll data should be carefully protected to prevent fraud.
  3. C) duties of hiring, payroll computation, and payment to employees should be segregated.
  4. D) payment by cheque to employees should be replaced with payment by automatic deposits.

 

Page Ref: 480

 

11) Master file data is the semi-permanent data in an employee’s file. Changes to master file changes

  1. A) should be adequately supported.
  2. B) should be checked by the originator.
  3. C) would be entered only once per month.
  4. D) would be implemented on an annual basis.

 

Page Ref: 480

 

 

12) The file for recording each payroll transaction for each employee and maintaining total employee wages paid for the year to date is the

  1. A) payroll master file.
  2. B) payroll transaction file.
  3. C) payroll journal.
  4. D) job time ticket.

 

13) A form issued for each employee summarizing the earnings record for the calendar year is the

  1. A) rate authorization form.
  2. B) summary payroll report.
  3. C) payroll master file.
  4. D) T-4 form.

 

Page Ref: 481

 

 

14) A wage rate form that also documents a change in job responsibility for one of the warehouse employees should be approved by the

  1. A) human resources and the corporate controller.
  2. B) warehouse supervisor and human resources.
  3. C) warehouse supervisor.
  4. D) human resources.

 

Page Ref: 481

 

 

15) Ricky recently got an internal transfer from payroll analyst to assistant regional manager of production.  An employee at the production facility came to see Ricky since he was not paid on the last payroll cheque for the overtime he had done.  Ricky apologized for this mistake and logged into the payroll system to modify the next paycheque for the employee to ensure that he would be paid for the additional hours.

  1. A) The company did not properly allocate access rights.
  2. B) The company did not properly complete the access rights approval form.
  3. C) The company did not properly check employee background when they hired Ricky.
  4. D) Ricky did not do anything wrong since the employee had worked the hours.

 

Page Ref: 481

 

16) Access rights management is important because it is the organizations method of

  1. A) establishing data tables usage.
  2. B) identifying master file data.
  3. C) identifying transaction file data.
  4. D) enforcing segregation of duties.

 

Page Ref: 481

 

 

 

17) Which of the following controls helps to prevent error with set up of access rights, and also helps to prevent unauthorized changes to the access rights?

  1. A) independent comparison to check that they have been set up properly
  2. B) access rights forms that are signed by the user’s manager
  3. C) tracking all accesses in an access log by user identification code
  4. D) using audit software to provide a list of who has accessed sensitive data

 

Page Ref: 482

 

 

18) Which of the following controls will help to detect unauthorized changes to payroll master files, and help to detect whether terminated employees are still being paid?

  1. A) use of authorized change forms
  2. B) periodic review of master files
  3. C) use of master files to print T4’s
  4. D) use of master files to print payroll cheques

 

Page Ref: 482

 

 

19) Which of the following controls best prevents employees from checking in for more than one employee? The use of

  1. A) numerically controlled punch-in cards.
  2. B) placing the punch clock in full view of the receptionist.
  3. C) time cards stored in a wall rack.
  4. D) a personalized swipe card.

 

Page Ref: 482

 

 

20) Which of the following controls could help to prevent unauthorized overtime?

  1. A) review by payroll supervisor of a report that lists all employees whose wage rate does not match the permanent file
  2. B) print a gap report for all employees who have not submitted their time reports for the current pay period
  3. C) review by payroll supervisor of a report that lists all employees working more than 44 hours per week
  4. D) have a calculation check for payroll calculations (gross pay less deductions = net pay)

 

Page Ref: 482

 

 

21) The internal auditor is running a computer-assisted audit test that compares names and wage rates in the personnel files (stored on optical disk) with the wage rates in the payroll master file and the whole year’s payroll transaction files. What is the purpose of these tests?

  1. A) determine whether any employees were not paid in the most recent pay
  2. B) check for wage rates that are under the amount specified by the union contract
  3. C) help with the reconciliation of wage rates to the T4 summary
  4. D) determine whether terminated employees are still being paid

 

Page Ref: 482

 

 

22) When manufacturing labour affects inventory valuation, a knowledgeable manager should approve wage rate allocations to make sure that labour is distributed to the proper accounts. Which of the following controls helps to prevent error in the resulting job costing?

  1. A) comparison of wage rates to the authorized payroll master file
  2. B) independent comparison of the approved amounts to the data entered
  3. C) continuity check of the payroll cheque numbers issued
  4. D) reconciliation of gross pay on the payroll register with gross pay according to the payroll master file

 

Page Ref: 482

 

 

23) To minimize the opportunity for fraud, unclaimed salary cheques should be

  1. A) immediately returned for redeposit.
  2. B) kept in the payroll department.
  3. C) left with the employee’s supervisor.
  4. D) held for the employee in the personnel department.

 

Page Ref: 483

 

 

24) A weak internal control system allows a foreman to clock in daily for a fictitious employee and to approve the time card at the end of the payroll period. This fraud would be detected if other controls were in place, such as having an independent party

  1. A) compare the date of the recorded cheque in the payroll journal with the date on the cancelled cheques and time cards.
  2. B) foot the payroll journal and trace postings to the general ledger and the payroll master file.
  3. C) recompute hours worked from time cards.
  4. D) distribute paycheques.

 

Page Ref: 483

 

 

25) Which of the following controls prevents error and helps to ensure that only authorized wages are paid by the payroll service provider?

  1. A) duplicate signatures required on payments to the Receiver General
  2. B) use of an imprest payroll account for the payment of all payroll payments
  3. C) independent approval of the payroll journal prior to payroll payment release
  4. D) reconciliation of the payroll imprest bank account on a timely basis

 

Type: MC

 

 

26) The careful and timely preparation of all payroll withholdings and employers’ portion of withholdings is necessary to avoid heavy fines. The most important control in the timely preparation of these returns is

  1. A) computerized preparation of income tax returns.
  2. B) a well-defined set of policies that indicate when each form must be filed.
  3. C) independent verification of computer output by a competent individual.
  4. D) a Gantt chart.

 

27) A) Discuss three important differences between the human resources and payroll cycle and other cycles in a typical audit.

 

  1. B) Describe each of the six business functions in a typical human resources and payroll cycle.

 

  1. C) Describe each of the primary documents and records used in the timekeeping and payroll preparation function in the payroll and personnel cycle.

 

  1. D) Discuss each of the primary documents and records used in the (1) payment of payroll function, and (2) preparation of employee withholdings and benefits remittance forms function in the payroll and personnel cycle.

 

 

28) The WhirlyGig Factory Ltd. manufactures WhirlyGigs of many different sizes and types. The company employs 55 employees, all paid on an hourly basis.

Employees fill in time sheets and hand them in every Monday to the payroll clerk, Pamela. For factory employees, the time sheet shows the hours worked by product job number, and indicates if the job has been completed. The payroll clerk tracks the hours worked by job, and when a job is complete, compares the totals to the estimate made by the owner, Faruq. A bonus is paid for actual hours paid less than the estimated amount.

 

Every Wednesday, Pamela prepares the cheques and gives them to Faruq for signing. Pamela then staples the cheques to the payroll stubs. Pamela hands out the office cheques and gives the other cheques to the factory supervisor for distribution.

 

Required:

 

  1. A) Identify control weaknesses and their impact, and provide recommendations for improvement.

 

  1. B) What is the impact of the control weaknesses upon your audit approach?

 

 

 

29) Joan has been the payroll supervisor at York Distribution Company (YDC) for ten years. She has never missed a payroll and Farah, the owner of the company is delighted with her conscientiousness and knowledge. This is particularly important, as Farah spends a lot of time on the road drumming up new business, and needs competent personnel back at the office.

 

There are two accounting personnel at the office, a receptionist, five shipping and receiving personnel, and thirty sales people employed by YDC. Office and shipping/receiving personnel are paid a salary, while the sales people are paid a monthly base salary plus a percentage of their sales, calculated quarterly. The base salary is low, at $20,000, with a 2% commission, calculated based upon sales less any bad debts written off related to their customers.

 

Joan prints off the sales by customer every month, and uses this information to calculate commission. She then prepares the payroll cheques and gives them to Farah, who signs them and gives them to the sales staff at the monthly sales meeting. The cheques are written against a payroll imprest bank account, kept at a balance of $1,000. This account is not reconciled, as the staff are very overworked with the increasing volume of business handled by the company.

 

Required:

 

  1. A) Identify control weaknesses and their impact, and provide recommendations for improvement.

 

  1. B) What is the impact of the control weaknesses upon your audit approach?

 

30) You have been working on the audit of Ballistic Defence Company for several years now. There are about 15,000 employees working at the company in various positions.

 

Recently, the company contracted for a new customized payroll system, which is to be implemented next month. You have been asked to assess the acceptance testing plan that is being prepared by accounting staff. In particular, they want you to help assess controls that will improve the accuracy of information entered into the new computer system.

 

The company uses mainframe computing systems. You need to assume that the typical payroll information is available on computer files, i.e. employee number, employee name, social insurance number, department code, payment type code (salaried or hourly), time worked, wage rate, gross pay, deductions (by type), net pay, and cheque number.

 

Required:

Identify the tests that should be conducted by the company’s accounting staff with respect to accuracy before accepting the software.

 

15.2   List typical audit tests of controls by assertion

 

1) General controls must be evaluated and their impact considered upon the human resources and payroll transaction cycle because

  1. A) there are frequently weaknesses in internal controls in the payroll cycle.
  2. B) automated techniques are normally used to prepare and post payroll transactions.
  3. C) the best way to test payroll transactions is usually by using test data.
  4. D) the best way to test payroll transactions is usually by using generalized audit software.

 

Page Ref: 485

 

2) Which of the following type of test is most important for the audit of payroll?

  1. A) Internal control
  2. B) Test of detail
  3. C) Analytical review
  4. D) Substantive test

 

Page Ref: 485

 

 

3) When examining payroll transactions, an auditor is primarily concerned with the possibility of

  1. A) overpayments and unauthorized payments.
  2. B) posting of gross payroll amounts to incorrect salary expense accounts.
  3. C) misfootings of employee time records.
  4. D) excess withholding of amounts required to be withheld.

 

Page Ref: 485

 

 

4) “Recorded payroll payments are for work actually performed by existing employees” is the control objective of

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

 

5) Which of the following is a test of controls?

  1. A) Review the payroll journal, general ledger, and payroll earnings records for large or unusual amounts
  2. B) Examine time cards for indication of supervisor approval
  3. C) Compare cancelled cheques with payroll journal for name, amount, and date
  4. D) Examine cancelled cheques for proper endorsement

 

Page Ref: 486

 

 

6) Which of the following internal control tests would assist in satisfying the occurrence transaction-related audit objective for payroll?

  1. A) Examine payroll records for evidence of approval
  2. B) Prove the payroll bank reconciliation
  3. C) Review chart of accounts
  4. D) Account for a sequence of payroll cheques

 

Page Ref: 486

 

7) Which of the following internal controls helps ensure that recorded payroll payments are for work actually performed by existing employees?

  1. A) Procedures requiring the recording of transactions as soon as possible
  2. B) Only valid employees from the computer data files are accepted for processing
  3. C) Internal verification of payroll file contents
  4. D) Independent preparation of payroll bank reconciliation

 

Page Ref: 486

 

 

8) “Existing payroll transactions are recorded” is the control objective of

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

 

Page Ref: 486

 

 

 

9) Which of the following internal controls would help ensure that existing payroll transactions are recorded?

  1. A) Time records are approved by supervisors
  2. B) Time clock is used to record time
  3. C) Independent preparation of payroll bank reconciliation
  4. D) Comparison of payroll master file totals with general ledger control account

 

Page Ref: 486

 

 

10) Which of the following tests of controls would pertain to whether existing payroll transactions are recorded?

  1. A) Compare cancelled cheques with payroll journal details
  2. B) Compare cancelled cheques with payroll records
  3. C) Foot payroll journal and trace details to general ledger
  4. D) Conduct gap testing for a sequence of payroll cheques

 

Page Ref: 486

 

 

11) “Recorded payroll transactions are for the amount of time actually worked and at the proper pay rate; withholdings are properly calculated” relates to which control objective?

  1. A) Authorization
  2. B) Completeness
  3. C) Existence
  4. D) Accuracy

 

Page Ref: 486

 

12) Which of the following internal controls would assist in ensuring that recorded payroll transactions are for the amount of time actually worked and at the proper pay rate, and that withholdings are properly calculated?

  1. A) Comparison of batch totals with computer summary reports
  2. B) Comparison of payroll master file with payroll general ledger totals
  3. C) Adequate personnel files
  4. D) Separation of duties between personnel, timekeeping, and payroll disbursements

 

Page Ref: 486

 

 

 

13) Recomputing hours worked from time records provides evidence that

  1. A) internal controls relating to payroll disbursements were operating effectively.
  2. B) payroll cheques were signed by an appropriate officer independent of the payroll preparation process.
  3. C) only bona fide employees worked and their pay was properly computed.
  4. D) employees worked the number of hours for which their pay was computed.

 

Page Ref: 486

 

 

14) Which of the following internal control tests would be used in assessing that recorded payroll transactions are for the amount of time actually worked and at the proper pay rate, and that withholdings are properly calculated?

  1. A) Foot payroll journal and trace to general ledger
  2. B) Prove the bank reconciliation
  3. C) Recompute gross pay
  4. D) Review the payroll journal for large or unusual amounts

 

Page Ref: 486

 

 

15) Which of the following internal control tests would help to assess whether payroll transactions were properly classified?

  1. A) Test clerical accuracy by footing the payroll journal
  2. B) Recompute net pay and gross pay
  3. C) Reconcile the disbursements in the payroll journal with the payroll bank statement
  4. D) Review time records and job records, tracing to labour distribution

 

Page Ref: 486

 

 

16) Which of the following internal control tests would help to assess whether payroll transactions were recorded on the correct dates?

  1. A) Compare cancelled cheques with payroll journal for name, amount, and date
  2. B) Compare date on cheque with date the cheque cleared the bank
  3. C) Compare cancelled cheques with personnel records
  4. D) Recompute hours worked from pay records

 

Page Ref: 486

 

 

17) The auditor should review the preparation of at least one of each type of payroll tax form the client is responsible for filing, as a part of the auditor’s responsibility for

  1. A) understanding internal controls.
  2. B) doing tests of controls.
  3. C) doing analytical procedures.
  4. D) doing tests of balances.

 

Page Ref: 487

 

 

18) To test whether the client has fulfilled its legal obligation in submitting payments for all payroll withholdings, the auditor must first

  1. A) contact client’s independent legal counsel.
  2. B) know the dates when tax payments are due.
  3. C) trace these payments to the imprest payroll account.
  4. D) determine the client’s requirements for submitting the payments.

 

Page Ref: 487

 

 

19) Which of the following is a substantive test of transactions?

  1. A) Review personnel policies
  2. B) Account for a sequence of payroll cheques
  3. C) Reconcile the disbursements in the payroll journal with the disbursements on the payroll bank statement
  4. D) Examine printouts of transactions rejected by the computer as having invalid employee numbers

 

Page Ref: 487

 

 

20) When labour is a material factor in inventory valuation, the auditor should place special emphasis on testing the internal controls concerning

  1. A) proper classification of transactions.
  2. B) authorization of wage rates.
  3. C) fictitious employees.
  4. D) completeness of recorded transactions.

 

Page Ref: 487

 

 

 

21) When the employees are paid automatically by bank deposits to the employees’ accounts, in an effort to identify potential fraud, the auditor can look for

  1. A) duplicated bank account numbers.
  2. B) duplicated name in the master payroll files.
  3. C) unusual employee names.
  4. D) cancelled cheques.

 

Page Ref: 488

 

22) Because of the lack of available evidence, it is usually difficult for an auditor to discover if an employee records more time on his or her time card than actually worked. One procedure is to reconcile the total hours

  1. A) paid this period with a previous period.
  2. B) paid according to the payroll records with an independent record of the total hours worked, such as those maintained by production control.
  3. C) worked this period with a previous period.
  4. D) worked according to the summary payroll report with the total hours worked as recorded on the time card for the period.

 

23) A) There are several internal controls in the human resources and personnel function that are important from an audit perspective. For example, there should be an adequate investigation of the competence and trustworthiness of new employees. Discuss other internal controls in the personnel and employment function that are important from an audit perspective.

 

  1. B) There are several key internal controls over the timekeeping and payroll preparation function that should be present. For example, adequate control over the time on employees’ time records includes the use of a time clock or other method of making certain that employees are paid for the number of hours they worked. Discuss other key internal controls over the timekeeping and payroll preparation function.

 

  1. C) There are several key internal controls over the payment of payroll function that should be present. For example, the payroll should be distributed by someone who is not involved in the other payroll functions. Discuss other key internal controls over the payment of payroll function.

 

24) Even though the tests of controls are the most important part of testing payroll, many auditors spend little time in this area.  In many audits, there is a minimal risk of material misstatements, even though payroll is frequently a significant part of total expenses.

Explain the reasons the auditors have for justifying this position.

 

 

25) State the six specific transactions-related audit objectives as related to payroll, and for each objective, state one common test of controls that can be used to test the objective.

postings to the general ledger and the payroll master file.

Page Ref: 486

 

 

26) Discuss the two most common ways in which employees can defraud a company in the payroll area.

 

27) You have been working on the audit of Big Insurance Company for several years now. There are about 5,000 employees working at the company in various positions.

 

Your audit partner has indicated that this year, the firm will be implementing computer assisted audit techniques (CAATs), using generalized audit software. The information systems audit specialist will be assisting the audit team with the implementation of these tests. She wants you to provide a draft list of CAATs that could assist with the coming year’s audit of payroll.

 

The company uses mainframe computing systems. You need to assume that the typical payroll information is available on computer files, i.e. employee number, employee name, social insurance number, department code, payment type code (salaried or hourly), time worked, wage rate, gross pay, deductions (by type), net pay, and cheque number.

 

Required:

Prepare a list of potential computer assisted audit techniques that could be prepared for the payroll audit. Identify the audit objective to which they relate, and indicate if any manual procedures are required to supplement the suggested CAAT.

28) As part of your audit of the payroll for Jones Chu Company Limited (JCC), you used generalized audit software. You had available to you the payroll transactions for the month of September and the employee master file as of the date of September 30. You conducted the following tests, with results noted:

  1. Ran a duplicates test on employee number in the transaction file. You found that one employee, employee number 320, had been paid twice, using cheque numbers 12376 and 12377.
  2. Check the calculation of “pay per period” in the employee master file. (Divide the salary field by 12 to derive the monthly pay). It was found that for two employees these calculations did not match. Employee #20 had a pay of $200 higher than the calculation, while employee # 220 had a pay that was $65 higher than the calculations.
  3. Check that “gross pay” less “unemployment insurance, Canada Pension Plan and income taxes deducted” equals “net pay.” No errors were found.

 

Required:

For each audit test

(i) Describe the audit assertion associated with your audit test.

(ii) Discuss the results that the auditor would have expected before running the test.

(iii) Discuss the implications of the findings upon the audit process or upon specific audit procedures.

 

15.3   Consider the impact of outsourcing on the controls over, and the audit of, payroll

 

1) Otto decided to outsource the payroll function to Magna Plus.  From the purpose of an assurance engagement, Magna is considered a

  1. A) service organization.
  2. B) user entity.
  3. C) payroll administrator.
  4. D) human resource company.

 

Page Ref: 489

 

 

2) Otto decided to outsource the payroll function to Magna Plus.  The controller of Otto should still

  1. A) recalculate the payroll and its remittance to ensure accuracy.
  2. B) review and authorize each individual payments to employees.
  3. C) review the payroll journal and compare the total hours worked with the payroll time records.
  4. D) inquire with the manager of Magna Plus if they suspect any unusual transaction.

 

15.4   Highlight the misstatements that could be detected by an analytical review of payroll

 

1) The auditor’s primary concern in testing payroll liabilities is to make sure that

  1. A) expense has not been overstated, thus reducing profits.
  2. B) there are no understated or omitted accruals.
  3. C) employees’ T-4 slips are accurate.
  4. D) salaries of officers have not been misclassified as wages.

 

Page Ref: 492

 

 

2) When auditing the human resources and payroll cycle, the auditor should verify the officers’ compensation because

  1. A) officers are more likely to commit fraud.
  2. B) officers’ compensation is likely more prone to error.
  3. C) some officers may have complex compensation packages.
  4. D) some officers may be in a position to pay themselves more than the authorized amounts.

 

Page Ref: 492

 

3) The correct cutoff and valuation of accrued salaries and wages

  1. A) is to calculate the exact hours of pay that were earned in the current period and paid in a subsequent period.
  2. B) is to compute an approximate proportion of the wages that were earned in the current period and use that amount as the accrual.
  3. C) allows the client to choose between A and B above each year.
  4. D) depends on company policy and whether it is consistently followed.

 

Page Ref: 493

 

 

4) Once the auditor has determined the company’s policy for accruing wages and knows it is consistent with that of previous years, the appropriate audit procedure to test for cutoff and accuracy is to

  1. A) recalculate the client’s accruals.
  2. B) compare the ledger balance with the journal and the T-4 form.
  3. C) confirm the amount with employees.
  4. D) compare the recorded accrued wages with the amount approved in the minutes of the Board.

 

Page Ref: 493

 

 

5) An important consideration in evaluating the fairness of the amounts accrued for vacation pay, sick pay, and other benefits is the

  1. A) consistent accrual of these liabilities relative to those of the preceding year.
  2. B) actual expense incurred for the prior period.
  3. C) amount expended to date in the current period.
  4. D) profitability of the client which will enable these liabilities to be met.

 

Page Ref: 493

 

 

6) Verification of the legitimacy of year-end unpaid bonuses to officers and employees can be accomplished by comparing the recorded accrual to the amount

  1. A) in the expense account.
  2. B) used in the prior period.
  3. C) authorized and recorded in the minutes of the board of directors.
  4. D) paid in the subsequent period.

 

Page Ref: 493

 

Auditing, 12e (Arens)

Chapter 16   Audit of the Acquisition and Payment Cycle

 

16.1   Describe the major business functions, documents, and records in the acquisition and payment cycle

 

1) The major balance sheet account in the acquisition and payment cycle is

  1. A) accounts payable.
  2. B) purchases.
  3. C) merchandise inventory.
  4. D) common stock.

 

Page Ref: 504

 

 

2) The most common fraud in the acquisitions area is for the perpetrator to

  1. A) alter the cheque payment file before it is printed so that the payee name is changed.
  2. B) issue payments to fictitious vendors and deposit the cheques to a fictitious account.
  3. C) change the optical characters at the bottom of a cheque to alter the account to be credited.
  4. D) issue duplicate payments for invoices and then pocket the second cheque.

 

Page Ref: 508

 

 

3) One of the ways to prevent the use of fictitious suppliers to steal company funds is to

  1. A) have adequate network access controls to prevent unauthorized access to transaction files.
  2. B) ensure that accounts payable programs are available only in source code.
  3. C) establish controls to establish only approved vendors.
  4. D) reconcile the accounts payable trial balance to the general ledger.

 

Page Ref: 506

 

 

4) One of the ways to prevent the use of fictitious suppliers to steal company funds is by

  1. A) having adequate network access controls to prevent unauthorized access to transaction files.
  2. B) ensuring that accounts payable programs are available only in source code.
  3. C) having software automatically check for duplicate invoice numbers before payment.
  4. D) having authorized personnel carefully scrutinize documentation supporting payments.

 

Page Ref: 506

5) One form of accounts payable fraud occurs when the accounts payable clerk or another employee steals a cheque made payable to a legitimate vendor. The purchases information is then resubmitted for payment and the second cheque sent to the vendor. How could such a theft be prevented?

  1. A) cancel supporting documents to prevent their being re-used
  2. B) make sure that all payments are supported by valid documents
  3. C) reconcile the transaction files to the accounts payable master file
  4. D) have receiving reports authorized independently

 

Page Ref: 506

 

 

6) To protect against theft of physical assets (such as computer equipment), the company should

  1. A) assign the computers to specific individuals at the company.
  2. B) assign the computers to specific areas within the company.
  3. C) use strong access controls (such as login passwords) to prevent access.
  4. D) have them engraved or otherwise permanently labeled and a subsidiary ledger maintained.

 

Page Ref: 506

 

 

7) To ensure that goods and services acquired are for authorized company purposes, and help acquire only needed items

  1. A) receiving reports should be independently signed and reconciled to the purchase order.
  2. B) proper authorization for acquisitions and changes to the master file should take place.
  3. C) purchase requisitions should be approved and matched to purchase orders.
  4. D) account allocations of vendor invoices should be carefully checked.

 

Page Ref: 506

 

 

8) When automatic purchase orders are generated, to help make sure that goods are ordered for products that the company still needs, the company should

  1. A) have all purchase orders approved by the purchasing manager.
  2. B) have suppliers automatically replenish the shelves.
  3. C) ensure that re-order points are monitored.
  4. D) have receiving reports matched to the purchase order amounts.

 

9) A document identifying the description, supplier, quantity, and related information for goods and services the company intends to purchase is the

  1. A) purchases catalogue.
  2. B) purchase requisition.
  3. C) receiving report.
  4. D) purchase order.

 

Page Ref: 507

 

 

10) The purchase order, usually in writing, is a legal document that is

  1. A) a non-binding agreement between client and vendor.
  2. B) an offer to buy.
  3. C) not enforceable if it is not in writing.
  4. D) an acceptance of a vendor’s catalogue offer to sell.

 

Page Ref: 507

 

 

11) Segregation of duties has an important role in providing for good quality internal controls. Which of the following segregation of duties improve controls over the inventory and distribution cycle?

  1. A) purchasing department should not be responsible for updating the economic order quantity
  2. B) the accounting staff should not be responsible for the data entry of supplier invoice detail
  3. C) the inventory transaction processing systems should not be accessible to the receiving department
  4. D) purchasing department should not be responsible for authorizing the acquisition or receiving the goods

 

Page Ref: 507

 

 

12) The point at which most companies first recognize the acquisition and related liability on their records is when the

  1. A) purchase requisition is completed.
  2. B) purchase order is completed.
  3. C) receiving report is completed.
  4. D) vendor’s invoice is paid.

 

13) Many companies have inventory that is easy to steal and is readily marketable. Which of the following controls help to prevent theft and misuse of inventory?

  1. A) physical control of inventory from time of receipt until use
  2. B) proper access controls over the inventory master and transaction files
  3. C) dual signatures required on all purchase orders over $10,000
  4. D) purchase requisitions are to be approved by the production manager

 

Page Ref: 508

 

 

14) The proper recognition of accounts payable liabilities are crucial to ensure fair statement of the ending accounts payable balance. What documents are required to adequately support accounts payable?

  1. A) receiving reports and bill of lading documents that indicate dates shipped
  2. B) bill of lading documents matched to the internal purchase requisition
  3. C) purchase requisition (authorized) matched with the purchase order to the supplier
  4. D) supplier invoices matched to receiving reports and authorized purchase documents

 

Page Ref: 508

 

 

15) An important control in the accounts payable and information systems departments is to require that those personnel who record acquisitions do not have access to

  1. A) lists of vendors’ names and addresses.
  2. B) cash, marketable securities, and other assets.
  3. C) vendors’ price lists.
  4. D) the accounts payable master file.

 

Page Ref: 509

 

 

16) Before a new supplier is added into the supplier master file (or the purchasing master file), the company should

  1. A) conduct a credit check on the new supplier.
  2. B) have the supplier detail matched against the invoice detail.
  3. C) ask the purchasing manager to verify the authenticity of the supplier.
  4. D) have the accounting department enter the necessary detail about the supplier.

 

17) After the supplier master file data has been entered, to best improve internal controls the

  1. A) supplier master file data should be matched to the accounts payable files.
  2. B) transaction file detail should be matched to the supplier master file.
  3. C) data entry should be independently verified.
  4. D) accounting department should file the new supplier authorization form sequentially.

 

Page Ref: 509

 

 

18) When processing and recording cash disbursements, it is important to have a method of cancelling the supporting documents to prevent their reuse as support for another cheque at a later time. A common method is to

  1. A) shred the documents so they can’t be reused.
  2. B) transfer possession of the documents to a bank vault such as a safety deposit box.
  3. C) move the documents to a permanent off-site facility such as a warehouse.
  4. D) write the cheque number and payment date on the supporting documents.

 

19) A) Describe each of the five business functions that comprise the acquisition and payment cycle.

 

  1. B) Describe the key documents used in processing purchase orders for the acquisitions and payment cycle.

 

  1. C) Discuss the key documents and records used in the recognizing the liability function in the acquisitions and payment cycle.

 

 

 

16.2   Develop tests of controls for the acquisition and payment cycle

 

1) When accounts payable and purchasing systems are highly automated, more detail is included in the transaction files. This deeper level of detail is illustrated by including

  1. A) economic order quantities for each item that is held in inventory, including delivery times.
  2. B) quantities, prices and item descriptions from each line of the supplier invoice.
  3. C) sequentially numbered purchase requisitions and purchase orders (with matching numbers).
  4. D) having receiving report numbers match the numbers on the supplier invoices for improved tracking.

 

Page Ref: 509

 

 

2) Since the audit of accounts payable generally takes a considerable amount of audit time, effective internal controls, properly tested, can significantly reduce audit costs by reducing

  1. A) tests of controls.
  2. B) confirmations.
  3. C) tests of details of balances.
  4. D) analytical procedures.

 

Page Ref: 510

 

3) Which of the following areas are tested as part of the audit of the acquisition and payment cycle?

  1. A) payment for raw materials, receipt of raw materials, shipment of goods to customers
  2. B) processing of sales orders, production of goods for clients, and subsequent invoicing
  3. C) processing supplier invoices, vendor master file changes, shipment of goods to customers
  4. D) processing purchase orders, vendor master file changes, receiving goods and services

 

4) Internal controls which are likely to prevent the client from including as a business expense those transactions that primarily benefit management or other employees rather than the entity being audited satisfy the control objective that

  1. A) recorded acquisitions are for goods and services received.
  2. B) existing acquisitions are recorded.
  3. C) acquisitions are correctly valued.
  4. D) acquisitions are correctly classified.

 

Page Ref: 511

 

 

5) Because of the importance of tests of controls for acquisitions and cash disbursements, it is common in this audit area to use

  1. A) attributes sampling.
  2. B) variables sampling.
  3. C) probability-proportional-to-size sampling.
  4. D) block sampling.

 

Page Ref: 511

 

 

6) Because many of the types of errors and irregularities that may be found in the acquisition and payment cycle represent a misstatement of earnings and are of significant concern to the auditor, the tolerable exception rate selected by the auditor for attribute testing of this cycle will be

  1. A) low.
  2. B) high.
  3. C) average.
  4. D) 15% or less.

 

Page Ref: 511

 

7) An auditor learns that his client has paid a vendor twice for the same shipment, once based upon the original invoice and once based upon the monthly statement. A control procedure that should have prevented this duplicate payment is

  1. A) attachment of the receiving report to the invoice only.
  2. B) prenumbering of disbursement vouchers.
  3. C) use of a limit or reasonableness test.
  4. D) prenumbering of receiving reports.

 

8) The internal control which requires “approval of acquisitions at the proper level” satisfies the objective of

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

 

Page Ref: 512

 

 

9) The internal control which requires “new vendors and changes to vendor file be approved” satisfies the objective of

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

 

Page Ref: 512

 

 

10) The internal control objective to determine that “existing acquisition transactions are recorded” describes the objective of

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

 

Page Ref: 512

 

 

11) The internal control which requires that “purchase orders, receiving reports, and vouchers are prenumbered and accounted for” satisfies the objective of

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

 

Page Ref: 512

 

 

12) The internal control which requires “purchase orders be prenumbered and accounted for” satisfies the objective of

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

 

Page Ref: 512

 

 

13) The internal control which requires an “independent verification of calculations and amounts” satisfies the objective of

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

 

Page Ref: 512

 

 

14) The control test which requires the auditor to “compare recorded transactions in the acquisitions journal with the vendor’s invoice, receiving report, and other supporting documentation” satisfies the objective of

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

 

Page Ref: 512

 

 

15) The test of transactions which requires “the recomputing of cash discounts” satisfies the objective of

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

 

Page Ref: 512

 

 

 

16) Which of the following controls help to ensure that the receipt of raw materials for inventory is recorded in the correct period?

  1. A) supplier details are automatically retrieved from the supplier master file
  2. B) receiving staff write down the date goods are received on the bill of lading
  3. C) accounting staff record the date that goods are received in the accounting systems
  4. D) transaction date entered must be the same as the system date

 

Page Ref: 512

 

17) ZyCo has recently converted to a new online accounts payable system. To test that only authorized vendors have been converted to the vendor master file (occurrence), the auditor would

  1. A) conduct cut-off tests, for receiving reports and vendor invoices.
  2. B) on a test basis, agree vendor file details for each vendor from the new (online) system to the old (batch) system.
  3. C) on a test basis, agree vendor file details for each vendor from the old (batch) system to the new (online) system.
  4. D) conduct tests of programs, to verify that programs in the new systems are functioning as designed.

 

Page Ref: 514

 

 

18) ZyCo has recently converted to a new online accounts payable system. To test that all vendor balances have been converted to the vendor master file (completeness), the auditor would

  1. A) conduct cut-off tests, for receiving reports and vendor invoices.
  2. B) on a test basis, agree vendor file details for each vendor from the new (online) system to the old (batch) system.
  3. C) on a test basis, agree vendor file details for each vendor from the old (batch) system to the new (online) system.
  4. D) conduct tests of programs, to verify that programs in the new systems are functioning as designed.

 

Page Ref: 514

 

 

19) The test of details of balances procedure to “inspect the accounts payable trial balance and master file for related parties, notes, or other interest-bearing liabilities” satisfies the objective of

  1. A) existence.
  2. B) completeness.
  3. C) classification.
  4. D) detail tie-in.

 

Page Ref: 518

 

 

20) State each of the five specific transaction-related audit objectives for acquisitions and, for each objective, describe one common test of transactions.

 

 

21) Describe the three types of tests that need to be performed by the auditor when auditing a client’s data conversion process.

 

16.3   Design substantive tests (analytical review and tests of details) for accounts payable

 

1) Which of the following situations would indicate increased inherent risk in the accounts payable and acquisition cycle?

  1. A) good quality internal controls for cash handling
  2. B) the use of packaged software for accounting (including accounts payable)
  3. C) the use of clear, standard terms when negotiating supplier discounts
  4. D) significant related party transactions

 

Page Ref: 516

 

 

2) Comparing expenses to prior years is an effective analytical procedure for accounts payable because expenses from year to year are

  1. A) relatively stable.
  2. B) erratic.
  3. C) variable.
  4. D) dynamic.

 

Page Ref: 517

 

3) The analytical procedure which requires the auditor to “inspect the list of accounts payable for unusual or non-vendor payables” would have the best chance of discovering which possible error?

  1. A) Misstatement of accounts payable and expenses
  2. B) Classification error for non-trade liabilities
  3. C) Unrecorded accounts or misstatements
  4. D) Invalid accounts or misstatements

 

Page Ref: 517

 

 

4) The main focus taken by the auditor in verifying liability balances is on the discovery of

  1. A) liabilities posted to the wrong account.
  2. B) overstated liabilities.
  3. C) understated or omitted liabilities.
  4. D) overstated or extraneous liabilities.

 

5) The purpose of the audit procedure to “examine underlying documentation for subsequent cash disbursements” is to

  1. A) uncover liabilities on the balance sheet which should not have been recorded until a subsequent period.
  2. B) find the documentation relating to a cash disbursement.
  3. C) uncover payments made in a subsequent accounting period that represent liabilities at the balance sheet date.
  4. D) uncover cash disbursements recorded in a subsequent accounting period which should be recorded in that period.

 

Page Ref: 519

 

 

6) The purpose of the audit procedure to “trace receiving reports issued before year-end to related vendors’ invoices” is to determine that all

  1. A) merchandise received is included in accounts payable.
  2. B) merchandise received is included in inventory.
  3. C) merchandise was received.
  4. D) invoices have been paid.

 

Page Ref: 519

 

 

7) In determining that the accounts payable cutoff is correct, it is essential that the cutoff tests be coordinated with the

  1. A) confirmation of accounts payable.
  2. B) tests on long-term liabilities.
  3. C) observation of inventory.
  4. D) cash count.

 

Page Ref: 519-520

 

8) An inventory acquisition is received late in the afternoon of December 31 after the physical inventory is completed. If the acquisition is included in accounts payable and purchases, but excluded from inventory, the result

  1. A) is an understatement of net earnings.
  2. B) is an overstatement of net earnings.
  3. C) does not affect earnings.
  4. D) is indeterminable from the information given.

 

Page Ref: 520

 

 

9) When an acquisition is on an FOB (freight on board) origin basis, the inventory and related accounts payable must be recorded in the current period if the goods were

  1. A) received prior to the balance sheet date.
  2. B) shipped prior to the balance sheet date.
  3. C) both shipped and received prior to the balance sheet date.
  4. D) paid for.

 

Page Ref: 520

 

 

10) Auditor confirmation of accounts payable balances at the balance sheet date may be unnecessary because

  1. A) this is a duplication of cutoff tests.
  2. B) accounts payable balances at the balance sheet date may not be paid before the audit is completed.
  3. C) correspondence with the audit client’s lawyer will reveal all legal action by vendors for nonpayment.
  4. D) there is likely to be other reliable external evidence available to support the balances.

 

11) State five specific balance-related audit objectives for accounts payable and, for each objective, describe one common test of details of balances.

 

 

12) Describe the audit procedures typically used to test for out-of-period liabilities (also referred to as the search for unrecorded accounts payable).

 

16.4   Consider the risks and audit processes for selected accounts

 

1) A set of records for each piece of equipment that includes descriptive information, date of acquisition, original cost, current year amortization, and accumulated amortization is the

  1. A) capital asset master file.
  2. B) file of purchase requisitions.
  3. C) amortization schedule.
  4. D) acquisitions journal.

 

Page Ref: 523

 

 

2) When verifying current-year additions to manufacturing equipment, the two major objectives for this part of the audit are

  1. A) accuracy and classification.
  2. B) detail tie-in and cutoff.
  3. C) disclosure and completeness.
  4. D) rights and existence.

 

Page Ref: 524

 

 

3) The starting point for the verification of current-year acquisitions of manufacturing equipment is normally

  1. A) the manufacturing equipment account in the general ledger.
  2. B) the acquisitions journal.
  3. C) the purchase requisitions file.
  4. D) a client schedule of all acquisitions recorded during the year.

 

Page Ref: 524

 

 

4) It is normal for the auditor to verify large and unusual transactions for the entire year as well as a representative sample of typical additions. The size of the sample for substantive testing depends on the auditor’s

  1. A) sampling selection methodology used.
  2. B) assessed control risk and assessed inherent risks.
  3. C) understanding of the nature of internal controls.
  4. D) availability of client resources to pull supporting documentation.

 

5) The tests of details of balances procedure for manufacturing equipment which requires the auditor to examine vendors’ invoices of closely related accounts such as repairs and maintenance to uncover items that should be manufacturing equipment would satisfy the audit objective of

  1. A) detail tie-in.
  2. B) existence.
  3. C) classification.
  4. D) accuracy.

 

Page Ref: 525

 

 

6) A normal audit procedure is to analyze the current year’s repairs and maintenance accounts to provide evidence in support of the audit proposition that

  1. A) expenditures for capital assets have been recorded in the proper period.
  2. B) capital expenditures have been properly authorized.
  3. C) non-capitalizable expenditures have been properly expensed.
  4. D) expenditures for capital assets have been capitalized.

 

Page Ref: 525

 

 

7) Ordinarily, it is unnecessary to test the valuation of capital assets recorded in prior periods because

  1. A) it will not affect the current valuations.
  2. B) they were verified in previous audits.
  3. C) the related amortization calculations for the current period are more important.
  4. D) the emphasis of the audit is on the income statement items, not the balance sheet items.

 

Page Ref: 525

 

 

8) The most important objectives for amortization expense are valuation and

  1. A) accuracy.
  2. B) classification.
  3. C) cutoff.
  4. D) understandability.

 

9) Estimated unpaid obligations for services or benefits that have been received prior to the balance sheet date are classified as

  1. A) accounts payable.
  2. B) accrued liabilities.
  3. C) miscellaneous assets.
  4. D) unearned revenues.

 

Page Ref: 527

 

10) State each of the seven specific balance-related audit objectives for manufacturing equipment additions and, for each objective, describe one common test of details of balances.

 

 

11) Discuss the key internal controls related to the disposal of manufacturing equipment.

 

12) Discuss the audit tests the auditor would use to audit capital assets acquired in prior years.

 

 

13) Describe the two objectives that are most important in auditing accumulated amortization. Explain why these objectives are important.

 

Auditing, 12e (Arens)

Chapter 17   Audit of the Inventory and Distribution Cycle

 

17.1   Describe the business functions, documents, and records of the inventory and distribution cycle

 

1) Obtaining an adequate understanding of the client’s business is important in physical observation of inventory because

  1. A) it is required by GAAP.
  2. B) it will help the auditor in assessing the risk of theft of inventory.
  3. C) inventory is normally a significant item.
  4. D) inventory varies significantly for different companies.

 

Page Ref: 536

 

 

2) The form used to request the purchasing department to place orders for inventory items is the

  1. A) purchase order.
  2. B) purchase requisition.
  3. C) materials requisition.
  4. D) bill of lading.

 

Page Ref: 538

 

 

3) The inventory and distribution cycle can be thought of as comprising two separate but closely related systems, one involving the actual physical flow of goods, and the other the

  1. A) internal control over those goods.
  2. B) related costs.
  3. C) storing of the goods.
  4. D) prevention of waste, obsolescence, and theft.

 

Page Ref: 538

 

 

4) The bias in recording inventory would be toward

  1. A) overstatement.
  2. B) understatement.
  3. C) increasing share price.
  4. D) income smoothing.

 

Page Ref: 538

 

5) The auditor has determined that the risks are high that the client would overvalue inventory. Which audit assertions would require additional testing?

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

 

Page Ref: 538

 

 

6) The auditor evaluates the internal transfer of assets and related costs during the

  1. A) acquisition and payments cycle.
  2. B) human resources and payroll cycle.
  3. C) sales and collection cycle.
  4. D) inventory and distribution cycle.

 

Page Ref: 539-540

 

 

7) The costs used to value the physical inventory must be tested to determine whether the client has correctly followed an inventory method that is in accordance with an acceptable financial reporting framework and is consistent with previous years. The audit procedures used to verify these costs are referred to as inventory

  1. A) price tests.
  2. B) compilation tests.
  3. C) cost allocation tests.
  4. D) consistency tests.

 

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

 

9) Describe the major risks of error or fraud in the inventory and distribution cycle, using the headings of (i) risks of error, (ii) risks of misappropriation of assets, other fraud or illegal acts, and (iii) risks of inadequate disclosure or incorrect presentation of financial information, including fraudulent financial reporting.

 

17.2   Select audit steps to audit the five different parts of the inventory and distribution cycle

 

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

  1. A) receiving report.
  2. B) materials requisition.
  3. C) bill of lading.
  4. D) inventory acquisition summary.

 

Page Ref: 538

 

 

2) The overall objective in the audit of the inventory and distribution cycle is to determine that

  1. A) costs of goods sold and gross profit are correctly stated on the income statement.
  2. B) inventory items on the balance sheet are neither fraudulent nor materially in error.
  3. C) gross profit and inventory are fairly presented on the financial statements.
  4. D) inventory and cost of goods sold are fairly stated on the financial statements.

 

Page Ref: 538

 

 

3) The controls over purchase requisitions and the related purchase orders are evaluated and tested as part of the

  1. A) inventory and distribution cycle.
  2. B) acquisitions and payments cycle.
  3. C) human resources and payroll cycle.
  4. D) capital acquisitions cycle.

 

Page Ref: 539

 

 

4) When labour is a significant part of inventory, verifying the proper accounting of these costs should be tested in the

  1. A) inventory and distribution cycle.
  2. B) human resources and payroll cycle.
  3. C) acquisitions and payments cycle.
  4. D) cash cycle.

 

5) Master files, worksheets, and reports that accumulate material, labour, and overhead as the costs are incurred are

  1. A) accounting system controls.
  2. B) storeroom documents.
  3. C) finished goods inventory records.
  4. D) cost accounting records.

 

Page Ref: 539

 

 

6) Segregation of duties between production, inventory control, and accounting are important controls in the inventory and distribution cycle. How would the auditor test these controls? Using

  1. A) inquiry and reperformance.
  2. B) observation and inquiry.
  3. C) observation and reperformance.
  4. D) discussion with managment.

 

Page Ref: 540

 

 

7) Shipping of finished goods is an integral part of the

  1. A) acquisitions and payments cycle.
  2. B) inventory and distribution cycle.
  3. C) sales and collections cycle.
  4. D) human resources and payroll cycle.

 

Page Ref: 540

 

 

8) The auditor must verify whether the physical counts were correctly summarized, the inventory quantities and prices were correctly extended, and the extended inventory was correctly footed. These tests are called

  1. A) price tests.
  2. B) compilation tests.
  3. C) cost tests.
  4. D) mechanical tests.

 

Page Ref: 540

 

 

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

  1. A) materials are ordered for purchase until the finished product is sold.
  2. B) raw materials are requisitioned until the finished product is sent to storage.
  3. C) raw materials are requisitioned until the finished product is completely manufactured.
  4. D) the customer’s order is received until the finished product is shipped.

 

Page Ref: 540

 

 

10) To protect the inventory, Globus Corp wants to assign the custody of inventory to a specific responsible individual. Globus can accomplish this by requesting

  1. A) a designated employee to authorize movement of inventory.
  2. B) employees to have photo id cards.
  3. C) have restricted access to the production facility.
  4. D) have frequent inventory counts.

 

Page Ref: 540

 

 

11) A well-designed computerized system of perpetual inventory data files includes information about the

  1. A) units of inventory purchased, sold, and on hand.
  2. B) unit costs of inventory purchased, sold, and on hand.
  3. C) units and unit costs of inventory purchased, sold, and on hand.
  4. D) units of raw materials, work-in-process, and finished goods.

 

Page Ref: 541

 

 

12) The auditor’s tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods are usually limited to

  1. A) observation and inquiry.
  2. B) inspection and observation.
  3. C) inspection and confirmation.
  4. D) inspection and inquiry.

 

Page Ref: 541

 

 

13) The existence of an adequate storeroom with a competent custodian in charge results in the orderly storage of inventory. It can protect inventory from theft and misuse. How would the auditor assess these controls? Using

  1. A) observation during the audit and inquiry of the accounting staff.
  2. B) inquiry of the accounting staff and inspection of theft statistics.
  3. C) observation during the inventory count and inquiry of inventory personnel.
  4. D) inspection of inventory damage statistics and inquiry of inventory personnel.

 

Page Ref: 541

 

 

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

  1. A) inquire of management the additional controls that can be put in place to enable a better count to be carried out.
  2. B) conduct additional control tests over the pricing and compilation of inventory to obtain a higher degree of accuracy.
  3. C) rely upon the perpetual inventory master files rather than the physical count.
  4. D) expand the observation of physical inventory tests to ensure that an adequate count is carried out.

 

Page Ref: 541

 

 

15) The auditor would like to test the existence and accuracy of the transfer of goods from the raw materials storeroom to the manufacturing assembly lines. Which of the following audit procedures should be used?

  1. A) conduct a variance analysis of the costs associated with manufacturing, looking for gross profit fluctuations
  2. B) account for a sequence of raw material requisitions, examining details and looking for proper approvals
  3. C) look at overtime records to determine the amount and timing of overtime hours used in the manufacturing process
  4. D) inquire of the inventory custodian with respect to procedures used to transfer raw materials to the production line

 

Page Ref: 542

 

 

 

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

  1. A) there are accurate perpetual inventory master files.
  2. B) year-end sales are small.
  3. C) the internal control system is no better at year-end than at an earlier point in time.
  4. D) client counts inventory at interim dates.

 

Page Ref: 542

 

17) The auditor has determined that the perpetual inventory master files are high quality, assessing control risk related to physical observation of inventory as low. How does this affect audit testing? The auditor may

  1. A) reduce the extent of control tests over data entry to the master file.
  2. B) reduce the extent of the tests of physical inventory.
  3. C) reduce the extent of control tests with respect to program change controls.
  4. D) increase assessed inherent risks over the tests of physical inventory.

 

Page Ref: 542

 

 

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

  1. A) gross margin percentage with previous years.
  2. B) unit costs of inventory with previous years.
  3. C) inventory turnover with previous years.
  4. D) current year manufacturing costs with previous years.

 

Page Ref: 543

 

 

19) To detect an overstatement or understatement of inventory and cost of goods sold, the auditor may perform an analytical procedure such as comparing

  1. A) gross margin percentage with previous years.
  2. B) inventory turnover with previous years.
  3. C) current year manufacturing costs with previous years.
  4. D) extended inventory value with previous years.

 

Page Ref: 543

 

 

 

20) Which analytical procedures will help the auditor identify possible misstatements in compilation, unit costs, or extensions that affect inventory and cost of goods sold? Compare

  1. A) compare gross margin percentage with previous years’.
  2. B) unit costs of inventory with previous years’.
  3. C) inventory turnover with previous years’.
  4. D) extended inventory value with previous years’.

 

Page Ref: 543

 

21) The CAS require that audit procedures for inventory include that the auditor

  1. A) must count the inventory.
  2. B) must be present at the count and must receive adequate documentation from client regarding the effectiveness of inventory-taking.
  3. C) must be present at the count and evaluate the methods followed in the determination of quantities and values.
  4. D) need not be present at the count but must review the methods followed in the determination of quantities and values.

 

Page Ref: 544

 

 

22) The audit of the inventory and distribution 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.

 

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

 

24) What are inventory price tests and inventory compilation tests? Provide an example of each.

udit procedures used to verify these inventory costs are referred to as inventory price tests. An example would be tracing inventory costs to supplier invoices for particular inventory items purchased.

In addition, the auditor must verify whether the physical counts were correctly summarized, the inventory quantities and prices were correctly extended, and the extended inventory was correctly footed. These tests are called inventory compilation tests.

Page Ref: 540

 

 

 

17.3   Explain the role of each of the following types of tests in the audit of inventory

 

1) If the auditor is appointed after the year end of the client, the auditor

  1. A) should qualify the audit opinion for the inventory balance and cost of sales.
  2. B) could attend a current perpetual inventory count and roll backward with the records.
  3. C) should do an inventory count as soon as he is appointed.
  4. D) will inquire with management of the company about the inventory count performed at year end.

 

Page Ref: 545

 

 

2) Dishware Distribution Limited uses average costing to cost its inventory. It keeps a perpetual inventory file that is linked to its sales systems. It orders inventory in for specific customers as needed, and traditionally has a slow time just before its year end. Accordingly, inventory at the yearend is about $2,000, while materiality is about $30,000. How should the auditor approach the audit of physical inventory?

  1. A) exclude testing of physical inventory from the audit program
  2. B) use attribute sampling to select a sample of items to count
  3. C) use dollar unit sampling to select a sample of items to count
  4. D) count only those items that have a dollar value in excess of $100

 

Page Ref: 545

 

 

3) The auditor has evaluated the effectiveness of the client’s procedures to count inventory, and has provided constructive suggestions for improvement. However, the client has not implemented the suggestions, so the auditor has concluded that the inventory instructions do not provide adequate controls. This means that the auditor

  1. A) must send a management letter informing management of the impact of these weaknesses.
  2. B) must spend more time ensuring that the physical count is accurate.
  3. C) should use attribute sampling to select a smaller sampling for testing the physical inventory.
  4. D) increase the level of price and compilation tests to ensure better quality inventory pricing data.

 

Page Ref: 545

 

 

4) The auditor has determined that the inventory procedures are highly automated, with limited use of a paper or physical trail. Rather than having people count inventory (since all inventory has RFID tags attached), inventory is being read using the wireless mesh network. To provide assurance with respect to ending inventory, the auditor should

  1. A) bring in additional audit staff, and conduct a high level of test counts, matching these counts to the automated systems.
  2. B) use dollar unit sampling to identify all high dollar inventory items, and ask the client to physically count these items using count teams.
  3. C) test the quality of the controls over the programs in use, and over tagging inventory items.
  4. D) request that the client implement manual rotating counts to test the quality of the automated systems.

 

Page Ref: 545

 

 

5) When a physical count of inventory is permitted at an interim date, the auditor observes it at that time, and also tests the perpetual inventory for transactions

  1. A) throughout the year.
  2. B) which are a representative sample of the period under audit.
  3. C) from the date of the count to year-end.
  4. D) from the date of the count to the end of the audit field work.

 

Page Ref: 545

 

 

6) The client has a perpetual inventory system, and takes an inventory count of 100 items every two weeks, for comparison to the perpetual records. There are no plans to have a complete year end physical count of inventory. How will the auditor conduct the audit of physical inventory?

  1. A) select an attribute sample of items to count at the year end for comparison to the perpetual records
  2. B) select a dollar unit sample of items to count at the year end for comparison to the perpetual records
  3. C) use roll-forwards to carry forward the inventory records from the cyclical counts for an attribute sample of inventory items
  4. D) conduct test counts and compare the perpetual records with a cyclical count during the intern audit

 

Page Ref: 545

 

 

 

7) Sample size in physical observation of inventory is

  1. A) determined using attributes sampling.
  2. B) determined using variables sampling.
  3. C) determined using dollar-unit sampling.
  4. D) difficult to specify because the emphasis is on observing client’s procedures.

 

Page Ref: 545

 

8) The most important part of the observation of inventory is determining whether

  1. A) the inventory-takers are qualified.
  2. B) the physical count is being taken in accordance with the client’s instructions.
  3. C) the counts are accurate.
  4. D) obsolete inventory has been identified.

 

Page Ref: 545

 

 

9) A public accountant observes his client’s physical inventory count on December 31. There are eight inventory-taking teams, and a tag system is used. The public accountant’s observation normally may be expected to result in detection of which of the following inventory errors?

  1. A) The inventory takers forgot to count all the items in one room of the warehouse.
  2. B) An error is made in the count of one inventory item.
  3. C) Some of the items included in the inventory had been received on consignment.
  4. D) The inventory omits items on consignment to wholesalers.

 

Page Ref: 546

 

 

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

  1. A) obtain and review industry ratios.
  2. B) review accounting theory covering special problems, such as gas and oil accounting, or lease-purchase agreements.
  3. C) read client’s Accounting Manual.
  4. D) tour the client’s facility.

 

Page Ref: 546

 

 

 

11) XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. What internal control is required with respect to these costs to ensure proper valuation of inventory?

  1. A) procedures must be designed to keep the standards updated for changes in production processes and costs
  2. B) computer software should be used to make sure that the standard costs are properly updated into the inventory item master file
  3. C) input edit routines should be used to help detect input data entry errors for the entry of the standard costs
  4. D) standard costs should be used to provide a value for inventory every month by calculating cost times quantity on hand

 

Page Ref: 546

 

12) XYZ Company uses standard costs for allocating costs to work-in-process and finished goods inventory. For the last few months, there have been high variances between total standard costs and actual costs. What is one of the likely reasons for this variance?

  1. A) the accounting department has been developing the costs
  2. B) production quantities are different than expected
  3. C) there is an increase in inventory quantities on hand
  4. D) receiving department has been stockpiling raw materials

 

Page Ref: 546

 

 

13) 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. The audit objective being achieved by this procedure is

  1. A) inventory as recorded on tags exists (existence).
  2. B) existing inventory is counted and tagged (completeness).
  3. C) inventory is counted accurately (accuracy).
  4. D) inventory is classified correctly (classification).

 

Page Ref: 547

 

 

 

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

  1. A) observation of physical inventory counts
  2. B) written inventory representations from management
  3. C) confirmation of inventories in a public warehouse
  4. D) auditor’s recomputation of inventory extensions

 

Page Ref: 547

 

 

15) The test of details of balance procedure which requires the auditor to review contracts with suppliers and customers and inquire of management for the possibility of the inclusion of consigned or other non-owned inventory is an attempt to satisfy the objective of

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

 

Page Ref: 547

 

16) The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been omitted is an attempt to satisfy the objective of

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

 

Page Ref: 547

 

 

17) 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

  1. A) classification.
  2. B) cutoff.
  3. C) valuation.
  4. D) rights.

 

Page Ref: 547

 

 

18) An inventory observation procedure which compares physical counts with the perpetual inventory master file is an attempt to satisfy the audit objective of

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

 

Page Ref: 547

 

 

19) A common inventory observation procedure is to record in the working papers for subsequent follow-up the last shipping document number used at year-end. The audit objective being achieved by this procedure is

  1. A) inventory as recorded exists.
  2. B) existing inventory is counted and tagged.
  3. C) information is obtained to make sure sales and inventory purchases are recorded in the proper period.
  4. D) tags are accounted for to make sure none is missing.

 

Page Ref: 547

 

20) When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that

  1. A) all goods purchased before year-end are received before the physical inventory count.
  2. B) no goods held on consignment for customers are included in the inventory balance.
  3. C) no goods observed during the physical count are pledged or sold.
  4. D) all goods owned at year-end are included in the current period inventory balance.

 

Page Ref: 547

 

 

21) 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 totalled, and included in the general ledger at the proper amount are known as

  1. A) standard cost records.
  2. B) pricing internal controls.
  3. C) compilation internal controls.
  4. D) count quantity internal controls.

 

Page Ref: 547

 

 

22) When considering pricing of inventory, three things are important. The first two are that the method must be in accordance with an acceptable financial accounting framework, and the application of the method must be consistent from year to year. What is the third? The

  1. A) input edits over the data entry of prices must be robust.
  2. B) cut-off testing for the use of supplier invoices should be carefully done.
  3. C) cost versus market value must be considered.
  4. D) freight should always be included in the cost of the inventory.

 

Page Ref: 548

 

 

23) What is the first step that the auditor takes when auditing the valuation of inventory?

  1. A) conduct analytical review, comparing gross margin for the current year to the prior year
  2. B) do an industry analysis to determine whether there is a potential for technology-induced obsolescence
  3. C) ask the client about the level of obsolete inventory that was on hand and counted during the inventory count
  4. D) establish clearly the valuation method used and how the calculations are being performed

 

Page Ref: 548

 

24) The auditor is determining which specific inventory items should be selected for pricing tests. The auditor has selected a representative sample, and those items that have a large dollar amount. In addition, the auditor should select those items that

  1. A) are prone to breakage or theft.
  2. B) have wide fluctuations in price.
  3. C) are stored in multiple locations.
  4. D) are likely to have been miscounted during the inventory count.

 

25) As part of the audit of valuation, the auditor is conducting pricing tests by comparison to supplier invoices. The auditor is making sure that, for each item tested, sufficient supplier invoices are examined to cover the quantity of inventory that was on hand during the physical inventory count. What type of pricing error could this detect?

  1. A) clients value their inventory on the basis of the most recent invoice only
  2. B) the client has used the incorrect accounting method to value its inventory
  3. C) extension errors could occur with numerous different inventory items
  4. D) the wrong inventory count quantity could have been recorded on the count sheets

 

Page Ref: 548

 

 

26) 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

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

 

Page Ref: 549

 

 

27) Identify three analytical procedures commonly used when auditing accounts in the inventory and distribution cycle.

ommon analytical procedures for the inventory and warehousing cycle include:

  • Compare gross margin percentage with previous year.
  • 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.

Page Ref: 543

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

 

  1. B) State the primary determinants of the amount of time needed to perform the physical observation of inventory.

 

 

 

29) State five specific balance-related audit objectives for physical inventory observation and, for each objective, describe one common test of details of balances related to that objective.

 

30) A) State five specific balance-related audit objectives for inventory pricing and compilation and, for each objective, describe one common test of details of balances related to that objective.

 

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

 

 

31) You are conducting the audit of Files R Us Inc. (FRI), a family-owned business that manufactures a variety of different types of wooden and metal file cabinets. In business for over twenty years, FRI has a reputation for providing high quality products on time or even ahead of schedule. FRI does not sell to the public, but only to fine furniture stores and to a variety of office supply chains.

As of the current year end, the company has a total of $6.3 million in assets. Inventory information is as follows:

Raw materials (metals and supplies)     $ 400,000

Raw materials (wood products)               450,000

Work in progress                                   1,350,000

Finished goods                                         250,000

$2,450,000

 

Finished goods consists of:

 

Material                                                          48%

Direct labour                                                   22

Overhead                                                        30

100%

 

File cabinet production is intensely competitive, primarily due to imports from Asia and Mexico. To help manage costs, FRI uses a job-order, standard cost system. Standard costs are assessed quarterly. Each job is costed and compared to standard. Inventory is counted only at the end of the year. There is no perpetual inventory system.

 

Due to problems with raw material quality and new staff, losses have been incurred in the last six months of the year. Your review of last year’s audit file indicated that there were numerous inventory adjustments required last year.

 

Required:

Using the audit risk model, assess the risks associated with the audit of inventory.

 

Auditing, 12e (Arens)

Chapter 18   Audit of the Capital Acquisition and Repayment Cycle

 

18.1   Describe the four key characteristics of the capital acquisition and repayment cycle and the risks of fraud or error in the cycle

 

1) The normal audit approach for the audit of bonds issued is to

  1. A) examine transactions that occurred near the year end date only.
  2. B) verify each transaction taking place in the cycle for the entire year.
  3. C) select a statistical sample of transactions throughout the year.
  4. D) rely upon controls rather than conducting substantive tests.

 

Page Ref: 556

 

 

2) The exclusion of a single transaction of the capital acquisition and repayment cycle could be material in itself. This means that the following audit assertion is a major audit concern

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

 

Page Ref: 556

 

 

3) In the audit of the transactions and amounts in the capital acquisitions and repayments cycle, the auditor must ensure that significant legal requirements affecting the financial statements have been properly fulfilled and

  1. A) any violations are reported to the relevant provincial securities commissions.
  2. B) any departures from the agreements are made with management’s knowledge and consent.
  3. C) are adequately disclosed in the financial statements.
  4. D) must issue a disclaimer if they haven’t been fulfilled.

 

Page Ref: 556

 

 

 

4) There is a direct relationship between the interest and dividend accounts and debt and equity. This means that in the audit of interest-bearing debt, it is desirable to simultaneously verify

  1. A) the related dividends declared and dividends payable.
  2. B) the related interest expense and interest payable.
  3. C) contracts and commitments that are long-term.
  4. D) details provided in the Board of Directors’ minutes.

 

Page Ref: 556

 

5) A note payable is

  1. A) a long-term account payable.
  2. B) a legal obligation to a creditor secured by assets.
  3. C) an unsecured legal obligation to a creditor.
  4. D) a legal obligation to a creditor which may be unsecured or secured by assets.

 

Page Ref: 557

 

 

6) Notes payable are easy for companies to correctly value and include in the financial statements. This means that with respect to notes payable, inherent risk is

  1. A) low.
  2. B) medium.
  3. C) high.
  4. D) not assessed.

 

Page Ref: 557

 

 

7) Control risk for notes payable is usually assessed as low. This occurs because internal controls are normally good for notes payable and

  1. A) creditors would complain if the notes are not paid.
  2. B) interest expense can easily be distinguished from bank service charges.
  3. C) there are a small number of large transactions or this type of transaction.
  4. D) inclusion in the accounts payable listing helps track the notes.

 

Page Ref: 557

 

 

 

8) When setting the objectives for auditing notes, the auditor should consider inherent risks associated with

  1. A) recording errors.
  2. B) uncollectible notes.
  3. C) duplicated notes.
  4. D) management bias.

 

Page Ref: 558

 

 

9) Responsibility for the issuance of new notes should be vested in the

  1. A) board of directors.
  2. B) accounting department.
  3. C) accounts payable department.
  4. D) purchasing department.

 

Page Ref: 559

 

10) Proper authorization for the issuance of notes payable requires that

  1. A) whenever notes are renewed (refinanced), they should be subject to the same authorization procedures as those used when they were first issued.
  2. B) responsibility for authorizing notes should lie with the manager who will receive the benefits of the loan.
  3. C) responsibility for authorization should lie with the treasurer’s function, since the treasurer’s department will receive the cash generated.
  4. D) responsibility for authorization should lie with the manager who must generate the revenue to repay the loan.

 

Page Ref: 559

 

 

11) Notes payable which have been repaid in full should be

  1. A) destroyed so that they will not be paid again inadvertently.
  2. B) cancelled and destroyed.
  3. C) cancelled and returned to the creditor.
  4. D) cancelled and retained by an authorized company official.

 

Page Ref: 559

 

 

 

12) Which of the following internal controls over notes payable address risks associated with the accuracy, allocation and completeness audit assertions?

  1. A) renewals or new notes should be approved by the Board of Directors (as evidenced in the minutes) or by senior management
  2. B) authorized employees should perform independent recalculations of interest and reconciliation of the notes payable balance to the general ledger
  3. C) subsidiary records should be maintained for each note, and there should be control over blank and paid notes
  4. D) paid notes should be cancelled and retained under the custody of an authorized official

 

Page Ref: 559

 

 

13) Tests of details for notes payable interest expense and accrued interest can frequently be eliminated when

  1. A) tests of controls are conducted over authorization and recording procedures.
  2. B) notes are issued by a person independent of the accounting department.
  3. C) the notes payable schedule indicates that all notes have been repaid.
  4. D) results of analytical review are favourable.

 

Page Ref: 559

 

14) If actual interest expense is materially larger than the auditor’s independent estimate, one possible cause could be

  1. A) interest payments on unrecorded notes payable.
  2. B) omitted payments of interest (i.e. underpayments).
  3. C) interest payments recorded at the wrong lower interest rate.
  4. D) notes payable that were set up incorrectly as short term notes.

 

Page Ref: 559

 

 

15) Comparison of the total balance in notes payable, interest expense and accrued interest with these accounts in the prior year could detect what type of possible misstatement?

  1. A) Misstatement of interest expense or accrued interest, or omission of a note payable
  2. B) Omission or misstatement of a note payable
  3. C) Misclassification of a note payable as long term rather than current
  4. D) Misstatement of notes payable, interest expense or accrued interest

 

Page Ref: 559

 

 

16) During the course of an audit, a public accountant observes that the recorded interest expense seems to be excessive in relation to the balance in the long-term debt account. This observation could lead the auditor to suspect that

  1. A) long-term debt is understated.
  2. B) discount on bonds payable is overstated.
  3. C) long-term debt is overstated.
  4. D) premium on bonds payable is understated.

 

Page Ref: 559

 

 

17) Recalculation of an approximate interest expense using the basis of average interests rates and overall monthly notes payable could detect what type of possible misstatement?

  1. A) Misstatement of interest expense or accrued interest, or omission of a note payable
  2. B) Omission or misstatement of a note payable
  3. C) Misclassification of a note payable as long term rather than current
  4. D) Misclassification of notes payable, interest expense or accrued interest

 

Page Ref: 559

 

18) Comparison of individual notes payable outstanding with the prior year could detect what type of possible misstatement?

  1. A) Misstatement of interest expense or accrued interest, or omission of a note payable
  2. B) Omission or misstatement of a note payable
  3. C) Misclassification of a note payable as long term rather than current
  4. D) Misstatement of notes payable, interest expense or accrued interest

 

Page Ref: 559

 

 

19) The normal starting point for the audit of notes payable is

  1. A) a discussion with management of any new notes payable for the year.
  2. B) a schedule of notes payable and accrued interest obtained from the client.
  3. C) the assessment of materiality.
  4. D) the minutes of the board of directors.

 

Page Ref: 560

 

 

 

20) The most important balance-related and presentation and disclosure-related audit objectives for notes payable are

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

 

Page Ref: 560

 

 

21) Two of the audit objectives for notes payable are important because a misstatement could be material even if one note is omitted or incorrect. Which assertions are they?

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

 

Page Ref: 560

 

22) Presentation and disclosure are important because acceptable financial reporting frameworks require that footnotes adequately describe the terms of notes payable outstanding and the assets pledged as collateral for the loans. Which assertion does this relate to?

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

 

Page Ref: 580

 

 

23) One of the reasons that the auditor reads debt agreements is to discover whether there are any restrictions on the company, such as restrictions on the payment of dividends. It is important for the auditor to identify such restrictions as

  1. A) corroborative evidence can then be obtained from management.
  2. B) the auditor can make sure that management is adhering to the restrictions.
  3. C) the auditor can include the restrictions in the management representation letter.
  4. D) they must be disclosed in the footnotes of the financial statements.

 

Page Ref: 560

 

 

 

24) The audit objective to determine that notes payable in the schedule exist is verified by the tests of balances procedure to

  1. A) foot the notes payable list.
  2. B) confirm notes payable.
  3. C) recalculate interest expense.
  4. D) examine the balance sheet for proper disclosure of noncurrent portions.

 

Page Ref: 561

 

 

25) The tests of details of balances procedure which requires the auditor to examine corporate minutes for loan approval would satisfy the audit objective of

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

 

Page Ref: 561

 

26) The tests of details of balances procedure which requires the auditor to examine notes paid after year-end to determine whether they were liabilities at the balance sheet date is an attempt to satisfy the audit objective of

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

 

Page Ref: 561

 

 

27) The audit objective to determine that existing notes payable are included in the notes payable schedule (completeness) is accomplished by the following test of balances procedure.

  1. A) Examine balance sheet for disclosure details.
  2. B) Recalculate accrued interest.
  3. C) Review the bank reconciliation for new notes credited directly to the bank account by the bank.
  4. D) Examine duplicate copies of notes for principal and interest rates.

 

Page Ref: 561

 

 

 

28) The audit objective requiring that existing notes payable are included in the notes payable schedule (completeness) is satisfied by performing the following audit procedure.

  1. A) Recalculate accrued interest.
  2. B) Examine duplicate copies of notes for details.
  3. C) Review the notes payable schedule to determine whether any are related parties.
  4. D) Obtain confirmations from creditors who have held notes from the client in the past and are not currently included in the notes payable schedule.

 

Page Ref: 561

 

 

29) Which of the following audit procedures assists the auditor with testing for completeness?

  1. A) Analyze interest expense to uncover a payment to a creditor who is not included in the notes payable schedule
  2. B) examine note to determine whether the company has obligations for payment
  3. C) examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date
  4. D) examine the dates on duplicate copies of notes to determine whether all or part of the notes are a non-current liability

 

Page Ref: 562

 

30) The tests of details of balances procedure which requires the auditor to trace the totals of the notes payable list to the general ledger satisfies the objective of

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

 

Page Ref: 561-562

 

 

31) Caroline is performing the audit of the capital acquisition and repayment cycle.  She is currently auditing the payments of interest made during the year.  The proper documentation that Caroline should use as supporting evidence of the payment is

  1. A) a copy of the note.
  2. B) a bank reconciliation.
  3. C) documentation of her inquiries with management.
  4. D) the notes payable sub-ledger.

 

Page Ref: 562

 

 

32) The audit objective to determine that notes payable and accrued interest on the notes payable schedule are accurate is accomplished by which of the following test of balances procedure?

  1. A) Examine duplicate copies of notes for principal and interest rates.
  2. B) Review the minutes of the board of directors for authorized but unrecorded notes.
  3. C) Trace the total of the notes payable schedule to the general ledger.
  4. D) Review the notes to determine whether any are with related parties or should be accounts payable.

 

Page Ref: 562

 

 

33) The test of details of balances procedure which requires the auditor to recalculate accrued interest will satisfy the audit objective of

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

 

Page Ref: 562

 

34) A common test of details of balances procedure for notes payable is “examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date.” Which audit assertion is this test of detail associated with?

  1. A) allocation (accuracy)
  2. B) allocation (cut-off)
  3. C) existence
  4. D) completeness

 

Page Ref: 562

 

 

35) The audit objective which requires the auditor to determine that notes payable on the notes payable schedule are properly classified can be tested with the following procedure.

  1. A) Review the notes to determine whether any are with related parties.
  2. B) Confirm notes payable.
  3. C) Examine corporate minutes for loan approval.
  4. D) Examine notes, minutes, and bank confirmations for restrictions.

 

Page Ref: 562

 

 

36) The audit procedure that requires the auditor to examine notes, minutes, and bank confirmations for restrictions is performed to satisfy the audit objective of

  1. A) existence.
  2. B) completeness.
  3. C) accuracy.
  4. D) presentation and disclosure.

 

Page Ref: 562

 

 

37) Discuss the four characteristics of the capital acquisition and repayment cycle that make it unique from other cycles.

 

38) Discuss the overall objectives of the audit of notes payable.

 

39) Discuss the three key controls over notes payable.

the detailed records.

Page Ref: 559

 

 

40) Identify three analytical procedures commonly performed for notes payable.

 

 

41) State the specific balance-related audit objectives applicable to notes payable and interest and, for each objective, identify one common test of details of balances.

 

42) Describe the risks of error and fraud in the debt or equity accounts.

 

 

18.2   Describe the difference in equity between public and closely held corporations

 

1) The amount of time spent verifying owners’ equity is frequently minimal for closely-held corporations because

  1. A) these companies are so small that it is not necessary to audit the capital section.
  2. B) the few owners all have access to the books so the auditor spends more time on accounts like liabilities, which affect outsiders.
  3. C) there are few if any transactions during the year for the capital stock accounts, except for earnings and dividends.
  4. D) there is no public interest in these companies.

 

Page Ref: 562

 

 

2) For publicly held corporations, the verification of owners’ equity is more complex due to the

  1. A) fact that there are many more equity accounts to audit.
  2. B) larger numbers of shareholders and frequent changes in the individuals holding the shares.
  3. C) problem of having to confirm shares held with many more different individuals.
  4. D) need to consider that audit risk will be lower, and different shareholders have different points of view with respect to materiality.

 

Page Ref: 562

 

 

 

3) As part of the audit, the auditor may examine authorization procedures with respect to the repurchase or redemption of capital stock. In particular, for a public company the auditor would verify that which of the following details have been authorized?

  1. A) general ledger accounts affected, dividends included, amount to be paid
  2. B) type of stock, timing, amount to be paid
  3. C) individuals from whom repurchase will be permitted, maximum amount
  4. D) type of stock, amount to be paid, effect upon bond sinking funds

 

Page Ref: 562

 

4) Kumar is the internal auditor of Tarragon Inc.  Kumar wants to put procedures in place in order to prevent misstatements in owners’ equity and ensure proper record keeping.  Kumar suggested that management implements well-defined policies for preparing stock certificates and recording capital stock transaction.  What else should Kumar recommend?

  1. A) Independent internal verification of information in the records
  2. B) Having all journal entries in the equity account reviewed by the controller
  3. C) Perform a monthly reconciliation of shareholder’s equity
  4. D) Reconcile the dividend payments with the bank statement

 

Page Ref: 563

 

 

5) Most large corporations employ the services of a stock transfer agent for the purpose of

  1. A) maintaining the shareholder records.
  2. B) recording share capital in the accounts.
  3. C) issuing the shares for the company.
  4. D) ensuring that stock issuances are complying with federal and provincial laws.

 

Page Ref: 563

 

 

6) It is normal practice to verify all capital stock transactions

  1. A) that are in excess of a material amount.
  2. B) if there aren’t very many during the year.
  3. C) regardless of the controls in existence, because of their materiality and permanence in the records.
  4. D) only when the client is small.

 

Page Ref: 563

 

 

 

7) If a company employs a capital stock registrar and/or transfer agent, the registrar or agent, or both, should be requested to confirm directly to the auditor the number of shares of each class of stock

  1. A) surrendered and cancelled during the year.
  2. B) authorized at the balance sheet date.
  3. C) issued and outstanding at the balance sheet date.
  4. D) authorized, issued, and outstanding during the year.

 

Page Ref: 563

 

 

8) The emphasis in the audit of dividends is on

  1. A) ending equity balance.
  2. B) transactions.
  3. C) opening dividends payable balance.
  4. D) confirming the number of shares outstanding.

 

Page Ref: 564

 

9) Usually dividends are audited

  1. A) using block sampling.
  2. B) on a 100% basis.
  3. C) using variables sampling.
  4. D) using attributes sampling.

 

Page Ref: 564

 

 

10) When the auditor examines the minutes of board of directors’ meetings for the amount of the dividend per share and the dividend date, the auditor is checking for

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

 

Page Ref: 564

 

 

 

11) When the auditor examines the board of directors’ minutes for dividends declared, the auditor should be alert to the possibility of unrecorded dividends declared, particularly shortly before the balance sheet date. Which audit assertion does this address?

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

 

Page Ref: 564

 

 

12) An audit procedure that is part of the audit of notes payable is the review of the permanent audit working paper files to determine if there are restrictions on the payment of dividends in bond indenture agreements or preferred share provisions. Which presentation and disclosure audit assertion is this associated with?

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

 

Page Ref: 564

 

13) The transfer agent confirmed to the auditor that the company had 2,500,000 shares outstanding at December 31, 2010.  To have assurance over the accuracy of the dividend payable, the auditor would multiply 2,500,000 by the

  1. A) dividend per share declared.
  2. B) dividend per share paid during the year.
  3. C) dividend per share as per the articles of incorporation, even if it was not declared during the year.
  4. D) average dividend for the industry.

 

14) The auditor recomputed the dividend declaration amount by multiplying the declared dividend per share by the number of shares outstanding. Which audit assertion is this associated with?

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

 

Page Ref: 564

 

 

15) The auditor has reconciled the dividend payment amounts disbursed according to the cash disbursements journal to the dividend declared.  Which audit assertions is this test associated with?

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

 

Page Ref: 564

 

 

16) When a dividend is declared by the Board, the source for determining who should receive dividend cheques is the

  1. A) shareholders’ capital stock register or master file.
  2. B) stock certificate books.
  3. C) common stock account in the general ledger.
  4. D) corporate directory.

 

17) As part of the audit of dividends, the auditor would verify whether the payment was made to the shareholders who owned the stock at the dividend record date. Which of the following audit tests assists with this objective?

  1. A) examine the minutes of board of directors’ meetings for the amount of the dividend per share and the dividend date
  2. B) review the permanent audit working paper file to determine if there are restrictions on the payment of dividends
  3. C) recomputed the amount of dividends declared by multiplying the dividend amount per share by the number of shares outstanding
  4. D) select a sample of recorded dividend payments and trace the payee’s name on the cancelled cheque to the dividend records

 

Page Ref: 364

 

 

18) A primary concern in determining whether retained earnings is correctly disclosed on the balance sheet is

  1. A) correct calculation of the net income or loss for the year.
  2. B) correct calculation of dividend payments for the year.
  3. C) whether adjustments to retained earnings have been made correctly.
  4. D) whether there are any restrictions on the payment of dividends.

 

Page Ref: 565

 

 

19) Explain why the auditor’s verification of owners’ equity is more complex for publicly-held corporations than closely-held corporations.

Answer:  For publicly-held corporations, the verification of owners’ equity is more complex due to the larger numbers of shareholders and frequent changes in the individuals holding the stock. Transfer agents, dividend declarations and payments.

Page Ref: 562

 

 

20) Describe the three objectives of the auditor’s examination of owners’ equity.

 

21) First Global is a public company.  You are currently performing the audit of the owner’s equity section and you have been asked to write a short memo about the control weaknesses you have identified and the potential risk attached to each weakness.

First Global is a public company since March of the current year as it underwent an IPO during the year.  The corporation has been implementing various controls with regards to keeping records of the company, but it is still a growing company, and Sasha, the equity accountant, has been having a tough time learning all the new regulations, keeping the records up to date and ensuring that the dividend payments are made on time.

First Global issued 2 classes of shares in the IPO.  Class A shares with 10 votes were issued to the Truman family so they could retain control and Class B shares with 1 vote each were issued to the general public.  When you reviewed the accounting records, you noticed that they contained only one account for capital stocks.

 

 

22) Discuss the internal controls related to owners’ equity that are of concern to the auditor.

 

23) State the four audit concerns for capital stock and describe how the auditor typically verifies each of these areas.

 

24) Describe the audit procedures and related audit assertions for the audit of dividends.

 

Auditing, 12e (Arens)

Chapter 19   Completing the Audit

 

19.1   Design and perform audit tests related to presentation and disclosure audit objectives

 

1) Which level of risk does the auditor normally assign to the presentation and disclosure-related assertion of completeness for contingent liabilities and subsequent events?

  1. A) low risk for inherent risks that required information may not be disclosed in the notes
  2. B) medium for control risk with respect to identifying relevant events
  3. C) medium with respect to providing adequate detail for the notes
  4. D) high that all required information may not be disclosed in the notes

 

Page Ref: 574

 

 

2) Which of the following is a required condition for a contingent liability to exist?

  1. A) There is a potential liability to an employee of the client.
  2. B) The amount of the future payment is known.
  3. C) The liability resulted from known events.
  4. D) The outcome has been resolved by a current event.

 

Page Ref: 574

 

 

3) What situation represents a contingent liability for a company?

  1. A) A candy company’s monthly production requires 1,000 kg of chocolate. The company entered into a contract with a chocolate producer to purchase 6,000 kg of chocolate over the next six months at the market price.
  2. B) A bike company learned that a racer using its bike was seriously injured in an accident on December 30th, 2012, as the front wheel of the bike was released in a curb as a result of a manufacturing defect. The company has not received a claim at December 31st, 2012 but management expects to receive a claim.
  3. C) A restaurant received a $10,000 claim from a customer for emotional damages as a result of poor service. The legal counsel of the restaurant indicated that the claim was not supported and there was less than a 5% chance that the restaurant would have to pay.
  4. D) A hotel chain was found guilty by a judge for not refunding customers with on-line reservations. The hotel chain will have to pay $50,000 to various customers in the following year.

 

4) When the proper disclosure in the financial statements of material contingencies is through footnotes, the footnote should describe the nature of the contingency to the extent it is known and

  1. A) the auditor’s opinion as to the expected outcome.
  2. B) the opinion of legal counsel or management as to the expected outcome.
  3. C) an estimate of the amount or a statement that the amount cannot be estimated.
  4. D) the steps client has taken to ensure that it doesn’t recur.

 

Page Ref: 574

 

 

5) If the amount of a probable loss on a contingent liability is not determinable, the liability should be

  1. A) accrued and indicated in the body of the financial statements.
  2. B) disclosed in footnotes, but not accrued.
  3. C) neither accrued nor disclosed in footnotes.
  4. D) disclosed in the auditor’s report but not disclosed on the financial statements.

 

Page Ref: 574

 

 

6) If the amount of a probable loss on a contingent liability cannot be estimated, but the event is likely, the liability should be

  1. A) accrued and indicated in the body of the financial statements.
  2. B) disclosed in footnotes, but not accrued.
  3. C) neither accrued nor disclosed in footnotes.
  4. D) disclosed in the auditor’s report but not disclosed on the financial statements.

 

Page Ref: 574

 

 

7) If a potential loss on a contingent liability is likely and the amount of the loss can be reasonably estimated, the liability should be

  1. A) accrued and indicated in the body of the financial statements.
  2. B) disclosed in footnotes, but not accrued.
  3. C) neither accrued nor disclosed in footnotes.
  4. D) disclosed in the auditor’s report but not disclosed on the financial statements.

 

8) Which of the following scenarios regarding a lawsuit filed against a client by a third party would qualify as a “contingent liability”? A lawsuit has been filed

  1. A) but not yet resolved.
  2. B) and concluded with the client winning.
  3. C) and concluded with a third party winning an award of $100,000, but the client hasn’t paid yet.
  4. D) and concluded with a third party winning an award of $100,000, which the client paid after the balance sheet date but before the statements are issued.

 

Page Ref: 574

 

 

9) If a potential loss on a contingent liability is unlikely and the event will not likely have a significant adverse financial effect, the liability should be

  1. A) accrued and indicated in the body of the financial statements.
  2. B) disclosed in footnotes, but not accrued.
  3. C) neither accrued nor disclosed in footnotes.
  4. D) disclosed in the auditor’s report but not disclosed on the financial statements.

 

Page Ref: 575

 

 

10) IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event. Which of the following would need to provide for the (i.e. the financial statements adjusted)?

  1. A) outflow of resources is required, but cannot be reliably estimated
  2. B) possibility that an outflow of resources is required
  3. C) likelihood is remote
  4. D) amount is yet to be confirmed

 

Page Ref: 575

 

 

11) IFRS uses specific terminology to refer to the likelihood of the occurrence of an organizational event. Which of the following would require note disclosure in the financial statements adjusted?

  1. A) likely to occur and the amount can be estimated
  2. B) possible that an outflow of resources is not required
  3. C) likelihood is remote
  4. D) amount is yet to be confirmed

 

Page Ref: 575

 

12) The auditor’s responsibility with regards to contingent liabilities is to

  1. A) identify the appropriate accounting treatment.
  2. B) decide on the appropriate accounting treatment.
  3. C) prepare note disclosure.
  4. D) evaluate the accounting treatment of known contingent liabilities.

 

Page Ref: 575

 

 

13) When auditing contingent liabilities, the primary objective at the initial stage of the tests is to determine

  1. A) the materiality of any liability.
  2. B) what constitutes adequate disclosure of the liability.
  3. C) the likelihood of the liability.
  4. D) the existence of the liability.

 

Page Ref: 576

 

 

14) An agreement which commits the firm to a set of fixed conditions in the future regardless of what happens to profits or the economy as a whole is a definition of a

  1. A) contingent liability.
  2. B) potentially hazardous agreement.
  3. C) commitment.
  4. D) conditional contract.

 

Page Ref: 576

 

 

15) What audit approach is used to search for unknown commitments?

  1. A) Include as part of the search for subsequent events
  2. B) Conduct with substantive tests associated with the cutoff assertion
  3. C) Perform as part of the audit of each cycle or audit area
  4. D) Include with the legal letter sent to lawyers

 

Page Ref: 576

 

 

16) Management furnishes the auditor with information concerning litigation, claims, and assessments. Which of the following is the auditor’s primary means of initiating action to corroborate such information? Request that client

  1. A) lawyers undertake a reconsideration of matters of litigation, claims, and assessments with which they were consulted during the period under examination.
  2. B) management send a letter of inquiry to those lawyers with whom management consulted concerning litigation, claims, and assessments.
  3. C) lawyers provide a legal opinion concerning the policies and procedures adopted by management to identify, evaluate, and account for litigation, claims, and assessments.
  4. D) management engage outside lawyers to suggest wording for the text of a footnote explaining the nature and probable outcome of existing litigation, claims, and assessments.

 

Page Ref: 577

 

 

17) There are two categories of lawsuits: an outstanding (or asserted) claim, and a(n)

  1. A) possible or unasserted claim.
  2. B) disputed claim among several parties.
  3. C) settled claim.
  4. D) claims that could result in material misstatements.

 

Page Ref: 577

 

 

18) Which of the following procedures might be useful in discovering a contingent liability for a lawsuit that management is intentionally neglecting to disclose?

  1. A) Inquiries (orally and in writing) of management
  2. B) Analyze legal expense and review invoices and statements from outside legal counsel
  3. C) Review current and previous years’ Canada Revenue Agency correspondence
  4. D) Obtain a letter of representation from management that it is not aware of any undisclosed contingent liabilities

 

19) Which of the following substantive tests would the auditor conduct as a search for contingent liabilities?

  1. A) select an attribute sample of legal expenses for matching to invoices
  2. B) select a dollar unit sample of legal expenses, for matching to invoices
  3. C) inspect legal expense invoices, doing a census test of legal expenses
  4. D) review a sample of legal invoices, looking for appropriate authorization for payment

 

Page Ref: 577

 

20) The standard letter of confirmation sent to the client’s legal counsel should be prepared on the

  1. A) auditor’s stationery and signed by an audit partner.
  2. B) lawyer’s stationery and signed by the lawyer.
  3. C) client’s stationery and signed by a company official.
  4. D) plain paper and be unsigned.

 

Page Ref: 577

 

 

21) What action will a lawyer likely take if they have information about a law suit that was not mentioned by the client?

  1. A) in the legal letter, tell the auditor the number of suits, and request the auditor to contact the client
  2. B) request the client to notify the auditor about the lawsuit
  3. C) they will not mention the lawsuits, they are confidential
  4. D) the law firm will refuse to answer the legal letter, since it is incorrect

 

Page Ref: 578

 

 

22) The auditor has sent inquiry letters to all of the client’s law firms. Two law firms stated that the client was unlikely to win the lawsuits in question, whereas the client had said the opposite. What action should the auditor take?

  1. A) ask management for invoices supporting the omitted lawsuits
  2. B) request a meeting with management and the respective law firms
  3. C) ask the law firms to provide additional details with respect to the lawsuits
  4. D) change control risk to maximum and increase substantive testing

 

23) The standard letter of confirmation from client’s legal counsel should ask for information about the period of time

  1. A) covered by client’s financial statements.
  2. B) covered by client’s financial statements plus the preceding year.
  3. C) covered by client’s financial statements plus the succeeding year.
  4. D) approximately up to the date of the auditor’s report.

 

Page Ref: 578

 

24) You sent a legal letter to a lawyer who had invoiced your client. The lawyer replied that “his practice consists of conducting real estate closings, and so he could not respond to the letter.” What impact does this have on the financial statement audit?

  1. A) there is no impact upon the financial statement audit
  2. B) the audit opinion will need to be qualified
  3. C) the auditor will need to provide a denial of opinion
  4. D) additional information is needed by reference to legal invoices from this lawyer

 

Page Ref: 578

 

 

25) If a lawyer refuses to provide the auditor with information that is within the lawyer’s jurisdiction and may directly affect the fair presentation of financial statements about material existing lawsuits (asserted claims) or unasserted claims, the audit report would have to be

  1. A) an adverse opinion.
  2. B) a qualified opinion.
  3. C) an unqualified opinion with an explanatory paragraph.
  4. D) modified to reflect the lack of available evidence (ie. scope limitation).

 

Page Ref: 578

 

 

26) The auditor has a responsibility to review transactions and activities occurring after the year-end to determine whether anything occurred that might affect the valuation or disclosure of the statements being audited. The auditing procedures required to verify these transactions are commonly referred to as the review for

  1. A) contingent liabilities.
  2. B) subsequent year’s transactions.
  3. C) late unusual occurrences.
  4. D) subsequent events.

 

Page Ref: 578

 

 

27) The auditor’s responsibility for “reviewing the subsequent events” of a client is normally limited to the period of time beginning with the

  1. A) balance sheet date and ending with the date of the auditor’s report.
  2. B) start of the fiscal year under audit and ending with the balance sheet date.
  3. C) start of the fiscal year under audit and ending with the date of the auditor’s report
  4. D) balance sheet date and ending with the date the registration statement becomes effective.

 

Page Ref: 579

 

28) Whenever subsequent events are used to evaluate the amounts included in the statements, care must be taken to distinguish between conditions that existed at the balance sheet date and those that come into being after the end of the year. The subsequent information should not be incorporated directly into the statements if the conditions causing the change in valuation

  1. A) did not take place until after year-end.
  2. B) did take place before year-end.
  3. C) occurred both before and after year-end.
  4. D) are reimbursable through insurance policies.

 

Page Ref: 580

 

 

29) The following events all occurred after the balance sheet date (6/30/12) but prior to the auditor’s report (9/10/12). Which one would require an adjustment to the account balances as of 6/30/12?

  1. A) Client will market a new series of equity securities ($2 million of preferred stock) on 8/1/12.
  2. B) Unused equipment on the books at 6/30/12 for $100,000 was disposed of 7/31/12 for $60,000.
  3. C) Securities costing $30,000 held for temporary investment on 6/30/12 declined in value by one-third when the market took a plunge on 8/15/12.
  4. D) Inventory valued at $100,000 on 6/30/12 was destroyed in a fire on 8/1/12.

 

30) Subsequent events affecting the valuation of assets ordinarily will require adjustments of the financial statements under examination because such events typically represent the

  1. A) culmination of conditions that existed at the balance sheet date.
  2. B) final estimates of losses relating to casualties occurring in the subsequent events period.
  3. C) discovery of new conditions occurring in the subsequent events period.
  4. D) preliminary estimate of losses relating to new events that occurred subsequent to the balance sheet date.

 

Page Ref: 580

 

 

31) A client has a calendar year-end. Listed below are four events that occurred after December 31. Which one of these subsequent events might result in adjustment of the December 31 financial statements?

  1. A) adoption of accelerated depreciation methods
  2. B) write-off of a substantial portion of inventory as obsolete
  3. C) collection of 90% of the accounts receivable existing at December 31
  4. D) sale of a major subsidiary

 

Page Ref: 580

 

32) Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued?

  1. A) sale of long-term debt or capital stock
  2. B) loss of a plant as a result of a flood
  3. C) major purchase of a business that is expected to double the sales volume
  4. D) settlement of litigation in excess of the recorded liability

 

Page Ref: 580

 

 

33) A client acquired 25% of its outstanding capital stock after year-end and prior to completion of the auditor’s fieldwork. The auditor should

  1. A) advise management to adjust the balance sheet to reflect the acquisition.
  2. B) issue pro forma financial statements giving effect to the acquisition as if it had occurred at year-end.
  3. C) advise management to disclose the acquisition in the notes to the financial statements.
  4. D) disclose the acquisition in the opinion paragraph of the auditor’s report.

 

Page Ref: 580

 

 

34) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures are in category 1?

  1. A) Make inquiries of client regarding contingent liabilities.
  2. B) Obtain a letter of representation written by client.
  3. C) Examine subsequent period sales and purchases transactions to determine whether the cutoff is accurate.
  4. D) Review the minute book to determine the existence of any transaction related to year 1.

 

Page Ref: 580

 

 

35) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures are in category 2?

  1. A) Examine subsequent-period sales and purchases transactions to determine whether the cutoff is accurate.
  2. B) Correspond with lawyers.
  3. C) Test the collectability of accounts receivable by reviewing subsequent period cash receipts.
  4. D) Compare the subsequent period purchase price of inventory with the recorded cost as a test of lower-of-cost-or-market valuation.

 

Page Ref: 580-581

 

36) Inquiries of management are used to help identify subsequent events. To help obtain meaningful answers

  1. A) the standard firm checklist should be followed.
  2. B) these inquiries must be conducted with the proper client personnel.
  3. C) the inquiries should be conducted by senior audit personnel.
  4. D) they should be asked after the effective date of the audit report.

 

37) Kendra is inquiring about subsequent events with regards to lawsuits and contingent claims.  To obtain a meaningful answer, Kendra should hold the enquiry with

  1. A) the Vice President, legal of the company.
  2. B) the accountant in charge of the legal liability reconciliation.
  3. C) the mail clerk.
  4. D) the assistant controller.

 

Page Ref: 581

 

 

38) As part of the review for subsequent events, the auditor will review financial statements prepared after the balance sheet date. The purpose of this review is to examine changes after year end and to look for

  1. A) errors in capital versus maintenance charge allocations that occurred after the year end.
  2. B) subsequent payments to accounts payable and long term debt.
  3. C) subsequent receipts in accounts receivable, especially for the larger customers.
  4. D) changes in the business relative to results for the same period in the year under audit.

 

Page Ref: 581

 

 

39) As part of the review for subsequent events, the auditor will review financial statements prepared after the balance sheet date. The statements should be discussed with management to determine whether they

  1. A) were approved by the controller prior to your review.
  2. B) are mathematically correct, including calculation of depreciation.
  3. C) are prepared on the same basis as the current-period statements.
  4. D) were completed on a comparative basis, showing the last three years.

 

Page Ref: 581

 

40) State the three conditions required for a contingent liability to exist.

 

41) Discuss three audit procedures commonly used to search for contingent liabilities.

 

42) State three types of information that should be included in a standard letter of inquiry of client’s law firms.

 

43) State the two primary types of subsequent events that require consideration by management and evaluation by the auditor, and give two examples of each type.

 

19.2   Provide examples of work completed as part of the final evidence-gathering process

 

1) The primary objective of analytical procedures used in the final review stage of an audit is to

  1. A) obtain evidence from details tested to corroborate particular assertions.
  2. B) identify areas that represent specific risks relevant to the audit.
  3. C) assist the auditor in looking for potential material misstatements.
  4. D) satisfy doubts when questions arise about a client’s ability to continue in existence.

 

Page Ref: 582

 

 

2) CAS 570Going Concern, requires that the auditor evaluates management’s assessment of the ability of the entity to continue as a going concern based on

  1. A) inquiry with management.
  2. B) the opinion of the legal counsel of the company.
  3. C) the liquidity and solvency ratios of the firm.
  4. D) the evidence collected throughout the audit.

 

Page Ref: 582

 

 

3) At the completion of the audit, management is asked to make a written statement that it is not aware of any undisclosed contingent liabilities. This statement would appear in the

  1. A) management letter.
  2. B) representation letter.
  3. C) engagement letter.
  4. D) letters testamentary.

 

Page Ref: 583

 

4) Which of the following auditing procedures is ordinarily performed last?

  1. A) Reading of the minutes of the directors’ meetings
  2. B) Confirming accounts payable
  3. C) Obtaining a client representation letter
  4. D) Testing of the purchasing function

 

5) Refusal by a client to prepare and sign the representation letter would require a(n)

  1. A) qualified opinion as to scope limitation or a disclaimer of opinion.
  2. B) adverse opinion or a denial of opinion.
  3. C) qualified opinion as to accounting treatment departure or an adverse opinion.
  4. D) unqualified opinion with an explanatory paragraph.

 

Page Ref: 583

 

 

6) One of the purposes of a client representation letter is to

  1. A) reduce the amount of audit procedures performed by the auditor.
  2. B) document the responses from management to inquiries about various aspects of the audit.
  3. C) serve as audit evidence for the accuracy of the contingent liabilities.
  4. D) reduce the detection risk.

 

Page Ref: 583

 

 

7) A client representation letter is a written statement from a non-independent source and therefore

  1. A) cannot be regarded as reliable evidence on its own.
  2. B) can be regarded as reliable evidence only if the auditor finds strong internal controls.
  3. C) can be regarded as reliable evidence if the high-level corporate officials who sign it are trustworthy.
  4. D) needs to be confirmed by an outside, independent source such as a financial institution, or law firm.

 

Page Ref: 584

 

 

8) The CAS require the auditor to review the other information in the annual report to ascertain its consistency with the financial statements. If there is a material inconsistency, the client should be requested to change the information. If the client refuses, the auditor should

  1. A) issue an adverse opinion.
  2. B) issue a qualified opinion.
  3. C) consider what further action is warranted, including making contact with the audit committee.
  4. D) issue an unqualified opinion, bill the client, and withdraw from any future engagements.

 

9) In addition to the financial statements, MD&A (management discussion and analysis) are appended to the financial statements to inform users of management’s expectations for the foreseeable future, as well as to provide management’s assessment of the financial results. MD&A is prepared primarily because it is

  1. A) an additional piece of evidence used by auditors to assess the financial statements.
  2. B) generally required by securities regulators in Canada.
  3. C) an unbiased view of the prospective future results of the company.
  4. D) required so that the company can borrow more funds or sell more shares to the public.

 

10) Klein Corporation has reported a loss for the 6th year in a row.  Klein also has a large bank loan due in the coming year, bringing its current ratio to .60.  Further, due to the economic crisis, Klein had to increase its bad debt expense by 4% and also saw its largest client, Forest Prairie filing for bankruptcy.  Forest Prairie’s purchases made up 18% of the total sales of Klein in the past year.  Forest Prairie also had an unpaid balance to Klein at year end.

 

In trying to reduce expenses, Klein has reduced the employee training from 5 days to 1 day.  During the year, an employee was seriously injured in the production process when his arm was caught in a press.  The employee has filed a lawsuit against Klein for $1,000,000 as he claims that he was not properly trained to use the equipment.  The legal proceeding for this case should begin in the next fiscal year.  Since Klein has never been involved in such as lawsuit before, the legal counsel indicated that they were not able to estimate the amount and likelihood that Klein would have to pay.

 

Required:  Evaluate the going concern situation at Klein and indicate what the auditor would be required to do under CAS 570.

 

11) A) Discuss the purposes of performing analytical procedures during the audit completion phase.

 

  1. B) State the two purposes of the client representation letter.

 

 

 

12) List four specific matters that should be included in a client representation letter.

 

 

13) Besides the search for contingent liabilities and the review for subsequent events, the auditor has four important final evidence accumulation responsibilities, all of which are required by current professional auditing standards. Discuss each of these four responsibilities.

 

19.3   Describe the actions that the auditor takes to evaluate the adequacy of accumulated evidence

 

1) An important part of evaluating whether the financial statements are fairly stated is summarizing the misstatements uncovered in the audit. Whenever the auditor uncovers misstatements that are in themselves material,

  1. A) entries should be proposed to the client to correct the statements.
  2. B) no entries need be made but footnote disclosure is required.
  3. C) it is necessary to combine individually immaterial misstatements with the material misstatements and make entries to correct the statements.
  4. D) it is necessary to combine individually immaterial misstatements with the material misstatements and make full disclosure in the footnotes.

 

Page Ref: 585

 

 

2) There are often a large number of immaterial errors discovered that do not require an adjustment at the time they are found. How should these errors be dealt with by the auditor?

  1. A) Since these items are individually immaterial, the auditor would not recommend adjusting entries to client.
  2. B) Since there are a large number of these, the auditor would recommend adjusting entries to the client.
  3. C) The auditor must combine the individually immaterial errors and evaluate whether the combined amount is material.
  4. D) The auditor would never combine these individually immaterial amounts because that would mix apples and oranges.

 

Page Ref: 585

 

 

3) The initial review of the working papers prepared by any given auditor is normally done by the

  1. A) partner assigned to the audit.
  2. B) supervisor or manager.
  3. C) senior.
  4. D) immediate supervisor.

 

4) When several staff are working together on an audit engagement, what type of quality control review is conducted on a daily basis?

  1. A) the partner reviews the electronic files
  2. B) team review by interview
  3. C) second partner review
  4. D) manager review of sections

 

Page Ref: 586

 

 

5) CAS 250 requires the auditor to communicate illegal acts to the audit committee

  1. A) if the illegal acts are slightly material.
  2. B) if the illegal acts are material.
  3. C) if the illegal acts are other than trivial.
  4. D) regardless of materiality.

 

Page Ref: 587

 

 

6) State the three main reasons why it is essential that working papers be thoroughly reviewed by another member of the audit firm at the completion of the audit.

 

19.4   Describe the communications the auditor is required to send after the completion of the audit

 

1) CAS 450 requires the auditor to communicate all misstatements to the audit committee

  1. A) if the misstatements are slightly material.
  2. B) if the misstatements are material.
  3. C) if the misstatements are other than trivial.
  4. D) regardless of materiality.

 

Page Ref: 587

 

2) The management letter

  1. A) is required by the CAS whenever there are “reportable conditions.”
  2. B) must follow the format prescribed by the CICA.
  3. C) spells out to the audit committee the auditor’s responsibilities under generally accepted auditing standards.
  4. D) is optional and is intended to help the client operate its business more effectively.

 

Page Ref: 588-589

 

 

3) Discuss the purpose of a management letter.

 

4) Describe the items the auditor is required to report to the audit committee.

 

 

Auditing, 12e (Arens)

Chapter 20   Auditor Reporting

 

20.1   State the requirements for a standard unqualified audit report

 

1) The most common type of audit report contains

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

 

Page Ref: 596

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 597

 

 

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

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

10) The phrase “in our opinion” indicates that

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

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

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

 

Page Ref: 598

 

 

16) Double dating a report is done when

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

 

Page Ref: 599

 

 

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

 

 

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

 

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

 

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

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

 

Page Ref: 599

 

 

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

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

 

Page Ref: 600

 

 

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

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

 

Page Ref: 600

 

 

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

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

 

Page Ref: 600

 

 

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

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

 

Page Ref: 600

 

 

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

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

 

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

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

 

Page Ref: 600

 

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

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

 

Page Ref: 600

 

 

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

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

 

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

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

 

Page Ref: 600

 

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

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

 

Page Ref: 601

 

 

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

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

 

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

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

 

Page Ref: 601

 

14) When a material uncertainty exists, the auditor must

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

 

Page Ref: 602

 

 

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

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

 

Page Ref: 602

 

 

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

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

 

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

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

 

Page Ref: 602-603

 

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

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

 

Page Ref: 604

 

 

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

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

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

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

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

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

 

11) An adverse opinion is issued when the auditor believes

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

 

12) Both disclaimers of opinion and adverse opinions are used

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 604

 

 

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

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

 

Page Ref: 605

 

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

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

 

Page Ref: 605

 

 

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

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

 

Page Ref: 605

 

 

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

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

 

Page Ref: 605

 

 

 

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

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

 

Page Ref: 605

 

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

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

 

Page Ref: 605

 

 

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

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

 

Page Ref: 606

 

 

 

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

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

 

Page Ref: 608

 

 

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

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

 

Page Ref: 609

 

24) The primary auditor who relies on a secondary auditor

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

 

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

 

 

26) Discuss how materiality affects audit reporting decisions.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

Required:

How does the above information affect the audit report?

 

 

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

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

 

Auditing, 12e (Arens)

Chapter 21   Assurance Services: Review and Compilation Engagements

 

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

 

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

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

 

Page Ref: 618

 

 

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

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

 

Page Ref: 618

 

 

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

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

 

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

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

 

Page Ref: 618

 

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

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

 

Page Ref: 619

 

 

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

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

 

Page Ref: 619

 

 

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

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

 

Page Ref: 619

 

 

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

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

 

Page Ref: 619

 

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

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

 

Page Ref: 621

 

 

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

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

 

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

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

 

Page Ref: 621

 

 

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

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

 

Page Ref: 621

 

13) Define “assurance engagements.”

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

Page Ref: 618

 

 

14) Define “attest engagements.”

 

 

15) Define “direct reporting engagements.”

 

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

report.

Page Ref: 619

 

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

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

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

 

Required:

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

 

21.2   Explain the importance of review and compilation services

 

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

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

 

Page Ref: 622

 

 

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

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

 

Page Ref: 622

 

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

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

 

Page Ref: 622

 

 

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

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

 

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

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

 

Page Ref: 623

 

 

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

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

 

Page Ref: 623

 

 

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

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

 

Page Ref: 623

 

8) A review engagement includes

  1. A) obtaining an understanding of the internal controls.
  2. B) tests of controls or transactions.
  3. C) inquiry, analytical procedures and discussion.
  4. D) independent confirmation or physical examination.

 

9) Before performing a review of an entity’s financial statements, an accountant should

  1. A) complete a series of inquiries concerning the entity’s procedures for recording, classifying, and summarizing transactions.
  2. B) apply analytical procedures to provide limited assurance that no material modifications should be made to the financial statements.
  3. C) obtain a sufficient level of knowledge of the accounting principles and practices of the industry in which the entity operates.
  4. D) inquire whether management has omitted substantially all of the disclosures required by generally accepted accounting principles.

 

Page Ref: 623

 

 

10) As part of the review engagement for a small manufacturing company, which of the following would be a typical review procedure for the sales cycle?

  1. A) review of internal controls over the granting of credit
  2. B) examination of sales documents to ensure credit approval is documented
  3. C) recalculation of the taxes and extensions on a sample of invoices
  4. D) comparison of sales and gross profit to the prior year

 

Page Ref: 624

 

 

11) As part of the conduct of a review engagement, which of the following would be a typical procedure used for the assessment of the ending accounts receivable balance?

  1. A) circularization of positive confirmations to all balances exceeding materiality
  2. B) comparison of the age of the accounts receivable to the prior year
  3. C) use of negative confirmations on all large balances
  4. D) detailed examination of all accounts over 120 days to assess the bad debt allowance

 

Page Ref: 624

 

 

12) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of inventory?

  1. A) discussion with management with respect to the costing method used
  2. B) observation of the inventory count
  3. C) observation of the warehouse, paying particular attention to dusty and damaged goods
  4. D) confirmation with customers that are holding consignment inventory with respect to quantity and condition of the inventory

 

13) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of accounts payable?

  1. A) sending zero balance confirmations to frequently used suppliers
  2. B) use of negative confirmations to suppliers with material balances
  3. C) comparison of the accounts payable balances by supplier to the prior year
  4. D) examination of invoices received after the year end to ensure that they were recorded in the proper period

 

Page Ref: 624

 

 

14) You have just recently become a member of your local non-profit housing co-op by moving into the largest unit. The Board of Directors has asked that you handle the review engagement, but you are concerned about independence. What is a practical way for you to stay in the co-op but also perform the review engagement?

  1. A) Request a bylaw stating that the accountant cannot vote for Board members.
  2. B) Do a compilation rather than a review engagement.
  3. C) Have all the preparation work for the review engagement completed by a Board member.
  4. D) Include a paragraph in the review engagement report stating that you are not independent.

 

Page Ref: 624

 

 

15) When assessing the plausibility of the financial statements for a review engagement, the auditor will use which of the following criteria for auditing a small, privately held company?

  1. A) standards of efficiency and effectiveness
  2. B) the audit objectives associated with the audit of financial statements
  3. C) an acceptable reporting framework such as ASPE
  4. D) an enterprise risk management framework, to help detect fraud

 

Page Ref: 624

 

 

16) An accountant who reviews the financial statements of an entity should issue a report stating that a review

  1. A) does not constitute an audit.
  2. B) provides negative assurance that the internal control structure is functioning as designed.
  3. C) provides only limited assurance that the financial statements are fairly presented.
  4. D) is substantially more in scope than a compilation.

 

Page Ref: 625

 

 

17) When would the public accountant conduct audit procedures during a review engagement? When

  1. A) junior staff are assigned to the engagement.
  2. B) required to assess plausibility.
  3. C) it is a first time review engagement.
  4. D) a higher level of assurance is required for the bank.

 

Page Ref: 624-625

 

 

18) When conducting a review engagement, how is materiality calculated?

  1. A) materiality is not calculated as a lower level of assurance is being provided
  2. B) the concept of significance is used, rather than the concept of materiality
  3. C) always as a percentage of net income before income taxes
  4. D) in the same manner as an audit engagement

 

Page Ref: 625

 

 

19) When is negative assurance used during a review engagement?

  1. A) when the standards applicable to a review engagement have been met
  2. B) if a qualification is required during the review engagement
  3. C) when the criteria associated with a review engagement have not been satisfied
  4. D) when the practitioner is unable to set appropriate criteria for the review engagement

 

Page Ref: 625

 

 

20) Why is it important for the review engagement report to state that the review is not an audit?

  1. A) to make sure that the public accountant is not sued
  2. B) to clarify that only review engagement procedures were used during the engagement
  3. C) to make users aware that a review provides a lower level of assurance
  4. D) so that the user does not ask any unnecessary questions about the engagement

 

Page Ref: 625

 

 

21) The statement that “nothing came to our attention which would indicate that these statements are not fairly presented” expresses which of the following?

  1. A) disclaimer of an opinion
  2. B) negative assurance
  3. C) negative confirmation
  4. D) piecemeal opinion

 

Page Ref: 626

 

22) The fact that a client has a material accounting departure for failure to follow ASPE would require the accountant to disclose that fact in a separate reservation paragraph, when the accountant is performing

  1. A) a compilation.
  2. B) a review and an audit.
  3. C) either a compilation or a review.
  4. D) neither a compilation nor a review, only an audit.

 

Page Ref: 626

 

 

23) Which of the following techniques would be conducted by a practitioner when conducting a review of compliance with agreements and regulations?

  1. A) use of a specialist to ensure that the terms of the agreement are complied with
  2. B) inquire about how the client monitors its compliance with the provisions
  3. C) testing control procedures throughout the year that pertain to the provisions of the agreement
  4. D) discussions with client’s legal counsel to identify any legal liabilities with respect to potential violations of the agreements

 

Page Ref: 626

 

 

24) Richard is performing a compilation engagement.  Richard is concerned that the information is

  1. A) arithmetically correct.
  2. B) accurate.
  3. C) complete.
  4. D) in accordance with ASPE.

 

Page Ref: 627

 

 

25) A compilation presents information, in the form of financial statements, that is the representation of management. The public accountant who prepares the compilation undertakes to express

  1. A) limited assurance on the statements.
  2. B) minimal assurance on the statements.
  3. C) no assurance on the statements.
  4. D) full assurance on the statements.

 

Page Ref: 627

 

 

 

26) Which one of the following engagements would most likely be a compilation engagement? An engagement with respect to financial statements

  1. A) attached to a personal tax return.
  2. B) for a large public company.
  3. C) for a company that has a large bank loan.
  4. D) that accompany future oriented information to obtain financing.

 

Page Ref: 627

 

27) Which one of the following procedures would most likely be conducted by an accountant during a compilation engagement?

  1. A) Enquire of management with respect to the purpose of new capital assets.
  2. B) Compare gross profit on a year-by-year basis over the last five years.
  3. C) Circularize negative accounts receivable confirmations.
  4. D) Assemble and re-calculate the financial statement allocations.

 

Page Ref: 627

 

 

28) The accountant is working on an engagement with respect to the client’s financial statements. Which of the following engagements would omit an assessment of the client’s accounting policies’ compliance with GAAP?

  1. A) Review
  2. B) Compilation
  3. C) Audit
  4. D) Attestation

 

Page Ref: 627

 

 

29) Which of the following items includes criteria for accepting a compilation engagement?

  1. A) evaluation of whether the financial statements are in accordance with ASPE
  2. B) no reason to believe that the financial statements are false or misleading
  3. C) completion of an independence threat analysis, ensuring that there are no threats to independence
  4. D) completion of a client risk analysis, with the conclusion that risks are low

 

Page Ref: 627

 

 

 

30) A public accounting firm can issue a compilation report

  1. A) only if the partners are independent.
  2. B) only if all the partners and the staff in the office performing the engagement are independent.
  3. C) if the partners have no material or direct immaterial interest in client.
  4. D) even if it is not independent.

 

Page Ref: 627

 

31) You are a public accountant retained by the manager of a cooperative retirement village to do “write-up work.” You are expected to prepare unaudited financial statements with each page marked “unaudited” and accompanied by a disclaimer of opinion stating no audit was made. In performing the work, you discover that there are no invoices to support $25,000 of the manager’s claimed disbursements. The manager informs you that all the disbursements are proper. What should you do?

  1. A) Submit the expected statements but omit $25,000 of unsupported disbursements
  2. B) Include the unsupported disbursements in the statements since you are not expected to make an audit
  3. C) Obtain, from the manager, a written statement that you informed him of the missing invoices and include his assurance that the disbursements are proper
  4. D) Obtain further information about the $25,000 unsupported items and withdraw if the situation is not satisfactorily resolved

 

Page Ref: 627

 

 

32) Which one of the following is a professional standard that must be followed by an accountant when conducting a compilation engagement?

  1. A) work being adequately planned and properly executed
  2. B) having adequate technical training and proficiency in auditing
  3. C) obtaining an adequate understanding of the business and its industry
  4. D) documenting the processes used to compile and record transactions

 

Page Ref: 627

 

 

33) A financial statement review emphasizes four broad areas, one of which is to “Perform analytical procedures.” State the other three areas emphasized.

 

 

34) Yvan is preparing the audit plan for Share the Wealth, a non-profit organization.  Share the Wealth is a large Montreal based organization and receives corporate donations and also has many stores that collect and re-sell costume jewelry and clothing.  The purpose of the organization is to build recreation areas for children in less fortunate areas of the city.

Share the Wealth was started by two sisters.  One of the sisters is still actively involved in the organization, but the other sister has been devoting less time to the organization since she has had triplets.

Share the Wealth has a total of 8 stores in the city where individuals can drop off donations and where customers can also purchase the second hand clothing and costume jewelry.  Share the Wealth has a total of 12 employees who work in the different stores across the city.  Depending on the schedule and availability, the employees will randomly be assigned to a store for the week.

 

Required:

Provide three procedures that Yvan should consider when performing the review engagement of Share the Wealth?

 

 

35) Describe the professional standards that must be followed when undertaking a compilation engagement as specified by the CICA Handbook.

 

36) Identify the reporting standards for compilation engagements.

 

37) Always Quick Manufacturing Limited is a small business that manufactures metal and plastic components for a variety of industries. The bulk of the business is in the computing industry, although the occasional contract is for the automotive industry.

Jose, the owner, would like to expand the business so that he can bid on larger contracts. This requires an investment of about $500,000 to finance capital assets and about $300,000 for a working capital loan. Jose has financed the business himself to this point, and has been given some alternatives by the bank.

The alternatives pertain to which assets are used as guarantees, and whether Jose also guarantees the loans personally (as he has substantial personal assets). The bank also stated that if Jose personally guarantees the loan, the company will only require a review engagement, whereas if the loan is only secured by corporate assets, then an audit of the company will be required.

Jose understands the differences among the guarantees, but is not sure about the difference between a review and audit engagement. Presently, the company financial statements are prepared using a compilation engagement.

 

Required:

Explain to Jose the difference between a review and audit engagement in the context of his present compilation engagement.

 

21.3   Describe the type of report that the public accountant provides for interim financial information for public companies

 

1) What is the title of a compilation report?

  1. A) Opinion
  2. B) Criteria Schedule
  3. C) Engagement Report
  4. D) Notice to Reader

 

Page Ref: 628

 

 

2) Prospective financial information prepared using assumptions reflecting management’s judgment as to the most probable courses of action for the entity is called a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

 

Page Ref: 629

 

 

3) ABC Company has requested PA to prepare prospective financial information to assist with the acquisition of a bank loan. The prospective financial information is being prepared using management’s best estimate of future sales and expenses. The type of information being prepared is a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

 

Page Ref: 629

 

 

4) Financial information prepared using one or more assumptions (hypotheses) that do not necessarily reflect the most likely course of action in management’s judgment is called a(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

 

Page Ref: 629

 

5) ABC Company is considering three different alternatives with respect to expansion. To assist with the decision process, the company has requested PA to perform simulations and prepare prospective financial information using several sets of assumptions. Some of these assumptions are likely, while others are less likely. What type of information is being prepared? A(n)

  1. A) forecast.
  2. B) projection.
  3. C) prospective financial statement.
  4. D) prospectus.

 

Page Ref: 629

 

 

6) Special use prospective financial statements are intended for

  1. A) internal management only.
  2. B) any third party.
  3. C) third parties with whom negotiations are being conducted directly by the responsible party.
  4. D) the relevant provincial securities commissions.

 

Page Ref: 629

 

 

7) With respect to working on an engagement to examine a financial forecast or projection included in a prospectus or other public offering document, the public accountant and the client should agree upon

  1. A) allocation of the responsibility of creating the assumptions to the public accountant.
  2. B) the period of time to be covered.
  3. C) delegation of forecast preparation to the public accountant.
  4. D) the fact that the forecast may not be prepared in accordance with standards.

 

Page Ref: 629

 

 

8) Prior to accepting an engagement to examine a financial forecast or projection included in a prospectus or other public offering document, the public accountant should

  1. A) obtain an understanding of the controls over preparation of internal forecasts such as budgets.
  2. B) increase the risk profile of the client with respect to management integrity.
  3. C) ensure that management will provide sufficient evidence to conduct the engagement.
  4. D) inform the client that the engagement may not detect errors in the client’s forecasts.

 

9) A public accountant has been engaged to conduct an examination of future-oriented financial information. Which of the following procedures would be included in the examination?

  1. A) creation of assumptions that fit the projected information
  2. B) developing the hypotheses with the assistance of management
  3. C) assessment of internal controls over the development of internal future-oriented information, such as budgets
  4. D) assessing the plausibility of hypotheses

 

Page Ref: 630

 

 

10) What type of opinion does the auditor provide with respect to FOFI (future-oriented financial information)? An opinion about the

  1. A) underlying assumptions.
  2. B) achievability of the forecast.
  3. C) statistical nature of projections.
  4. D) plausibility of forecasts.

 

Page Ref: 630

 

 

11) Describe the purpose of

  1. i) a forecast
  2. ii) a projection, and

iii) prospective financial statements