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1

Analytical procedures performed during an audit indicate that accounts receivable doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations would satisfy the auditor?

The client opened a second retail outlet during the current year, and its credit sales approximately equaled the older outlet.

Opening a second outlet with about the same credit sales as the first explains the receivables effects. Given no change in credit policy, the characteristics of the customers served, or economic conditions, the ratio of doubtful accounts should not change.

2

Assuming a low assessed risk of material misstatement, which of the following audit procedures would be least likely to be performed?

Search for unrecorded cash receipts.

GAAS do not specifically require a search for unrecorded cash receipts. Given a low assessed RMM, the auditor might decide to reduce the audit effort devoted to substantive tests of assertions about cash and omit the procedure.

3

An auditor’s analytical procedures performed during the overall review stage indicated that the client’s accounts receivable had doubled since the end of the prior year. However, the allowance for doubtful accounts as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor?

The client opened a second retail outlet in the current year, and its credit sales approximately equaled those of the older, established outlet.

Typically, an increase in accounts receivable usually indicates that a company is either increasing sales or making its credit terms less stringent. If a company is making its credit terms less stringent, then it should have a corresponding increase in the allowance for doubtful accounts because it is more likely that customers will default on payments. Because the allowance for doubtful account percentage remained the same, a reasonable explanation is that sales increased.

4

The standard AICPA form to financial institutions requesting information on direct liabilities on loans asks for the following information

The principal amount paid:
Description of collateral:
Dates through which interest is paid:

No
Yes
Yes

The principal amount paid on a direct liability is not listed on the Standard Form to Confirm Account Balance Information with Financial Institutions. The form confirms account number/description, balance, due date, interest rate, date through which interest is paid, and a description of collateral.

5

Tracing copies of computer-prepared sales invoices to copies of the corresponding computer-prepared shipping documents provides evidence that

Sales billed to customers were actually shipped.

Sales invoices are billing documents sent to customers. Tracing sales invoices to shipping documents tests for failure to ship.

6

All of the following are examples of substantive tests to verify the valuation of net accounts receivable except the

Inspection of accounts for current versus noncurrent status in the statement of financial position.

The inspection of accounts for current versus noncurrent status is a test of management’s assertion relating to statement presentation and disclosure. It is not a test of valuation.

7

An inappropriate audit procedure relative to accounts receivable is to determine that the

Accounts are collected by the balance sheet date.

Accounts receivable represent the amounts due the client at the balance sheet date. The auditor should not expect the accounts to be collected at the balance sheet date.

8

The negative request form of accounts receivable confirmation may be used when the

RMM is:
Number of small balances:
Consideration by the recipient is:

Low
Many
Likely

AU-C 505 states, “Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly, the auditor should not use negative confirmation requests as the sole substantive audit procedure to address an assessed risk of material misstatement at the assertion level, unless all of the following are present: (1) the auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertion; (2) the population of items subject to negative confirmation procedures comprises a large number of small, homogeneous account balances, transactions, or conditions; (3) a very low exception rate is expected; and (4) the auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such requests.” Returned negative confirmations provide evidence about assertions in the financial statements, but unreturned negative confirmation requests rarely provide significant evidence about assertions other than some aspects of existence. Unreturned requests provide no explicit evidence that the intended parties received them and verified the correctness of the information stated.

9

When scheduling the audit work to be performed on an engagement, the auditor should consider confirming accounts receivable balances at an interim date if

The risk of material misstatement relative to financial statement assertions about receivables is acceptably low.

If the risk of material misstatement for assertions about receivables is acceptably low, the auditor may decide to adopt a less effective procedure, for example, confirming these balances at interim dates rather than at year-end. The auditor is then expected to obtain assurance that conclusions formed at the interim date are still valid at the balance sheet date. Moreover, the presumption in favor of confirmation may be overcome in certain limited circumstances.

10

A large university has relatively ineffective internal control. The university’s auditor seeks assurance that all tuition revenue has been recorded. The auditor could best obtain the desired assurance by

Comparing business office revenue records with registrar’s office records of students enrolled.

To be assured that all tuition revenue is being recorded, the auditor must perform substantive procedures, which are tests of details and substantive analytical procedures to detect material misstatements in an account balance, transaction class, or disclosure component. Comparing business office revenue records with registrar’s office records of students enrolled provides analytical evidence based on independently generated records.

11

An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past 5 years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue?

The auditor should inspect transactions occurring in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period.

Tests of the details of transactions at year end are most effective given that total sales consist mostly of a few transactions. Also, because most occur in the last month of the year, the auditor should establish that management made a proper cutoff.

12

If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts?

Allowance for doubtful accounts.

During a recession, receivables may increase because collections have slowed. Whenever collections of receivables have slowed, the auditor should determine the effects on the allowance for doubtful accounts. (S)he should therefore expand tests of collectibility, e.g., with a review of collections subsequent to the balance sheet date and investigation of credit ratings.

13

An auditor discovered that a client’s accounts receivable turnover is substantially lower for the current year than for the prior year. This may indicate that

There was an improper cutoff of sales at the end of the year.

The receivables turnover equals net credit sales divided by average receivables. An improper sales cutoff could result in recognition of next-year sales in the current year. The effect of adding the amount of these presumably uncollected receivables to the numerator and denominator is to decrease a ratio that exceeds 1.0.

14

Confirmation of accounts receivable is a generally accepted auditing procedure. The presumption is that an auditor will request confirmation of accounts receivable. Confirmation is necessary when

The combined assessed level of inherent and control risk is high.

The presumption may be overcome if (1) the risk of material misstatement (the combined assessed inherent risk and control risk) is low and (2) other procedures address the assessed risk for the relevant assertions. An auditor who has decided not to request confirmations must document how the presumption was overcome.

15

In the audit of which of the following general ledger accounts will tests of controls be particularly appropriate?

Sales

In auditing the sales or revenue account, tests of controls are particularly appropriate, provided the auditor believes that the risks of material misstatement at the relevant assertion level can be assessed at a low level. Because of the large volume of transactions, examining all items will seldom be cost-effective.

16

Once a CPA has determined that accounts receivable have increased because of slow collections in a tight money environment, the CPA is likely to

Expand tests of collectability.

Whenever collections of receivables have slowed, the auditor should determine the effects on the allowance for doubtful accounts. (S)he should therefore expand tests of collectibility, e.g., with a review of collections subsequent to the balance sheet date and investigation of credit ratings. The verification of the allowance for doubtful accounts ensures that receivables are fairly presented at their net realizable value in the balance sheet and that bad debt expense is fairly stated in the income statement.

17

To establish illegal “slush funds,” corporations may divert cash received in normal business operations. An auditor would encounter the greatest difficulty in detecting the diversion of proceeds from

Scrap sales.

Because scrap sales often provide little documentary evidence to corroborate cash receipts, it is difficult to detect abstraction of proceeds from unrecorded sales.