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Flashcards in 11.3 Deck (19):
1

An auditor most likely would review an entity’s periodic accounting for the numerical sequence of shipping documents and invoices to support management’s financial statement assertion of

Completeness.

The completeness assertion concerns whether all transactions (or assets, liabilities, and equity interests) that should be recorded are recorded. Testing the numerical sequence of shipping documents and invoices is a means of detecting omitted items.

2

An auditor is determining whether internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices. The auditor most likely would select a sample of transactions from the population represented by the

Shipping document file.

Matching shipping documents to sales invoices will indicate whether the shipping documents generated the preparation of a sales invoice.

3

An auditor should test bank transfers for the last part of the audit period and first part of the subsequent period to detect whether

Cash balances were overstated because of kiting.

Kiting is the recording of a deposit from an interbank transfer in the current period while failing to record the related disbursement until the next period. This fraud exploits the lag (float period) between the deposit of a check in one account and the time it clears the bank on which it is drawn. To detect kiting, the auditor should examine a schedule of bank transfers for a period covering a few days before and after the balance sheet date. For the procedure to be effective, however, the auditor should be assured that all transfers have been identified.

4

A CPA is engaged in the annual audit of a calendar year client. The client took a complete physical inventory under the CPA’s observation on December 15 and adjusted its inventory account and detailed perpetual inventory records to agree with the physical inventory. The client considers a sale to be made in the period that goods are shipped. Listed below are four items taken from the CPA’s sales cutoff test worksheet. Which item does not require an adjusting entry on the client’s books?

Shipped:
Recorded as sale:
credited to inventory:

12/10
12/19
12/12

Goods shipped on 12/10 would have been properly recorded as a sale on 12/19, a date within the same accounting period. Moreover, the credit to inventory on 12/12 preceded the physical count on 12/15. No adjustment is necessary.

5

Auditors are often concerned with the possibility of overstatement of sales and receivables. However, management may also have reasons for understating these balances. Which of the following would explain understatement of sales and receivables?

To avoid paying taxes.

State sales taxes and federal and state income taxes are based upon sales or profits, respectively. Management may attempt to reduce or avoid tax liability by not recording and reporting all sales and receivables.

6

Which of the following sets of information does an auditor usually confirm on one form?

Cash in bank and collateral for loans.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used by auditors to confirm the deposit balance held by the bank for a client. In addition, this confirmation requests loan information, such as a description of the collateral securing the loan.

7

In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support management’s financial statement assertion of

Valuation and allowance.

Assertions about valuation and allocation concern whether financial statement components have been included at appropriate amounts in accordance with the applicable financial reporting framework. For example, management asserts that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Aging the receivables is a procedure for assessing the reasonableness of the allowance.

8

The primary purpose of sending a standard confirmation request to financial institutions with which the client has done business during the year is to

Corroborate information regarding deposit and loan balances.

The AICPA Standard Form to Confirm Account Balance Information with Financial Institutions is used to confirm specifically listed deposit and loan balances. The form confirms the account name, account number, interest rate, and balance for deposits.

9

The accounts receivable turnover ratio increased significantly over a two-year period. This trend could indicate that

The company is more aggressively collecting customer accounts.

The accounts receivable turnover ratio equals net credit sales divided by average accounts receivable. Thus, the ratio increases if the entity more effectively collects accounts while holding other factors, such as credit policy, constant.

10

Which of the following procedures would an auditor most likely perform to identify unusual sales transactions?

Performing a trend analysis of quarterly sales.

Trend analysis considers ratios or accounts over time. Quarterly sales analysis compared with last year’s amounts or budgets will identify unusual sales transactions and raise questions that the auditor may want to address. Trend analysis is based on the assumption that performance will continue in line with previous performance or industry trends unless unusual transactions exist.

11

Which of the following comparisons would be most useful to an auditor in evaluating the results of an entity’s operations?

Current-year revenue to budgeted current-year revenue.

Revenues result from an entity’s ongoing major or central operations. These operations reflect numerous activities and affect many accounts. Consequently, comparing current-year revenue with the budgeted current-year revenue provides evidence as to the completeness of revenue. Revenue is a broad measure of the effects of the entity’s main activities and is a primary component of the results of operations.

12

Which of the following most likely would give the most assurance concerning the valuation assertion about accounts receivable?

Assessing the allowance for uncollectible accounts for reasonableness.

Assertions about valuation concern whether balance sheet components have been included at appropriate amounts. One such assertion is that trade accounts receivable are stated at net realizable value (gross accounts receivable minus allowance for uncollectible accounts). Hence, assessing the allowance provides assurance about the valuation of the account.

13

The best evidence regarding year-end bank balances is documented in the

bank reconciliation.

A bank reconciliation verifies the agreement of the bank statements obtained directly from the institution and the amount of cash reported in the financial statements. These amounts should be equal after adjustment for deposits in transit, outstanding checks, bank charges, etc. Thus, a bank reconciliation documents direct (primary) evidence of the year-end bank balance.

14

Tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about management’s assertion of

Cutoff.

The cutoff assertion is that transactions and events have been recorded in the correct accounting period. It is tested by examining recorded sales for several days before and after the balance sheet date and comparing them with sales invoices and shipping documents. The auditor may detect the recording of a sale in a period other than that in which title passed.

15

If the objective of an auditor’s test of details is to detect a possible understatement of sales, the auditor most likely would trace transactions from the

Shipping documents to the sales invoices.

If a shipment occurred, matching shipping documents to recorded sales would disclose the understatement if no recorded sale could be found.

16

Tracing bills of lading to sales invoices provides evidence that

Shipments to customers were invoiced.

Comparing the seller’s copies of shipping documents (such as bills of lading) with billing documents (sales invoices) provides evidence that the amounts shipped were billed to customers. The absence of invoices for goods shipped would suggest that the related sales were unrecorded at the balance sheet date.

17

Which of the following would be a consideration in planning a sample for a test of subsequent cash receipts?

Preliminary judgments about materiality levels.

Judgments about materiality will affect the sample sizes in a variables sampling plan. The smaller the levels of materiality, the larger the sample sizes needed to support the auditor’s conclusions.

18

An auditor who has confirmed accounts receivable may discover that the sales journal was held open past year end if

Most of the returned positive confirmation requests indicate that the debtor owes a smaller balance than the amount being confirmed.

When the majority of the returned positive confirmation requests indicate smaller balances at year end than those in the client’s records, the client may have held open the sales journal after year end. Thus, the client debited customers’ accounts for the period under audit rather than for the subsequent period. The effect is to overstate sales and receivables.

19

On the last day of the fiscal year, the cash disbursements clerk drew a company check on bank A and deposited the check in the company account bank B to cover a previous theft of cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by

Examining paid checks returned with the bank statement of the next accounting period after year end.

Because the check used to make the bank transfer is not recorded in the current period, the check is not listed as outstanding on the reconciliation of the bank account on which it was drawn. The auditor detects kiting by comparing paid checks, returned in the next period and dated prior to year end, with the checks listed as outstanding on the related bank reconciliation. In other words, the auditor searches for checks that should have been listed as outstanding but were not.