Performing Specific Procedures to Obtain Evidence -- Observation and Inspection Flashcards
An auditor observes the mailing of monthly statements to a client’s customers and reviews evidence of follow-up on errors reported by the customers. This test of controls most likely is performed to support management’s financial statement assertions of
Classification and understandability
Existence or occurrence
A. Yes Yes
B. Yes No
C. No Yes
D. No No
C.
The existence or occurrence assertions concern whether assets or liabilities exist as of the financial statement date and whether recorded transactions actually occurred during a reporting period. Even though this is a test of controls, this procedure also provides evidence that customers’ balances actually exist. The presentation and disclosure assertions concern proper classification, description, and disclosure in the financial statements.
As part of the process of observing a client’s physical inventories, an auditor should be alert to
A. The inclusion of any obsolete or damaged goods
B. Any change in the method of pricing from prior years
C. The existence of outstanding purchase commitments
D. The verification of inventory values assigned to goods in process
A.
As part of the process of observing a client’s physical inventories, an auditor should be alert to the inclusion of any obsolete or damaged goods. The other answers are auditing considerations for inventories, but they do not directly relate to the observation of the client’s physical count of inventory quantities.
Which of the following internal control procedures most likely would justify a reduced assessed level of control risk concerning property, plant and equipment acquisitions?
A. Periodic physical inspection of property, plant and equipment by the internal audit staff
B. Comparison of current year property, plant and equipment account balances with prior year actual balances
C. The review of prenumbered purchase orders to detect unrecorded trade-ins
D. Approval of periodic depreciation entries by a supervisor independent of the accounting department
A.
The periodic inspection of physical equipment and comparison to the accounting records by the internal auditor (who does not participate in the acquisition or disposal process) may allow for a reduction in the scope of the auditor’s tests of asset acquisitions. The comparison of account balances and entries is an analytical procedure that would highlight unusual and unanticipated fluctuations; however, it would not indicate acquisitions that were not approved. The review of prenumbered purchase orders would indicate trade-ins or retirements of fixed assets in exchange for new assets; thus, there would be no change in the quantity of fixed assets on hand.
Under which of the following conditions may an auditor’s observation procedure for inventory be performed during or after the end of the period under audit?
A. When the client maintains periodic inventory records
B. When the auditor finds minimal variations in client records and test counts in prior periods
C. When total inventory has not varied more than 5% in the last five years
D. When well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts
D.
When well-kept perpetual inventory records are checked by the client periodically by comparisons with physical counts, an auditor’s observation procedures for inventory may be performed either during or after the end of the period under audit. When a client maintains periodic inventory records, the physical count required is normally made at the balance sheet date or very close to it. Minimal variation in client records and test counts in prior periods or lack of significant variation in the last five years are not sufficient justification for leaving the observation of inventories to after the end of the period under audit.
To satisfy the valuation assertion when auditing an investment accounted for by the equity method, an auditor most likely would
A. Inspect the stock certificates evidencing the investment
B. Examine the audited financial statements of the investee company
C. Review the broker’s advice or canceled check for the investment’s acquisition
D. Obtain market quotations from financial newspapers or periodicals
B.
The valuation assertion for an investment accounted for by the equity method can generally be satisfied by referring to the audited financial statements of the investee company.
B is corrent because examination of the audited financial statements of the investee company will reveal the investee’s operating and financing results and will allow the auditor to test whether changes in the account have been properly reflected.
Evidence concerning the proper segregation of duties for receiving and depositing cash receipts ordinarily is obtained by
A. Completing an internal control questionnaire that describes the control activities
B. Observing the employees who are performing the control activities
C. Performing substantive tests to verify the details of the bank balance
D. Preparing a flowchart of the duties performed and the entity’s available personnel
B.
The best way to obtain evidence about the proper segregation of duties is by observing the employees who are performing the control activities. Procedures to verify the details of the bank balance, if they included examining signatures on deposit slips, could indicate which employees prepared the deposits, but this would not provide conclusive evidence as to which employees actually collected (physically handled) the receipts. Flowcharts and internal control questionnaires speak more to the effectiveness of the design rather than the operation of this control, but even if they are based on inquiries about the operation of the control, they do not provide as high a degree of evidence as simply actually observing who does what.
Which of the following procedures most likely would provide an auditor with evidence about whether an entity’s internal control activities are suitably designed to prevent or detect material misstatements?
A. Reperforming the activities for a sample of transactions
B. Performing analytical procedures using data aggregated at a high level
C. Vouching a sample of transactions directly related to the activities
D. Observing the entity’s personnel applying the activities
D.
Observing the entity’s personnel applying the activities provides evidence about the design and implementation of internal control activities. Entity personnel may have trouble implementing poorly designed activities. Reperformance alone would not provide evidence about whether and how the activities are actually performed. The procedures in answers B. and C. might detect misstatements, but would not provide much information about internal controls.
Which of the following procedures concerning accounts receivable would an auditor most likely perform to obtain audit evidence to support the operating effectiveness of a control?
A. Observing an entity’s employee prepare the schedule of past due accounts receivable
B. Sending confirmation requests to an entity’s principal customers to verify the existence of accounts receivable
C. Inspecting an entity’s analysis of accounts receivable for unusual balances
D. Comparing an entity’s uncollectible accounts expense to actual uncollectible accounts receivable
A.
Observation of an entity’s preparation of a schedule is a test of a control. Confirmation requests, inspection of an analysis of accounts receivables, and comparison of an entity’s uncollectible accounts expense to actual uncollectible accounts receivables are all substantive procedures (i.e. procedures performed by the auditor and not the entity).
Which of the following control objectives is achieved by reviewing and testing control procedures over physical inventory count?
A. Validation of purchase transactions.
B. Verification of existence of inventory.
C. Authorization of the manufacturing orders.
D. Posting and summarization of inventory transactions.
The correct answer is (B).
Observation of the ending physical inventory counts is a required audit procedure, which provides evidence regarding the existence of ending inventory. The auditor selects items from the inventory summary report and physically verifies these items to the actual goods located in the warehouse. Observing the process for the physical verification of goods at the client is a control procedure by which the auditor can verify the existence of inventory.
Validation of Purchase Transactions is done by recalculating the mathematical accuracy of the subsidiary ledger, not by testing control procedures over the physical inventory count.
A manufacturing order is an order required to manufacture items in-house or by a sub-contractor. Checking the authorization of a manufacturing order is done by a review of the manufacturing order.
The posting and summarization of inventory transactions are part of the process of recording inventory.
Which of the following audit techniques most likely would provide an auditor with the most assurance about the effectiveness of the operation of an internal control procedure?
A. Confirmation with outside parties
B. Inquiry of client personnel
C. Recomputation of account balance amounts
D. Observation of client personnel
D.
Answer a., confirmation with outside parties, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Answer b., inquiry of client personnel, should be performed in combination with other audit procedures to obtain audit evidence about the operating effectiveness of the controls; so it is not the best answer.
Answer c., recomputation of account balance amounts, is not as effective as the auditor’s direct observation of client personnel performing the control procedure. Further, it is not nearly as likely as observation is to be a relevant procedure for testing the operating effectiveness of controls.
Editor note: Per GAAS, the audit procedures of inspection, observation, external confirmation, recalculation, reperformance, analytical procedures, and inquiry may be used as risk assessment procedures, tests of controls, or substantive procedures, depending on the context in which they are applied by the auditor. However, you need to use judgment when answering exam questions in that some procedures will generally be more commonly used for one type of audit procedure than another, for example, recomputation of account balances, will be used most often as a substantive test of details because it is effective for that purpose.
An auditor scans a client’s investment records for the period just before and just after the year-end to determine that any transfers between categories of investments have been properly recorded. The primary purpose of this procedure is to obtain evidence about management’s financial statement assertions of
A. Rights and obligations; and existence or occurrence
B. Valuation and allocation; and rights and obligations
C. Existence or occurrence; and classification
D. Classification; and valuation and allocation
D.
Classification concerns whether financial information is appropriately presented in the proper accounts within the financial statements. Valuation and allocation deals with whether assets, liabilities, and equity interests are valued properly and any resulting valuation or allocation adjustments are appropriately recorded. When accounting for investments, the classification has an impact on the appropriate method of valuation in the financial statements. Rights and obligations concern whether, at a given date, recorded assets indeed represent rights of the entity and liabilities represent obligations. Reviewing investment records regarding transfers between categories (internal documents) provides little evidence that ownership rights in the investments still exists at the balance sheet date, that the investment is not pledged as loan collateral, that the investments exist at the balance sheet date, or that an external transaction involving the investment occurred during the period.
Investments may be classified as trading, available-for-sale, or held-to-maturity. The classification of each investment into one of these three categories determines how it will be shown on the balance sheet (understandability and classification) and whether it will be valued at market or at amortized cost (valuation and accuracy).
On receiving a client’s bank cutoff statement, an auditor most likely would trace
A. Prior year checks listed in the cutoff statement to the year-end outstanding checks
B. Deposits in transit listed in the cutoff statement to the year-end bank reconciliation
C. Checks dated after year-end listed in the cutoff statement to the year-end outstanding checks
D. Deposits recorded in the cash receipts journal after year-end to the cutoff statement
A.
An auditor compares prior year checks listed in the cutoff statement compared to the year-end outstanding checks to make sure that all year-end outstanding checks were handled correctly on the bank reconciliation. Deposits in transit are listed on the bank reconciliation, not on the cutoff statements; once on the cutoff statement, they cease to be in transit. Checks dated after year-end in the cutoff statement should not be listed as outstanding at year-end. Checks and deposits dated after year-end merely provide information about liabilities or assets available at year-end.
Which of the following procedures would best detect a liability omission by management?
A. Inquiry of senior support staff and recently departed employees
B. Review and check mathematical accuracy of financial statements
C. Review articles of incorporation and corporate bylaws
D. Review purchase contracts and other legal documents
D.
D is corrent because purchase contracts and other legal documents (which one would expect to result in liabilities) may be compared to recorded purchases and associated liabilities to determine whether omissions exist.
This is an instance of testing for completeness, i.e., that all transactions and events that should have been recorded have been recorded. The best test for this would be to trace (review) information contained in source documents (purchase contracts and other legal documents) to the financial statements. Inquiry is not as effective as this tracing procedure. Reviewing the financial statements for mathematical accuracy would not detect an unrecorded liability; this would only provide evidence about recorded liabilities. A company’s articles of incorporation and corporate bylaws generally do not contain liability information and they would prove an even less likely source of evidence of recent omissions.
A client maintains a large data center where access is limited to authorized employees. How may an auditor best determine the effectiveness of this control activity?
A. Inspect the policy manual establishing this control activity.
B. Ask the chief technology officer about known problems.
C. Observe whether the data center is monitored.
D. Obtain a list of current data center employees.
C.
Observation of the application of the control, i.e., whether the data center is monitored to limit access, yields the most reliable audit evidence (of the choices listed) about the effectiveness of this control. The control may not be practiced as it is described in the policy manual. Inquiry of the chief technology officer does not provide as reliable evidence as the auditor’s observation of the control’s application. Obtaining a list of current data center employees by itself does not provide evidence of the effectiveness of the control’s application.
Editor note: Have a close look at the answer choices; of the four choices, which choice seems to be the most effective?
An auditor observed that a client mails monthly statements to customers. Subsequently, the auditor reviewed evidence of followup on the errors reported by the customers. This test of controls most likely was performed to support management’s financial statement assertion(s) of
Classification and understandability
Rights and obligations
A. Yes Yes
B. Yes No
C. No Yes
D. No No
C.
This procedure helps ensure that the accounts receivable (a right to payment) amount is correct, but not that it is reported or disclosed appropriately and clearly. Classification and understandability is an assertion about presentation and disclosure.
