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Flashcards in A4-1 Deck (41)
1

Which of the following is a true statement regarding documentation requirements for analytical procedures?

a.

When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document the reasons analytical procedures were performed instead of tests of details.

b.

When an analytical procedure is used during the overall review stage of the audit, the auditor is required to document the auditor's expectation and any additional procedures performed to investigate significant unexplained differences.

c.

When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document both the auditor's expectation and the factors considered in developing that expectation.

d.

When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document his or her expectation and management's concurrence with that expectation.

Choice "c" is correct. When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor is required to document both the auditor's expectation and the factors considered in developing that expectation.

Choice "a" is incorrect. There is no requirement that the auditor document the reasons analytical procedures were performed instead of tests of details.

Choice "d" is incorrect. There is no requirement that the auditor document management's concurrence with the expectation.

Choice "b" is incorrect. When an analytical procedure is performed during the overall review stage, there are no specific documentation requirements. The requirement that the auditor document the expectation and any additional procedures performed to investigate significant unexplained differences relates to analytical procedures performed as principal substantive tests.

2

Which of the following comparisons would an auditor most likely make in evaluating an entity's costs and expenses?

a.

The current year's payroll expense with the prior year's payroll expense.

b.

The budgeted current year's warranty expense with the current year's contingent liabilities.

c.

The budgeted current year's sales with the prior year's sales.

d.

The current year's accounts receivable with the prior year's accounts receivable.

Choice "a" is correct. The most likely analytical review procedure involving costs and expenses would be to compare the current year's payroll expense (average amount per employee) to the prior year, taking into consideration an average increase in wage rates. This is a very effective technique in auditing payroll expense.

Choice "d" is incorrect. Comparing the current year's accounts receivable balance with the prior year provides little evidence because accounts receivable may fluctuate based on timing of cash payments, which is unpredictable.

Choice "c" is incorrect. Comparing the budgeted current year's sales with the prior year's sales provides evidence regarding the reasonableness of the current year sales budget, but does not provide evidence about costs and expenses.

Choice "b" is incorrect. The current year's budgeted warranty expense would likely be compared to the current year's actual warranty expense, not to all of the contingent liabilities for the year.

3

An auditor may achieve audit objectives related to particular assertions by:

a.

Increasing the level of detection risk.

b.

Performing analytical procedures.

c.

Preparing audit documentation.

d.

Adhering to a system of quality control.

Choice "b" is correct. The auditor relies on substantive tests to achieve audit objectives related to particular assertions. Analytical procedures are one type of substantive procedure.

Choice "d" is incorrect. CPA firms performing audits are required to adhere to a system of quality control, but adhering to such a system does not directly help the firm achieve specific audit objectives.

Choice "c" is incorrect. Audit documentation is used to record the results of audit procedures that have been performed to achieve audit objectives. Mere preparation of audit documentation does not achieve audit objectives.

Choice "a" is incorrect. Increasing the level of detection risk does not enable the auditor to achieve audit objectives related to a particular assertion.

4

An auditor's analytical procedures most likely would be facilitated if the entity:

a.

Segregates obsolete inventory before the physical inventory count.

b.

Uses a standard cost system that produces variance reports.

c.

Develops its data from sources solely within the entity.

d.

Corrects material weaknesses in internal control before the beginning of the audit.

Choice "b" is correct. An auditor's analytical procedures are facilitated when an entity uses a standard cost system with variance reports because the comparison of actual to budget will already have been performed. In addition, it is likely that management will already be aware of significant variations from budget and will be better able to address any questions the auditor may have.

Choice "a" is incorrect. Segregation of obsolete inventory would not be an important factor in determining whether analytical procedures would be effective.

Choice "d" is incorrect. Correction of internal control weaknesses prior to the beginning of the audit would not affect analytical procedures.

Choice "c" is incorrect. Analytical procedures using data developed solely within the entity are not as reliable as analytical procedures using data developed externally.

5

In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of management's financial statement assertion of:

a.

Completeness.

b.

Existence.

c.

Rights and obligations.

d.

Valuation and allocation.

Choice "d" is correct. Assertions about valuation and allocation deal with whether assets, liabilities, and equity interests have been included in the financial statements at appropriate amounts. Recalculation of the amortization and review of the amortization period would test the valuation and allocation assertion.

Choice "b" is incorrect. Assertions about existence deal with whether assets, liabilities, and equity interests exist at a given date. Evaluating amortization does not relate to this assertion.

Choice "a" is incorrect. Assertions about completeness deal with whether all assets, liabilities, and equity interests that should be presented in the financial statements are so included. Evaluating amortization does not relate to this assertion.

Choice "c" is incorrect. Assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the obligations of the entity at a given date. Evaluating amortization does not relate to this assertion.

6

Which of the following would not be considered an analytical procedure?

a.

Estimating payroll expense by multiplying the number of employees by the average hourly wage rate and the total hours worked.

b.

Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.

c.

Developing the expected current-year sales based on the sales trend of the prior five years.

d.

Computing accounts receivable turnover by dividing credit sales by the average net receivables.

Choice "b" is correct. Analytical procedures involve comparison of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. Projecting an error rate from a statistical sample does not involve such a comparison.

Choice "a" is incorrect. An analytical procedure involves comparison of an independently developed expectation to a recorded amount. Comparing an estimate of payroll expense (developed by multiplying the number of employees by the average hourly rate and the total hours worked) to the recorded expense is an analytical procedure.

Choice "d" is incorrect. An analytical procedure involves comparison of an independently developed expectation to a recorded amount. Ratio analysis is often performed in order to compare recorded results to industry norms or to past performance, and therefore calculation of accounts receivable turnover is likely to be an analytical procedure.

Choice "c" is incorrect. An analytical procedure involves comparison of an independently developed expectation to a recorded amount. Comparing an estimate of sales (developed based on a trend analysis) to the recorded amount is an analytical procedure.

7

Which of the following types of audit evidence generally is the most reliable?

a.

Review of prior-year audit procedures.

b.

Inquiries made of management.

c.

Analytical procedures.

d.

Confirmation of account information.


Explanation

Choice "d" is correct. Confirmations are among the most reliable types of evidence, as they constitute external evidence sent directly to the auditor.

Choice "b" is incorrect. Inquiries provide oral evidence, which is less reliable than confirmations.

Choice "c" is incorrect. Analytical procedures provide the auditor with direct personal knowledge, but because these procedures often are based on internal accounting data, the evidence obtained is not as reliable as that obtained from confirmations.

Choice "a" is incorrect. Review of audit procedures from the previous year does not provide appropriate audit evidence regarding the current year's financial statements.

8

An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that:

a.

The annual provision for uncollectible accounts expense was inadequate because of worsening economic conditions.

b.

Unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities.

c.

Fourth quarter payroll taxes were properly accrued and recorded, but were not paid until early in the subsequent year.

d.

Notice of an increase in property tax rates was received by management, but was notrecorded until early in the subsequent year.

Choice "b" is correct. Unrealized gains on available-for-sale securities should properly be recorded in other comprehensive income. If such gains were erroneously recorded in the income account for trading securities, this might be discovered through comparison of the current year and prior year revenues and expenses (assuming the error occurred only in the current year, and not in the prior year).

Choice "c" is incorrect. If payroll taxes were properly accrued and recorded, there is unlikely to be a significant change in revenues and expenses for the current year as compared to the prior year. Payables would not be part of the comparison of revenues and expenses.

Choice "a" is incorrect. In times of worsening economic conditions, one would expect the annual provision for uncollectible accounts to increase. Since this answer option indicates that the provision was inadequate, it would appear that the client did not increase the provision appropriately. Investigating changes in revenues and expenses would not be likely to identify this error, since failing to increase the provision would likely result in there being little change between the two years.

Choice "d" is incorrect. An increase in property tax rates should cause a corresponding increase in accrued property tax expense; however, the question indicates that the appropriate increase was not recorded in the current year. Investigating changes in revenues and expenses would not be likely to identify this error, since failing to increase the expense would likely result in there being little change between the two years.

9

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?

a.

The client tightened its credit policy during the current year and sold considerably less merchandise to customers with poor credit ratings.

b.

A greater percentage of accounts receivable are listed in the "more than 120 days overdue" category than in the prior year.

c.

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

d.

Internal control activities over the recording of cash receipts have been improved since the end of the prior year.

Choice "c" is correct. If a second, similar retail outlet were opened, one would expect sales and accounts receivable to double. As long as the collection rates for the new outlet's receivables were expected to be similar to those of the original outlet, the allowance for doubtful accounts as a percentage of accounts receivable would remain the same.

Choice "b" is incorrect. If more receivables are potentially uncollectible in the current year (as opposed to the prior year), the allowance for doubtful accounts as a percentage of receivables should increase to reflect the greater level of estimated bad debts.

Choice "d" is incorrect. Improved control activities related to the recording of cash receipts might result in a decrease in accounts receivable in the current year as compared to the prior year, not an increase. In addition, improving such controls would not be likely to affect the allowance for doubtful accounts as a percentage of receivables.

Choice "a" is incorrect. If the client sold less merchandise to customers with poor credit ratings, the allowance for doubtful accounts as a percentage of receivables should decrease to reflect the lower level of estimated bad debts.

10

Which of the following procedures would yield the most reliable evidence?

a.

A scanning of trial balances.

b.

A recalculation of bad debt expense.

c.

A comparison of beginning and ending retained earnings.

d.

An inquiry of client personnel.

Choice "b" is correct. The auditor's direct personal knowledge (obtained through observation, examination, inspection, or recalculation) is one of the most reliable forms of evidence.

Choice "a" is incorrect. Scanning of trial balances may indicate areas where more attention should be focused (e.g., unusual balances, zero balances, etc.), but would seldom provide reliable evidence in and of itself.

Choice "d" is incorrect. Inquiry of client personnel provides evidence that is not particularly reliable, which is why it often needs to be corroborated by the auditor.

Choice "c" is incorrect. A comparison of beginning and ending retained earnings may provide information about certain transactions and events (e.g., dividends, income, etc.), but would not in and of itself provide evidence supporting those items.

11

Which of the following procedures would be most effective in reducing attestation risk?

a.

Examination of evidence.

b.

Analytical procedures.

c.

Discussion with responsible individuals.

d.

Inquiries of senior management.

Choice "a" is correct. Evidence obtained directly by the accountant (e.g., through physical examination) provides more persuasive evidence than evidence obtained through inquiry, discussion, or analytical procedures, and therefore reduces attestation risk.

Choices "c", "d", and "b" are incorrect, based on the above explanation.

12

Which of the following factors would most likely influence an auditor's consideration of the reliability of data when performing analytical procedures?

a.

Whether the data were developed in a computerized or a manual accounting system.

b.

Whether the data were developed under a system with adequate controls.

c.

Whether the data were prepared on the cash basis or in conformity with GAAP.

d.

Whether the data were processed in an online system or a batch entry system.

Choice "b" is correct. Strong, effective internal controls improve the reliability of data.

Choice "a" is incorrect. The type of accounting system used does not affect the reliability of data. Both computerized and manual accounting systems can provide reliable data, as long as there are appropriate controls in place.

Choice "c" is incorrect. The accounting basis used does not affect the reliability of data. Reliable data may be provided regardless of whether the cash basis or accrual basis (GAAP) is used, as long as there are appropriate controls in place.

Choice "d" is incorrect. The type of processing system used does not affect the reliability of data. Both online systems and batch systems can provide reliable data, as long as there are appropriate controls in place.

13

An auditor's decision whether to apply analytical procedures as substantive tests usually is determined by the:

a.

Extent of accounting estimates used in preparing the financial statements.

b.

Precision and reliability of the data used to develop expectations.

c.

Number of transactions recorded just before and just after the year end.

d.

Availability of documentary evidence that should be verified.

Choice "b" is correct. The decision as to whether or not to use analytical procedures as substantive tests is based in part on the availability, reliability, and precision of the data used to develop expectations.

Choice "d" is incorrect. Verification of documentary evidence is a test of details, not an analytical procedure.

Choice "a" is incorrect. The extent of accounting estimates used in preparing the financial statements is not a factor that affects the auditor's decision with respect to the use of analytical procedures as a substantive test. If there is a plausible and predictable relationship, estimated amounts should still fall within expected ranges.

Choice "c" is incorrect. Transaction volume is not a factor that affects the auditor's decision with respect to the use of analytical procedures as a substantive test.

14

Auditors try to identify predictable relationships when applying analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

a.

Accounts receivable.

b.

Allowance for doubtful accounts.

c.

Interest expense.

d.

Accounts payable.

Choice "c" is correct. Income statement accounts tend to be more predictable than balance sheet accounts, and therefore interest expense would likely yield a higher level of evidence than the allowance for doubtful accounts, accounts receivable, or accounts payable.

Choice "b" is incorrect. The allowance for doubtful accounts is affected by write-offs of specific receivables, which is not particularly predictable.

Choice "a" is incorrect. Accounts receivable is affected by payments received from customers, which is not particularly predictable. 

Choice "d" is incorrect. Accounts payable is affected by payments made at the discretion of the client, which may not be particularly predictable.

15

Which of the following documents are examples of audit evidence generated by the client?

a.

Shipping documents and receiving reports.

b.

Vendor invoices and packing slips.

c.

Bills of lading and accounts receivable confirmations.

d.

Customer purchase orders and bank statements.

Choice "a" is correct. Shipping documents and receiving reports are internally-generated evidence, since they are created by the client rather than received from independent sources outside the enterprise.

Choice "d" is incorrect. Customer purchase orders and bank statements are both external evidence, since they are received from independent sources outside the enterprise.

Choice "b" is incorrect. Vendor invoices and packing slips are both external evidence, since they are received from independent sources outside the enterprise.

Choice "c" is incorrect. Bills of lading and accounts receivable confirmations are both external evidence, since they are received from independent sources outside the enterprise.

16

Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

a.

Travel and entertainment expense.

b.

Accounts receivable.

c.

Interest expense.

d.

Accounts payable.

Choice "c" is correct. Relationships among income statement accounts tend to be more predictable than balance sheet accounts (accounts receivable, accounts payable) because they represent transactions over a period of time rather than at one point in time. In addition, relationships involving transactions subject to management discretion (travel and entertainment) are less predictable.

Choices "b", "d", and "a" are incorrect, per the above explanation.

17

In determining whether transactions have been recorded, the direction of the audit testing should be from the:

a.

Adjusted trial balance.

b.

General journal entries.

c.

Original source documents.

d.

General ledger balances.

Choice "c" is correct. To determine whether transactions have been recorded (completeness assertion), the auditor should trace from the source documents to the accounting records (general ledger, trial balances, etc.).

Choices "d", "a", and "b" are incorrect. Testing from the accounting records to the source documents provides evidence of existence or occurrence, not completeness.

18

Which of the following pairs of accounts would be analyzed together in the audit documentation?

a.

Notes receivable and interest income.

b.

Interest income and interest expense.

c.

Accrued interest receivable and accrued interest payable.

d.

Notes payable and notes receivable.

Choice "a" is correct. The auditor would most likely analyze notes receivable and its related income statement account, interest income, together.

Choice "c" is incorrect. Accrued interest payable would be analyzed along with notes payable; accrued interest receivable would be analyzed along with notes receivable.

Choice "d" is incorrect. Notes payable would be analyzed along with interest payable and interest expense; notes receivable would be analyzed along with interest income.

Choice "b" is incorrect. Interest income would be analyzed with notes receivable; interest expense would be analyzed with notes payable.

19

The objective of tests of details of transactions performed as substantive tests is to:

a.

Evaluate whether management's controls operated effectively.

b.

Comply with generally accepted auditing standards.

c.

Detect material misstatements in the financial statements.

d.

Attain assurance about the reliability of the information system relevant to financial reporting.

Choice "c" is correct. Substantive tests are concerned with dollar amounts and consist of tests of details of transactions and balances and analytical procedures. The objective of tests of details of transactions performed as substantive tests is to detect material (dollar) misstatements in the financial statements.

Choice "b" is incorrect. Tests of details of transactions (performed as substantive tests) are used to evaluate management's assertions. While tests of details of transactions do help the auditor comply with GAAS, such compliance is not the primary objective of the tests.

Choice "d" is incorrect. Attaining assurance about the reliability of the information system relevant to financial reporting is an objective of tests of controls rather than of substantive tests.

Choice "a" is incorrect. Evaluation of the operating effectiveness of management controls is an objective of tests of controls rather than of substantive tests.

20

Which of the following types of audit evidence is the most persuasive?

a.

Bank statements obtained from the client.

b.

Client work sheets supporting cost allocations.

c.

Prenumbered client purchase order forms.

d.

Client representation letter.

Choice "a" is correct. When audit evidence can be obtained from independent sources outside an entity, it provides greater assurance of reliability for the purposes of an independent audit than does evidence secured solely within the entity. While the bank statement was obtained from the client, it is still more persuasive than any of the other three items because it was not prepared by the client.

Choice "c" is incorrect. Prenumbered client purchase orders are client-generated documents; as such, they are not as persuasive as externally generated evidence received through a client.

Choice "b" is incorrect. Client work sheets supporting cost allocations are client-generated documents; as such, they are not as persuasive as externally generated evidence received through a client.

Choice "d" is incorrect. The client representation letter is a client-generated document; as such, it is not as persuasive as externally generated evidence received through a client.

21

Analytical procedures are most appropriate when testing which of the following types of transactions?

a.

Payroll and benefit liabilities.

b.

Long-term debt transactions.

c.

Operating expense transactions.

d.

Acquisitions and disposals of fixed assets.

Choice "c" is correct. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts because income statement accounts represent transactions over a period of time, whereas balance sheet accounts represent amounts as of a point in time. As a result, analytical procedures are more appropriate for operating expense accounts. 

Choice "a" is incorrect. Payroll and benefit liabilities are generally recalculated and are a balance sheet account.

Choice "d" is incorrect. Acquisition and disposal of fixed assets are generally vouched to supporting documentation. Fixed assets is a balance sheet account.

Choice "b" is incorrect. Long-term debt transactions are generally vouched to supporting documentation. Long-term debt is a balance sheet account.

22

Which of the following procedures would an auditor most likely perform when auditing the statement of cash flows?

a.

Reconcile the cutoff bank statement to the proof of cash to verify the accuracy of the year-end cash balance.

b.

Confirm the amounts included in the statement of cash flows with the entity's financial institution.

c.

Vouch a sample of cash receipts and disbursements for the last few days of the current year.

d.

Reconcile the amounts included in the statement of cash flows to the other financial statements' amounts.

Choice "d" is correct. To audit the statement of cash flows, the auditor reconciles the amounts on the statement to amounts on other financial statements.

Choice "c" is incorrect. Vouching a sample of cash receipts and disbursements is a procedure used to audit the cash balance, rather than the statement of cash flows.

Choice "a" is incorrect. Reconciling the cutoff bank statement to the proof of cash to verify the accuracy of the year-end cash balance is a procedure used to audit the cash balance, rather than the statement of cash flows.

Choice "b" is incorrect. Confirming cash amounts with the entity's financial institution is a procedure used to audit the cash balance, rather than the statement of cash flows.

23

At the conclusion of an audit, an auditor is reviewing the evidence gathered in support of the financial statements. With regard to the valuation of inventory, the auditor concludes that the evidence obtained is not sufficient to support management's representations. Which of the following actions is the auditor most likely to take?

a.

Obtain a statement from management supporting their inventory valuation.

b.

Consult with the audit committee and issue a disclaimer of opinion.

c.

Consult with the audit committee and issue a qualified opinion.

d.

Obtain additional evidence regarding the valuation of inventory.

Choice "d" is correct. If an auditor has doubts about a material assertion (such as the valuation of inventory), he/she should gather sufficient evidence to eliminate the doubt.

Choices "b" and "c" are incorrect. The auditor would not consult with the audit committee regarding the sufficiency of audit evidence obtained, as this is determined based on the auditor's own judgment. In addition, if the auditor is able to obtain additional evidence, it might be possible to issue an unmodified opinion. Finally, even if no additional evidence is available, the auditor will still need to decide whether a qualified opinion or a disclaimer of opinion is more appropriate, depending on materiality.

Choice "a" is incorrect. Since management representations are in fact "statements from management," obtaining additional statements from management would not provide additional support.

24

When applying analytical procedures during an audit, which of the following is the best approach for developing expectations?

a.

Comparing client data with client-determined expected results to reduce detailed tests of account balances.

b.

Identifying reasonable explanations for unexpected differences before talking to client management.

c.

Considering the pattern of several unusual changes without trying to explain what caused them.

d.

Considering unaudited account balances and ratios to calculate what adjusted balances should be.

Choice "b" is correct. Identifying reasonable explanations for unexpected differences before talking to client management helps the auditor in assessing if management's explanation is reasonable. Management's explanation should always be corroborated with other evidence.

Choice "d" is incorrect. Unaudited account balances are less reliable.

Choice "c" is incorrect. Analytical procedures assume that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Conditions that might cause variations in these relationships include unusual events. Expectations cannot be developed when there is no explanation of what caused a pattern of unusual changes.

Choice "a" is incorrect. Since the data is obtained from sources within the entity, it is not as reliable for developing expectations.

25

Which of the following most likely would cause an auditor to consider whether a client's financial statements contain material misstatements?

a.

Management did not disclose to the auditor that it consulted with other accountants about significant accounting matters.

b.

Audit trails of computer-generated transactions exist only for a short time.

c.

The results of an analytical procedure disclose unexpected differences.

d.

The chief financial officer will not sign the management representation letter until the last day of the auditor's field work.

Choice "c" is correct. If the results of an analytical procedure disclose unexpected differences, the auditor should consider that the financial statements may contain a material misstatement.

Choice "a" is incorrect. Management's failure to disclose to the auditor that it consulted with other accountants about significant accounting matters would not heighten the auditor's concern about whether the financial statements contain material misstatements.

Choice "d" is incorrect. The management representation letter is typically not signed until the last day of the auditor's field work.

Choice "b" is incorrect. If audit trails of computer-generated transactions exist only for a short time, the auditor should adjust the timing of his/her audit procedures accordingly, but this would not heighten the auditor's concern about whether the financial statements contain material misstatements.

26

Which of the following procedures would an auditor most likely perform in auditing the statement of cash flows?

a.

Reconcile the cutoff bank statements to verify the accuracy of the year-end bank balances.

b.

Vouch all bank transfers for the last week of the year and first week of the subsequent year.

c.

Compare the amounts included in the statement of cash flows to similar amounts in the prior year's statement of cash flows.

d.

Reconcile the amounts included in the statement of cash flows to the other financial statements' balances and amounts.

Choice "d" is correct. To audit the statement of cash flows, the auditor reconciles the amounts on the statement to amounts on other financial statements.

Choice "c" is incorrect. Comparison of amounts on the cash flow statement with those of the previous period is an analytical procedure that is not commonly used to audit the statement of cash flows, since sources and uses of cash in the current year are not necessarily predictable based on sources and uses from the prior year.

Choice "a" is incorrect. Reconciling the cutoff bank statement is a procedure used to audit the cash balance, rather than the statement of cash flows.

Choice "b" is incorrect. Vouching all bank transfers is a procedure used to audit the cash balance, rather than the statement of cash flows.

27

PCAOB standards state that the relevance of audit evidences depends on all but which of the following?

a.

The timing of the audit procedure.

b.

Whether the audit procedure is designed to directly test an assertion.

c.

The auditor's risk assessment.

d.

Whether the audit procedure is designed to test for an understatement or overstatement.

Choice "c" is correct. The auditor's risk assessment affects the nature, extent, and timing of audit procedures, but does not determine the relevance of audit evidence. 

Choice "b" is incorrect. The relevance of audit evidence depends in part on whether the audit procedure is designed to directly test an assertion. If the audit procedures is designed to directly test an assertion and the evidence doesn't tell us anything about that assertion, then the evidence would not be relevant. 

Choice "d" is incorrect. The relevance of audit evidence depends in part on whether the audit procedure is designed to test for an understatement or overstatement.

Choice "a" is incorrect. The relevance of audit evidence depends in part on the timing of the audit procedure.

28

Which of the following best explains why an analytical procedure might be used as a substantive test?

a.

To achieve audit objectives in the most effective and efficient manner possible.

b.

To determine the adequacy of evidence gathered in response to unusual or unexpected balances.

c.

To assess the conclusions reached by staff auditors.

d.

To assist in planning the nature, timing, and extent of the auditing procedures to be performed.

Choice "a" is correct. For some assertions, analytical procedures are more effective and efficient at providing an appropriate level of assurance than are tests of details.

Choice "d" is incorrect. The objective of analytical procedures used in the planning stageof the audit is to assist in planning the nature, timing, and extent of auditing procedures to be performed.

Choices "c" and "b" are incorrect. The purpose of applying analytical procedures in theoverall review stage of the audit is to assist the auditor in assessing the conclusions reached and the overall financial statement presentation. The overall review would also generally include consideration of the adequacy of evidence gathered in response to unusual or unexpected balances.

29

Which of the following would provide an auditor with the most reliable evidence regarding the existence of accounts receivable?

a.

An aging schedule showing the composition of the year-end accounts receivable balance.

b.

An accounts receivable confirmation received by the auditor from the client's customer.

c.

A copy of the invoice sent to the customer.

d.

A copy of the customer's sales order held by the client.

Choice "b" is correct. External evidence received by the auditor is considered to be highly reliable and valid.

Choice "c" is incorrect. An invoice sent to the customer by the client is internal evidence, which is not as reliable as external evidence.

Choice "d" is incorrect. The customer's sales order is external evidence received and held by the client, which is not as valid as external evidence received directly by the auditor. In addition, a sales order alone is only evidence that an order was placed, not that it was filled or that a receivable exists.

Choice "a" is incorrect. An aging schedule is internal evidence, which is not as valid as external evidence.

30

Which of the following activities is an analytical procedure an auditor would perform in the final overall review stage of an audit to ensure that the financial statements are free from material misstatement?

a.

Reading the minutes of the board of directors' meetings for the year under audit.

b.

Comparing the current year's financial statements with those of the prior year.

c.

Ensuring that a representation letter signed by management is in the file.

d.

Obtaining a letter concerning potential liabilities from the client's attorney.

Choice "b" is correct. Analytical procedures performed during the overall final review stage generally include a review of the current and prior year's financial statements.

Choice "a" is incorrect. This would not be considered an analytical procedure.

Choice "d" is incorrect. This would not be considered an analytical procedure.

Choice "c" is incorrect. This would not be considered an analytical procedure.

31

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?

a.

Inquire about payroll checks that were recorded before year end but cashed after year end.

b.

Investigate changes in capital stock recorded after year end.

c.

Determine whether inventory ordered before the year end was included in the physical count.

d.

Review tax returns prepared by management after year end.

Choice "b" is correct. A change in capital stock that is recorded after the year end is an example of a subsequent event that might require disclosure in the footnotes to the financial statements.

Choice "c" is incorrect. The inventory issue would not be considered a subsequent event because the inventory was ordered before year end.

Choice "a" is incorrect. If the payroll checks were recorded prior to year end, there is no subsequent event issue.

Choice "d" is incorrect. Tax returns prepared after year end would not be considered a subsequent event issue.

32

What type of evidence would provide the highest level of assurance in an attestation engagement?

a.

Evidence obtained from independent sources.

b.

Evidence secured solely from within the entity.

c.

Evidence obtained from multiple internal inquiries.

d.

Evidence obtained indirectly.

Choice "a" is correct. Audit evidence obtained from independent sources outside of the entity is more reliable.

Choice "b" is incorrect. Audit evidence obtained from independent sources outside the entity is more reliable that internal evidence.

Choice "d" is incorrect. Audit evidence obtained directly by the auditor (observation) is more reliable than evidence obtained indirectly (inquiry about the application of a control).

Choice "c" is incorrect. Audit evidence obtained from independent sources outside the entity is more reliable than internal evidence. Note that the multiple internal sources could be in collusion.

33

Which of the following would not be considered an analytical procedure?

a.

Developing the current year's expected net sales based on the sales trend of similar entities within the same industry.

b.

Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages.

c.

Estimating the current year's expected expenses based on the prior year's expenses and the current year's budget.

d.

Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics.

Choice "d" is correct.  This would not be considered an analytical procedure because there is no comparison or conversion of an entity's financial information/data. Instead, this represents a procedure used in statistical sampling.

Choice "b" is incorrect. Preparing a common-sized income statement and then comparing the entity's information to a corresponding industry average represents an analytical procedure.

Choice "a" is incorrect. Using trend analysis on the sales of competing firms to develop a current year sales forecast for an entity is considered an analytical procedure.

Choice "c" is incorrect. Using trend analysis on the entity's past expenses along with the current year's budget to develop an estimate of entity's current expenses is a viable analytical procedure.

34

An auditor observed that a client mails monthly statements to customers. Subsequently, the auditor reviewed evidence of follow-up on the errors reported by the customers. This test of controls most likely was performed to support management's financial statement assertion(s) of:

Understandability and
classification
Rights and
obligations
a.

Yes

No

b.

No

No

c.

Yes

Yes

d.

No

Yes

Choice "d" is correct. Assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the obligations of the entity. Errors reported by customers might indicate receivables for which the company has no right of collection.

Choices "c" and "a" are incorrect. Assertions about classification and understandability deal with whether financial information is appropriately presented and described, and disclosures are clearly expressed. Follow-up of errors reported by customers would not impact the proper presentation, description, and disclosure of accounts receivable in the financial statements.

Choice "b" is incorrect. Assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the obligations of the entity. Errors reported by customers might indicate receivables for which the company has no right of collection.

35

Which of the following types of audit evidence provides the least assurance of reliability?

a.

Prenumbered receiving reports completed by the client's employees.

b.

Prior months' bank statements obtained from the client.

c.

Municipal property tax bills prepared in the client's name.

d.

Receivable confirmations received from the client's customers.

Choice "a" is correct. Prenumbered receiving reports completed by the client's employees are considered internal evidence and are the least reliable of the items listed.

Choice "d" is incorrect. Receivable confirmations received from client's customers, which are considered external evidence, are more reliable than internal evidence.

Choice "b" is incorrect. Prior months' bank statements obtained from the client, which are considered external evidence, are more reliable than internal evidence.

Choice "c" is incorrect. Municipal property tax bills prepared in the client's name, which are considered external evidence, are more reliable than internal evidence.

36

Which of the following would be considered an analytical procedure?

a.

Testing purchasing, shipping, and receiving cutoff activities.

b.

Projecting the deviation rate of a statistical sample to the population.

c.

Comparing inventory balances to recent sales activities.

d.

Reconciling physical counts to perpetual records and general ledger balances.

Choice "c" is correct. Comparing relationships among data, such as inventory balances to recent sales activities, represents an analytical procedure.

Choice "a" is incorrect. Testing purchasing, shipping, and receiving cutoff activities represents a test of details procedure.

Choice "b" is incorrect. Projecting the deviation rate of a statistical sample to the population is used to evaluate sample results.

Choice "d" is incorrect. Reconciling physical counts to perpetual records and general ledger balances represents a test of details procedure.

37

Which of the following is a management assertion regarding account balances at the period end?

a.

Amounts and other data related to transactions and events have been recorded appropriately.

b.

Transactions and events have been recorded in the proper accounts.

c.

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

d.

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

Choice "c" is correct. "The entity holds or controls the rights to assets" and "liabilitiesare obligations of the entity" are management assertions that relate to the rights and obligation assertion about account balances at period end.

Choice "d" is incorrect. Transactions and events that have been recorded have occurred and pertain to the entity are statements that relate to the existence and occurrence assertion about transactions and events.

Choice "b" is incorrect. The statement "transactions and events have been recorded in the proper accounts" relates to the understandability and classification assertion abouttransactions and events.

Choice "a" is incorrect. Amounts and other data related to transactions and events have been recorded appropriately is a statement that relates to the valuation, allocation and accuracy assertion about transactions and events.

38

Which of the following steps should be performed first in applying analytical procedures?

a.

Determine whether the difference between the expectation and the recorded amount is reasonable.

b.

Compare the client's recorded balance or ratio with the expectation.

c.

Investigate and evaluate significant differences from the expectation.

d.

Develop an expectation of a balance or ratio by using relationships that are expected to exist.

Choice "d" is correct. Of the steps listed, "develop an expectation of a balance or ratio by using relationships that are expected to exist" should be performed first when applying analytical procedures.

Choice "a" is incorrect. "Determine whether the difference between the expectation and the recorded amount is reasonable" should be performed after the expectation of a balance or ratio is developed.

Choice "c" is incorrect. "Investigate and evaluate significant differences from the expectation" is one of the last steps performed in applying analytical procedures.

Choice "b" is incorrect. "Compare the client's recorded balance or ratio with the expectation" should be performed after the expectation of a balance or ratio is developed.

39

Which of the following actions is an analytical procedure that an auditor most likely would use while auditing a company's notes payable?

a.

Sending a confirmation to the lender requesting verification of the loan's outstanding balance.

b.

Reviewing the details of the company's loan and interest expense accounts to determine that all payments were properly recorded.

c.

Performing calculations to determine if the company is in compliance with debt covenants.

d.

Multiplying the average outstanding loan balance by the interest rate and comparing the result to interest expense actually recorded.

Choice "d" is correct. Analytical procedures involve developing an expectation (based on plausible relationships) and comparing recorded amounts or ratios based on recorded amounts to that expectation. An example of an analytical procedure related to notes payable is multiplying the average outstanding loan balance by the interest rate (auditor's expected amount) and comparing the result to interest expense actually recorded.

Choice "c" is incorrect. Performing calculations to determine if the company is in compliance with debt covenants is not an analytical procedure because it does not involve the auditor developing an expectation and comparing it to the actual recorded amount.

Choice "a" is incorrect. Sending a confirmation to the lender requesting verification of the loan's outstanding balance is an example of a confirmation, not analytical, procedure.

Choice "b" is incorrect. Reviewing the details of the company's loan and interest expense accounts to determine that all payments were properly recorded is not an analytical procedure because it does not involve the auditor developing an expectation and comparing it to the actual recorded amount.

40

Analytical procedures are required for which of the following?

a.

Client retention decision.

b.

Tests of balances.

c.

Audit planning.

d.

Internal control evaluation.

Choice "c" is correct. Analytical procedures are required during an audit's planning and final review.

Choice "b" is incorrect. Analytical procedures may be used to test the balance of accounts, but are not required to be utilized as a substantive procedure.

Choice "a" is incorrect. Analytical procedures are not required to be performed when deciding whether to retain a client.

Choice "d" is incorrect. Analytical procedures are not utilized to perform the evaluation of internal control. Procedures performed to evaluate internal control may include inquiry of appropriate personnel, observation of the entity's operation, and/or inspection of relevant documentation.

41

Which of the following statements is correct regarding the predictability of analytical procedures in a financial statement audit?

a.

Relationships in a dynamic environment tend to be more predictable than relationships in a stable environment.

b.

Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts.

c.

Relationships involving transactions subject to management discretion tend to be more predictable than automated transactions.

d.

Relationships involving only balance sheet accounts tend to be more predictable than relationships involving income statement accounts.

Choice "b" is correct. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. Income statement accounts are more predictable because they are for a period of time, rather than a balance sheet account, which is of a point in time.

Choice "d" is incorrect. The opposite is true. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts.

Choice "c" is incorrect. The opposite is true. Relationships involving automated transactions tend to be more predictable than transactions subject to management discretion.

Choice "a" is incorrect. The opposite is true. Relationships in a stable environment tend to be more predictable than relationships in a dynamic environment.