Chapter 5

Question 1

Under current auditing standards, management assertions fall into the following categories:

Answer 1

1. Assertions about classes of transactions and events for the period under audit.
2. Assertions about account balances at the period end.
3. Assertions about presentation and disclosure.

Question 2

Assertions about classes of transactions and events for the period under audit:

Answer 2

1. Occurrence - transactions and events that have been recorded have occurred and pertain to the entity (sometimes referred to as a validity).
2. Completeness - all transactions and events that should have been recorded in the correct accounting model.
3. Authorization - all transactions and events have been properly authorized.
4. Accuracy - amounts and other data relating to recorded transactions and events have been recorded appropriately.
5. Cutoff - transactions and events that have been recorded in the correct accounting period.
6. Classification - transactions and events have been recorded in the proper accounts.

Question 3

Assertions about account balances at the period end:

Answer 3

1. Existence - assets, liabilities, and equity interests exist.
2. Rights and obligations - the entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
3. Completeness - all assets, liabilities, and equity interests that should have been recorded have been recorded.
4. Valuation and allocation - assets, liabilities, and equity interests are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

Question 4

Assertions about presentation and disclosure:

Answer 4

1. Occurrence and rights and obligations - disclosed events, transactions, and other matters have occurred and pertain to the entity.
2. Completeness - all disclosures that should have been included in the financial statements have been included.
3. Classification and understandability - financial information is appropriately presented and described, and disclosures are clearly expressed.
4. Accuracy and valuation - financial and other information is disclosed fairly and in appropriate amounts.

Question 5

Relating to audit evidence, an auditor must consider:

Answer 5

The nature, sufficiency and appropriateness of it.

Question 6

Types of evidence: Inspection of records or documents

Answer 6

Examining internal or external records or documents.

Question 7

Types of evidence: Inspection of tangible assets

Answer 7

Physical examination of the assets.

Question 8

Types of evidence: Observation

Answer 8

Looking at a process or procedure being performed by others.

Question 9

Types of evidence: Inquiry

Answer 9

Consists of seeking information from knowledgeable persons.

Question 10

Types of evidence: Confirmation

Answer 10

A direct written response to the auditor from a third party (the confirming party).

Question 11

Types of evidence: Recalculation

Answer 11

Consists of checking the mathematical accuracy of documents or records.

Question 12

Types of evidence: Re-performance

Answer 12

The independent execution by the auditor of procedures or controls that were originally performed by company personnel.

Question 13

Types of evidence: Analytical procedures

Answer 13

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data.

Question 14

Types of evidence: Scanning

Answer 14

The auditor’s exercise of professional judgement to review accounting data to identify significant or unusual items to test. This includes searching for large and unusual items in the accounting records, as well as reviewing transaction data.

Question 15

Audit documentation has 3 functions:

Answer 15

1. To provide principal support for the representation in the auditor’s report that the audit was conducted in accordance with GAAS.
2. To aid in the planning, performance, and supervision of the audit.
3. To provide the basis for the review of the quality of the work by providing a written documentation of the evidence supporting the auditor’s significance conclusions.

Question 16

Ownership of audit documentation

Answer 16

Although the auditor owns the audit documents, they cannot be shown, except under certain circumstances, to outside parties without the entity’s consent.

Question 17

Archiving and retention

Answer 17

SOX and PCAOB standards require that audit documentation be retained for 7 years from that date of completion of the engagement, as indicated by the date of the auditor’s report (or the date that fieldwork is substantially completed.)

Question 18

3 types of analytical procedures:

Answer 18

1. Trend analysis
2. Ratio analysis
3. Reasonableness analysis

Question 19

Trend analysis

Answer 19

The analysis of changes in an account over time.

Question 20

Ratio analysis

Answer 20

The comparison, across time or to a benchmark, of relationships between financial statement accounts.

Question 21

Reasonableness analysis

Answer 21

Involves forming an expectation using a model, because it forms an explicit expectation, reasonableness analysis typically forms a more precise expectation than trend or ratio analysis.

Question 22

Short-Term Liquidity Ratios

Answer 22

Indicate the entity’s ability to meet its current obligations. (Current, quick, and operating cash flow ratios)

Question 23

Current Ratio

Answer 23

Current Assets/Current Liabilities
-It includes all current assets and current liabilities and is usually considered acceptable if it is 2 to 1 or better. Generally, a high current ratio indicates an entity’s ability to pay current obligations. However, if current assets include old accounts receivable or obsolete inventory, this ratio can be distorted.

Question 24

Quick Ratio

Answer 24

Liquid Assets/Current Liabilities
-Thus, inventories and prepaid items are not included in the numerator of the quick ratio. The quick ratio may provide a better picture of the entity’s liquidity position if inventory contains obsolete or slow-moving items. A ratio greater than 1 generally indicates that the entity’s liquid assets are sufficient to meet the cash requirements for paying current liabilities.

Question 25

Receivables Turnover

Answer 25

Credit Sales/Receivables - Provides information on the activity and age of AR. - The receivables turnover ratio indicates how many times accounts receivable are turned over during a year.

Question 26

Inventory Turnover

Answer 26

COGS/Inventory - Inventory turnover indicates the frequency with which inventory is consumed in a year. - The higher the ratio, the better the entity is at liquidating inventory. -This ratio can be easily compared to industry standards.