Further Procedures Flashcards
1
Q
Proper segregation of duties reduces the opportunities to allow persons to be in positions to both
A
Perpetrate and conceal errors and irregularities.
An employee should not normally (1) authorize transactions (execution function), (2) have access to the related assets (custody function), and (3) perform accounting activities (record keeping function)
2
Q
Transaction Cycle
A
Group of essentially homogeneous transactions
Within a given category of transactions, control risk is essentially constant, since all transactions within that category are processed subject to the same configuration of internal control policies and procedures
A transaction cycle is, therefore, the highest level of aggregation for which control risk may be viewed as a constant.
3
Q
Transaction cycle examples:
A
- Revenue/receipts
- Expenditures/disbursements
- Payroll
- Inventory, especially manufactured inventory -
- Fixed assets
- Investing/financing
4
Q
Remember that internal controls (specifically, “control activities”) should “SCARE” (AICPA)
A
Segregation of duties, Controls (as in physical controls), Authorization, Reviews (as in performance reviews)-Actual performance should be compared to appropriate budgets and forecasts EDP/IT (information processing)
5
Q
An auditor’s tests of controls for completeness for the revenue cycle usually include determining whether
A
An invoice is prepared for each shipping document.
The auditor starts with a source document and agrees the item to the accounting records. Starting with a shipping document and tracing it to the sales journal (i.e., to a sales invoice recorded in the sales journal)
6
Q
Which of the following would most likely be the result of ineffective internal control policies and procedures in the revenue cycle?
A
Final authorization of credit memos by personnel in the sales department could permit an employee defalcation scheme.
Allowing sales personnel to authorize credit memos is an internal control weakness
7
Q
Sound internal control procedures dictate that defective merchandise returned by customers should be presented initially to the
A
Receiving clerk
Defective merchandise returned by customers should be presented initially to the receiving clerk. The function of the receiving department is to receive and inspect goods and to document the receipt in the form of a receiving report.
8
Q
Proper authorization of write-offs of uncollectible accounts should be approved in which of the following departments?
A
Treasurer
Authorization of write-offs should be made by a department independent of recording or authorization duties pertaining to accounts receivable. The accounts receivable department maintains the accounts receivable records; the credit department approves credit for customers.
9
Q
Flow Chart of Typical Internal Controls for Sales
A
Sales Order (PO) received - Shipping Documents - Sales invoice (billing) - Record in Sales Journal - Post to GL
10
Q
Audit Considerations for Revenue (Sales) Cycle
A
- Segregation of duties- Credit to customers should be granted by an independent department, Returns should be accounted for by an independent clerk in the shipping/receiving area.
- Controls
- Authorization- Management should usually establish general approvals of transactions within specified limits and specifically approve transactions outside of those prescribed limits.
- Reviews (Performance Reviews) - entity’s recorded sales should be compared to appropriate budgets and forecasts.
- EDP/IT (Information Processing) - Important accounting documents (e.g., shipping documents and sales invoices) should be prenumbered and the numerical sequence should be accounted for.
- An aged trial balance for accounts receivable should be agreed (or reconciled) to the general ledger control account
11
Q
Immediately upon receipt of cash, a responsible employee should
A
Prepare a remittance listing.
The same employee should not be responsible for both the receipt and the recording of cash in cash receipts journal.
12
Q
Employers bond employees who handle cash receipts because fidelity bonds reduce the possibility of employing dishonest individuals and
A
Deter dishonesty by making employees aware that insurance companies may investigate and prosecute dishonest acts.
13
Q
Upon receipt of customers’ checks in the mailroom, a responsible employee should prepare a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to the
A
Accounts receivable bookkeeper to update the subsidiary accounts receivable records.
14
Q
An auditor would be most likely to limit substantive audit tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting
A
Cash receipts and accounts receivable.
Consider the accounts which are impacted by sales transactions, DR Cash or Accounts Receivable and CR Sales. The combination of low control risk in this area plus evidence supporting cash receipts and accounts receivable provides the auditor with assurance that sales transactions have actually occurred.
15
Q
Which of the following internal control procedures would most likely deter lapping of collections from customers?
A
Lapping occurs when a remittance received from one customer is stolen and the shortage is hidden by crediting the first customer’s account with the cash received from a second customer. Lapping is best prevented by separating custody from recording. The person responsible for receiving cash should not also be responsible for posting the amounts to the accounts receivable subsidiary ledger.
16
Q
Which of the following internal controls would be most likely to reduce the risk of diversion of customer receipts by an entity’s employees?
A
Establishing a bank lockbox system would provide the best control over customer receipts because it would prevent the employees from having access to the receipts.
17
Q
An auditor would consider a cashier’s job description to contain compatible duties if the cashier receives remittances from the mailroom and also prepares the
A
Daily deposit slip.
Adequate segregation of duties provides for the separation of authorizing, recording, and custodial duties. Receiving remittances from the mailroom is a custodial duty. It may properly be combined with preparation of the daily deposit slip which would also require custody of the asset.
18
Q
Cash Receipts SCARE- Segregation of Duties
A
- Segregation of Duties- A listing of cash receipts (sometimes referred to as a remittance listing or log of cash receipts ) is prepared upon opening the mail in the mail room; checks are restrictively endorsed immediately (“for deposit only . . . ”)
a. Cash-related activities, which are handled by separate personnel as appropriate are as follows:
- Opening the mail—handling the checks received, and verifying the accuracy of the payment indicated on the enclosed “remittance advice”
- Making the deposit—deposits should be made daily
- Applying payments received to the appropriate customers’ accounts receivable
- Preparing the bank reconciliation on a timely basis
19
Q
Cash Receipts SCARE
A
- Controls (Physical Controls)- Employees with access to cash receipts should be “bonded,” Receipts should be deposited daily,The company might use a lockbox
- Authorization-Bank reconciliations should be appropriately reviewed with the reviewer’s approval indicated., adjusting journal entries should be approved by management
- Reviews (Performance Reviews)- The initial cash receipts listing from the mail room should be compared to the total according to the cash receipts journal, and traced to that day’s bank deposit, The cash accounts should be reconciled with the bank statements on a timely basis by someone not involved in handling cash receipts or updating the accounting records.
- EDP/IT (Information Processing)
20
Q
In testing controls over cash disbursements, an auditor would be most likely to determine that the person who signs checks also
A
Is responsible for mailing the checks.
Having the signer mail the checks eliminates the opportunity for the check preparer or others with conflicting duties to modify and/or divert the checks before mailing.
21
Q
In a well-designed internal control structure, employees in the same department most likely would approve purchase orders, and also
A
Negotiate terms with vendors.
Approval of purchase orders and negotiation of terms with vendors are both authorization functions which are properly performed by employees in the purchasing department.
22
Q
Which of the following controls should prevent an invoice for the purchase of merchandise from being paid twice?
A
The check signer reviews and cancels the voucher packets.
An effective procedure to prevent duplicate payments is to cancel the documentation supporting the payment request at the time payment is made. For example, by stamping the documents as “paid.”
23
Q
When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the
A
Debit memo.
A debit memo advises accounting that the vendor invoice should not be paid in full due to returned goods. When the shipping department returns nonconforming goods to a vendor, purchasing should send accounting a debit memo.
24
Q
When there are numerous property and equipment transactions during the year, an auditor who plans to assess control risk at a low level usually performs
A
Tests of controls and limited tests of current year property and equipment transactions.
The assessment of control risk at a low level requires that the auditor provide the basis for reducing the assessment.
25
Which of the following internal control procedures would most likely prevent direct labor hours from being charged to manufacturing overhead?
Use of time tickets to record actual labor worked on production orders.
26
Equipment acquisitions that are misclassified as maintenance expense would most likely be detected by an internal control procedure that provides for
Investigation of variances within a formal budgeting system.
27
When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud would most likely be reduced if the
Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.
The concealment of fraud pertaining to marketable securities is best controlled through controlling access and providing for adequate segregation of duties. Use of a trust company aids in both respects. Access to the marketable securities is controlled by the trust company, an independent entity, and the duties of authorization and recording are automatically separated from the duty of custody.
28
Management's objectives in establishing and maintaining an internal control structure are to ensure that:
1) transactions are executed in accordance with management's general or specific authorization;
2) transactions are recorded as necessary to permit preparation of the financial statements in accordance with GAAP and to maintain accountability for assets;
3) access to assets is permitted only in accordance with management's authorization; and
4) the recorded accountability for assets is compared with the existing assets at reasonable intervals and differences are investigated and resolved. Ensuring that custody of work in process and of finished goods is properly maintained is an example of the third objective.
29
The safeguarding of inventory most likely includes
Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical count.
30
The authority to accept incoming goods in receiving should be based on a(an)
Approved purchase order.
31
In a well-designed internal control structure, the same employee may be permitted to
Mail signed checks, and also cancel supporting documents. both are custodial functions.
32
Which of the following internal control procedures is not usually performed in the vouchers payable department?
Accounting for unused prenumbered purchase orders and receiving reports.
33
Which of the following is usually a benefit of using electronic funds transfer for international cash transactions?
Reduction of the frequency of data entry errors.
34
An auditor generally tests the segregation of duties related to inventory by
Personal inquiry and observation.
This is a test of controls, not a substantive procedure
35
Which of the following controls would a company most likely use to safeguard marketable securities when an independent trust agent is not employed?
Two company officials have joint control of marketable securities, which are kept in a bank safe-deposit box.
An independent trust agent maintains custody over the marketable securities so that the company does not have physical responsibility for the asset. If an independent trust agent is not employed, the securities will physically come to the company and must be safeguarded. The combination of a bank safe-deposit box and dual access
36
Which of the following controls would be most effective in assuring that the proper custody of assets in the investing cycle is maintained.
The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safety deposit box by independent personnel.
37
Which of the following ratios would an engagement partner most likely consider in the overall review stage of an audit?
Cost of goods sold/average inventory.
This ratio is called "inventory turnover," which is a traditional ratio that is useful in evaluating whether inventory might be slow-moving. In that event, inventory might need to be written down to better reflect the estimated future benefits. This might be appropriately considered in the partner's review.
38
Which of the following factors would most likely influence an auditor's determination of the auditability of an entity's financial statements?
The adequacy of the accounting records.
39
Which of the following is an analytical procedure?
Comparing current-year balances to prior-year balances.
Analytical procedures are defined as “evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.”
40
Which of the following best identifies the effect of an increase in the risk of material misstatement on detection risk and the extent of substantive procedures?
The acceptable level of detection risk decreases, and the extent of substantive procedures increases.
41
The Audit Risk Model
- Nature—The auditor has to decide what specific substantive procedures to perform. This includes determining how much emphasis should be placed on tests of details (which tend to be labor intensive and expensive, but which provide a relatively stronger basis for conclusions for most financial statement assertions) versus substantive analytical procedures
- Timing
- Extent
42
Substantive Audit Procedures
Tests of Details—These are the relatively precise (but usually rather expensive, labor-intensive) procedures (that suggest whether the client's recorded amounts are right or not).
Analytical Procedures- Analytical procedures serve three distinct purposes:
1. They are useful as a risk assessment procedure for planning purposes;
2. They are useful (but not required) as a form of substantive evidence
3. The auditor is required to perform analytical procedures as near the end of the audit to assist the auditor when forming an overall conclusion about the financial statements.
43
The AICPA states that the effectiveness and efficiency of substantive analytical procedures depends on the following four factors or considerations:
1. Nature of the assertion—Substantive analytical procedures may be particularly effective in testing for omissions of transactions that would be hard to detect with procedures that focus on recorded amounts
2. Plausibility and predictability of the relationship—Developing a meaningful expectation to compare to the client's recorded balance is critical to the skillful use of analytical procedures (stable environment is more predictable)
3. Availability and reliability of data used—The reliability of the expectation increases when the data used is (1) obtained from independent outside sources; (2) when it is subject to audit testing (either currently or in the past); or (3) is developed under conditions of effective internal control.
4. Precision of the expectation—The likelihood of detecting a misstatement decreases as the level of aggregation of the data increases
44
Liquidity Ratios (also known as solvency ratios)
Working Capital = Current assets – Current liabilities.
Current ratio = Current assets/Current liabilities
Quick ratio (acid-test rat io) = (Cash + Marketable securities + A/R)/Current liabilities
Current cash to debt ratio = Net cash from operations/Average current liabilities
45
Activity Ratios (also known as turnover or efficiency ratios):
Asset turnover = Net sales/Average total assets
Receivable turnover = Net (credit) sales/Average trade receivable (net)
Number of days sales in receivables = 365 days/Receivable turnover
Inventory turnover = Cost of goods sold/Average inventory
Number of days sales in inventory = 365 days/Inventory turnover
46
Profitability Ratios
Profit margin on sales = Net income/Net sales
Gross profit percentage = (Sales – Cost of goods sold)/Sales
Rate of return on assets = Net income/Average total assets
Rate of return on common stockholders’ equity = (Net income – Dividends attributable to preferred stockholders)/Average common stockholders’ equity
Earnings per share = (Net income – Preferred dividends)/Average number of common shares outstanding
Price earnings ratio (P-E ratio) = Market price of stock/earnings per share
47
Coverage Ratios (also known as leverage ratios)
Debt to total assets ratio = Total liabilities/Total assets
Debt to equity ratio = Total liabilities/Total stockholders’ equity
Times interest earned = Income before interest expense and income taxes/Interest expense
Cash to debt coverage ratio = Net cash from operations/Average total liabilities
48
Which of the following is a management assertion regarding account balances at the period end?
There are 4 assertions applicable to account balances at the period end: (1) existence; (2) completeness; (3) rights or obligations; and (4) valuation and allocation.
49
Which of the following statements concerning evidential matter is correct?
A client's accounting data cannot be considered sufficient audit evidence to support the financial statements.
The auditor must test the accounting data in order to develop persuasive evidence to support the opinion
50
Which of the following questions would most likely be included in an internal control questionnaire concerning the completeness assertion for purchases?
Are purchase orders, receiving reports, and vouchers prenumbered and periodically accounted for?
The standard control for completeness is controlling prenumbered forms.
51
Which of the following statements concerning audit evidence is correct?
The measure of the validity of audit evidence lies in the auditor's judgment.
52
Sufficient Appropriate Audit Evidence
"Sufficient" refers to the quantity of evidence, whereas "appropriate" refers to the quality of evidence in terms of its relevance and reliability.
The quantity of evidence required (related to "sufficient") is directly related to the risk of misstatement (the greater the risk, the more evidence is needed) and inversely related to the quality of evidence (the higher the quality, the less evidence is needed).
53
"Reliability" is affected by the source and nature of evidence
- Evidence obtained directly by the auditor is more reliable than evidence obtained indirectly or by inference (e.g., observation of the application of a control is more reliable than inquiry of entity personnel about the application of a control).
- Evidence is more reliable when obtained from independent (knowledgeable) sources
- Evidence generated internally is more reliable when the related controls are effective;
- Evidence is more reliable when it exists in documentary form
- Evidence provided by original documents is more reliable than evidence based on photocopies/fax
54
AICPA Professional Standards now classify assertions in three separate categories for the auditor's consideration
Account balances;
Presentation and disclosure; and
Classes of transactions and events.
55
There are four assertions specific to "account balances at period end"
1. Existence-assets, liabilities, and equity interests exist.
2. Completeness- assets, liabilities, and equity interests that should have been recorded have been recorded. There are no omissions.
3. Rights and obligations-entity holds or controls the rights to its assets, and the liabilities are the obligations of the entity. Any restrictions on the rights to the assets or obligations for the liabilities must be disclosed.
4. Valuation and allocation-That assets, liabilities, and equity interests are included in the financial statements at appropriate amounts
56
There are four assertions about "presentation and disclosure."
1. Occurrence and rights and obligations- disclosed events and transactions have occurred and pertain to the entity.
2. Completeness-disclosures that should have been included have been included. There are no omissions
3. Classification and understandability- financial information is appropriately presented, described, and clearly expressed.
4. Accuracy and valuation-That financial and other information are disclosed fairly and at appropriate amounts.
57
There are five assertions about "classes of transactions and events during the period."
Accuracy-amounts and other data have been recorded appropriately.
Occurrence-transactions and events that have been recorded have occurred. In other words, they are properly recorded and valid.
Completeness- all transactions and events that should have been recorded have been recorded. There are no omissions.
Cutoff- transactions and events have been recorded in the correct accounting period. Note that there are only two ways to record a transaction in the wrong period. One is by recorded a transaction prematurely, which violates the "occurrence" assertion; and the other is to record a transaction belatedly, which violates the "completeness" assertion.
Classification-transactions and events have been recorded in the proper accounts.
58
Before applying principal substantive tests to the details of accounts at an interim date prior to the balance sheet date, an auditor should:
Consider whether the amounts of the year-end balances selected for interim testing are reasonably predictable.
59
Which of the following procedures would an auditor most likely perform during an audit engagement's overall review stage in formulating an opinion on an entity's financial statements?
Consider whether the results of audit procedures affect the assessment of the risk of material misstatement due to fraud.
During the overall review stage, the auditor assesses the conclusions reached and the evaluation of the overall financial statement presentation.
60
An auditor of a nonissuer should design tests of details to ensure that sufficient audit evidence supports which of the following?
The planned level of assurance at the relevant assertion level.
61
Before applying principal substantive tests to an entity's accounts receivable at an interim date, an auditor should:
The auditor would consider the difficulty in controlling the incremental audit risk, i.e., the risk that material misstatements will not be detected due to the early testing at interim.
This difficulty would be impacted by the effectiveness of internal controls, the presence of rapidly changing business conditions or circumstances, and the availability of relevant information.
62
AICPA Professional Standards (specifically, AU-C 500, Audit Evidence) identifies seven types of audit procedures:
(1) inspection;
(2) observation;
(3) external confirmation;
(4) recalculation;
(5) reperformance;
(6) inquiry; and
(7) analytical procedures.
The AICPA describes examining accounting records as “inspection.”
63
PCAOB vs. AICPA—Structural Differences
These PCAOB Auditing Standards are applicable to integrated audits of an issuer's financial statements and the internal controls over financial reporting. In contrast, the AICPA's Statements on Auditing Standards focus solely on audits of nonissuers’ financial statements.
64
The PCAOB identified the five traditional financial statement assertions
- Existence—That the assets or liabilities exist at a given date or that the recorded transactions have occurred during a given period
- Completeness—That there are no omissions of transaction or accounts that should have been recorded
- Rights and obligations —That the company has the rights to the assets and the obligations for the liabilities at a given date
- Valuation or allocation —That the financial statement elements are presented at appropriate amounts relative to the applicable accounting framework
- Presentation and disclosure —That the elements of the financial statements are properly classified, described, and disclosed
65
Each of the following might be considered as a type of factual misstatement, EXCEPT
Differences between management and the auditor's judgment regarding accounting estimates.
These are judgmental misstatements
66
An auditor is not required to document
Senior management's awareness of (and agreement with) the tolerable misstatement specified by the auditor for material elements of the financial statements.
The auditor should document the levels of materiality used and the basis for determination. The auditor should not divulge to management the specific levels of materiality used or the materiality levels allocated to individual elements of the financial statements. So obtaining such agreement would not be appropriate.
67
Factual misstatements
Misstatements for which there is no doubt.
68
Judgmental misstatements
Differences due to the judgments of management that the auditor considers unreasonable or to the selection of accounting policies that the auditor views as inappropriate.
69
Projected misstatements
The auditor's best estimate of misstatements in populations as suggested by audit sampling.
70
Consideration of Identified Misstatements as the Audit Progresses
The auditor should determine whether the overall audit strategy and audit plan need to be revised as a result of the identified misstatements.
71
Evaluating the Effect of Uncorrected Misstatements
1. Reassess materiality
2. Determine whether uncorrected misstatements are material
3. The auditor should consider whether the detected and undetected misstatements might exceed materiality.
4. Circumstances affecting the evaluation of materiality include the following: (a) compliance and regulatory requirements; (b) debt covenants; (c) the effect on future periods’ financial statements; (d) the effects on changes in earnings (such as changing income to a loss or vice versa) or other trends; (e) the impact on ratios; (f) the effects on segment information; (g) an effect that increases management compensation; (h) the omission of information important to users’ understanding
72
Documentation of misstatements
(1) the amount below which misstatements would be viewed as clearly trivial
(2) all misstatements accumulated during the audit and whether they have been corrected
(3) the auditor's conclusion (and the basis for that conclusion) about whether the uncorrected misstatements are material
73
Which of the following statements is correct about actions taken after the documentation completion date?
The auditor must not make any deletions to audit documentation before the end of the specified retention period. They can add to it with justification.
74
Which of the following is not required documentation for an audit, in accordance with generally accepted auditing standards?
A flowchart or an internal control questionnaire that evaluates the effectiveness of the entity's internal control policies and procedures.
While flowcharts and internal control questionnaires both provide an accepted means of documenting the auditor's understanding of the internal control structure, neither is required. Furthermore, neither is used to evaluate the effectiveness of internal control; they are used to document an understanding of internal control.
75
Using microcomputers in auditing may affect the methods used to review the work of staff assistants because
Working paper documentation may not contain readily observable details of calculations.
The use of microcomputers impacts the manner in which audit documentation is completed and displayed. If a spreadsheet program is used to create the documentation, it may not contain readily observable details of calculations because the formulas will be hidden in the cells.
76
Audit Documentation:
This is the record of audit procedures performed, relevant audit evidence obtained, and conclusions reached (terms such as working papers or work papers are also sometimes used).
- Provides the principal support for the auditor's report
- Documents the auditor's compliance with GAAS and any applicable legal and regulatory requirements
- The audit documentation assists in controlling the audit work—that is, breaking the overall audit project into manageable tasks that can be delegated to the various members of the audit team
77
AICPA Requirements of work papers
Audit documentation should permit an experienced auditor without prior connection to the audit to understand the following:
- The nature, timing, and extent of procedures performed;
- The results of those procedures;
- The conclusions reached on significant matters; and
- Whether the accounting records agree or reconcile with the audited financial statements.
78
Revisions to Work Papers
1. Documentation Completion Date—The auditor should complete the assembly of the final audit file no later than 60 days after the report release date. The PCAOB specifies a limit of 45 days for public companies.
2. Before the Documentation Completion Date—The auditor may add information received after the report date or delete unnecessary documentation up to the documentation completion date.
3. After the Documentation Completion Date—The auditor must not delete any audit documentation before the end of the retention period; the auditor may add to the documentation, but must document any materials added, by whom, when, reasons for the change, and the effect, if any, on the auditor's conclusions.
4. Retention Requirements—The AICPA requires that the audit documentation be retained for at least 5 years from the report release date. (The PCAOB requires retention for at least 7 years for public companies.)
79
Permanent File
Involves matters having ongoing audit significance and may include:
- Description of the client's industry, a brief history of client, and a description of the client's facilities
- Abstracts or copies of important legal documents and important long-term contracts
80
Current Year's Audit Files
The current year's audit files include the auditor's documentation of important administrative matters (such as the audit team's time budget) along with the supporting working papers related to the financial statement items. Ex. Audit plan (sometimes called the audit program).
81
Under which of the following circumstances would the use of the blank form of confirmations of accounts receivable most likely be preferable to positive confirmations?
Using the blank form of confirmation of accounts receivable provides greater assurance that the recipient of the confirmation has verified that the information is correct. It is more likely to be used when the auditor is concerned that recipients will not devote proper attention to the confirmations.
AICPA Professional Standards indicate that using blank confirmation requests may provide a greater degree of assurance about the information confirmed because of the need to fill in the amount. However, blank forms might also result in lower response rates
82
Under which of the following circumstances should an auditor consider confirming the terms of a large complex sale?
When the combined assessed level of inherent and control risk (RMM) over the sale is high.
83
Which of the following statements is correct concerning the use of negative confirmation requests?
Unreturned negative confirmation requests rarely provide significant explicit evidence.
Thus, it is assumed that the balances are correct unless the confirmation is returned. Unreturned negative confirmation requests, therefore, are considered to be evidence. This evidence is implied, it is not explicit.
84
In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?
A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.
The use of negative accounts receivable confirmations requires 1 or more of the following:
1) a low risk of material misstatement;
2) a large number of small balances; and
3) an expected very low exception rate;
4) no reason to believe that the recipients of the confirmations would not review them properly.
85
Positive Confirmation Request:
A request that the confirming party respond directly to the auditor by providing the requested information or indicating whether the confirming party agrees or disagrees with the information in the request. A nonresponse is viewed as a “loose end” that must be addressed.
1. When individual accounts are large
2. Requires second (or possibly third) requests as a follow-up procedure for nonresponses
3. If no response is obtained, the auditor must perform alternative procedures.
86
Negative Confirmation Request:
A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request.
87
Alternative Procedures when no response received:
1. Receivables—The auditor would first look to see whether cash was received subsequent to the date of the confirmation request.
2. Payables—The auditor would usually verify subsequent cash disbursements as evidence of payment of the account.
88
“The auditor should use external confirmation procedures for accounts receivable, except when one or more of the following is applicable:
1. The overall account balance is immaterial.
2. External confirmation procedures for accounts receivable would be ineffective.
3. The auditor's assessed level of risk of material misstatement at the relevant assertion level is low, and the other planned substantive procedures address the assessed risk.
89
In evaluating the reasonableness of an accounting estimate, an auditor concentrates on key factors and assumptions that are:
1. significant to the accounting estimate;
2. sensitive to variations;
3. deviations from historical patterns; and
4. subjective and susceptible to misstatement and bias.
90
Which of the following procedures most likely would assist an auditor in determining whether management has identified all accounting estimates that could be material to the financial statements?
Review the lawyer's letter for information about litigation.
If the auditor is concerned about identifying all material accounting estimates, the auditor is seeking to discover unrecorded estimates. The auditor is most likely to review the lawyer's letter for information about litigation. Litigation losses is an area that commonly requires estimates and one in which estimates could be material to the financial statements.
It is also an area that falls outside of the normal financial reporting process and, thus, is more likely to be missed.
91
Basis for Risk Assessment for accounting estimate
The auditor should obtain an understanding of the following:
- The requirements of the applicable financial reporting framework
- How management makes the accounting estimates and the data used, including how management has assessed the effect of estimation uncertainty
92
Evaluating the Reasonableness of the Accounting Estimates and Disclosures
The auditor should evaluate whether the accounting estimates are reasonable (or are misstated) relative to the applicable financial reporting framework.
The auditor should obtain sufficient appropriate audit evidence as to whether the disclosures meet the requirements of the applicable financial reporting framework.
The auditor should consider whether the accounting estimates might indicate possible management bias.
93
The auditor's responsibility to communicate with those charged with governance about fair value measurements and disclosure issues is best described by the following statement:
The auditor should determine whether those charged with governance are informed about management's processes in developing material fair value estimates, including significant assumptions used by management.
94
Which of the following statements describing the auditor's responsibilities when evaluating an entity's fair value measurements and disclosures is correct?
The auditor is responsible for obtaining an understanding of relevant controls related to fair value measurement and disclosures.
The auditor is responsible for determining that the entity's fair value measurements and methods used meet the requirements of GAAP and are consistently applied.
The auditor is responsible for obtaining sufficient appropriate evidence to provide reasonable assurance that fair value measurements and disclosures meet the requirements of GAAP.
95
For fair value accounting estimates, assumptions (inputs) affect estimation uncertainty and vary as follows:
Observable inputs—Assumptions that market participants would use in pricing an asset or liability based on market data from sources independent of the reporting entity or
Unobservable inputs—An entity's own judgments about what assumptions market participants would use. Estimation uncertainty increases when the fair value estimates are based on unobservable inputs.
96
Which of the following procedures would be most likely to assist an auditor in identifying litigation, claims, and assessments?
Read the file of correspondence from taxing authorities.
A taxing authority could impose an assessment on an entity related to tax matters. The auditor might then identify the existence of such an assessment by reviewing correspondence between the entity and the taxing authority.
97
What is an auditor's primary method to corroborate information on litigation, claims, and assessments?
Reviewing the response from the client's lawyer to a letter of audit inquiry.
98
In auditing contingent liabilities, which of the following procedures would an auditor be most likely to perform?
Read the minutes of the board of directors' meetings.
Issues that are significant to the entity (for example, litigation issues that result in contingent liabilities) normally rise to the level of discussion by those charged with governance.
99
The scope of an audit is not restricted when an attorney's response to an auditor, as a result of a client's letter of audit inquiry, limits the response to
A lawyer may appropriately limit the response to matters to which the lawyer has given substantive attention in the form of legal consultation or representation.
100
The primary source of information to be reported about litigation, claims, and assessments is the
Client's management.
101
The refusal of a client's attorney to provide information requested in an inquiry letter generally is considered
A limitation on the scope of the audit.
It would result in a disclaimer or a qualified opinion.
102
A lawyer's response to an auditor's inquiry concerning litigation, claims, and assessments may be limited to matters that are considered individually or collectively material to the client's financial statements. Which parties should reach an understanding on the limits of materiality for this purpose?
The client and the auditor should reach an understanding about materiality. This understanding is then communicated to the attorney who will limit his/her response accordingly.
103
Asserted Claims
With respect to asserted claims and active litigation “asserted” means that someone has already filed a claim or has at least announced the intention to make such a claim, which is synonymous with the AICPA's term “pending or threatened litigation.”
According to the American Bar Association, the lawyer should inform the auditor directly about any omissions of asserted claims in the lawyer's letter responding to the letter of inquiry.
104
Unasserted Claims
With respect to unasserted claims and potential litigation, “unasserted” means that the entity has exposure to litigation, but no one has yet announced an intention to sue.
The lawyer cannot inform the auditor directly about any omission of unasserted claims as identified in the letter of inquiry.
An unasserted claim must be disclosed according to GAAP if the following two conditions exist:
- It is probable that a claim will be asserted, and
- It is at least reasonably possible that a material unfavorable outcome will occur.
105
Management's responses to inquiries can be corroborated by each of the following, except
Preparation of the summary of unadjusted differences.
The purpose of the “summary of unadjusted differences” is to determine whether identified differences between the accounting records and the audit evidence that are not individually material might be material in the aggregate.
106
An auditor is reporting on comparative financial statements for three years. Which of the following statements is correct regarding written representations from management?
The representation letter needs to address all of the years being covered in the report.
107
To which of the following matters would an auditor not apply materiality limits when obtaining specific written representations from management?
Fraud involving employees with significant roles in the internal control structure.
Because of the possible effects of fraud on other areas of the audit, materiality limits would not apply to the reporting of fraud involving employees with significant roles in internal control in the written management representations.
108
Which of the following statements would most likely be included among the written client representations obtained by the auditor?
The management representations letter would appropriately include statements about the disclosure of compensating balances and other arrangements involving restrictions on cash balances.
109
"We have disclosed to you all known instances of noncompliance or suspected noncompliance with laws and regulations whose effects should be considered when preparing financial statements." The foregoing passage most likely is from a(n)
Management representations letter.
110
The date of the management representation letter should coincide with the date of the
Auditor's report.
111
Key Co. plans to present comparative financial statements for the years ended December 31, 2005, and 2006, respectively. Smith, CPA, audited Key's financial statements for both years and plans to report on the comparative financial statements on May 1, 2007. Key's current management team was not present until January 1, 2006. What period of time should be covered by Key's management representation letter?
January 1, 2005, through May 1, 2007.
This requirement exists even if management was not present during all periods covered by the auditor's report.
112
The Specific Content of the Representations in Management Representations letter on Financial Statements:
1. That management is responsible for the fairness of the financial statements
2. That management is responsible for internal control over financial reporting
3. That management is responsible for internal control to prevent and detect fraud
4. That significant assumptions used for any accounting estimates are reasonable
5. That related party transactions have been properly accounted for and disclosed
6. That subsequent events have been properly accounted for and disclosed
7. That any uncorrected misstatements are immaterial
8. That the effects of litigation and claims have been properly accounted for and disclosed
113
The Specific Content of the Representations in Management Representations letter on Information provided:
1. That all relevant financial records and unrestricted access to personnel were made available to the auditor
2. That all transactions have been recorded
3. That management has made available the results of their assessment of fraud risks
4. That regarding fraud, there is no fraud involving management or employees having significant internal control responsibilities, or others where the financial statement effect could be material
5. That management has no knowledge of suspected fraud communicated by employees, former employees, or others
6. That management has disclosed all instances of noncompliance with laws and regulations relevant to financial reporting
7. That there are no (undisclosed) litigations, claims, and assessments relevant to the financial statements
8. That management has disclosed all known related party relationships and transactions
114
What is the primary purpose of reviewing conflict-of-interest statements signed by members of management?
To identify transactions with related parties.
115
In auditing related party transactions, an auditor ordinarily places primary emphasis on
The adequacy of the disclosure of the related party transactions.
116
Which of the following events most likely indicates the existence of related parties?
Making a loan without scheduled terms for repayment of the funds.
117
After identifying related party transactions, an auditor most likely would
Determine whether the transactions were approved by the board of directors or other appropriate officials.
The auditor's primary concern with regard to related party transactions is disclosure
118
After determining that a related party transaction has, in fact, occurred, an auditor should
Obtain an understanding of the business purpose of the transaction.
The auditor should apply the procedures considered necessary to determine the purpose, nature, and extent of the related party transactions and their effects on the financial statements.
119
PCAOB auditing standards dealing with related-party issues specifically require an auditor of an issuer to obtain an understanding of the company's process for each of the following:
(1) identifying related parties and transactions with related parties;
(2) authorizing and approving transactions with related parties; and
(3) accounting for and disclosing relationships and transactions with related parties in the financial statements.
120
PCAOB auditing standards require an auditor of a public company to communicate with the audit committee about a variety of related-party matters. Each of the following is required to be communicated with the audit committee:
The auditor's evaluation of the company's identification and financial reporting treatment of related-party relationships and transactions.
Related-party relationships or transactions with parties discovered by the auditor that were previously undisclosed to the auditor.
Related-party transactions identified by the auditor that appear to lack an appropriate business purpose.
121
Suppose that management of an issuer makes an assertion in a footnote to the company's financial statements that material transactions with related parties were conducted on terms equivalent to those prevailing in arm's-length transactions. If evidence cannot be obtained to support this assertion and management declines to alter that footnote, what type of audit opinion would be appropriate?
PCAOB auditing standards (specifically, AS Section 2410) state that the auditor should consider a qualified or adverse opinion under such circumstances.
122
Which of the following events that occurred after a client's calendar-year end, but before the audit report date, would require disclosure in the notes to the financial statements, but no adjustment in the financial statements?
New convertible bonds are issued to expand the company's product line.
GAAP requires that material changes in debt (or capital) structure during the subsequent events period be disclosed in the financial statements. Such changes would not require adjustment.
123
An auditor should be aware of subsequent events that provide evidence concerning conditions that did not exist at year end but arose after year end. These events may be important to the auditor because they may
Require disclosure to keep the financial statements from being misleading.
Events that did not exist at year end but arose after year end require disclosure.
124
Subsequent to issuing a report on audited financial statements, a CPA discovers that the accounts receivable confirmation process omitted a number of accounts that are material, in the aggregate. Which of the following actions should the CPA take immediately?
Perform alternative procedures to verify account balances.
The auditor should immediately gather sufficient appropriate audit evidence with respect to the receivables in question in order to determine whether the financial statements are fairly stated and whether the previously expressed opinion is appropriate.
125
Which of the following procedures would an auditor ordinarily perform during the review of subsequent events?
In reviewing subsequent events, the auditor would read the latest interim financial statements and board of directors' minutes, inquire with legal counsel concerning litigation, claims, and assessments, and make specific inquiries of management.
126
Wilson, CPA, completed the field work of the audit of Abco's December 31, 2009, financial statements on March 6, 2010, at which time Wilson believed that sufficient appropriate audit evidence had been obtained to support the auditor's opinion. However, a subsequent event requiring adjustment to the 2009 financial statements occurred on April 10, 2010, and came to Wilson's attention on April 24, 2010, which preceded the issuance of the audit report on Abco's 2009 financial statements. If the adjustment is made without disclosure of the event, Wilson's report ordinarily should be dated
March 6, 2010.
When a subsequent event occurs requiring adjustment of the financial statements but no disclosure of that subsequent event is made, the report will still be dated when sufficient appropriate audit evidence had been obtained, that is, March 6, 2010.
127
An auditor issued an audit report that was dual dated for a subsequent event occurring after the audit report date but before release of the auditor's report.
The auditor's responsibility for events occurring subsequent to the audit report date was
Limited to the specific event referenced.
When a subsequent event disclosed in the financial statements occurs after audit report date but before release of the report, the auditor may elect to dual date his/her report. In doing so, the auditor is limiting responsibility for events occurring subsequent to the audit report date to the specific event referenced.
128
Which of the following audit procedures most likely would assist an auditor in identifying conditions and events that may indicate there could be substantial doubt about an entity's ability to continue as a going concern?
Review of compliance with terms of debt agreements.
The normal effect of violating the terms of debt agreements (including debt covenants) is to render the associated debt immediately due, which may cause significant financial stress on the entity and cause the auditor to have substantial doubt about the entity's ability to continue as a going concern.
129
When an auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to
Consider the adequacy of disclosure about the entity's possible inability to continue as a going concern.
A going concern problem is addressed through the addition of an emphasis-of-matter paragraph to the auditor's report without modification of the opinion.
130
Which of the following auditing procedures most likely would assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern?
Confirming with third parties the details of arrangements to maintain financial support.
GAAS indicate that it is not necessary to design procedures solely directed toward an entity's going concern capabilities. Auditing procedures designed for other purposes may also be used to investigate potential going concern issues.
131
An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. The entity's financial statements adequately disclose its financial difficulties. Under these circumstances, the auditor's report is required to include an emphasis-of-matter paragraph that specifically uses the phrase(s)
AICPA Professional Standardsoffer the phrase "substantial doubt about the entity's ability to continue as a going concern."
132
Management's Responsibility for the Evaluation of Going Concern Issues
FASB requires management to evaluate whether substantial doubt exists within one year of the issuance of the financial statements; GASB has a similar requirement for governmental entities.
133
Written Representations about Going Concern issues
Should request written representations from management (1) about management's plans intended to mitigate the relevant conditions or events, and (2) whether disclosure of all relevant matters is appropriate (including the conditions or events involved and management's plans).
134
Implications of Going Concern Issues for the Auditor's Report
1. When the use of the going concern basis of accounting is inappropriate—express an adverse opinion when liquidation is imminent
2. If disclosure is inadequate—Should either express a qualified or adverse opinion
3. If the auditor is unable to obtain sufficient appropriate audit evidence— express a qualified opinion or disclaimer of opinion
4. When there is substantial doubt about the entity's ability to continue as a going concern (but the use of the going concern basis of accounting is appropriate)— Should include an “emphasis-of-matter” paragraph (after the opinion paragraph) in the auditor's report. The SAS prohibits using “conditional language” in expressing a conclusion about the existence of substantial doubt
135
Which of the following types of audit evidence is the least persuasive?
Prenumbered purchase order forms.
Prenumbered purchase order forms are the least persuasive type of audit evidence among those listed. They are internally generated.
136
Which of the following procedures would be most effective in reducing attestation risk?
Examination of evidence.
Evidence that can be examined is considered more reliable than oral evidence and analytical procedures.
137
Each of the following is identified by both the PCAOB risk assessment standards and the AICPA risk assessment standards as an assertion to be specifically addressed by the auditor except for
Presentation and disclosure.
PCAOB identified "presentation and disclosure" as an assertion, whereas the AICPA standards ( AU-C Section 315) identified "presentation and disclosure" as a separate category of assertions consisting of four separate, specific assertions
138
An auditor ordinarily uses a working trial balance resembling the financial statements without footnotes, but containing columns for
Reclassification and adjustments.
139
Although the quantity and content of audit documentation vary with each particular engagement, an auditor's permanent files most likely include
Analyses of capital stock and other owners' equity accounts.
A permanent file contains information that is referred to for more than one audit period. Therefore, an auditor's permanent files most likely would include analyses of capital stock and other owners' equity accounts.
