Auditing The Art and Science of Assurance Engagements, Canadian Eleventh Edition with GradeTracker, 11E By Alvin A. Arens
Email: richard@qwconsultancy.com
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In the audit of historical financial statements by PA firms, the criteria used are 1) _______ A) generally accepted accounting principles. B) generally accepted auditing standards. C) regulations of the provincial securities commissions. D) regulations of the Canada Revenue Agency.
2) Auditing should be done by A) a professional accountant. C) a chartered accountant.
2) _______ B) a competent and independent person. D) a certified management accountant.
3) A large PA firm has assessed evidence collected during an engagement. Criteria used to assess the financial statements were generally accepted accounting principles. A high level of assurance was obtained. The type of engagement conducted was: A) review B) compilation C) audit D) management consulting
3) _______
4) George had a conversation with the accounting personnel and documented information about how the accounting systems function. He has also placed copies of accounting forms in his files. George is performing which task? A) accounting procedures B) tax audit C) evidence gathering D) audit report preparation
4) _______
5) The auditor and the entities should agree on the criteria to be used in the audit A) at the end of the audit. B) after the audit planning has been done. C) before the audit starts. D) as they progress with the audit as they can determine which criteria is more suitable.
5) _______
6) Because an external auditor is paid a fee by a client company, he or she A) may be sufficiently independent to conduct an audit. B) must receive approval of the relevant provincial securities commission before conducting an audit. C) is never considered to be independent. D) is absolutely independent and may conduct an audit.
6) _______
7) It is important for the auditor to be independent because A) the auditor would not charge a fair rate to the client. B) the Canadian Tax Authorities require that the auditor be independent. C) the audit conclusions cannot be relied upon if the auditor was biased in accumulating and evaluating evidence. D) the auditor might not be as knowledgeable of the subject matter and the criteria.
7) _______
8) The auditor's report is A) the report presented to management about the possible improvements. B) the communication of audit findings to users. C) the set of audited financial statements. D) the invoice of the auditor detailing the work they have performed.
8) _______
9) In the audit of an individual's tax return, the criteria used would be A) GAAP. B) the auditor's judgement. C) the Income Tax Act. D) the client's policies for taxable income.
9) _______
10) Joe is recording sales transactions in the accounting system so that they can be summarized in a logical manner for the purpose of providing financial information for decision-making. Joe is doing A) review. B) management consulting. C) auditing. D) accounting.
10) ______
11) In "auditing" accounting data, the concern is with A) analyzing the financial information to be sure that it complies with government requirements. B) determining whether recorded information properly reflects the economic events that occurred during the accounting period. C) determining if taxable income has been calculated correctly. D) determining if fraud has occurred.
11) ______
12) What type of organizations use auditing services? A) Businesses C) Governments
12) ______ B) Non-for-profit organizations D) All of the above
13) An accountant records information. When conducting an audit, the distinguishing abilities are the A) requirement to possess education beyond the bachelor's degree. B) ability to interpret generally accepted accounting principles. C) organize and summarize economic events. D) accumulation and interpretation of evidence.
13) ______
14) In Canada, publicly traded company A) are not required to have an audit. B) are not required to have an audit if they have a review. C) are required to have audits. D) are strongly encouraged to have audits.
14) ______
15) A shareholder of a public Canadian firm can have access to the audited financial statements A) by calling the accounting department of the company. B) on the internet.
15) ______
C) if he holds more than 1% of the shares of the company. D) requesting a copy from the auditors.
16) A reason for private companies to be audited is A) facilitating access to capital. B) complying with the laws requiring them to be audited. C) having a professional accountant perform their bookkeeping. D) ensuring that their financial statement do not contain errors.
16) ______
17) The Sarbanes-Oxley Act requires the auditor to attest to A) the compliance of the company with the generally accepted accounting principles. B) the accuracy of the financial statements. C) the effectiveness of internal controls. D) the efficiency of the internal controls in financial reporting.
17) ______
18) There is an increasing demand for assurance about computer controls surrounding financial information transacted electronically and the security of the information related to the transaction. This is in large part due to A) the many transactions and information shared online and in real time by companies. B) the use of computer assisted auditing tools. C) client's uncertainty about the proper functioning of their computer system. D) the increasing presence of internet sales in many businesses.
18) ______
19) The WebTrust principle of processing integrity refers to A) providing assurance that the information designated as confidential is protected. B) providing assurance that the transactions are processed completely and accurately. C) providing assurance that the systems and data will be available to the users when they need it. D) providing assurance that access to the system and data is restricted to authorized individuals.
19) ______
20) The WebTrust principle of security refers to A) providing assurance that the systems and data will be available to the users when they need it. B) provides assurance that the information designated as confidential is protected. C) providing assurance that access to the system and data is restricted to authorized individuals. D) providing assurance that the transactions are processed are completely and accurately.
20) ______
21) The auditor must have a thorough understanding of the entity and its environment. The auditor must also consider the client's business strategies, processes, and measurement indicators for critical success factors related to those strategies. This analysis helps the auditor A) identify risks associated with the client's strategy that could affect the financial statements. B) identify the potential for fraud in the financial reporting process. C) assess the level of materiality that is appropriate for the audit. D) decide if they want to accept the engagement.
21) ______
22) Blader Ng. Inc. has recently placed into production new air-cleaning systems in their smoke-stacks to meet clean-air quality regulations. PA has been engaged to assess air quality and compare results to legislated requirements. What type of audit or engagement is PA conducting? A) financial statement B) operational C) compliance D) review
22) ______
23) A review of any part of an organization's procedures and methods for the purpose of evaluating efficiency and effectiveness is classified as a(n) A) production audit. B) audit of financial statements. C) operational audit. D) compliance audit.
23) ______
24) Which one of the following is more difficult to evaluate objectively? A) presentation of financial statements in accordance with Canadian generally accepted accounting principles B) efficiency and effectiveness of operations C) compliance with government regulations D) All three of the above are equally difficult.
24) ______
25) A typical objective of an operational audit is for the auditor to A) evaluate the feasibility of attaining the entity's operational objectives. B) report on the entity's relative success in attaining profit maximization. C) make recommendations for improving performance. D) determine whether the financial statements fairly present the entity's operations.
25) ______
26) Which of the following audits can be regarded as being solely "compliance" audits? A) Canada Revenue Agency's examinations of the returns of taxpayers B) the Auditor General's evaluation of the computer operations of governmental units C) a public accounting firm's audit of the local school district D) an internal auditor's review of his employer's payroll authorization procedures
26) ______
27) The predominant type of assurance service performed by large public accounting firms is A) review. B) management consulting. C) audit. D) compilation.
27) ______
28) The No-Name Advertising Rating Agency conducts independent surveys to determine the sources of purchases by consumers (e.g. newspaper ad, magazine ad, television ad). This information is then used by those media (i.e. newspapers, magazines, and television broadcasters) to indicate to purchasers of advertising the breadth of coverage that they have. For example, Small Local Newspaper can say that 10% of the purchasers of soap products made their decisions based upon their ads. This helps in selling advertising. What type of service is No-Name providing? A) Assurance B) Compilation C) Review D) Attest
28) ______
29) Which of the following services provides a moderate level of assurance about the client's financial statements? A) Forecasts and projections B) Audit C) Review D) Compliance
29) ______
30) PA is attempting to sell a service to his clients that will provide assurance on information systems reliability. PA is attempting to sell a(n): A) SysTrust service B) WebTrust service C) compilation service D) audit engagement
30) ______
31) Which of the following services provides no assurance about the client's financial statements? A) review B) compilation C) audit D) None of the above; they all provide some level of assurance.
31) ______
32) Herbert Zora is having financial statements prepared by his PA to accompany his tax return. His primary concern is cost. Of the following, the lowest cost engagement that the PA can perform for Zora's financial statements is: A) review B) compilation C) WebTrust D) audit
32) ______
33) Auditors General are responsible for auditing which types of organizations? A) Private companies that have loans outstanding to banks or other creditors B) Any organization that submits tax returns to the tax authorities C) Ministries, departments, agencies, and crown corporations D) Public companies with shares issued to investors
33) ______
34) In Canada, the two bodies whose members perform most of the attest audits are the A) SMAC and CGAAC. B) SMAC and CICA. C) CICA and CGAAC. D) CIA and CICA.
34) ______
35) External auditors (PAs) can obtain professional experience to satisfy the requirements of their professional designation at which of the following organizations? A) Internal audit departments of large organizations B) Any type of business that has accounting personnel C) Public accounting firms or auditor general offices D) Public accounting firms of various sizes only
35) ______
36) To operate effectively, an internal auditor must be independent of A) the employer-employee relationship which exists for other employees in the organization. B) the line functions of the organizations. C) the entity. D) all of the above.
36) ______
37) The internal auditor typically reports directly to A) the management of the company. B) the audit committee and the management of the company. C) the audit committee and the board of director. D) the board of director and the external auditor
37) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 38) Discuss the differences and similarities between the roles of accountants and auditors. What additional expertise must an auditor possess beyond that of an accountant?
39) Frederic is an account manager at a large Canadian bank. Frederic has to decide if the bank will make a loan to Frost Corp, a snow removal company. Further, Frederic has to decide how much they will lend to Frost and at what rate. Assuming that Frederic makes the loan, what factors will he use to decide the rate of interest? What factors are impacted by auditing and how?
40) To do an audit, it is necessary to have information in a verifiable form and some criteria by which the auditor can evaluate the information. (A) What information and criteria would a public accounting firm use when auditing a company's financial statements? (B) What information and criteria would a Canada Revenue Agency auditor use when auditing that same company's tax return? (C) What information and criteria would an internal auditor use when performing an operational audit to evaluate whether the company's computerized payroll processing system is operating efficiently and effectively?
41) Two types of services provided by public accounting firms are audits and reviews. Discuss the similarities and differences between these two types of services. Which type provides the most assurance?
42) Mega Manufacturing Company is thinking about acquiring Localized Small Producer Inc., a small manufacturing company that produces related products. Mega has examined the financial statements of the company, which show only a small profit in the last five years. Management has taken reasonable salaries, and cost of goods sold is higher than the industry average for Localized. Mega believes that they will be able to introduce operational efficiencies, improving the profitability of the small company, if acquired. Required: A) What type of engagement should be conducted to assess the operational efficiencies of Localized? Justify your response. B) Who should be engaged to conduct the engagement? C) What major problems might the auditors encounter when conducting the audit and writing the report?
43) Jordan set up a nonprofit corporation several years ago to provide scholarships to poor youth in his community. From a small start, Scholarships Get up and Go Foundation now has assets of over $5 million, and provides about ten university scholarships every year. Jordan is proud of the new doctors, dentists and other health care practitioners that his Foundation has funded. Jordan is thinking of starting another foundation in an old building that he has purchased. It would be a
youth facilities in a gym, with linkages to local high schools so that there could be a homework club to encourage drop in good grades. centre, Required: with music lessons, A) Why should Jordan have the financial statements of both of these foundations audited? art facilities, B) Who would be the users of the financial statements of the foundations? basketbal C) What other types of services could PAs provide to Jordan and the foundations? l
44) You, PA, have been asked to prepare the year-end financial statements of your sister. Betty is a photographer, and is the sole shareholder of a small company called Best Weddings Ltd. She photographs weddings, graduations and schools, earning about $75,000 per year. Betty has said that she only needs the financial statements for her tax returns, and would like you to prepare the tax returns too. Required: A) Would you be able to prepare the financial statements for your sister? Why or why not? B) If yes, what type of report would you prepare to accompany the financial statements? C) Would you be able to prepare the tax returns for your sister? Why or why not?
45) There are four types of auditors: public accountants, government auditors, Canada Revenue Agency auditors and internal auditors. Briefly describe the work and responsibilities of each type.
1) A 2) B 3) C 4) C 5) C 6) A 7) C 8) B 9) C 10) D 11) B 12) D 13) D 14) C 15) B 16) A 17) C 18) A 19) B 20) C 21) A 22) C 23) C 24) B 25) C 26) A
27) C 28) A 29) C 30) A 31) B 32) B 33) C 34) C 35) C 36) B 37) C 38) The role of accountants is to record, classify, and summarize economic events in a logical manner for the purpose of providing financial information for decision making. To do this, accountants must have a sound understanding of the principles and rules that provide the basis for preparing the financial information. In addition, accountants are responsible for developing systems to ensure that the entity's economic events are properly recorded on a timely basis and at a reasonable cost. The role of auditors is to determine whether the financial information prepared by accountants properly reflects the economic events that occurred. To do this, the auditor must not only understand the principles and rules that provide the basis for preparing financial information, but must also possess expertise in the accumulation and evaluation of audit evidence. It is this latter expertise that distinguishes auditors from accountants. 39) 1 - Risk free interest rate: Rate bank could earn in a risk free investment such as government bonds. 2 - Business risk for the customer: Possibility that the customer will not be able to repay their loan because of economic or business conditions. 3 - Information risk - Possibility that the information upon which the business decision was made was inaccurate. The audit impacts the 3rd factor. The importance of an audit is reflected as there is less risk of the financial misstatement containing material errors if they have been audited. Having a set of audited financial statement can reduce the information risk and increase the likelihood that the bank will make the loan. 40) (A) The information used by a public accounting firm in a financial statement audit is the financial information in the company's financial statements. The criteria used are Canadian generally accepted accounting principles. (B) The information used by a Canada Revenue Agency auditor is the financial information in the auditee's federal tax return. The criterion is the Income Tax Act and interpretations. (C) The information used by an internal auditor when performing an operational audit of the payroll system could include various items such as the number of errors made, costs incurred by the payroll department, and number of payroll records processed each month. The criteria would consist of company standards for departmental efficiency and effectiveness.
41) Two primary types of services are: audits of historical financial statements and reviews of historical financial statements. While both services involve the accumulation and evaluation of evidence regarding assertions made by management in the company's financial statements, an audit involves a more extensive examination and provides a higher level of assurance about the client's financial statements than a review. 42) A) Mega should have an operational audit conducted. An operational audit is a review of any part of an organization's operating procedures and methods for the purpose of evaluating economy, efficiency, and effectiveness. B) The operational audit could be conducted by Mega's internal auditors, assuming that they have internal auditors. It could also be conducted by a public accounting firm. For reasons of independence, if Mega is a listed company (see Chapter 2 of the textbook), then Mega should engage a different public accounting firm than its present auditors. C) Operational audits are not easily defined. First, the auditors would need to prepare criteria with the assistance of management to define efficiency. Then, the auditors would need to consider the type of evidence that might be available. For example, if Localized has older manufacturing equipment than Mega, Localized might be operating at peak efficiency — evidence will need to be geared to the criteria. Then, the report will need to be prepared in the context of the criteria and the evidence that will be collected. As there are no standard reports in operational auditing, the auditors will need to customize the report based upon the criteria and evidence collected. 43) A) Auditing provides added assurance with respect to the information provided in the financial statements: perhaps he could get a better interest rate on invested funds at a financial institution. It might also give added credibility to potential donors of funds. If the Foundations are registered Canadian Charities, they are required to have an audit to keep their registration status. B) Users could be financial institutions that are holding the Foundations' money, Jordan, his employees, donors and potential donors, tax authorities, and organizations that regulate charitable organizations, such as provincial and federal regulatory agencies. If the Foundations receive government funding, then the organizations providing funding would also be users of the financial statements. C) PAs could provide advice on how to invest the capital funding that is used for the scholarships. They could help design the accounting procedures in place at both foundations. They could provide bookkeeping and compilation assistance, as well as preparing tax returns and any regulatory filings. They could assist the foundation in obtaining working capital funding for the new drop in centre, if needed. 44) A) Yes, I would be able to prepare the financial statements as a bookkeeping (or compilation) assignment. No assurance is provided for a compilation, so independence is not required. An audit or review could not be prepared, because for those engagements, assurance is provided, which means that I would need to be independent. B) A compilation report would be prepared to accompany the financial statements. The report would need to disclose the relationship and that independence was absent. C) Yes, I would be able to prepare the tax returns, as assurance is not required for tax returns. Identification of the preparer is required on tax returns. It would be important to discuss with my sister why she wants me to prepare the tax returns (does she just want to save some money?) or is she trying to prepare tax returns that are fraudulent
(to taxes). Even for a sister, it would be inappropriate (and professionally dangerous) to be associated with false and save misleading information, with the potential to be sued by the tax department and expelled from the profession. 45) Public Accountants: Primary function is the audit of financial statements of publicly traded companies. The type of audit normally performed is known as an attestation engagement because they attest to the fair presentation of the financial statements. To conduct audit of financial statements of large public companies, the auditor must be a CA or a CGA meeting the licensing requirements. Government Auditors: Primary function is the audit of ministries, departments and agencies which report to the government. A government auditor performs the audit function for the government. Canada Revenue Agency Auditors: Primary responsibility is the enforcement of federal tax laws. The Canada Revenue Agency auditors audit the returns of taxpayers to determine whether they have complied with the tax laws. They only perform compliance audit. Internal Auditors: Internal auditors are normally members of the IIA and work for individual companies to audit for management. The internal auditor's responsibilities can vary considerably but often include operations auditing and report their findings directly to the board of director and audit committee. The internal auditor must be independent from the line function in the organization he is auditing.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) One of the main advantages of a "big" public accounting firm is 1) _______ A) the ability to serve all major international cities as globalization of businesses increases. B) the ability to share knowledge and experience of similar companies they audit with the client. C) the lower professional fees due to economies of scale. D) the increased reliance that can be placed on the audit report by financial statement users.
2) The most common organizational form used by public accounting firms is A) corporation. B) sole proprietorship or partnership. C) co-operative. D) professional corporation.
2) _______
3) The professional accounting organization for Canadian Chartered Accountant is the A) ISACA B) SMAC C) CICA D) CA
3) _______
4) When the criteria to be used in the financial statement audit is established, the auditor's responsibility is to A) creating and documenting the framework. B) evaluate the framework. C) make a recommendation to management for selecting the framework. D) select the acceptable financial reporting framework.
4) _______
5) Starting December 15, 2009, audits will be conducted using the CAS. The reason for adopting the CAS is to A) be consistent with the international standards of auditing. B) comply with the requirement from the Canada Business Corporations Act. C) respond to the increased litigation risks faced by the auditors. D) to simplify the auditing process.
5) _______
6) The implementation of the Sarbanes-Oxley requirements in the US resulted in increased independence requirements for the auditors. The impact of this requirement in Canada was A) additional training requirements to become an auditor. B) modification of the type of opinion provided in an assurance engagement by the auditor. C) creation of the CPAB to oversee Canadian audit professionals. D) revisions of the rules of professional conduct for CAs and CGAs.
6) _______
7) The implementation of the Sarbanes-Oxley requirements in the US resulted in the creation of the PCAOB to oversee listed companies' auditors and develop audit standards. The impact of this requirement in Canada was the A) creation of new auditing standards to ensure better quality control of the audit. B) additional training requirements to become an auditor. C) creation of the CPAB to oversee Canadian audit professionals. D) revisions of the rules of professional conduct for CAs.
7) _______
8) ISAs and Canadian auditing standards require that the audit be conducted using A) a standard approach. B) a substantive approach. C) a risk assessment approach. D) an independent approach.
8) _______
9) The first step in the financial statement audit using a risk assessment approach is to A) gather evidence to assess the likelihood of material misstatement. B) assess the auditor's independence. C) identify risks of material misstatement. D) evaluate the framework.
9) _______
10) The codes of professional conduct of the various accounting bodies are meant to A) interpret the assurance recommendations and views of the AASB. B) establish the norms for quality control of an audit. C) provide the rules underlying the audits and related service activities carried on by the accountants. D) provide a standard of conduct for members who are in public practice.
10) ______
11) The general standard indicated that performance of all aspects of auditing should be performed with due care. This means that the auditor must fulfill his duties A) to the satisfaction of the client. B) in accordance with the CAS. C) diligently and carefully. D) carefully and in a timely manner.
11) ______
12) Adequate technical training and proficiency in auditing is a requirement of which generally accepted auditing standard? A) General B) Quality C) Reporting D) Examination
12) ______
13) Identifying management's responsibility for the financial statements is a requirement of which generally accepted auditing standard? A) Reporting B) Examination C) Quality D) General
13) ______
14) Adequate planning and execution to reduce risk to an acceptable level is a requirement of which generally accepted auditing standard? A) Quality B) Examination C) General D) Reporting
14) ______
15) Jessica is a summer junior at Branes & Castle, a PA firm. Jessica has only completed 3 accounting courses in university and has not yet taken her auditing class. A team of auditors from Branes & Castle are starting the audit and Jessica was sent to help them. Jessica A) should be limited to assisting the audit team with support functions such as photocopies and file assembly. B) should not perform any work pertaining to the audit engagement since she doesn't have sufficient knowledge. C) can perform work for the audit engagement as long as she is supervised and proper review of her work is performed.
15) ______
D) can perform work for the audit engagement on cycles where risk was assessed as low.
16) The most authoritative requirements for public accountants performing financial statement audits in Canada are the A) standards used by the client. B) industry specific standards. C) assurance guildelines. D) CICA handbook requirements.
16) ______
17) When conducting an audit, the auditor should look at GAAS as A) ultimate standards of performance. B) normal standards of performance. C) minimum standards of performance. D) practical standards of performance.
17) ______
18) A PA firm has an organizational structure that assures the technical review of every engagement by a partner who has expertise in the client's industry. This is an example of good A) quality controls. B) business risk management. C) entity level controls. D) adherence to the professional standards.
18) ______
19) Steve is the partner in charge of the quality control review of the audit file of Xtron. To comply with CSQC-1, Steve should perform the quality control review A) before the audit opinion is issued. B) before the financial statements are filed with the securities commission. C) before the end of the field work. D) at the beginning of the audit.
19) ______
20) CPAB's purpose is to A) develop auditing standards. B) improve the public's confidence in independent auditing. C) clarify and communicate the role of the auditor to the public. D) provide training and continuing education to auditors.
20) ______
21) Gary West is a sole practitioner. He has conducted the audit of Reggie's Farm for the past 12 years. In the current year, Reggie's Farm expanded by acquiring two other farms, installed a new accounting system and also started to export to the United States. Gary accepted to perform the audit of Reggie's Farm for the upcoming year even if he has no experience with exportations to the US or companies of the size of Reggie's Farm. Which element of quality control is compromised for Gary's firm? A) Client acceptance or continuance B) Independence C) Extent of professional development D) General ethical requirements
21) ______
22) Farah is currently auditing Software Synx, a public company. After a long day of work, Farah goes for a drink with her friend John who mentions that he owns shares of Software Synx. Farah indicates that John should hold on to his shares as they will go up next week when the financial statements are released and show an increase of 12% for revenues. Which element of quality control is compromised by Farah? A) General human resource policies B) Engagement performance C) Independence D) General ethical requirements
22) ______
23) Dimitri works at a large public accounting firm. Dimitri referred one of his friend for a junior auditor position. Dimitri's friend was hired despite the fact that he had a criminal record dating from 3 years ago. The partner did not perform a background check on Dimitri's friend since he was recommended by an employee. Which element of quality control is compromised? A) Independence B) General ethical requirements C) Engagement performance D) General human resource policies
23) ______
24) Stafford & Sandiford is a Public Accounting firm with 30 reporting issuers. Stafford & Sandiford can expect to be inspected by the CPAB A) randomly. B) once every 3 years. C) once per year. D) once every 5 years.
24) ______
25) Securities regulations in Canada are ruled by A) the professional accounting organizations. B) provincial securities commission. C) office of the auditor general of Canada. D) national securities commission.
25) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 26) What are the three main factors that influence the organizational structure of all Public Accounting firms?
27) The CICA is the professional accounting organization for Chartered Accountants (CAs). Describe the role and responsibilities of the organization in serving its members.
28) For each of the following situation, explain what element of the profession or society encourages the public accountant to conduct himself at high level. A) Marco attended a seminar on the topic of business combinations to ensure he was up to date with the new standard. B) Barbara referred to the standard on hedging to ensure that her client had the appropriate documentation to qualify for hedge accounting. C) Gretchen refused to perform the audit of her uncle's restaurant chain. D) Walid worked overtime all week to ensured that the file was properly documented and met the quality control requirements. E) Sarah took the summer off to study for the Uniform Final Examination (UFE) to ensure that she would pass the entrance exam to become a chartered accountant.
29) The generally accepted auditing standards can be divided in three categories of standards. List the three categories.
30) GAAS and the Assurance and Related Services Recommendations are the authoritative auditing pronouncements for members of the profession. A) It is said that GAAS and Assurance Related Services Recommendation provide less direction to auditors than might be assumed. Explain what are some of the areas where direction might not be provided. B) Explain the positive and negative aspects of having less directed standards and recommendations.
1) A 2) B 3) C 4) B 5) A 6) D 7) C 8) C 9) C 10) D 11) C 12) A 13) A 14) B 15) C 16) D 17) C 18) A 19) A 20) B 21) A 22) D 23) D 24) B 25) B 26) 1. The need for independence from clients. Independence permits auditors to remain unbiased in drawing
concl their client's financial statements. usio 2. The importance of a structure to encourage competence. The ability of the structure to encourage competence ns permits auditors to conduct audits and perform other services efficiently and effectively. abou 3. The increased litigation risk faced by auditors. In the last decade, firms have experienced increases in t litigation-related costs. Some organizational structures afford a degree of protection to individual firm members. 27) Research and Publication: The CICA publishes the CA Magazine along with accounting and auditing research studies. The CICA also coordinates the UFE exam. Continuing Education: The order provides courses, seminars and on-line material to update their members on a variety of topics relating to accounting and auditing. The order also established six specific specializations for their members. Establishing standards and rules: The order sets accounting and auditing standards that must be followed by public accountants. 28) A) Continuing Education B) CICA Handbook C) Rules of professional conduct D) CPAB review and quality control E) Professional examination. 29) 1. General qualifications and conduct 2. Examination performance of the audit 3. Reporting results 30) A) Some of the areas where direction is not provided include: - almost no specific audit procedures are required - there are no specific requirements for auditor's decisions to - determine sample size - select sample items from population - evaluate the results. - no clearly defined guidelines for determining the extent of audit evidence to be accumulated. B) If the standards were more directed, it would eliminate some difficult audit decisions and provide a line of defence for a public accounting firm charged with conducting an inadequate audit. However, highly specific requirements could turn auditing into mechanistic evidence gathering without the auditor's professional judgement. The audit would be less responsive to the risks identified for a particular client.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Ethical behaviour is considered to be a cornerstone for trust in everyday life as well as in 1) _______ business practices. Ethics are A) beliefs that we have about our own behaviour. B) laws that govern how businesses should behave. C) rules in society that help us to do the right thing. D) a set of moral principles or values.
2) Ethical dilemmas occur when A) you know what you want to do but the rules say otherwise. B) businesses flout the laws and engage in illegal behaviour. C) a choice must be taken about appropriate behaviour. D) a person chooses to act in his/her own interest.
2) _______
3) A public accountant would be facing an ethical dilemma when deciding whether or not to A) participate in a charitable activity organized by the client. B) overlook a material overstatement of revenues to maintain a good client relationship. C) accept an invitation from the client to go golfing in order to maintain a good client relationship. D) overlook a non material error in the financial statements.
3) _______
4) Which of the following is not a commonly employed rationalization method that can easily result in unethical conduct? A) It is prescribed by GAAP B) Everybody does it C) Likelihood of discovery and consequences D) If it's legal, it's ethical
4) _______
5) Formal frameworks have been developed to help people resolve ethical dilemmas. After obtaining the relevant facts and identifying the ethical issues from the facts, what is the next step in the six-step ethical framework? A) Determine who is affected by the outcome of the dilemma and how they are affected B) Decide on the appropriate action to be taken in resolving the ethical dilemma C) Identify the likely consequences of actions that will be taken D) Identify the alternatives available to the person who must resolve the dilemma
5) _______
6) The New Canadian audit standards CAS 220 (Quality control for an audit of financial statements) and CSQC-1 (Quality control for firms that perform audits and reviews of financial statements and other assurance engagements) require the engagement partner A) to ensure that the financial statements are in accordance with GAAP. B) to ensure that engagements are in compliance with firm policies and procedures. C) to ensure that the internal controls of the company being audited are effective. D) to ensure that the audit opinion is unqualified.
6) _______
7) Society has attached a special meaning to the term professional. A professional is A) a person who is expected to conduct himself or herself at a higher level than the requirements of society's laws or regulations. B) someone who has passed a qualifying exam to enter the job market. C) someone who has both an education in the trade and on-the-job experience received under an experienced supervisor. D) any person who receives pay for the services performed.
7) _______
8) The underlying reason for a code of professional conduct for any profession is A) that it allows licensing agencies to have a yardstick to measure deficient performance. B) that it is required by federal legislation. C) the need for public confidence in the quality of service of the profession. D) that it provides a safeguard to keep unscrupulous people out.
8) _______
9) It is not practical for users to evaluate the quality of the performance of most professional services because of their A) legal standing. B) salaries and working conditions. C) veracity. D) complexity.
9) _______
10) The need to implement philosophies and practices commonly referred to as "improved business practices" comes from A) a need to increase profitability on assurance type mandates. B) a CAS pronouncement. C) a GAAP pronouncement. D) increased competition resulting in public accounting firms being more concerned about keeping clients and maintaining a reasonable profit.
10) ______
11) In a code of conduct, the advantage of general statements of ideal conduct, as opposed to specific rules of behaviour, is A) the tendency to define the rules as maximum rather than minimum standards. B) the emphasis on positive activities. C) the enforceability of minimum behaviour and performance standards. D) the ability to enforce the ideals.
11) ______
12) The disadvantage of general statements in codes of professional conduct is A) the emphasis on positive activities. B) that they identify ideal conduct. C) that there are too many to remember. D) the difficulty of enforcing general ideals without minimum standards of behaviour.
12) ______
13) One difference between auditors and other professionals is that most professionals A) need not be concerned about maintaining independence. B) aren't expected to act in the public interest. C) don't have requirements for continuing education beyond university. D) don't have to pass a rigorous examination.
13) ______
14) Generally, all of the rules of professional conduct for CAs apply to A) members in public practice. B) students and members. C) all members. D) students in public practice.
14) ______
15) Which portions of the code of professional conduct are enforceable? A) Interpretations B) Rules and interpretations C) Principles and rules D) The rules of conduct
15) ______
16) As a member of a professional accounting association, when considering the applicability of the rules of professional conduct, a PA would be responsible for compliance by A) themselves, their employees, and partners. B) their employees. C) their partners in the practice and themselves. D) themselves only.
16) ______
17) According to the profession's ethical standards, an auditor would be considered independent in which of the following instances? A) The client owes the auditor fees for two consecutive annual audits B) The client comprises 75% of the auditor's fees C) The audit does not have enough employees to meet the client's reporting deadline D) The auditor's chequing account, which is fully insured by CDIC, is held at a client financial institution
17) ______
18) "Independence" in auditing means A) remaining aloof from the client. B) being an advocate for the client. C) not being financially dependent on the client. D) impartiality in performing professional services.
18) ______
19) When public accountants are able to maintain an independent attitude in fulfilling their responsibility, it is referred to as independence A) in conduct. B) in total. C) in fact. D) in appearance.
19) ______
20) When the users of financial statements have confidence in the independence of the public accountant, it is referred to as independence A) in appearance. B) in fact. C) in total. D) in conduct.
20) ______
21) When should a PA assess the five threats to independence with respect to an audit engagement? A) After signing the engagement letter and before commencing field work B) When deciding to accept a client or whether to continue an existing engagement C) After a discussion with the Board of Directors D) After the completion of this year's audit, before starting the next engagement
21) ______
22) Which of the following situations would be an example of a self-interest threat that would prevent a PA from auditing the client? A) The PA has purchased a used car from one of the employees of the client. B) The PA's uncle owns the business that the PA is auditing. C) The PA has a small bank loan at normal business interest rates with the bank that his firm is auditing. D) For the last two years, the client could not pay their fees, so the PA created a loan agreement covering the fees, with the client paying 10% interest on the fees.
22) ______
23) Which of the following situations would be an example a of self-review threat? PA has completed the following work prior to commencing the audit engagement: A) audit of the non-for profit organization of the client B) audit of a company where the client owns a minority interest C) purchase price allocation calculation for a company that the client purchased during the year D) personal and corporate tax returns
23) ______
24) Why does a self-review threat pose a problem when conducting an audit engagement? A) The audit is more expensive, as you have to provide clear documentation B) The audit can be conducted more efficiently C) You are auditing your own work, and may not detect inadequacies D) The auditor may not have the expertise to complete the special work
24) ______
25) Which of the following situations best describes an advocacy threat? PA has been hired to A) consult with the corporate controller and the bank manager about the conditions for financing a loan. B) prepare the year end journal entries for a subsidiary company. C) manage the accounting department for three weeks while the corporate controller is on vacation. D) complete the personal tax returns of all executive management.
25) ______
26) Which of the following situations best describes a familiarity threat? A) Preparation and entry of bookkeeping transactions B) Completion of corporate transactions for subsidiary companies C) Design and implementation of a new payroll system D) PA has been working with this client for ten years, first as a manager, now as a partner
26) ______
27) A familiarity threat at an audit engagement occurs when A) the member has a financial interest in the client. B) the member discloses financial information about the client. C) PA promotes the client's position to third parties. D) it is difficult to behave with professional skepticism.
27) ______
28) Which of the following is the best example of an intimidation threat? Management A) threatens to change auditors if you do not let them overstate accounts receivable by
28) ______
$100,000 (the bad debt allowance is too low). B) has changed auditors of all of its subsidiary companies as they can get the audit done for a lower cost. C) threatens to resign from the company if the board of directors does not give them a 15% raise. D) has decided to sue you because the audit fee was twice as high as they expected.
29) An intimidation threat occurs when A) the auditor suspects that fraud has occurred at the middle management level of the organization. B) it is difficult to believe the actions of management because there is a suspicion of irregular activity with respect to the recording of transaction activity. C) a client threatens the firm or its staff with respect to the content of the financial statements or with respect to the conduct of the audit. D) the auditor has been working on a client engagement for many years and has trouble believing that management would deceive the auditors.
29) ______
30) Some independence rules apply to all assurance engagements, while others apply only to a listed entity. For the purposes of assessing the independence rules, a listed entity is defined as A) any organization that has shares or debt listed on a stock exchange. B) an organization that has shares or debt listed on a stock exchange, and that has redeemed shares. C) an organization with share capital exceeding $10 million that has public accountability. D) an entity whose debt or shares is listed on a stock exchange, with market capitalization and total assets greater than $10 million.
30) ______
31) If a PA firm provided corporate finance services to a company during the year, which of the following engagements could the PA firm accept to provide to the company? A) Audit of non-listed entity B) Other assurance engagement C) Non-assurance services D) Audit of listed entity
31) ______
32) Where an independence threat occurs, it is possible that only the person affected be removed from the engagement. In this case, other members of the firm can complete the engagement. An example of a situation where only the student or member would be excluded from the engagement is where PA A) has a significant financial interest in the client, such that influence could be exerted. B) owns ten percent of the shares of the client. C) used to be a controller at the client, but now works for the PA firm. D) is a board member of the client with signing authority for cheques.
32) ______
33) For listed clients, the audit committee must approve both the appointment of the auditor and A) all services that the PA firm provides to the client. B) the material that is included in the management letter by the PA firm. C) an engagement that might affect the appearance of independence, such as design of control systems. D) any services that are provided for senior management.
33) ______
34) At a small practice where the bulk of the work is accounting, bookkeeping, and review engagements, what is an important procedure that should be followed by the PA to help ensure independence? A) Management should be trained in accounting principles so that they can adequately assess the PAs work B) Transactions and journal entries should be discussed with and approved by the client C) The accountant should avoid doing bookkeeping for review engagements, and restrict this to compilation engagements only D) All transactions should be prepared and processed by client personnel
34) ______
35) Which of the following professional requirements helps prevent opinion shopping from becoming an intimidation threat? A) The accounting firm consulted should communicate with the incumbent accountant B) The incumbent accounting firm needs to contact the consulting accounting firm with full information C) Management needs to inform the incumbent accounting firm that they are going to change auditors D) Management should inform the consulted accounting firm what the existing accounting firm's opinion is
35) ______
36) To ensure they remain independent, an audit firm should A) prohibit an employee from the Toronto office to have an investment in a company audited by the Hong Kong branch of the PA firm. B) ask employees to sign a form confirming that they do not have an investment in a company that they are auditing. C) refuse an audit mandate where the cousin of a staff member works in the marketing department. D) include a section in the code of conduct indicating that the employees should not invite their client to dinner.
36) ______
37) The confidential relationship will be violated if, without the client's permission, the public accountant provides working papers about a client to A) an investigative or disciplinary body of the relevant provincial institute which is conducting a review of the public accountant's practice. B) a court of law which subpoenas them. C) another public accounting firm which has just purchased the public accountant's entire practice. D) the relevant provincial institute as part of a practice inspection.
37) ______
38) In which of the following circumstances would a public accountant be bound by ethics to refrain from disclosing any confidential information obtained during the course of a professional engagement? A) The public accountant is issued a subpoena that orders the public accountant to present confidential information B) Confidential client information is made available as part of a practice inspection of the public accountant's practice C) An inquiry by a disciplinary body of a provincial institute requests confidential client
38) ______
information D) A major shareholder of a client company seeks accounting information from the public accountant after management declined to disclose the requested information
39) What should a PA do if approached by a client where he and his firm lack or do not have access to the technical knowledge required to complete the audit? A) Subcontract the audit to another firm B) Indicate that they can do a review engagement, not an audit C) Conduct the engagement, but prepare a qualified audit report D) Decline the new audit engagement
39) ______
40) The provincial institutes' Rules of Professional Conduct state, in part, that a public accountant should maintain integrity and due care. Integrity in the Rules refers to a public accountant's A) reputation for honesty and fair dealing. B) ability to be unyielding in all matters dealing with auditing procedures C) ability to maintain an impartial attitude on all matters that come under the public accountant's review. D) ability to distinguish independently between accounting practices that are acceptable and those that are not.
40) ______
41) The rules of accounting bodies in Canada require their members to behave in the best interest of the profession and the public. Identify the situation where the accountant is acting in the best interest of the profession. A) An accountant openly criticizes a fellow accountant's competences after having lost a bid for a new client B) An accountant reports a fellow accountant to the order after noticing that the accountant helped a client with tax evasion C) An accountant brags about his competence and professional title, and encourages clients to invest in a new venture he is starting D) An accountant refuses to cooperate with the new auditor after having lost a client
41) ______
42) The accountant is not conducting his work with due care when A) he ensures that he is up to date with the auditing and accounting standard B) he accepts to modify to audit procedures planned to help the client after they lost a key member of their accounting staff. C) he requires the help of a valuation expert to perform the audit work on a section of the audit where he lacks the knowledge and skills. D) he ensures that all the junior staff on his team are properly supervised
42) ______
43) Which one of the following forms of advertisement would violate solicitation rules? PA A) placed an advertisement in a newspaper indicating the opening of a new office. B) conducted a survey asking companies about the types of services that are provided by their accounting firms. C) conducted a cold-calling campaign where companies were asked if they would like to change PA firms. D) placed a media advertisement listing the different types of expertise available at the firm's major office locations.
43) ______
44) How is GAAP enforced via legislation? A) PAs who do not prepare financial statements in accordance with GAAP are expelled from their professional association B) The Canada Business Corporations Act and many provincial incorporating acts require that financial statements be prepared in accordance with GAAP C) Tax authorities may sue corporations who do not prepare their financial statements in accordance with GAAP D) Financial executives may be sued if the financial statements prepared by their company are not in conformance with GAAP
44) ______
45) Which one of the following situations is a violation of the professional rules of conduct? PA A) prepared personal and corporate tax returns for a client and all of its executive officers. B) placed an advertisement in the local paper indicating that she conducted audit engagements for five major insurance companies. C) resigned so that he could accept a position on the Board of Directors at a major client. D) looked the other way when he noticed that one of his firm's accounting staff accepted money from client management.
45) ______
46) For which of the following engagements is a contingent fee permitted? A) A tax consulting assignment assessing the excise tax payment processes B) A review engagement of a small manufacturing corporation C) An assurance engagement of leasehold payments for a rental agreement D) An audit engagement of a large listed corporation
46) ______
47) PA has been asked to accept the audit engagement of BarneyBlues Corporation. PA sent a letter to the predecessor auditor requesting whether there was any reason why he should not accept the engagement. Assuming that the prior year audit went smoothly, what would be an appropriate response by the predecessor auditor? A) Provide a brief statement that there is no reason of which he or she is aware that would prevent accepting the engagement. B) Send a copy of the tax returns and tax assessments to PA. C) Telephone PA and say that PA should not take the engagement because the fee charged was too large. D) Send a copy of the entire working paper file to PA.
47) ______
48) The Rules of Professional Conduct require a successor auditor to communicate with the previous auditor. The primary concern in this communication is A) to enable the successor to perform a more efficient audit. B) to acquire information which will help the successor auditor determine whether the client management has integrity. C) to learn about the client by examining the predecessor's working papers. D) to save the successor auditor time and money in gathering data.
48) ______
49) Many PAs prepare tax returns for individuals and for corporations. Under what circumstances is liability insurance required to cover the preparation of tax returns? When
49) ______
A) the PA is a member of a professional accounting association. B) fees are being charged and more than a handful of returns are being prepared. C) any number of tax returns are prepared, including no charge tax returns. D) the bulk of the PA's income comes from preparing tax returns.
50) PAs are members of a professional association that can impose sanctions for violations of the professional code of conduct. What is an example of a severe penalty that can be imposed by a professional association? A) Publication of information about the offence in a newsletter B) Requirement to have another peer review conducted within one year C) Expulsion from the professional association D) Requirement of the completion of training courses
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) Describe an ethical dilemma that an auditor or an accountant might face in his or her business career, then illustrate how the auditor or accountant might use the six-step approach presented in Chapter 3 to resolve that dilemma. Be specific.
52) Discuss the ways the accounting profession and society encourage public accountants to conduct themselves in a professional manner; i.e., the factors that influence the ethical conduct of audit practitioners.
53) Identify and describe each of the three parts to the Code of Professional Conduct. Also discuss which parts are officially enforceable and which are not.
54) Each of the following situations involves a possible violation of the independence requirements of the provincial institutes' Rules of Professional Conduct. For each situation, (1) decide whether the Rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the Rules. A) Mike Lednicky, public accountant, is a partner in the Oshawa office of Arthur & Thompson, public accountants. Mike's brother is employed as an inventory warehouse supervisor (an audit-sensitive position) by Sweeny Appliances, a publicly-held company in Manitoba. Sweeny Appliances is one of Arthur & Thompson's audit clients. Neither Mike nor the Oshawa office of Arthur & Thompson is involved in the audit of Sweeny Appliances. Violation? Explanation:
Yes
No
B) The accounting firm of Finke & Hersley, public accountants, provides bookkeeping and tax services for Hendershot Corporation. Finke & Hersley also performs the annual audit of Hendershot Corporation. Violation? Explanation:
Yes
No
C) Brent Shaw, public accountant, is the auditor of Cafe Eccel. A couple of weeks ago, Cafe Eccel's management expressed an intention to commence litigation against Brent, alleging he was negligent in last year's audit. Brent believes there is a strong possibility that management will proceed with the litigation. However, Cafe Eccel has not fired Brent as its auditor, and he is now working on the current year's audit of Cafe Eccel.
D) Melissa Barry, public accountant, is the auditor of Audio Video Inc. Audio Video has not paid Melissa's Viola audit fee for the past two years. Melissa is working on the current year's audit of Audio Video. tion? Yes No Expl Violation? Yes No anation: Explanation:
55) Each of the following situations involves a possible violation of the provincial institutes' Rules of Professional Conduct. For each situation, (1) decide whether or not the Rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the Rules. A) Johnny Line has a successful dentistry practice in Calgary. Johnny has recommended one of his patients to Leslie King, public accountant. To show gratitude for the referral, Leslie has agreed to pay Johnny 5% of the fee for audit services rendered by Leslie to Johnny's patient. Leslie discloses the payment agreement to her new client. Violation? Explanation:
Yes
No
B) The accounting firm of Bayer & Peng, public accountants, is negotiating a fee with a new audit client. They agree the client will pay $75,000 if Bayer & Peng issues a clean, unqualified opinion, $50,000 if a qualified opinion is issued, $40,000 if an adverse opinion is issued, and $10,000 if a denial of opinion is issued. Violation? Explanation:
Yes
No
C) Don Smith, public accountant, takes part in the audit of Shaw Corporation. Don is not a partner or a manager in the public accounting firm, and does not own any stock in Shaw Corporation. Don's five year-old daughter, Betty Lou, received one share of Shaw Corporation's common stock for her fifth birthday. The stock was a gift from Betty Lou's grandmother. Betty Lou treasures that share of stock and is absolutely unwilling to part with it. Violation? Explanation:
Yes
No
D) Samantha Matthews, public accountant, is a partner in the Vancouver office of Dell & Bates, PAs. Samantha's brother is employed as the chief financial officer of Scotch Appliances, a large, publicly-held company in Toronto. Scotch Appliances is one of Dell & Bates' audit clients. Neither Samantha nor the Vancouver office of Dell & Bates is involved in the audit of Scotch Appliances. Violation? Explanation:
Yes
No
E) On August 5, 2010, Page Dane, public accountant, issued the audit report on Borhut Corporation's June 30, 2010 financial statements. On August 30, 2010, Borhut paid Page's audit fee with stock rather than cash. Page sold the stock on September 15, 2010, two months prior to the beginning of the planning phase for the audit of the June 30, 2011, financial statements. Violation? Explanation:
Yes
No
56) Each of the following situations involves a possible violation of the provincial institutes' Rules of Professional Conduct. For each situation (1) decide whether or not the rules have been violated, and (2) briefly explain how the situation violates (or does not violate) the rules. A) Carla is the CFO of a Xenon Company. Carla was very happy after her husband Dwayne, a partner at a large PA firm was assigned as the new auditor of the company. Carla is confident that this will be helpful to Xenon since Dwayne already knows so much about the business. Violation?
Yes
No
Explanation: B) Jeremy accepted a summer internship at a PA firm. Jeremy's parents own 0.1% of Raven Inc, a large public company in Austria. Raven Inc. is a client of the Austrian branch of the PA firm. Jeremy reported this to the partner of his office. Violation?
Yes
No
Explanation: C) Ken Burns is a partner at Burns and Fields LLP, a PA firm. Ken was approached by a friend who asked him to invest in Safran Group Inc., a growing high tech company. The proposal would be for Ken to invest $650,000 to obtain 1% of the company. Ken decided to go ahead with the investment because Safran is a client from their Seattle office and he has never provided any services to Safran Inc. Ken indicates that he will ensure that he does not work on the audit of Safran. Violation?
Yes
No
Explanation: D) In order to grow his business, Jimmy decided to rent a billboard on the side of the freeway to post an ad for his practice. To catch the attention of the commuters Jimmy came up with the slogan: Jimmy, not your typical boring accountant. Violation?
Yes
No
Explanation: E) Sintron Inc. is a payroll processing company. Over the past 5 years, Clarkson Coppers LLP, a PA firm, has outsourced the payroll processing and other human resources tasks to Sintron. Clarkson Coopers LLP is happy to outsource more functions to Sintron as Sintron has asked Clarkson for additional consulting services with regards to system implementation and application of new accounting policies. Violation?
Yes
No
Explanation:
57) Raul, PA, received a call from his friend Cristobal Franco. He needed an audit urgently, because the bank might call his loan for his computer store CF Ltd. Since Cristobal had been his high school friend and they still played soccer together every two weeks, Raul agreed. Raul and Cristobal had a quick meeting, where Raul fixed the audit fee at $10,000. Cristobal stressed the importance of an unqualified opinion for the bank. Raul sent two available junior staff to CF's offices. The junior staff were experienced in review
engagem the store, noting the documents strewn everywhere. The accounting staff came in and chatted briefly after ents, and their smoke break. They were about a month behind on recording transactions, because Cristobal had laid off had been one sales person. The accounting staff also helped out with providing sales quotes and Cristobal did all of working the technical work. for Raul At the end of the day, the junior staff were each given a $250 gift certificate to be used in the computer for about store. This was great, because CF also sold MP3 players and supplies such as CDs and DVDs. six At dinner that night, the junior staff told their family that it would probably be a great idea to hold off on months. any computer supplies or equipment purchases that they needed, since CF would likely hold a sale in the The two next month or two to improve cash flow. staff had a quick Required: look around Identify and discuss the violations in the rules of conduct with respect to CF.
58) You are having lunch with a former employee of your firm, a friend of yours. Gino had been laid off last year when he had failed to pass his professional examinations for the third year in a row. Gino told you that he managed to obtain a CMA designation in the past year, and has started his public practice. He has been circulating flyers and electronic email announcements with fixed rates: $400 for a compilation engagement, $1,000 for a review, and $5,000 for an audit where revenues are less than $1 million, $15,000 for an audit for a client with revenues up to $5 million. He already has clients to keep him busy for the next three months. He even has some feelers for clients that he personally handled while he was working for your firm — there were a lot of contacts developed during the five years that he was working there! To help attract some of the larger clients, he is considering not charging any fee for the first ten hours spent on tax-related services. Gino ended the conversation by asking you if you would like to join him in his new firm, because at this rate he'll need a second person real soon! Required: Identify the violations in the professional rules of conduct and explain why they are violations.
59) You are the senior in charge of the accounts receivable section of the audit of a large clothing manufacturer downtown in the clothing district. The client sells to local clothing stores as well as to other retailers in the province. Accounts receivables seem to be deteriorating, with many more accounts in the over 90 days column than in the past. You sent out twenty accounts receivable confirmations, but only six were returned. Of these six, only three confirmed the balance as in agreement with the client, while the others indicated that they kept their records on an open item basis (rather than a balance forward basis) and were unable to respond to the confirmation request. When you looked at the prior year's file, it seemed that the same thing had happened last year. When you phoned the supervisor in charge of the audit engagement, she told you to not bother with follow up, as the engagement was already over budget and costs need to be kept down. You were concerned that you would be unable to state a conclusion with respect to the fairness of the accounts receivable balance and she was really angry with you, saying that she would have to sign off for you then. Required: Discuss the ethical and quality issues raised by this audit engagement.
60) Kimora is a senior manager at a public accounting firm. Kimora was assigned to the audit of Toble Corp.
Upon arriving at the client, Kimora
met with the controller, Brad, who was a classmate in college, 20 years ago. She had not been in contact with Brad since college, but they realized that they still had many friends in common. Brad invited Kimora to go to the company box to watch a hockey game and catch up. Discuss the issue of independence between Kimora and Toble Corp.
1) D 2) C 3) B 4) A 5) A 6) B 7) A 8) C 9) D 10) D 11) B 12) D 13) A 14) A 15) D 16) A 17) D 18) D 19) C 20) A 21) B 22) D 23) C 24) C 25) A 26) D
27) D 28) A 29) C 30) D 31) C 32) C 33) A 34) B 35) A 36) B 37) C 38) D 39) D 40) A 41) B 42) B 43) C 44) B 45) D 46) A 47) A 48) B 49) B 50) C 51) Although students' answers will vary depending on the dilemma, their answer should list the following six steps, along with a discussion of how each step relates to their particular dilemma: 1. Obtain the relevant facts. Students should list the key facts from their dilemma.
2 from the facts. Students should identify the key ethical issue(s) in their dilemma. 3. Determine who is affected by the outcome of the dilemma and how each person or group is affected. Students should I identify who is involved and how each party is affected by the dilemma. dentif 4. Identify the alternatives available to the person who must resolve the dilemma. Students should list the alternatives y the available to the auditor or accountant. ethica 5. Identify the likely consequence of each alternative. Students should identify both the short- and long-term effects l of each alternative. issues 6. Decide on the appropriate action. .
52) There are many factors that encourage public accountants to conduct themselves at a high level, including: ∙ GAAS and interpretations. ∙ Rules of Professional Conduct. ∙ Legal liability. ∙ Public accounting firm quality control standards. ∙ Practice inspection. ∙ Canadian Public Accountability Board. ∙ Continuing professional education requirements. ∙ Professional examinations such as the CICA Uniform Final Examination. ∙ Provincial securities commissions. ∙ Audit committees. 53) The three parts to the Code are: ∙ Principles. These establish ideal standards of ethical conduct stated in philosophical terms. They are not officially enforceable. ∙ Rules of conduct. These are the minimum standards of ethical conduct stated as specific rules. They are officially enforceable. ∙ Interpretations. Interpretations of rules are intended to clarify the rules of conduct. They are not officially enforceable, but a practitioner must justify any departure. 54) A) No violation. Although partners in a public accounting firm are not allowed to have close relatives employed in a position of significant influence by a client, it is acceptable to have a close relative employed in an audit-sensitive position (with no significant influence), particularly as Mike is not involved in the audit engagement. B) No violation. The Rules of Professional Conduct do not prohibit public accounting firms from providing bookkeeping, tax, and audit services to the same client, as long as the client is not a listed entity and management approves the journal entries. C) Violation. When there is a lawsuit or intent to start a lawsuit between a public accountant and an audit client's management, independence is impaired. D) No violation. While independence may be impaired if fees remain unpaid for services provided more than one year prior to the date of the report in some cases, there is no requirement under the Rules of Professional Conduct not to continue in the role as auditor. Melissa should document in her audit file how she has dealt with this self-interest threat and the steps that the client is taking to pay fees. See the ICAO Rules of Professional Conduct at www.icao.on.ca, 55) A) Violation. A public accountant may not pay a referral fee to a non-public accountant. B) Violation. This is a contingent fee agreement which is prohibited by the Rules of Professional Conduct. C) Violation. Participants in an audit are prohibited from having a financial interest in the client. The rule also applies to the participant's dependents.
D)
tion. A partner's independence is impaired when he or she has a close relative employed by a client in a position of significant influence such as chief financial officer.
Viola E) Violation. Public accountants are prohibited from owning stock in a client. 56) A) Violation. Independence is violated as a direct family member holds a position overseeing the financial reporting. B) No violation. Since Jeremy is only a student, this will not be a violation as long as Jeremy is not staffed to work on any mandate for Raven. Jeremy did the right thing by reporting his interest in Raven to the Partner. C) Violation. As a partner, Ken is not able to own more than 0.1% of any company audited by the PA firm, even if it is not a direct client of Ken's office. D) Violation. Advertising should be informative. Jimmy's slogan is not. Further, Jimmy is not representing the profession well by using a stereotype. E) No Violation. The type of services that Clarkson Coopers appears to be providing is non-assurance type of services. Therefore, this would not create a conflict of interest. See the ICAO Rules of Professional Conduct at www.icao.on.ca. 57) Raul is too familiar (familiarity threat) with Cristobal (i.e. they are close friends socially, and have known each other for many years). This violates independence. Raul set a fixed price for the audit without even assessing the amount of work to be conducted. This is a self-interest threat (the appropriate amount of work may not be completed as it will cost Raul money to do so), and jeopardizes the ability of the work to be properly completed in accordance with GAAS. Cristobal indicated that he needed a clean audit opinion, and Raul complied. This could be as a consequence of the familiarity threat, but means that Raul could be associating himself with false and misleading financial information. The junior staff are not competent to conduct an audit, so technical competence (GAAS) has been violated. They were also not properly supervised (a violation of GAAS). Junior staff were bribed (the gift certificate) and should not have accepted the certificates. The junior staff violated confidentiality when they discussed the likelihood of a sale at CF with their families. See the ICAO Rules of Professional Conduct at www.icao.on.ca. 58) Gino is actively soliciting clients of other firms (including his former employer) which is a violation. He should be placing general advertisements or providing only announcements. Gino is providing fixed fee engagements, without conducting any planning or assessing the risk in the engagements. This means that he may be likely to conduct inadequate field work, violating GAAS. Not charging for the tax work is also a violation, since this creates the same type of pressure for Gino to not conduct his work in accordance with GAAS. See the ICAO Rules of Professional Conduct at www.icao.on.ca. 59) The engagement indicates a lack of planning, as you were only aware of the problems with the accounts receivable
confi received the replies. The likelihood of non-response should have been considered before selecting and sending the rmati confirmations. on proc The pressures by the supervisor to sign off on the audit engagement without completing the necessary audit ess procedures indicate a poor human resources environment at your audit firm. It also means that this audit (and after other audits) may have inadequate evidence on file to support an opinion on the financial statements. This violates you the general principle of due care and the third examination standard of sufficient appropriate audit evidence under had GAAS. 60) Kimora might not be independent in appearance, given that she knows Brad who is overseeing the financial reporting of the company. However, Kimora can likely remain independent in fact because ∙ she has not been in contact with Brad for 20 years. ∙ she doesn't have any close relationship with Brad or any personal interest in the company ∙ going to a hockey game with a client is not a breach of independence.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) While performing services for their clients, professionals have always had a duty to provide a 1) _______ level of care which is A) greater than average. B) reasonable. C) guaranteed to be free from error. D) superior.
2) In rare cases, auditors have been held liable for criminal acts. A criminal conviction against an auditor can result only when it is demonstrated that the auditor A) was negligent. B) caused a financial loss to an innocent third party. C) intended to deceive or harm others. D) was grossly negligent.
2) _______
3) Which of the following are conditions of fiduciary duty? A) The fiduciary can exercise discretionary power. B) The fiduciary is vulnerable. C) The beneficiary owes a duty of care to the fiduciary. D) The beneficiary has the ability to exercise discretion or power.
3) _______
4) What situation situation represents a fiduciary duty? A) A professional accountant performs a non-assurance mandate. B) A professional accountant acts as a director of an organization. C) The owner of a private company prepares financial statements. D) A professional accountant performs an audit.
4) _______
5) Canadian PAs are required to have controls in place to identify and track suspicious transactions and comply with the reporting requirements of the Proceeds of Crime and Terrorist Financing Act. This Act requires PAs to report to FINTRAC A) Any cash payment to a related party. B) Any cash payment of $100,000 or more. C) Any transaction of $1,000 or more from clients suspected of being terrorists. D) Any cash payment of $10,000 or more.
5) _______
6) A bank sues the auditor after having lost a significant amount of money from a loan granted to a client based on the financial statements that contained a material error. The source of the legal liability is A) liability under provincial securities law. B) criminal liability. C) third party liability. D) client liability.
6) _______
7) Amin is distraught. There is a big box stereo store that opened just down the block from his independent stereo and music business six months ago, and he is unable to continue operating his business. Only eight months ago, you issued an unqualified audit opinion on his financial statements, which showed the financial results of a well run, profitable store. Amin's business is
ex ng: pe rie nci
7)
_______ A) business failure C) customer expectation gap
B) fiduciary duty D) audit failure
8) When the auditor issues an erroneous opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards, it results in A) audit failure. B) audit risk. C) business failure. D) business risk.
8) _______
9) An example of an audit failure is A) the audit opinion is qualified. B) the auditor issues an erroneous audit opinion as the result of a failure to comply with the requirements of GAAS. C) the auditor issues an erroneous audit opinion as the result of an undiscovered fraud that took place in the period being audited. D) the company files for bankruptcy less than 12 months after receiving an unqualified opinion.
9) _______
10) An auditor would be found negligent if A) he relied a report that contained errors that had been concealed by management. B) failed to discover a payroll fraud by testing a statistical sample of transaction in the salary expense account. C) he relied on a report from management without considering management integrity. D) he did not consider the expenses from a division due to management intentionally withholding that information.
10) ______
11) Conflict between financial statement users and auditors often arises because of the A) expectation gap. B) extremely technical vocabulary which the auditor uses in the report. C) high cost of performing an audit. D) placement of the auditor's report in the back of the client's annual report where it is hard to locate.
11) ______
12) If the public accountant negligently failed to properly prepare and file a client's tax return, the public accountant can be held liable for A) the penalties which client owes Canada Customs and Revenue Agency. B) the penalties and interest, the tax preparation fee, and the amount of tax which was underpaid. C) the penalties and interest, plus the tax preparation fee which the public accountant charged. D) the penalties and interest which client owes.
12) ______
13) Most of the major lawsuits against public accounting firms have dealt with A) unaudited financial statements. B) disputes over income tax preparation services. C) audited and unaudited financial statements.
13) ______
D) disputes arising in the performance of management consulting services contracts.
14) There is agreement within the auditing profession and the courts that the auditor A) is an insurer but not a guarantor of the statements. B) is a guarantor but not an insurer of the statements. C) is both a guarantor and an insurer of the financial statements. D) is not a guarantor or insurer of financial statements.
14) ______
15) The standard of due care to which the auditor is expected to be held is referred to as the A) common law doctrine. B) prudent person concept. C) reckless regard doctrine. D) due care concept.
15) ______
16) An individual PA sets up his or her own business as a sole practitioner. With additional firms, a common structure is a partnership. Why would a large firm set up their organizational structure as a limited liability partnership (LLP)? If the audit was conducted in accordance with GAAS A) more formal reporting requirements are in place to federal tax authorities. B) partners not on the engagement would not be liable on their personal assets. C) improved quality control practices can be initiated using technical personnel. D) partners are liable for only a limited portion of their personal assets when sued.
16) ______
17) During the audit engagement, the primary auditor may rely on other individuals, such as specialists, other auditors and internal auditors (secondary auditors). The primary way to defend the auditor against negligence should such other individuals conduct poor quality work is whether the A) appropriate level of materiality had been used during the conduct of the engagement. B) secondary auditor had ever been sued before. C) primary auditor conducted sufficient quality control work with respect to the secondary auditor. D) other individuals were professionals with recognized credentials.
17) ______
18) A bank sues the auditor after making a loan to a Klaxxon, company that went bankrupt. The bank indicates that they relied on the year-end financial statements of Klaxxon to make the lending decision. The bank analyst indicates that the audit opinion was unqualified so he assumed that Klaxxon was a going concern. The auditor defends himself by referring to a note disclosure in the financial statements about the company's economic dependence on one buyer, Dexters Corp. Dexters Corp had experienced some significant financial trouble for the past year and went bankrupt 3 months after the financial statements Klaxxon were released. The PA's liability is A) contributory negligence. B) gross negligence. C) fraud. D) breach of contract.
18) ______
19) The PA is having a discussion with his client about the outcome of several lawsuits that are presently in progress. The client has requested that the comments during the discussion be removed from the audit file. The client would like the only documentation in the audit file to be the legal letter from the client, and brief comments with respect to the auditor's judgments with respect to the quality of disclosure in the financial statements. The client is concerned that
19) ______
A) the auditor's working paper files may be subpoenaed by the courts. B) the audit firm does not have adequate quality control procedures. C) auditors may breach confidentiality and disclose information about the client. D) only high quality audit working papers be included in the working paper files.
20) The assessment against a defendant of the full loss suffered by plaintiff regardless of the extent to which other parties shared in the wrongdoing is called A) separate and proportionate liability. B) shared liability. C) unitary liability. D) joint and several liability.
20) ______
21) The assessment against a defendant of that portion of the damage caused by the defendant's negligence is called A) shared liability. B) unitary liability. C) separate and proportionate liability. D) joint and several liability.
21) ______
22) Small Town Lumberyard Limited (STLL) needed an additional loan from their bank to finance their operations. To make their financial statements look better, they overstated their inventory and overstated their accounts payable. The auditors did not detect this deliberate misstatement because they conducted limited tests of inventory and did not confirm accounts payable. Other auditors agreed that the procedures conducted during this audit were inadequate. The auditors of STLL would likely be considered to be A) negligent. B) guilty of constructive fraud. C) guilty of fraud. D) contributorily negligent with STLL.
22) ______
23) An example of a breach of contract would be A) a public accounting firm's failure to deliver a tax return on the agreed-upon date because the firm had a backlog of other work which was more lucrative. B) a bank's claim that an auditor had a duty to uncover material errors in financial statements that had been relied on in making a loan. C) an auditor's failure to complete the audit by the agreed-upon date because client's financial records had been destroyed. D) an auditor's refusal to return client's general ledger book until client paid last year's audit fees.
23) ______
24) Laws that have been passed through federal or provincial governments are A) statutory law. B) judicial law. C) common law.
24) ______ D) criminal law.
25) The principal issue to be resolved in cases involving alleged negligence is usually A) whether defendant was involved in fraud. B) whether to impose punitive damages on defendant. C) the level of care required to be exercised. D) the amount of the damages suffered by plaintiff.
25) ______
26) In the auditing environment, failure to meet generally accepted auditing standards is often A) a suggestion of negligence. B) strong evidence of negligence.
26) ______
C) an accepted practice.
D) tantamount to criminal behaviour.
27) Most accounting and auditing professionals agree that when an audit has failed to uncover material misstatements, and the wrong type of audit opinion is issued, the audit firm A) should not be held responsible for the financial loss suffered by others. B) should be asked to defend the quality of the audit. C) deserves to lose the lawsuit. D) has failed to follow generally accepted auditing standards (GAAS).
27) ______
28) To succeed in an action against the auditor, the client must be able to show that A) the auditor was grossly negligent. B) there was a written contract. C) the auditor was fraudulent. D) there is a close causal connection between the auditor's breach of the standard of due care and the damages suffered by the client.
28) ______
29) A common way for a public accounting firm to demonstrate its defence of a lack of duty to perform is by use of a(n) A) confirmation letter. B) expert witness. C) letter of representation. D) engagement letter.
29) ______
30) PA was engaged by Microcomputer Distributor Limited (MDL) to conduct a review engagement. The financial statements are used primarily by the shareholders, management, and by the bank. Recently, an employee was fired for stealing computer parts, primarily chips and boards that could easily be placed in a pocket. MDL is suing PA because they believed that audit procedures, such as counting inventory, would have detected this fraud. What is PA's best defence? A) lack of negligence B) contributory negligence C) lack of duty to perform D) absence of causal connection
30) ______
31) Joan talked to the owners of Fancy Clothing Limited before investing. She obtained a copy of their financial statements and saw that profits were low, even considering the fact that the owners did not take any money for themselves in the current year. However, she decided to invest in the company because she believed her superior knowledge of the clothing industry would turn the business around, resulting in enough profits for all owners. Unfortunately, this did not occur and the company went bankrupt. Joan is suing the auditors because she relied upon the financial statements during her investment decision. What is the auditor's best defence? A) contributory negligence B) absence of misstatement C) non-negligent performance D) duty of care
31) ______
32) Fabio recently sold his restaurant for $650,000, the value of the net assets as reported on the balance sheet. After the sale, Fabio realized that he could've sold the restaurant for as much as $950,000 as the fair value of the assets was $300,000 higher than what was reported on the balance sheet. Fabio is suing the auditors for his loss. The auditor's best defence is: A) absence of causal connection B) absence of a misstatement
32) ______
C) no damages
D) lack of duty
33) According to the CICA Handbook, the auditor's responsibility for failure to detect fraud arises A) only when the examination was specifically designed to detect fraud. B) whenever the amounts involved are material. C) when such failure clearly results from failure to comply with generally accepted auditing standards. D) only when such failure clearly results from negligence so gross as to sustain an inference of fraud on the part of the auditor.
33) ______
34) Winston Chang, PA conducted the audit of Manra Manufacturing Ltd., a small company that produces a variety of machined parts for the automotive and computer industry. The audit showed that the company produced a small profit after paying the owners of the company a high salary. Manra was purchased by a competitor, Cheblay. Cheblay had hoped to produce efficiencies by combining the two companies and was unable to do so. Cheblay sued Chang because it relied upon the financial statements when purchasing the company's shares, claiming that the machines, which were about fifteen years old, had been overvalued. The machines were recorded at cost, which was below net realizable value. What is the auditor's best defence? A) contributory negligence B) duty of care C) absence of liability D) absence of negligence
34) ______
35) The court ruled that Jones did not rely on the financial statements in his decision to purchase shares of Manumite Limited. Instead, Jones relied upon his discussions with the owners and with financial analysts. This result illustrates A) lack of privity. B) absence of causal connection. C) absence of negligence. D) contributory negligence.
35) ______
36) An investor suing an auditor for not discovering that the financial statements of a company are materially misstated is an example of A) criminal liability. B) third party liability. C) liability to client under common law. D) fiduciary duty.
36) ______
37) A client is suing a PA firm claiming that they are responsible for the losses suffered from a fraud in the payroll department that was not uncovered during the year end testing done by the auditor. The auditors did indicate to management that controls over disbursements were weak as there was improper segregation of duties. The auditor's best defence is: A) contributory negligence. B) absence of causal connection. C) absence of negligence. D) no damages.
37) ______
38) The Ultramares doctrine is that ordinary negligence is insufficient for liability of auditors to third parties because of the lack of privity of contract between the third party and the auditor. What type of behaviour on the part of an auditor would result in liability to more general third parties according to this doctrine? A) conducting an audit engagement when a review engagement had been contracted B) deliberate misstatement of the financial statements by management C) completing work in accordance with a contract that was signed with the client
38) ______
D) fraud or constructive fraud
39) The Sarbanes-Oxley Act of 2002 made it a felony to A) to destroy or create documents to impede a federal investigation. B) to have internal control weaknesses. C) to engage in transactions with related parties. D) to have a significant internal control weakness.
39) ______
40) In the case of Enron, Andersen was ultimately convicted on the count of A) refusing to testify in court against their client. B) failing to discover the fraud. C) obstruction of justice for shredding documents relating to the audit of Enron. D) obstruction of justice for altering a memo.
40) ______
41) The King Surety Company wrote a general fidelity bond covering defalcations by the employees of Wilson, Inc. Thereafter, Cooney, an employee of Wilson, embezzled $17,200 of company funds. When the activities were discovered, King paid Wilson the full amount in accordance with the terms of the fidelity bond, and then sought recovery against Wilson's auditors, Lynch & Merritt, public accountants. Which of the following would be Lynch & Merritt's best defence? A) King is not in privity of contract. B) The shortages were the result of clever forgeries and collusive fraud which would not be detected by an examination made in accordance with generally accepted auditing standards. C) Lynch & Merritt were not aware of the King-Wilson surety relationship. D) Lynch & Merritt were not guilty either of negligence or fraud.
41) ______
42) As a consequence of his failure to adhere to generally accepted auditing standards in the course of his examination of the Lamp Corp, Harrison, public accountant, did not detect the embezzlement of a material amount of funds by the company's controller. As a matter of common law, to what extent would Harrison be liable to the Lamp Corp. for losses attributable to the theft? A) He would have no liability, since the ordinary examination cannot be relied upon to detect defalcations. B) He would be liable for losses attributable to his negligence. C) He would have no liability because privity of contract is lacking. D) He would be liable only if it could be proven that he was fraudulent.
42) ______
43) In connection with the examination of financial statements, an auditor could be responsible for failure to detect a material fraud if A) the fraud was perpetrated by one client employee, who circumvented the existing internal controls. B) statistical sampling techniques were not used on the audit engagement. C) the auditor planned the work in a hasty and inefficient manner. D) accountants performing important parts of the work failed to discover a close relationship between the treasurer and the cashier.
43) ______
44) In third party suits, which of the auditor's defences usually means non-reliance on the financial statements by the user? A) absence of causal connections B) non-negligent performance C) lack of duty D) contributory negligence
44) ______
45) Pierre was convicted of stealing money from his clients and for deliberately preparing personal tax returns that were false. In addition, Pierre will likely A) be charged with misconduct by his professional institute (or ordre). B) need to defend himself to prove non-negligent performance. C) have lack of privity with the federal and provincial tax authorities. D) need to take additional training courses to upgrade his tax skills.
45) ______
46) Enron and Equity Funding are companies that suffered from large frauds by corporate management. One important lesson with respect to such cases is that A) securities and exchange commissions expect auditors to be perfect in their assessment of management. B) partners and staff should cooperate in preparing working papers that prove the accuracy of the financial statements. C) an investigation of the integrity of management is an important part of deciding upon the extent of audit work. D) when a company does really well financially it is important to suspect that such results are always inflated.
46) ______
47) What is the role of generally accepted accounting principles (GAAP) in assessing whether financial statements are fairly presented? GAAP A) cannot be relied upon exclusively. B) is so flexible that it is easy to misstate the financial statements and still be in accordance with GAAP. C) is a firm set of rules that help decide upon the accounting policies that are used. D) should be relied upon exclusively in deciding whether financial statements are fairly presented.
47) ______
48) Individuals who accept fees (or property), should they know or be willfully blind to the fact that the property was obtained illegally can be charged with money laundering, a criminal offence. Which of the following techniques will help a PA prevent such charges? A) carefully assess management integrity. B) ensure that the financial statements are in accordance with GAAP. C) require that clients carefully document the sources of their funds. D) obtain a detailed letter of representation from management confirming the sources of their funds.
48) ______
49) There are a number of things that the CICA, representing the profession as a whole, can do to reduce the practitioner's exposure to lawsuits. One of them is to A) deal only with clients possessing integrity. B) hire qualified auditors and train and supervise them. C) sanction members for improper conduct and performance. D) perform quality audits.
49) ______
50) There are a number of things that the practising auditor can do to reduce liability to lawsuits. One of them is to A) lobby for changes in laws. B) revise auditing standards to meet the changing needs of society. C) establish peer review requirements. D) carry adequate insurance.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) There are four major sources of auditor's legal liability. Briefly summarize the four sources. B) Discuss three major factors that have contributed to the recent increase in the number of lawsuits against auditors and the size of awards to plaintiffs.
52) One of the lessons learnt from accounting scandals such as Enron is that generally accepted accounting principles cannot be relied upon exclusively in deciding whether financial statements are fairly presented. Why is this the case?
53) A) List the four items which a defendant must prove in an action for negligence against a public accountant. B) Discuss each of the four defences a public accounting firm can normally use when facing legal claims by clients. C) Discuss what is meant by the term "expectation gap."
54) A) Discuss some of the steps the CICA and the accounting profession as a whole can and are taking to reduce the practitioner's exposure to lawsuits. B) Discuss some of the steps individual practising auditors can take to minimize their legal liability.
55) A) What are the different business organization structures that an accountant may use? What are the advantages of these structures? B) What is the difference between auditors and lawyers with respect to privileged information?
56) You are the auditor of Jehello Incorporated, a public company with a December year end. Your firm has audited Jehello for the past three years. The following issues were documented in the working paper files for the prior year audit: ∙ The company had incurred expenditures of $400,000 related to the development of a new music format for electronic media. The large majority of the costs were related to development of software, hardware, and presentation of the results to customers who participated in focus groups. Management had been optimistic that the new sound system would work well, even though focus group results had been poor. These costs had been fully capitalized. ∙ About 40% of the company's revenues were from one customer. That contract had been due for renewal on May 15, ten days after the audit report had been issued. Documents on file indicated that the customer seemed likely to renew the contract, although quality control disputes were escalating. On May 14, Jehello was informed that the contract would not be renewed. Jehello has defaulted on its bank loans and the bank is suing you, saying that the financial statements presented last year were false and misleading.
Required A) Which defences should the auditor use? : B) Do you believe that the auditor will lose the suit? Why or why not?
57) Your firm has been the auditor of Chappello Design and Construction Limited for several years. During the current year, a consultant on staff at your firm assisted Chappello in the selection and implementation of a new computer system. The audit staff were not involved in this process. The new system was an enterprise wide system that was to be implemented without modification using the direct cut-over approach (the old system was discontinued and the new one continued the next day). Unfortunately, staff had extreme difficulty using the system, and discontinued it after two months. During that time, Chappello was unable to document and bill their work for progress billings, and borrowed heavily to continue to pay its employees while work continued. The company reverted to its old system and claims that it has lost several hundreds of thousands of dollars in revenues as it was unable to issue quotes and bids on new contracts. Chappello has sued your firm for negligence with respect to the implementation of the computer system. Required: Which defences should the firm use? Support your answer with reasons.
58) Cassette Productions Limited has had declining sales as more and more media are being presented on CD and DVD rather than video or streaming cassette. They diversified their business by moving into backup systems, but are still having trouble boosting their income. The audit team was led by Theresa Sanford, who obtained her CA last year. Theresa had two assistants, Marv and Uhta, who did the work in the accounts receivable and inventory area. Theresa felt that they did not require supervision, as they had been with the firm for two years, and were expected to do well on their professional exams this year. Marv found that the accounts receivable had many old accounts, and customers were tough to get hold of. Accordingly, he decided to accept management's representations with respect to the balances. Similarly, Uhta noted that there were still many cassettes in inventory that had been there for over three years. Management insisted on recording these at cost, since they were looking at software that would allow these tapes to be used by computer systems rather than music systems. Uhta accepted managements' valuation. Two months after the audit report was issued, Cassette Productions Limited went bankrupt. It was found that many accounts receivable were for fictitious customers, and the receiver was only able to obtain five cents on the dollar for the inventory, which was sold as scrap. The bank is suing the auditors to recover its bank loan, which had been renegotiated based upon the results of the financial statements. Required: Will the bank be successful in its suit? Why or why not?
59) PA has been recently appointed auditor of Foible Ltd., a company that sells high cost knickknacks to third world countries. To facilitate the rapid preparation of the financial statements, management intends to have the physical inventory counted in October, rather than at the December year end. During the inventory count, PA noticed that several of the boxes were labelled with receiving documents from a competitor. PA was told that the new warehouse supervisor worked part time at the competitor, and must have picked up the wrong boxes. Several employees have sued Foible Ltd. for wrongful dismissal, claiming that they were promised a job that would last at least one year, with low cost accommodations as well. They are suing for the balance of the
year's es are all from an eastern European country. The law firm has responded in the legal letter that this suit is wages without merit. and During the year Foible obtained legal services from a firm in which the Chairman of the Board of the claiming company is a partner. Fees and disbursements for these services for the year was $125,000, a material that they amount. were During the audit, employees often spoke in a foreign language among themselves before responding to brought PA, then one employee would respond after some often heated discussion. into the Subsequent to the year end, the warehouse supervisor was arrested on criminal charges of theft, and country Foible charged with selling stolen goods. PA was charged as an accomplice to money laundering, as all of the under management for Foible were members of a criminal group laundering money from eastern Europe. false pretenses Required: . These employe Discuss the actions that PA could have taken during the engagement to prevent these charges.
60) Sandra is a new partner at a PA firm. Sandra recently signed a new contract with Gretchen Fabrics to become their auditor. In the process of accepting the client and planning the first year's audit, Sandra did the following: - Sandra contacted the previous auditor to enquire if there were any reasons not to accept the audit of this client. Unfortunately, the previous auditor was on vacation and did not respond to Sandra before she accepted the client. - Upon his return, the previous auditor did communicate with Sandra and indicated that the client had aggressive expense deferral policies that they disagreed on. Sandra asked to review the working papers of the previous auditor with regards to these expenses and found them to be right below the materiality threshold. - Gretchen Fabrics imports most of their fabrics and has two production facilities in Asia. Kravet therefore has a complex tax structure and many import duties. Since this is not the area of expertise of Sandra, she asked another auditing firm to provide the required audit procedures for the international taxes and duties expense. When selecting the other audit firm, Sandra researched the firm on the internet, she also ensured that they had their professional designation and enquired with the order if the firm had any complaints or litigation outstanding for malpractice. - Since the bidding process took time, Sandra had to start the audit almost right after learning she had the winning bid. She did not prepare an engagement letter before starting the work. She does not see this as being a problem since waiting until the audit has begun will provide her with a better idea of what work has to be done and what the engagement letter should include.
Required: Identify the good and bad steps that Sandra has undertaken in reducing her exposure to legal liability.
1) B 2) C 3) A 4) B 5) D 6) C 7) A 8) A 9) B 10) C 11) A 12) C 13) C 14) D 15) B 16) B 17) C 18) A 19) A 20) D 21) C 22) A 23) A 24) A 25) C 26) B
27) B 28) D 29) D 30) C 31) B 32) B 33) C 34) D 35) B 36) B 37) A 38) D 39) A 40) D 41) B 42) B 43) C 44) A 45) A 46) C 47) A 48) A 49) C 50) D 51) A) The three sources of auditor's legal liability are: ∙ Liability to third parties under common law and statute law. ∙ Liability under provincial securities acts.
∙
law. ∙ Criminal liability. Liabi B) Major factors include: lity ∙ The growing awareness of the responsibilities of public accountants by users of financial statements. to ∙ An increased consciousness on the part of provincial securities commissions regarding its responsibility for clien protecting investors' interests. ts ∙ Greater complexity of auditing and accounting. unde ∙ Society's increasing acceptance of lawsuits against anyone who may be able to provide compensation r ("deep-pockets" concept). contr ∙ The willingness of public accounting firms to settle out of court to avoid costly legal fees and adverse publicity. act ∙ The difficulty courts have in interpreting technical accounting and auditing matters. 52) This is a more open ended question so students' answers may differ. Judgement should be used in grading to reward valid points. - GAAP prescribes the accounting principles that should be followed, but does not consider internal controls or management integrity. Those are important factors that affect the financial statements and should be considered in the preparation of financial statements - GAAP also contains a lot of <grey areas> and requires the firms' accounting personnel to use their knowledge and judgement in reporting a transaction. Also, GAAP may not have a given set of criteria for a situation encountered by the company. In those situation the auditor must be vigilant and consider more than simply the prescribed GAAP in assessing if the financial statements are free from material misstatements. 53) A) The four items which a defendant must provide are as follows: ∙ The accountant owed a duty of care to the plaintiff. ∙ The accountant was negligent in the performance of that duty (i.e., did not act in accordance with the prudent person concept). ∙ The plaintiff suffered a loss. ∙ There was a connection between the accountant's negligence and the plaintiff's loss. B) Lack of duty. The public accounting firm could claim that there was no implied or expressed contract to perform between the public accounting firm and the client. Absence of misstatement: the financial statements as relied upon are accurate in all material respects. Nonnegligent performance. The public accounting firm could claim that the audit was performed in accordance with GAAS. Contributory negligence. The public accounting firm could claim that the client's actions either caused the loss, or interfered with the auditor's ability to discover the cause of the loss. Absence of causal connection. The public accounting firm could claim that the auditor's substandard performance did not cause the damages suffered by the client. C) The expectation gap refers to the difference in the beliefs of auditors and users of financial statements concerning the role of the auditor. Most auditors believe that the conduct of the audit in accordance with GAAS is all that can be expected of them, whereas many users of financial statements believe that the auditor guarantees the financial viability of the company. 54) A) Steps the profession is taking toward reduce practitioners' exposure to lawsuits include: ∙ Research in auditing. ∙ Standard and rule setting and revisions to meet the changing needs of the profession. ∙ Set requirements to protect auditors. ∙ Establish practice inspection requirements. ∙ Defend unjustified lawsuits. ∙ Educate investors and other users of financial statements as to the meaning of the auditor's report and the nature of the auditor's work. ∙ Sanction members for improper conduct.
∙
y steps individual practitioners can take to minimize legal liability including: ∙ Deal only with clients possessing integrity. Lobb ∙ Hire qualified personnel and train and supervise them properly. y for ∙ Follow the standards of the profession. chan ∙ Maintain independence. ges ∙ Understand the client's business. in ∙ Perform quality audits. laws. ∙ Document the work properly. B) ∙ Obtain an engagement letter and a representation letter. ∙ Maintain confidential relations. Ther ∙ Carry adequate insurance. e are ∙ Seek legal counsel. man 55) A) Accountants may establish a sole proprietorship, a partnership, or a limited liability partnership or a limited liability corporation. These latter two structures are permitted only in certain provinces, based upon provincial legislation. Advantages: A sole proprietorship is the only choice if there is only one PA. It is a simple business structure. A partnership is used to allocate income to all partners, and helps ensure that all partners are responsible for the actions of the organization. A limited liability partnership (or limited liability corporation) is used to limit liability to only those partners who worked on or supervised a particular engagement. This helps protect personal assets of partners. B) Public accountants do not have the right under common law to withhold information from the courts on the grounds that the information is privileged. A court can subpoena information in an auditor's working papers. Lawyers can withhold confidential information from the courts. 56) A) The auditor could argue lack of privity, i.e. that there was no duty of care to the bank. This is likely to fail, as the bank is a foreseeable user of the financial statements. Absence of misstatement: From the facts presented, it seems that the development costs should have been written off, rather than capitalized, so the financial statements were misstated. However, it was not foreseeable that the large customer would not renew the contract. The nature of the contract and its expiry date would have been disclosed in the financial statements. Non-negligent performance: The auditor appears to have conducted the audit in accordance with GAAS. Absence of causal connection: If the bank did not renew the loan recently, or if it was a long term loan, then there would not be a connection between the information presented in the financial statements and the bank's loss (unless there were specific debt/equity ratios that needed to be preserved). Contributory negligence: This defence would likely be unusable. B) This question could be argued either way. The student could say that the suit would be lost because of the deferred expenses (that they should have been expensed) or that the auditor may win the suit as they conducted their audit in accordance with GAAS. 57) (This question requires applying the defences that were discussed in the chapter to other situations that a firm
migh ble defences that the firm could use: t enco Non-negligent performance: The consulting staff conducted the work in accordance with standards that were unter appropriate for such engagements. This would require reference to such standards and that the firm use expert witnesses or such documented standards to assess the quality of the work conducted. .) Ther Contributory negligence: The firm would need to consider actions taken on the part of Chappello. Did the firm e are allocate sufficient resources in the way of proving time for staff to learn how to use the new system, or in providing two resources to move information from the old system to the new system accurately and completely. If such resources possi were not provided, then it would be considered partially Chappello's responsibility that the system did not succeed 58) Yes, the bank will be successful. The bank is a foreseeable user, so the auditor could not argue lack of privity. The financial statements were misstated, as both inventory and accounts receivable were overstated. If the audit had been conducted in accordance with GAAS, then it is likely that the errors would have been detected. The audit was not conducted in accordance with GAAS due to lack of adequate supervision and lack of sufficient appropriate audit evidence. The bank suffered a loss, and would likely be able to link the loss to the reliance on the financial statements and to the misstatements. 59) Prior to accepting an engagement, an auditor should assess the integrity of management. This would could involve credit checks and background checks using a credit bureau. During the audit, PA had many warning signs. For example, the possibility of stolen goods being included in inventory. Management conflict of interest and possible illegal actions with respect to employees are also present. When these signs occurred, PA should have consulted legal advice, and also required second partner review or peer assistance from his provincial professional association. PA should have ensured that the lawsuits were disclosed in the financial statements and that the related party transactions (the legal fees) also were disclosed in the financial statements. PA could have consulted independent legal advice with respect to the employee lawsuits. 60) - Contacting the previous auditor is a good step, however, Sandra did not wait to have a response before accepting. Sandra should've waited to hear from the previous auditor. - Reviewing the working paper of the previous auditor is a good step, however, when she learned that the client had aggressive expense deferral policy, Sandra should not have been so quick to dismiss this based on materiality. The deferral of expenses might exceed materiality in the upcoming year, causing the financial statements to be misstated, and this is also evidence of questionable management integrity. Sandra should've considered to end the relationship with the client upon learning this information. - It appears that Sandra did not assess management integrity prior to accepting the client. This creates a higher audit risk. - Sandra did a good job in verifying the credentials of the other audit firm upon which she is going to rely. It is correct to accept a client even if you cannot perform the entire audit yourself. If you can find an expert to assist you in the process and you can ensure that the work of the expert is properly done, you will be following GAAS. The steps to verify the qualification of the other auditors appear to be sufficient. Note that Sandra will also have to review their work, once it is done. - Sandra should have done an engagement letter prior to starting the work. - If the time frame is too short, Sandra should've indicated to the client that she will need additional time to complete the work.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The objective of the audit of financial statements by the auditor is the expression of an opinion 1) _______ on A) the annual report. B) the fairness of the financial statements. C) the accuracy of the financial statements. D) the balance sheet and income statement.
2) CAS 200 explains that the purpose of the financial statement audit is to express an opinion on the financial statements. This opinion is an assessment of whether the financial statements are presented fairly using A) Canadian generally accepted accounting principles (GAAP). B) Rules of professional conduct. C) Canadian auditing standards (CAS). D) Management's assertions.
2) _______
3) The reason auditors accumulate evidence is to A) enable them to reach conclusions about the fairness of the financial statements and issue an appropriate audit report. B) justify the conclusions they have otherwise reached. C) satisfy the requirements of the relevant provincial securities regulations. D) defend themselves in the event of a lawsuit.
3) _______
4) The new Canadian auditing standards indicate that a precondition for the auditor to accept an audit engagement is: A) The auditor is confident that there are no errors in the financial statements. B) Management of the company has prepared their financial statements for the year. C) The auditor has completed their tests of the entity level controls and found no weaknesses. D) Management of the company has an acceptable financial reporting framework.
4) _______
5) The auditor gives an audit opinion on the fair presentation of the financial statements and associates his or her name with it when, on the basis of adequate evidence, the auditor concludes that the financial statements are unlikely to mislead A) a prudent user. B) the reader. C) investors. D) management.
5) _______
6) The responsibility for adopting sound accounting policies, maintaining adequate internal controls, and making fair representations in the financial statements rests A) with the internal audit department. B) with the auditor. C) equally with management and the auditor. D) with management.
6) _______
7) The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to A) both management and the auditor equally.
7) _______
B) management for the statements and the auditor for the notes. C) the auditor. D) management.
8) The requirement for an attitude of skepticism means that the auditor should A) plan and conduct the audit with an attitude of distrust in management. B) not consider management's explanation as evidence on any subject. C) not be blind to evidence that suggests the documents, books or records have been altered or are incorrect. D) perform additional tests of controls to increase the probability of discovering fraud or errors.
8) _______
9) The auditor has considerable responsibility for notifying users as to whether or not the statements are properly stated. This imposes upon the auditor a duty to A) be an insurer of the fairness in the statements. B) be a guarantor of the fairness in the statements. C) provide reasonable assurance that material misstatements will be detected. D) be equally responsible with management for the preparation of the financial statements.
9) _______
10) The factor which distinguishes an error from fraud and other irregularity is A) materiality. B) intent. C) whether it is a caused by the auditor or the client. D) whether it is a dollar amount or a process.
10) ______
11) If the auditor were responsible for making certain that all the assertions of management in the statements were correct, A) bankruptcies could no longer occur. B) audits would be much easier to complete. C) audits would not be economically feasible. D) bankruptcies would be reduced to a very small number.
11) ______
12) In comparing management fraud with employee fraud, the auditor's risk of failing to discover the fraud is greater for A) management fraud because of management's ability to override existing internal controls. B) employee fraud because of the larger number of employees in the organization. C) management fraud because managers are inherently smarter than employees. D) employee fraud because of the higher crime rate among blue collar workers.
12) ______
13) When comparing the auditor's responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility A) more on discovering errors than employee fraud. B) on the senior auditor for detecting errors and on the manager for detecting employee fraud. C) more on discovering employee fraud than errors. D) equally on discovering either one.
13) ______
14) The auditor's evaluation of the likelihood of material employee fraud is normally done initially as a part of A) the assessment of whether to accept the audit engagement. B) the tests of controls. C) understanding the entity's internal controls. D) the tests of transactions.
14) ______
15) Due to criticism of the profession resulting from auditors' non-discovery of several large management frauds, there is greater emphasis on the auditors' responsibility to A) reduce materiality in an audit engagement to increase the likelihood of detecting a fraudulent transaction. B) evaluate factors that may indicate an increased likelihood of management fraud. C) perform substantive tests specifically designed to detect fraud. D) increase the audit risks associated with an audit engagement.
15) ______
16) Brenda is the senior auditor of the Grosvenor Lodge. While performing her audit, Brenda noticed that the catering staff at the Lodge had been stealing food and also providing friends with free meals and drinks at the restaurant. She estimates that the expense related to this fraud could be as much as $30,000, which would be material for Grosvenor. Brenda should start by: A) Walk away from the audit to avoid being associated with a company where fraud exists. B) Approach the catering staff to obtain more information and see if there is an explanation. C) Notifying the local police of her discovery. D) Inform management and the audit committee of the lodge about her findings.
16) ______
17) Auditing standards regarding the detection of illegal acts clearly state that the auditor provides A) assurance that they will be detected, if material. B) no assurance that they will be detected. C) assurance that they will be detected, if highly material. D) the same reasonable assurance provided for other items.
17) ______
18) At what point during the audit should the auditor conduct an independence threat analysis? A) after the audit evidence assessment and collection process B) after gathering sufficient knowledge of the client's business C) prior to signing the audit report D) prior to the acceptance of the engagement
18) ______
19) The decision to continue doing the audit of an existing client is A) as important as deciding whether or not to accept a new client. B) more important than deciding whether or not to accept a new client. C) less important than deciding whether or not to accept a new client. D) only to be reconsidered if the client's operations or upper management has changed.
19) ______
20) Your PA firm has just obtained a new client and you have been assigned the task of preparing the knowledge of business section of the file. Which of the following best describes the process of gathering the knowledge of business for a client?
20) ______
A) discussing processes and business objectives with company employees B) examining the legal expenses file for possible regulatory infractions C) understanding the client's business, industry, and regulatory environment D) gathering information about the industry and regulatory environment
21) Marianne is currently performing tests of controls on the presence of an employee code of conducts, the presence of a whistle blower line and on how management responded and implemented systematic penalties for instances where violations of the code of conduct existed. Marianne is currently evaluating A) the entity-level controls. B) the risk of fraud C) the industry and business environment D) the client acceptance
21) ______
22) Where the auditor has assessed control risk of a particular area at a reduced level, he or she will then A) test the effectiveness of the controls in that area. B) eliminate the need to gather evidence in that area. C) negotiate with management to determine which controls will be tested in that area. D) proceed to expand the sample sizes in that area.
22) ______
23) Analytical procedures are those that A) review the effectiveness of internal controls. B) assess the overall reasonableness of transactions and balances. C) analyze the effect of management procedures on the accounting system. D) evaluate the accuracy of the account balances.
23) ______
24) Tests of details of balances are specific procedures intended to A) test for monetary errors in the financial statements. B) identify the details of internal controls. C) prove that the trial balance is in balance. D) prove that the accounts with material balances are classified correctly.
24) ______
25) After the auditor has completed all the procedures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This is a highly subjective process that relies heavily on A) generally accepted auditing standards. B) the provincial institutes' Rules of Professional Conduct. C) the auditor's professional judgment. D) generally accepted accounting principles.
25) ______
26) Prior to looking at the specific cycles, the auditor will first A) perform a risk assessment for the audit of the organization. B) perform analytical review of the financial statements. C) inquire and document corporate governance systems. D) perform test of controls on significant cycles.
26) ______
27) Transaction cycles begin and end A) at the beginning and end of the fiscal period. B) at the balance sheet date. C) at the origin and final disposition of the company. D) at January 1 and December 31.
27) ______
28) For the most part, auditors treat each transaction cycle A) as a separate business unit with different audit teams. B) as an interrelated unit with the other cycles throughout the entire audit. C) as a joint venture with other clients in the same industry. D) separately as the audit is being performed.
28) ______
29) Often, numerous classes of transactions affect the ending balance of a particular general ledger account. This is handled during the audit engagement by A) ensuring that tests are conducted for each class of transactions. B) using a combination of assurance for each class of transactions and for the ending balance. C) obtaining a high level of assurance for at least one of the transaction types. D) testing only the ending balance, as this is the significant amount on the financial statements.
29) ______
30) Management assertions are A) stated in the footnotes to the financial statements. B) explicitly expressed representations about the financial statements. C) implied or expressed representations about the accounts in the financial statements. D) provided to the auditor in the assertions letter, but are not disclosed on the financial statements.
30) ______
31) Management assertions are A) directly related to generally accepted auditing standards. B) indirectly related to generally accepted auditing standards. C) indirectly related to generally accepted accounting principles. D) directly related to generally accepted accounting principles.
31) ______
32) Frankinfurter Limited decided that it wanted to improve earnings. To do this, they understated their expenses by omitting unpaid expenses from the accrued liabilities account at year end. Which management assertion has been violated? A) disclosure B) rights and obligations C) existence D) completeness
32) ______
33) Gabori Company would like to pay less income tax this year. They decided that they could do this by understating their inventory values, increasing costs of goods sold. This was done by deliberately pricing the inventory at incorrect amounts, so that it would be shown at a lower value than it was really worth (for example, items worth five dollars each were shown at fifty cents each). Which management assertion(s) have been violated? A) accuracy, measurement or allocation B) statement presentation C) completeness D) valuation
33) ______
34) If a long-term note receivable is included on an accounts receivable listing, there is a violation of the A) timing objective. B) classification objective. C) existence objective. D) completeness objective.
34) ______
35) XYZ Brick Company decided to inflate sales by recording fictitious sales. Several non-existent clients were created and the sales were added into the sales journal throughout the year. The general transaction-related audit objective affected with these actions is A) completeness. B) accuracy. C) posting and summarization. D) occurrence.
35) ______
36) Georgina was working as the part time accountant for three small businesses. Whenever she could, she pocketed cash and neglected to record the sale in the sales system. The general transaction-related audit objective affected by her actions is A) completeness. B) accuracy. C) posting and summarization. D) occurrence.
36) ______
37) Flagpole Company Limited recently upgraded its accounting software due to changes in the payroll income tax rates. Unfortunately, there was an error in the software, and income tax was calculated incorrectly. The general transaction-related audit objective affected by these errors is A) completeness. B) occurrence. C) accuracy. D) posting and summarization.
37) ______
38) Heavy Manufacturing Company is in the business of making steel plates, forming heavy metal slabs and drilling and scoring metals. Recently, it upgraded many of its forming machines. Fortunately, the company was able to sell its old equipment at a reasonable price. The effect was that sales for the quarter are substantially improved over the same period in the prior year. The general transaction-related audit objective affected by this activity is A) timing. B) occurrence. C) classification. D) accuracy.
38) ______
39) Big Bank had a program failure occur on Sunday night due to a maintenance program error. Transaction posting was interrupted, with several errors occurring in posting to the master files. Although sales had been posted to the general ledger, individual accounts were not recorded until subsequent days. The general transaction-related audit objective affected by this activity is A) occurrence. B) accuracy. C) posting and summarization. D) timing.
39) ______
40) When considering each material type (or class) of transactions during the audit, which general transaction-related audit objectives are assessed during the audit? A) those transaction-related audit objectives where there are poor internal controls B) all six transaction-related audit objectives C) primarily completeness, occurrence and accuracy, since this is where most errors occur D) those transaction-related audit objectives where there is the highest risk of error
40) ______
41) Camilla is preparing the audit program for the inventory of Summers, a large department store. Camilla listed "select a sample of invoices from suppliers to verify that the risks and rewards of the inventory were transferred to Summers". Camilla is concerned that some of the inventory in the store might be on consignment. The account balance related objective that Camilla is concerned about is: A) Valuation B) Accuracy C) Existence D) Rights and obligation (ownership)
41) ______
42) Balance-related audit objectives are applied to which types of general ledger accounts? A) income statement accounts only B) balance sheet accounts and some income statement accounts C) balance sheet accounts only D) accounts that affect the cash flow statement
42) ______
43) Heavy Manufacturing Company is in the business of making steel plates, forming heavy metal slabs and drilling and scoring metals. Recently, it upgraded many of its forming machines. There were five machines purchased on four different invoices. Unfortunately, one of the invoices was recorded twice, resulting in five invoices being recorded. The general balance-related audit objective affected by this activity is A) existence. B) classification. C) completeness. D) accuracy.
43) ______
44) The Big Insurance Company implemented a new computer system to track and record insurance premiums receivable. The program automatically prints invoices and sends them to customers when premiums are due. Due to a program error, a whole series of invoices were included in sales but not in accounts receivable. The general balance-related audit objective affected by this activity is A) classification. B) existence. C) accuracy. D) completeness.
44) ______
45) Radio Supplies Limited sells parts and components to organizations that repair radios and other forms of audio equipment. They have many parts on their inventory listing at cost that were purchased up to fifteen years ago. Some of these parts have not seen any movement in the last ten years. The general balance-related audit objective affected by this activity is A) existence. B) completeness. C) accuracy. D) valuation.
45) ______
46) Formamould Inc. sells plastic moulds to a variety of companies. Some moulds are custom made and cost thousands of dollars. To help customers finance these purchases, Formamould uses a variety of methods, such as payment terms stretched over three years, delayed payment, and pay-as-you-produce models tailored to the individual customer's needs. The outstanding balance is included in current accounts receivable. The general balance-related audit objective affected by this activity is A) completeness. B) classification. C) accuracy. D) existence.
46) ______
47) To help improve the cash balance on the financial statements, the controller recorded several deposits from early January in the month of December. The general balance-related audit objective affected by this activity is
47) ______
A) cutoff.
B) classification.
C) existence.
D) accuracy.
48) In testing for cutoff, the objective is to determine A) whether transactions are recorded in the proper period. B) that no transactions from the prior period are included in the current period's balances. C) that no transactions of the current period have been delayed and recorded in a future period. D) whether all of the current period's transactions are recorded.
48) ______
49) Jane's employer purchased a new calculator this month. When Jane added up the sales listing, she was a bit confused with the new calculator and made numerous adding errors. The daily sales total for the next week were incorrectly posted to the general ledger. The general balance-related audit objective affected by this activity is A) existence. B) accuracy. C) classification. D) cutoff.
49) ______
50) The sole shareholder of Jade Company had a contractor pave the parking lot at the company building, and also pave the driveway of his home. Both paving jobs were billed to the company on a single invoice. The general balance-related audit objective affected by this activity is A) rights and obligations. B) accuracy. C) presentation and disclosure. D) classification.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A financial statement audit typically consists of three sections. Identify each of the three sections of an audit and discuss the major activities performed by the auditor in each section.
52) In the following table, there are listed common audit objectives for accounts payable or purchases. For each procedure, list the management assertion, and the related general audit objective. State whether the audit objective is transaction-related or balance-related.
Accounts payable or purchases Management objectives assertion 1. Accounts payable in the accounts payable trial balance are for valid purchases. 2. Recorded acquisitions are for goods and services received, consistent with the best interests of the client. 3. All acquisition transactions are recorded. 4. Recorded acquisition transactions are recorded at the correct amount. 5. Acquisition transactions are correctly allocated between current and long-term. 6. Acquisition transactions are
TransactionAudit objective related? (Y/N)
Balancerelated? (Y/N)
recorded on ledger. the correct dates. 7. Purchase 9.transactions The accountsare payable recorded in recorded in liabilities the proper are period. obligations of the company. 8. Purchase transactions are properly included 10. Liabilities in theand vendor contingent and inventory liabilities master arefiles, properly and are presented correctly posted and disclosed. to the general
53) In May 2006, the firm of Chang and Crown (C&C) became the auditors of Laua Limited (LL) for the fiscal year ended December 31, 2005. LL's Board of Directors approved the change from its previous audit firm on the recommendation of LL's senior management. One of the new board members is a bit confused about management's role with respect to the financial statements and thought that Chang and Crown would be preparing the financial statements. He was also glad that the auditors would be able to help prevent illegal acts and fraud. Required: A) Distinguish between management's responsibility and the auditor's responsibility for the financial statements under audit. B) Explain to the board member why the auditor does NOT help prevent illegal acts and fraud. What is the role of the auditor with respect to illegal acts and fraud?
54) Your PA firm audits the Barney Bloke Parts company, which manufactures plastic bumpers and other automobile parts in eight factories scattered across southern Ontario. The company has a December year end. It is now November 14. The planning file indicates that internal controls in the accounts receivable area are poor, as there has been significant employee turnover. A review of the prior year's working paper file indicates that there was a poor response to the accounts receivable and accounts payable confirmation requests. There were several errors in inventory pricing and problems with obsolescence. Required: List the financial statement cycles that need to be tested. For each cycle, identify at least one transaction that needs to be examined. For that transaction, identify a management assertion that may have a high risk of error associated with it and explain why you believe the risk of error is high.
55) You have been assigned the in-charge-auditor for a new client, Beltair House. Beltair House is a non-profit charitable organization which operates a home for unwed mothers who have decided that they would like to keep their child. In the past, the organization had been almost fully funded by the provincial government. However, due to recent budget cut-backs, Beltair has to raise operating funds from public donations. Because of financial constraints, there is now only one full time manager, Joan Ng. Joan has the help of several volunteers, and the residents help out with the chores and with maintenance and cleaning. Ng has been able to arrange for a local food bank to provide a large portion of the food required for meals. Door-to-door canvassers have been able to raise money to keep the House going, but Ng is concerned that this will change. Required: Identify issues that you will need to consider that affect the risk of this audit engagement.
56) Sean Clem has done a review engagement and prepared the tax return for your web design business for the last five years. The books and records have always been well organized, although year end adjusting entries have been required. You do some of the accounting yourself and the rest of the accounting records are handled by your wife, who is also an employee of the business. This year, you would like to expand your business to provide ISP (internet service provider) services to your clients. This would entail you purchasing additional computer equipment and software. You are also considering hiring an additional employee (you currently have three), and you are looking at obtaining a loan for $100,000 from the bank. The bank says that you should have your records audited, but you are not sure what this will mean. Required: A) What would Sean say to you about the differences between an audit and a review? B) Identify the issues that Sean needs to consider during the planning of the audit.
57) Frank has come to you because he is worried about recovering the cost of his share of a law firm partnership. His partner, Jennifer, is exercising the "shotgun" clause in their partnership agreement, and wants to buy him out. Over the last two years, Frank and Jennifer have had numerous battles over the way that Frank handles his accounts receivable. Frank is lenient with his customers, and has converted many of his accounts into long term notes extending two and three years into the future. He is confident that these amounts are collectible, because every one of his clients continues to make small monthly payments. Frank thinks that Jennifer may have been hiding profits from him and collecting some of her accounts in cash. He wants you to audit the books so that he can figure out what the 'true' profits are and how much Jennifer should pay him for his share of the partnership. Required: A) Explain to Frank what you would be able to do during the audit engagement. B) List the management assertions that may have been violated. Justify your answer.
58) Pet Shop Ltd. is a large retail outlet with ten full time employees in addition to the owner. You dropped by on your way home one day to organize the audit planning process for the coming year, and noticed brand new terminals at the cashier's desk. One of the employees was having fun zapping inventory items. The owner teased him about the new laser scanning devices and told him to get to work to see which items needed to be ordered. It turns out that Pet Shop Ltd. has implemented a new point of sale computer system that is integrated with inventory. The last time you were there to buy dog food (about three months ago) there were old computer terminals that were totaled and recorded manually in the sales journal. Required: List the three sections of the audit. For each section, explain how these new computer systems might affect the audit process.
59) Your PA firm has been auditing Ontario Pulp Company for three years. Two years ago, a letter was received from the provincial government informing them that they needed to reduce the level of contaminants that they were releasing into the air and into local waterways. The deadline for this reduction is three months
from hundred thousand dollars) if the targets are not met. Alternatively, the Company will need to shut down today. operations until the targets are met. The During your audit planning process management informed you that they have not taken any action, but letter plan to start construction of the new pollution devices next month. indicates significa Required: nt fines (several Explain the impact the above situation has upon your audit planning process.
60) The controller who had been with Bianca Limited for six years was fired last month, allegedly for pocketing cash. Unfortunately, there was a fire in the accounting department the week before he was fired, destroying the accounting records, including the computer equipment and current backup disks. The only records available for the current year is a copy of the computer system that is a month old. There are also disks for the year ends going back three years. These were at the president's home, the place where the company kept archival records. Required: Explain how this situation might affect the audit process.
1) B 2) A 3) A 4) D 5) A 6) D 7) D 8) C 9) C 10) B 11) C 12) A 13) A 14) C 15) B 16) D 17) B 18) D 19) A 20) C 21) A 22) A 23) B 24) A 25) C 26) C
27) C 28) D 29) B 30) C 31) D 32) D 33) A 34) B 35) D 36) A 37) C 38) C 39) C 40) B 41) D 42) B 43) A 44) D 45) D 46) B 47) A 48) A 49) B 50) A 51) I: Risk assessment. In this section, the auditor obtains an understanding of the client's business and industry. In addition, the auditor obtains an understanding of the client's internal control structure and makes a preliminary assessment of control risk. The planning takes place in this phase by developing a strategic audit approach overall
and Response. In this section, the auditor develops audit programs and tests internal controls. The auditor also by performs substantive tests and assesses the impact upon the risk of material misstatements. The results of the tests cycle are evaluated and risk is reassessed if required. Final evidence and documentation is gathered. . III: Reporting.In this section, the auditor communicates with the audit committee and management as required. A II: final quality control review is also performed before the report is issued. Risk 52) Accounts payable or purchases Management objectives assertion 1. Accounts payable in the accounts payable trial balance are for valid purchases. Existence 2. Recorded acquisitions are for goods and services received, consistent with the best interests of the client. Occurrence 3. All acquisition transactions are recorded. Completeness 4. Recorded acquisition transactions are recorded at the correct amount. Measurement 5. Acquisition transactions are correctly allocated between current and long-term. Measurement 6. Acquisition transactions are recorded on the correct dates. Allocation 7. Purchase transactions are recorded in the proper period. Allocation 8. Purchase transactions are properly included in the vendor and inventory master files, and are correctly posted to the general ledger. Measurement 9. The accounts payable recorded in liabilities are Rights and obligations of the company. obligations 10. Liabilities and contingent liabilities are properly Presentation presented and disclosed. and disclosure
BalanceTransactionrelated? Audit objective related? (Y/N) (Y/N)
Existence
Occurrence
Y
Y
Completeness Y
Accuracy
Y
Classification
Y
Timing
Y
Cutoff
Y
Posting and summarization Detail tie-in
Y
Y
Obligations
Y
Presentation and disclosure
Y
53) A) Management: Management is responsible for adopting appropriate accounting policies, maintaining adequate internal control, and making fair representations in the financial statements. Auditor: The auditor is required to plan and perform the audit with an attitude of professional skepticism, recognizing that circumstances may exist that cause the financial statements to be materially misstated.
le for maintaining internal control, it is management's responsibility to design and monitor internal controls to help prevent and detect illegal acts and fraud.
B)
S ince The auditor considers fraud and illegal acts in the context of whether they have a material effect upon the financial man statements. Accordingly, the auditor is responsible for obtaining reasonable assurance that the financial statements age are free of material error, which includes illegal acts that may have a material indirect effect on the financial ment statements, and material fraud, which may have a direct effect on the financial statements. is resp Audits cannot be expected to provide the same degree of assurance for the detection of material management fraud, onsib since concealment by management makes fraud more difficult for auditors to find. 54)
Transaction to Financial statement cycle be tested Management assertion at risk with reason Timing: new employees may record the transaction in the wrong period or on the Sales and collection Cash receipts wrong date Cash Classification: new employees may post Acquisition and payment disbursement transactions to the wrong account Payroll Accuracy: employees could be paid the Payroll and personnel disbursement wrong wage rate Accuracy: inventory issued might be Inventory and Inventory recorded at the wrong cost or wrong sales warehousing issuance price Capital acquisition and Timing: payments may be recorded in the repayment Note payment wrong period or in the wrong date [Note: Students may select other transactions that are at high risk. Above is a representative response.]
55) Factors impacting risk include: ∙ a first time audit engagement (increases inherent risk) ∙ the reduction in government funding, affecting the going concern of the House ∙ numerous financial statement users (e.g. government, donors) ∙ cash collected by volunteers is subject by theft (receipts may not be issued for all donations–this may result in a need to qualify the audit report) ∙ a lack of segregation of duties (there is only one employee) ∙ there may be inexperienced people recording accounting transactions, leading to the potential for more errors (especially if accounting transactions are recorded by volunteers) ∙ since the food bank is providing a large portion of the food, this donation may need to be recorded at fair market value (need to determine how it is being recorded, and whether there are any additional services that need to be recorded) 56) A) ∙ An audit has a higher degree of assurance, so additional work will be required. ∙ This will result in a higher fee for the work completed. ∙ It will be important to clearly document the role of the auditor and management. ∙ The report may be qualified if it is not possible to audit the opening balances. ∙ It may be possible to continue to have a review engagement rather than an audit if the owner (you) has other collateral–then the bank would not require such a high level of collateral. B) ∙ This is a first audit engagement, so additional time will be needed to develop a client risk profile, document
kno wledge of the industry. wled ∙ There is a need to conduct an independence threat analysis. ge of ∙ Since the bank will be requiring the audit to possibly review the collectability of the loan, this increases the risk busi of the engagement. ness ∙ Internal controls will be poor since records are kept by a husband and wife team. and ∙ Risks of management override or management deception are high because of the incentive to obtain the bank kno loan. 57) A) ∙ The purpose of an audit is to provide reasonable assurance that the financial statements are free of material error or fraud. ∙ The financial statements would not be 100% accurate. ∙ Since management fraud is difficult to detect, it would be impossible for you to quantify the amount of money that Jennifer has taken, if any. ∙ Frank might not be happy with the audit results, because one of the things that you would have to do would be to assess the collectability of the accounts receivable. B) Existence: some accounts receivable may not be recorded, if Jennifer took funds. Completeness: some sales may not have been recorded, if Jennifer took the funds. Valuation: accounts receivable may be overvalued for Frank's receivables, if they are not collectible. Presentation and disclosure: If some receivables are long term rather than current, they may be incorrectly recorded as current in the financial statements. 58) Risk assessment: ∙ The auditor will need to gather information about how internal controls have changed with the use of the new computer system. ∙ Since there are two different systems of internal control, the audit will need to consider both systems during the risk assessment, planning and execution phases. ∙ Depending upon the nature of the information that was stored in the old systems, the auditor may need to conduct a conversion audit. Risk Response: ∙ The controls will be different, so the auditor will need to design different tests of controls for each of the two systems. The audit programs will need to be updated. ∙ The system conversion will also have to be tested to ensure that data integrity was not compromised. ∙ Particular attention should also be given to the inventory and sales account. Given the scanning of items by the employee, it is possible that this recorded false sales and also recorded false decreases in inventory. ∙ Analytical procedures will need to take account of the fact that there may be a large shift in amounts in the accounts (for example, there may be capital expenditures for the computer equipment and software; inventory amounts may be lower if inventory management has improved with the new system). Reporting: ∙ The audit report will be prepared and total evidence gathered in the risk response section will be analysed to determine if there is a material misstatement. An audit opinion will be formed based on the results and the audit report can be issued. 59) ∙ The above situation seems to indicate that management does not take the letter from the provincial government seriously. ∙ This could affect the ability of the company to continue as a going concern, and as a minimum would require disclosure in the financial statements, with possibly a qualification.
∙
would need to include gathering knowledge about other companies in this sector–have they also received such letters and have they complied? Have there been charges laid by the provinces where compliance did not occur? The The answers to these questions will help asses the potential impact upon the client. audit ∙ The auditor should also look at any proposals that the company has received about implementing the plan anti-pollution equipment to see how quickly it can be implemented. ning ∙ The negative attitude about the anti-pollution equipment may also apply to other areas of the business. proc ∙ The auditor will need to assess the quality of corporate governance and of management integrity and assess the ess effect upon the engagement. 60) ∙ The absence of records will make it difficult to complete the audit; management actions with respect to reconstructing the one month of lost records will need to be assessed and the potential for material error considered. ∙ If records cannot be obtained from alternative sources (e.g. customers and suppliers and financial institutions) then a qualified audit report may be required. ∙ Due to the possible management fraud, it will be necessary to conduct extensive additional testing; it may not be possible to quantify the amount of the fraud (if any). ∙ It will be necessary to look at the quality of internal controls–if this fraud was possible, then other errors and irregularities could also have occurred at the business. ∙ It will not be possible to conduct tests of internal controls or tests of details of balances if there are no records.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) CAS 330, the auditor's response to assessed risks, explains that the auditor needs to link 1) _______ completed audit work to the assessed risks at the assertion level and A) ensure that they test the entire population for areas that are considered to have a high risk of errors. B) have the reviewing partner sign off on the assessed risk. C) document the conclusions and results of the audit procedures. D) perform substantive procedures in areas where there is a high risk of fraud.
2) "The detailed instructions for the collection of a particular type of audit evidence" that is to be obtained at some time during the audit is the definition of a(n) A) audit plan. B) audit procedure. C) sampling plan. D) audit program.
2) _______
3) "The detailed instruction for the entire collection of evidence for an audit area" is the definition of an A) audit program. B) audit procedures. C) sampling plan. D) audit plan.
3) _______
4) The decision of how many items to test must be made by the auditor for each audit procedure. The sample size for any given procedure A) must cover the entire period under audit. B) will be the same if the same level of assurance is required. C) is focused on high dollar items only. D) is likely to vary from audit to audit.
4) _______
5) The two most important factors that determine the appropriate sample size in audits are A) the auditor's expectation of errors and materiality. B) the effectiveness of the client's internal controls and materiality. C) the auditor's expectation of errors and the effectiveness of the client's internal controls. D) materiality and the type of audit procedure to be applied to the population.
5) _______
6) In determining the quantity and quality of evidence to gather, the auditor will be satisfied when the evidence is A) highly persuasive. B) conclusive. C) completely convincing. D) irrefutable.
6) _______
7) Those procedures specifically outlined in an audit program are primarily designed to A) prevent litigation. B) test internal controls. C) gather evidence. D) detect errors or irregularities.
7) _______
8) Audit evidence is generally considered sufficient when
8) _______
A) it has been obtained by random selection. B) there is enough of it to afford a reasonable basis for an opinion on financial statements. C) it has the qualities of being relevant, objective, and free from known bias. D) it is appropriate.
9) Evidence is generally considered appropriate when A) it has the qualities of being relevant, objective, and free from known bias. B) it consists of written statements made by managers of the enterprise under audit. C) it has been obtained by random selection. D) there is enough of it to afford a reasonable basis for an opinion on financial statements.
9) _______
10) The auditor is tracing from the duplicate sales invoices to related shipping documents with respect to the occurrence transaction-related audit objective. This type of evidence is A) timely. B) relevant. C) independent. D) related to external documentation.
10) ______
11) Last year, the client's internal controls were weak. This year, the internal controls are stronger. This means that information recorded on internal documentation is A) more reliable. B) more timely. C) less reliable. D) less timely.
11) ______
12) Gina is performing the audit of the payables section of Reno Inc. She wants to confirm the payables from an independent source. Which of the following sources would represent an independent provider? A) Confirm the account payable to Suco Inc. The CEO of Reno owns 30% of the outstanding shares of Suco. B) Confirm an interco payable with the CEO of the US branch of Reno Inc. C) Confirm the margin of credit balance with Citizen Bank. Reno does all their banking with Citizen and they also have a long-term loan. D) Confirm the account payable with Clarkson Corp. The CFO of Clarkson is the wife of the controller of Reno.
12) ______
13) Which of the following is an example of objective evidence? A) the physical count of securities and cash B) observation of cobwebs on some inventory bins C) inquiries of the credit manager about the collectability of noncurrent accounts receivable D) a letter written by a client's lawyer discussing the likely outcome of outstanding lawsuits
13) ______
14) Which of the following is an example of subjective evidence? A) the physical count of securities and cash B) inquiries of the credit manager about the collectability of noncurrent accounts receivable C) a positive confirmation of an account receivable D) a bank confirmation
14) ______
15) Evidence is usually more persuasive for balance sheet accounts when it is obtained A) only from transactions occurring on the balance sheet date.
15) ______
B) as close to the balance sheet date as possible. C) from the time period when transactions in that account were most numerous during the fiscal period. D) from various times throughout the client's year.
16) For income statement accounts, evidence is more persuasive if there is a sample from A) December, since this would include large holiday sales. B) the period closest to the end of the fiscal period. C) at least three months of the fiscal year. D) the entire period under audit.
16) ______
17) In making decisions about evidence for a given audit, the auditor's goal is to obtain a sufficient amount of timely, reliable evidence that is relevant to the information being verified, and to do so A) at any cost because the costs are billed to the client. B) only if the cost is reasonable. C) no matter what the cost involved in obtaining such evidence. D) at the lowest possible total cost.
17) ______
18) Inspection is the inspection or count by the auditor of assets such as A) cash, inventory, securities, notes receivable, and tangible capital assets. B) cash or inventory only. C) cash, inventory, cancelled cheques, and sales documents. D) cash, inventory, cancelled cheques, and tangible capital assets.
18) ______
19) Inspection of assets is not a sufficient form of evidence when the auditor wants to determine the A) existence of the asset. B) condition or quality of the asset. C) quantity and description of the asset. D) ownership of the asset.
19) ______
20) Although considerable evidence is obtained from the client through inquiry, it usually cannot be regarded as conclusive because A) the client cannot be trusted. B) it is not from an independent source and may be biased. C) the client may not have sufficient knowledge to answer the question. D) there is a risk that the auditor will misinterpret what the client said.
20) ______
21) Confirmations from outside organizations such as banks and law firms are A) expensive and rarely used during the audit. B) difficult to obtain and infrequently required. C) a highly regarded and often-used type of evidence. D) internal documents that provide low quality evidence.
21) ______
22) Mary is entering a dummy transaction in the purchase order system to see if the system will reject the order for a client that is already exceeding his credit limit. Mary is performing A) analytical procedure. B) parallel simulation.
22) ______
C) test data.
D) observation.
23) When the auditor examines the client's documents and records to support recorded transactions or amounts, it is commonly referred to as A) vouching. B) inquiry. C) confirmation. D) physical examination.
23) ______
24) An example of an internal document is A) employees' time reports. C) a cancelled cheque.
24) ______ B) a bill of lading for purchases. D) a bank statement.
25) An example of an external document is A) a cancelled cheque. B) the minutes of the Board of Directors' meetings. C) inventory receiving reports. D) employees' time reports.
25) ______
26) A document which the auditor receives from the client, but which was prepared by someone outside the client's organization, is a(n) A) external document. B) inquiry. C) internal document. D) confirmation.
26) ______
27) When comparing the reliability of external versus internal documents, the external documents are generally considered A) equally reliable. B) unreliable. C) more reliable. D) less reliable.
27) ______
28) An example of vouching would be to trace from A) the acquisitions journal to supporting vendors' invoices. B) receiving reports to the acquisitions journal. C) cancelled cheques to the cash disbursement journal. D) duplicate bank deposit slips to the cash receipts journal.
28) ______
29) Observation is an important audit technique where the auditor can use sight, hearing, touch, and smell. Observation needs to be used together with other audit techniques because A) employees will often perform their procedures consistently over time. B) auditors may not accurately observe what is happening. C) it is a high cost technique that is rarely used by auditors. D) it is a point in time technique limited to the time of the observation.
29) ______
30) Inquiry is a valuable technique during the planning phase of the audit because it A) is conclusive evidence from an independent source. B) helps obtain information about how procedures and internal controls operate. C) is a type of audit evidence that provides a very high level of assurance.
30) ______
D) involves the rechecking of controls to ensure that they are conducted accurately.
31) Reperformance is often conducted using computer-assisted audit techniques so that it A) can determine on a test basis whether posting and summarization is performed accurately. B) confirms whether evidence has been recorded for the entire period under audit. C) involves selecting a sample of transactions for recalculation. D) can occur for a whole class of transactions, helping to quantify dollar errors.
31) ______
32) An abnormal fluctuation in gross profit that might suggest the need for extended audit procedures for sales and inventories would most likely be identified in the planning phase of the audit by the use of A) specialized audit programs. B) analytical procedures. C) procedures to obtain an understanding of internal controls. D) tests of details of balances.
32) ______
33) "Use of comparisons and relationships to determine whether account balances or other data appear reasonable" is a definition of A) tests of balances. B) tests of controls. C) auditing. D) analytical procedures.
33) ______
34) Analytical procedures may be performed in the engagement during A) the completion phase. B) the planning phase. C) the testing phase. D) any or all of the three phases.
34) ______
35) Which one of the following forms of evidence would be least persuasive in forming the auditor's opinion? A) responses to auditor's questions by the president and controller regarding the investments account B) the auditor's count of marketable securities C) minutes of the board of directors authorizing the purchase of stock as an investment D) correspondence with a stockbroker regarding the quantity of client's investments held in street name by the broker
35) ______
36) Audit evidence can come in different forms with different degrees of persuasiveness. Which of the following is the least persuasive type of evidence? A) vendor's invoice B) bank statement obtained from the client C) prenumbered client sales invoices D) computations made by the auditor
36) ______
37) Which one of the following forms of evidence would be least reliable? A) monthly bank statement B) client's file copy of a purchase requisition C) positive confirmation of customer's balance D) a letter from client's lawyer stating that there are no known lawsuits pending against client
37) ______
38) Most auditors prefer to replace tests of details with analytical procedures whenever possible because A) the tests of details are more expensive. B) the tests of details are more difficult to interpret. C) the analytical procedures are more persuasive. D) the analytical procedures are more reliable.
38) ______
39) The Bank of New Haven relies heavily on computers to calculate the settlements of amounts due to other banks. Given that the process is highly automated, the auditor would not be able to obtain sufficient evidence with substantive procedures. The auditors of the Bank of New Haven should A) hire a specialist to give an opinion on the proper functioning of the system. B) qualify the opinion for the section of settlements. C) perform a walkthrough of the system. D) design and perform tests of controls.
39) ______
40) When an auditor calculates the gross margin as a percent of sales and compares it with previous periods, this type of evidence is called A) observation. B) enquiries of client. C) analytical procedures. D) physical examination.
40) ______
41) When a higher than normal ratio of long-term debt to net worth is coupled with a lower than average ratio of profits to total assets, the company A) is comparable with industry standards. B) has a high risk of financial failure. C) is highly successful. D) has a liquidity problem.
41) ______
42) An aspect of analytical procedures is referred to as "attention-directing" when it highlights A) areas of improvement. B) irregularities. C) errors. D) areas that need more detailed procedures.
42) ______
43) For some audit objectives and in some circumstances, analytical procedures may be the most effective procedure to apply. The objectives that most likely would benefit from the use of analytical review with respect to the allowance for uncollectible accounts would be A) validity of sales transactions recorded for individual customer accounts. B) classification and completeness of transactions, accuracy of judgments and estimates. C) allocation of transactions to the proper accounting period. D) collectability of individual customer account balances.
43) ______
44) When the current year's unaudited trial balance is compared to the prior year's audited trial balance, A) errors are identified. B) irregularities become apparent. C) discrepancies are discovered. D) changes are highlighted.
44) ______
45) In the completion phase of the audit, possible oversights in the audit can be identified by A) review the minutes from the board meetings. B) the partner's knowledge of the client's business combined with effective analytical procedures. C) conducting a meeting with the audit team. D) conducting a closing interview with management of the client.
45) ______
46) An important benefit of industry comparisons is as A) an indicator of irregularities. B) an aid to understanding the client's business. C) a least-cost indicator for audit procedures. D) an indicator of errors.
46) ______
47) If most companies in the industry use FIFO inventory valuation and straight-line depreciation, and the audit client uses LIFO and double-declining balance, comparisons of client and industry data A) will enable the auditor to spot errors but not irregularities. B) may not be meaningful, affecting the comparability of data. C) will enable the auditor to spot irregularities but not errors. D) will be a meaningful highlight of the result of these differences in accounting methods.
47) ______
48) A common comparison occurs when the auditor calculates the expected balance and compares it with the actual balance. The auditor's expected account balance may be determined by A) inquiry of the client. B) using industry standards. C) using credit bureau reports. D) relating it to some other balance sheet or income statement account or accounts.
48) ______
49) The most common statistical technique for analytical procedures is A) bell-curve analysis. B) regression analysis. C) analysis of variance. D) time-series analysis.
49) ______
50) A major benefit of computerized analytical procedures is A) the ease of updating the calculations. B) the ease of doing the calculations. C) the ease of correcting math calculations. D) the ability to push the work down to lower levels of the audit staff to do the analysis.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) The auditor's decisions regarding evidence accumulation can be broken into four subdecisions. One decision relates to determining the nature of the audit procedure to be used to collect the evidence; i.e., "which audit procedures to use." Identify and discuss the remaining three audit evidence decisions that the auditor makes.
52) Identify and explain the three determinants of the persuasiveness of evidence.
53) There are six factors that affect the reliability of audit evidence. One factor is the independence of the provider; i.e., evidence obtained from a source outside the client company is more reliable than that obtained within. Identify and discuss the remaining four factors that affect the appropriateness of evidence.
54) Identify and define the seven categories of audit evidence. Which two types of evidence are the most expensive? Which three types of evidence are the least expensive? Which type of evidence would be most persuasive when testing the existence objective for long-term assets?
55) A) Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable? B) Below are 10 documents typically examined by auditors. Classify each document as either internal or external. Type of Document
Documents 1. Cancelled cheques for payments of accounts payable. 2. Payroll time cards. 3. Duplicate sales invoices. 4. Vendor's invoices. 5. Bank statements. 6. Minutes of the board of directors' meetings. 7. Signed leases agreements. 8. Notes receivable. 9. Subsidiary accounts receivable records. 10. Remittance advices.
56) A) The are four important purposes of analytical procedures. Identify each of these four purposes and, for each purpose, give a specific example of an analytical procedure that an auditor might perform. B) Identify each of the five major types of analytical procedures and give an example of each. C) One purpose of performing analytical procedures in the planning phase of an audit is to assess the client's financial condition. Explain how the assessment of a client's financial condition can affect the
auditor's decisions concerning evidence accumulation in later phases of the audit.
57) Below are 12 audit procedures. Classify each procedure according to the following types of audit evidence: (1) inspection, (2) confirmation, (3) recalculation, (4) observation, (5) inquiry of the client, (6) reperformance, and (7) analytical procedure. Type of Evidence
Audit Procedures 1. Watch client employees count inventory to determine whether company procedures are being followed. 2. Count inventory items and record the amount in the audit working papers. 3. Stand by the payroll time clock to determine whether any employee "punches in" more than one time. 4. Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of gross margin relative to the preceding year. 5. Obtain information about the client's internal controls by asking questions of client personnel. 6. Trace totals from the cash disbursements journal to the general ledger. 7. Examine a piece of equipment to make sure a recent purchase of equipment was actually received and is in operation. 8. Review the total of repairs and maintenance for each month to determine whether any month's total was unusually large. 9. The auditor computes the debt covenant based on the fiancial information to ensure that the client's calculation was performed correctly. 10. Re-foot entries in the sales journal to determine whether they were correctly totalled by the client. 11. Make a surprise count of petty cash to verify that the amount of the petty cash fund is intact. 12. Obtain a written statement from the client's bank stating the client's year-end balance on deposit.
58) Following are examples of evidence that could be collected during an audit of financial statements. 1. Duplicate copies of sales invoices. 2. Examination of new $100,000 cutting machine. 3. Bank confirmation. 4 Remittance advices. 5. Vendor's invoices. 6. Standard letter from lawyer to auditor. 7. Auditor inventory count sheets. 8. Shipping documents. 9. Payroll cheques. 10. Long-term debt agreements review notes. 11. Auditor interest expense calculation worksheet. 12. Observation by auditor of computer error message (invalid supplier number). 13. Gross margin calculation. 14. Interview notes from interview with credit manager. Required: Classify each type of evidence as to its reliability (1 — high, 2 — moderate, 3 — low). Justify your classification.
59) An auditor is conducting the audit of the financial statements of a retail department store. The auditor is aware that he must obtain sufficient appropriate evidence with respect to various audit assertions associated with management assertions and thus with material financial statement amounts. The following is a list of specific audit procedures the accountant plans to perform: 1. Send negative confirmation requests to a large sample of the store's customers with balances due on account at year end. 2. Perform test counts of goods on hand during the company's normal physical inventory taking, one month prior to the year end. 3. Examine receiving reports dated prior to the year end which have not been matched to vendor's invoices. 4. Review paid invoices and supporting documents for amounts classified as repair and maintenance expense for large or unusual items. 5. Examine audited financial statements of several foreign companies in which the client owns shares, and which are being held as temporary investments. Required: For each of the five audit procedures listed, describe only the PRIMARY management assertion being tested, the PRIMARY audit assertion being tested, and the quality of evidence (high, medium, low) obtained, explaining WHY the evidence is the quality level you specify.
60) The following are audit procedures in the sales and collection cycle. 1. Examine a sample of shipping documents to determine if each has a sales invoice number included on it.
on the aged trial balance and compare the total with the general ledger. 2. Disc 4. Observe whether the controller makes an independent comparison of the total on the general ledger with uss with the trial balance of accounts receivable. the sales manager 5. For the month of May, count the approximate number of shipping documents filed in the shipping whether department, and compare the total with the number of sales invoices in the sales journal. any sales allowanc 6. Compare the date on a sample of shipping documents throughout the year with related duplicate sales es have invoices and the accounts receivable master file. been granted 7. Examine a sample of customer orders and see if each has a credit authorization. after the 8. Send letters directly to former customers whose accounts have been charged off as uncollectible to balance determine if any have actually been paid. sheet date that 9. Examine the master file of accounts receivable to see if each has an indication of "C" for a regular may customer, "N" for interest-bearing receivables, and "R" for related parties. apply to the 10. Compare the date on a sample of shipping documents a few days before and after the balance sheet date current with related sales journal transactions. period. Required: 3. Add the For each procedure, identify the type of evidence being used. For each procedure, identify either the columns transaction-related audit objective(s) being met or the balance-related audit objective(s) being met.
1) C 2) B 3) A 4) D 5) C 6) A 7) C 8) B 9) A 10) B 11) A 12) C 13) A 14) B 15) B 16) D 17) D 18) A 19) D 20) B 21) C 22) C 23) A 24) A 25) A 26) A
27) C 28) A 29) D 30) B 31) D 32) B 33) D 34) D 35) A 36) C 37) B 38) A 39) D 40) C 41) B 42) D 43) D 44) D 45) B 46) B 47) B 48) D 49) B 50) A 51) The remaining three audit evidence decisions are: ∙ What sample size to select for a given procedure. This decision relates to the extent of testing to be performed. Once the auditor has identified which procedure to perform, he or she needs to decide the appropriate number of items
in —ranging from one to all items in the population. the ∙ Which items to select from the population. Once the auditor has decided the appropriate number of items to test, he popu or she needs to decide which particular items in the population to examine. latio ∙ When to perform the procedures. This decision relates to the timing of the testing to be performed. Audit n to procedures related to balance sheet accounts which are performed close to the balance sheet date are generally test considered more reliable than procedures performed during the interim period. 52) The three determinants of the persuasiveness of evidence are: ∙ Sufficiency. The sufficiency of evidence is affected primarily by the quantity of evidence obtained. ∙ Appropriateness. Evidence must be considered believable or worthy of trust. The appropriateness of evidence is influenced by six factors: relevance, independence of the provider, effectiveness of the client's internal control, the auditor's direct knowledge, the qualifications of individuals providing the information, and the degree of the evidence's objectivity. ∙ Timeliness. The timing of the evidence in relation to the period covered by the audit.. 53) The remaining four factors that affect the reliability of evidence are: ∙ Auditor's direct knowledge. Evidence obtained directly by the auditor is more reliable than information obtained indirectly. ∙ Independence of provider. Evidence obtained from a source outside the entity is more reliable than that obtained from the organization. ∙ Effectiveness of client's internal control. When a client's internal controls are effective, evidence obtained from the client is more reliable than when controls are weak. ∙ Qualifications of individuals providing the information. Information obtained from persons not familiar with the business world would generally not be considered as reliable as information from an expert in a business-related field. ∙ Degree of objectivity. Objective evidence is more reliable than evidence that requires considerable judgment to determine whether it is correct. ∙ Consistency from multiple sources. Evidence with all sources consistent is more reliable than inconsistent evidence. 54) The seven categories of audit evidence are: ∙ Inspection. Inspection is the inspection or count by the auditor of a tangible asset. ∙ Confirmation. Confirmation involves the receipt of a written or oral response from an independent third party verifying the accuracy of information that was requested by the auditor. ∙ Recalculation. Recalculation involves rechecking the computations and mathematical work completed by the client. ∙ Observation. Observation involves the use of the senses to assess certain activities and events. ∙ Inquiry. Inquiry involves written or oral information from the client in response to questions from the auditor. ∙ Reperformance. Reperformance is the auditor's verification, or rechecking, of the computations and transfers of information made by the client during the period under audit. ∙ Analytical procedures. Analytical procedures involve the use of comparisons and relationships to determine whether account balances or other data appear reasonable. The two most expensive types of evidence are physical examination and confirmation. The three least expensive types of evidence are observation, enquiries, and reperformance. Physical examination would be most persuasive when testing the existence of long-term assets. 55) A) Internal documentation involves the auditor's examination of documents that have been prepared and used within the client's organization and are retained without ever going to an outside party. Examples would include duplicate sales invoices, employees' time reports, and inventory receiving reports. External documentation involves the auditor's examination of documents that have been in the hands of someone outside the client's organization. Examples include vendors' invoices, cancelled cheques, cancelled notes payable, and insurance policies.
as more reliable evidence than internal documents. Exter nal B) docu 1. External 6. Internal ment 2. Internal 7. External s are 3. Internal 8. External regar 4. External 9. Internal ded 5. External 10. External 56) A) Four important purposes of analytical procedures are: ∙ To help the auditor understand the client's industry and business, the auditor might analyze recent trends in the client's gross margin percentages to assess the effects of competition in the industry. ∙ To aid in the assessment of the client's ability to continue as a going concern, the auditor might analyze several of the client's key ratios including the ratio of long-term debt to net worth, the ratio of profits to total assets, and the current ratio. ∙ To indicate the presence of possible misstatements in the financial statements, the auditor might compare the current year's unaudited account balances with the previous year's audited balances. ∙ To reduce the extent of detailed tests, the auditor might perform a simple analytical procedure such as multiplying the client's monthly rent times 12 as a test of the client's rent expense account. If the product agrees with the balance in rent expense, no additional testing of the account may be necessary. B) The five major types of analytical procedures are: ∙ Compare client and industry data. Compare the client's gross margin percentage with the industry's average gross margin percentage to compare the client's performance with that of the average company in the industry. ∙ Compare client data with similar prior-period data. Compare the client's gross margin percentage for the current year with that of the previous two years to compare the client's performance in the current year with that of previous years. ∙ Compare client data with client-determined expected results. Compare client's current year raw material expense with budgeted expense. ∙ Compare client data with auditor-determined expected results. Calculate an expected value for the allowance for bad debts account by multiplying the three-year moving average of the client's allowance as a percentage of gross accounts receivable by the current year's ending balance in gross accounts receivable, then compare this expected value with the client's actual value. ∙ Compare client data with expected results using nonfinancial data. Calculate an expected value for the client's payroll by multiplying total hours worked by the wage rate, then compare the resulting product with the client's recorded payroll expense. C) The weaker the client's financial condition, the more assurance the auditor will require that the financial statements are free of material misstatements. As the auditor requires greater assurance, he or she can (1) perform detailed testing closer to the balance sheet date, (2) increase the extent of detailed testing, or (3) perform more reliable procedures. If the auditor believes the entity is not a going concern, he or she will require proper financial statement disclosure and presentation in order to issue an unqualified audit opinion. 57) 1. 2. 3. 4. 5. 6.
Observation Inspection Observation Analytical procedure Inquiry of the client Reperformance
58) 1.
Moderate — Internal Documentation if internal control (I/C) is good; otherwise, low if I/C is poor mark
2.
7. Inspection 8. Analytical procedure 9. Recalculation 10. Recalculation 11. Inspection 12. Confirmation
High — Physical Examination — Auditor's direct knowledge
— Document has been circulated to a party outside the entity 3. 5. High — 6. Conf irmat 7. ion 8. —
High — External Documentation — Evidence comes from an external party High — Confirmation — Independence of provider High — Physical Examination — Auditor's direct knowledge Moderate — Internal Documentation if internal control is good; otherwise, low if I/C is poor
Inde pend 9. High— External Documentation — Evidence comes from an external party ence 10. High — External Documentation — Evidence comes from an external party of provi 11. Moderate — Analytical Review — Reasonableness test der 4.
(Also valid: High — reperformance)
12. Moderate — Observation — Client is aware that the auditor will be observing High — 13. Moderate — Analytical Review — Reasonableness test Exter nal (Also valid: High — reperformance) Docu ment 14. Low — Enquiry of Client — Evidence is not from an independent source ation 59) Management Assertion
Quality of Audit Assertion Evidence Evidence Explanation - negative confirmations involve third parties 1. existence, or - but treat non-responses as agreement with the validity, or recorded balance occurrence, or existence or - negative confirmations provide the best form accuracy or accuracy or of evidence when internal controls are cut-off cut-off low considered good - personal observation by auditor - but it occurs a month prior to the balance sheet 2. existence or date validity or medium - [difference between medium or high] depends occurrence existence or high upon the quality of the internal controls - formal client document - quality depends on strength of internal controls surrounding preparation of receiving 3. completeness completeness medium reports - third party document (invoice) and - client documents (receiving report and purchase order) - quality depends on strength of internal controls surrounding preparation of internal 4. measurement classification high documents valuation (or - third party document held by client increases realizable quality but 5. valuation value) low - document is not audited
60) Type of evidence 1. reperformance 2. inquiry 3. recalculation 4. observation 5. analytical review procedures 6. reperformance 7. reperformance 8. confirmation 9. reperformance 10. reperformance
Audit objective(s) Completeness Cut-off Detail tie in/posting and summarization Detail tie in/posting and summarization n/a Timing Occurrence Existence, accuracy, realizable value Classification, presentation, and disclosure Cut-off
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If the auditor assessed the detection risk as high, the extent of evidence the auditor plans to 1) _______ accumulate is A) need more information to conclude. B) medium. C) high. D) low.
2) Audit risk is ordinarily set by the auditor during planning and A) varies by each major cycle but is constant by account. B) held constant for each major cycle and account. C) held constant for each major cycle but varies by account. D) varies by each major cycle and by each account.
2) _______
3) The audit risk model is used primarily A) to evaluate the evidence which has been gathered. B) to determine the type of opinion to express. C) for planning purposes in determining how much evidence to accumulate. D) while doing tests of controls.
3) _______
4) The audit risk model is A) useful in evaluating results but of limited use in planning. B) a planning, testing, and evaluation model. C) useful in planning but of limited value in evaluating results. D) useful when performing the tests of balances, but of little value in either the planning or evaluation stages.
4) _______
5) Audit risk is a measure of A) the probability that the financial statements contain errors. B) the probability that errors in the financial statements that were not detected by the internal controls of the firm are not detected by the auditor. C) the auditor's assessment of the likelihood that a material misstatement might occur in the first place. D) how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed.
5) _______
6) PA has set audit risk at 2% and determined that inherent risk is 60%. What is the level of targeted audit assurance? A) 98% B) 40% C) 60% D) 2%
6) _______
7) If audit risk is increased, what happens to detection risk? It A) decreases. B) changes based upon the audit procedures conducted. C) increases. D) stays the same.
7) _______
8) Using the audit risk model, audit risk is targeted assurance, while control risk and inherent risk are assessed based upon a variety of factors. Of the components of the audit risk model, which is likely to be set to 100%? A) audit risk B) detection risk C) control risk D) inherent risk
8) _______
9) Assessing design effectiveness and tests of controls are required when A) the auditor is planning the audit. B) the auditor chooses to set control risk below 100 percent even it there is no reliance placed on controls. C) the auditor chooses to set control risk below 100 percent and relies on the controls. D) the auditor should always test the design effectiveness.
9) _______
10) What is the role of internal controls during the assessment of inherent risk? A) As the quality of internal controls improves, inherent risk increases. B) Internal controls are considered separately, so they are ignored during the assessment of inherent risk. C) As the quality of internal controls increases, inherent risk decreases. D) There is a direct relationship between the quality of internal controls and inherent risk.
10) ______
11) In addition to representing an assessment of whether a client's internal control is effective for preventing or detecting misstatements, control risk also represents the A) possibility of collusion occurring between two employees. B) reliability of management in preventing or detecting fraud. C) auditor's intention to rely on internal controls. D) likelihood that the auditor will detect illegal acts.
11) ______
12) As the effectiveness of internal control increases, what happens to the risk factor that could be assigned to control risk? It A) changes based upon the audit procedures conducted. B) decreases. C) stays the same. D) increases.
12) ______
13) The risk that an auditor's procedures will lead to the conclusion that a material error does not exist in an account balance when, in fact, such error does exist is referred to as A) inherent risk. B) audit risk. C) detection risk. D) control risk.
13) ______
14) Because control risk and inherent risk vary from cycle to cycle, account to account, or objective to objective, A) detection risk and required audit evidence will also vary. B) detection risk will vary but audit evidence will remain constant. C) detection risk will remain constant but audit evidence will vary. D) audit risk must remain a constant.
14) ______
15) An inherent risk (IR) of 40% and a control risk (CR) of 60% affect detection risk and planned evidence differently than an A) IR of 70% and CR of 30%. B) IR of 80% and CR of 30%. C) IR of 100% and CR of 24%. D) IR of 60% and CR of 40%.
15) ______
16) The auditor set audit risk at 5%, inherent risk at 100%, and control risk at 50%, and determined a detection risk of 10%. If control risk had been 80%, detection risk would be about A) 5%. B) 16%. C) 6%. D) 10%.
16) ______
17) If detection risk is reduced, the amount of evidence the auditor accumulates will A) remain unchanged. B) be indeterminate. C) increase. D) decrease.
17) ______
18) With respect to clients, business risk arises when conditions, events, circumstances or inactions A) adversely affect the entity's ability to achieve its objectives. B) cause employees to not do their job properly. C) result in an assessment of poor internal controls. D) result in the company continuing profitable operations.
18) ______
19) A PA firm can experience high levels of business risk if the audit firm A) has a generous vacation policy for its staff. B) has clients that do not pay their bills, or experiences significant litigation. C) pays its employees wages that are not in line with the market. D) does a poor job on preparing client risk profiles.
19) ______
20) When external users place heavy reliance on the financial statements it is appropriate that A) audit risk be decreased. B) audit risk be increased. C) inherent risk be decreased. D) inherent risk be increased.
20) ______
21) All other factors held constant, if the auditor decreases audit risk then A) it will also be necessary to decrease either control risk or inherent risk. B) there will be less documentation in the audit file. C) less supervision will be required of the audit team. D) total audit evidence and audit costs will increase.
21) ______
22) An important role of inherent risk assessment during the audit process is the need to A) increase the level of analytical review. B) train the audit staff to assess the integrity of management. C) attempt to predict where misstatements are most and least likely in the financial statement segments. D) document the quality of the disaster recovery plan.
22) ______
23) How much control does the auditor have over inherent risk? The auditor
23) ______
A) calculates inherent risk values as a residual — no control. B) adjusts the controls that are considered — high levels of control. C) considers inherent risk for the business as a whole — some control. D) assesses the factors that make up inherent risk — no control.
24) If inherent risk is considered at the assertion level, why does the nature of the client's business affect inherent risk? A) When there is a risk of technological obsolescence, a specialist must be used during the engagement. B) If the client has really basic manufacturing processes, inherent risk is low. C) Certain accounts, such as inventory, are affected by the nature of the client's business. D) Accounts such as cash, notes and mortgages payable vary depending upon the type of business.
24) ______
25) The inherent risk of programming errors (and thus processing errors for the affected application systems) increases when A) programs are customized by an external software house. B) programs are customized by an understaffed information system group. C) the company uses an internet-based applications service provider. D) standard software packages are used for processing transactions.
25) ______
26) Which one of the following would be a signal as to possible problems with management integrity? A) frequent disagreements with regulators and the Canada Revenue Agency B) rotation of holidays in the supervisory area over a period of months C) rapidly declining profits or increasing losses over a period of years D) reliance on debt rather than equity for financing permanent assets
26) ______
27) You generally consider your audit client's management to be honest. However, they do have a bias towards wanting to understate their income to lower income taxes. How would this bias be implemented in the audit risk model? A) reduce audit risk and reduce inherent risk B) reduce audit risk and increase inherent risk C) increase audit risk and reduce inherent risk D) increase audit risk and increase inherent risk
27) ______
28) PA is auditing a client where the accounts receivable are in worse shape than last year: many accounts are significantly overdue. How would this fact be dealt with in the audit risk model? A) decrease control risk for accounts receivable B) decrease inherent risk for accounts receivable C) increase control risk for accounts receivable D) increase inherent risk for accounts receivable
28) ______
29) If it is probable that the judgment of a reasonable person would have been changed or influenced by the omission or misstatement of information, then that information is, as defined in the CICA Handbook,
29) ______
A) insignificant.
B) significant.
C) relevant.
D) material.
30) CAS 320 (Materiality in planning and performing an audit) defines materiality in terms of three key concepts. The first and second concepts are that a material misstatement should be considered in the context of knowledgeable users and the effect on decision making and that material is relative to circumstances surrounding the decision and nature of the information. The third concept is A) that the users should be informed and approve of the materiality used by the auditor. B) that the auditor should consider users of financial statements as a group. C) that the auditor should consider users of financial statements individually. D) that the auditor should be conservative in setting the materiality level.
30) ______
31) If an auditor determines that there is a material misstatement, brings it to the client's attention, and the client refuses to correct the statements, the auditor will issue A) a denial of opinion. B) an unqualified or qualified opinion. C) either a qualified or an adverse opinion, depending on how material the misstatement is. D) an adverse opinion.
31) ______
32) The first step in applying materiality is A) setting a preliminary judgment about materiality. B) estimating the misstatement in a segment. C) comparing the error estimate with the materiality levels. D) estimating the combined effects of errors.
32) ______
33) Which of the following types of misstatements has the highest level of certainty? A) further possible misstatements B) likely aggregate misstatements C) likely misstatements D) identified misstatements
33) ______
34) Further possible misstatement considers A) imprecision in the audit procedures. B) possible presence of management fraud. C) imprecision in the sampling process. D) possible lack of knowledge of the audit team.
34) ______
35) The preliminary judgment about materiality is the ________ amount by which the auditor believes the statements could be misstated and still not affect the decisions of reasonable users. A) median average B) minimum C) maximum D) mean average
35) ______
36) Silka is in the process of performing the audit. In this process, Silka decided to change the materiality. A valid reason for this would be A) a fraud was discovered in the accounts payable section. B) the reviewing partner indicated he would feel more comfortable if additional tests were performed and materiality was lower.
36) ______
C) the planning materiality required the auditors to perform too many tests. D) a new user of the financial statement was identified in the process.
37) If the auditor sets a low dollar amount as the preliminary judgment about materiality, A) it has no effect on the amount of evidence required. B) less evidence is required than for a high amount. C) the same amount of evidence is required as for a high dollar amount. D) more evidence is required than for a high amount.
37) ______
38) Since materiality is relative, it is necessary to have bases for establishing whether misstatements are material. Normally, the most important base for deciding what is material, because it is regarded as a critical item of information for users, is A) net income before taxes. B) total assets. C) net working capital. D) net income.
38) ______
39) The auditors have decided upon a materiality level of $100,000 for their audit of ABC Manufacturing. Which one of the following errors would be considered more important by the auditors? An A) overstatement of accounts payable by $15,000 B) illegal payment of $5,000 C) error in allocation between accounts receivable and accounts payable by $75,000 D) error in accounts receivable cut-off of $50,000
39) ______
40) The preliminary judgment about materiality for Holloy Company is $75,000. There are carryforward misstatements of $25,000 from the previous year. Current year anticipated misstatements are $15,000, with anticipated corrections of $10,000. What is the materiality available for unanticipated misstatements? A) $50,000 B) $55,000 C) $45,000 D) $90,000
40) ______
41) The preliminary judgment about materiality should be adjusted for the effect of net anticipated misstatements to determine materiality available for A) further possible misstatements. B) likely misstatements. C) unanticipated misstatements. D) identified misstatements.
41) ______
42) When an auditor allocates materiality to segments, then the materiality amount for different accounts under audit will A) potentially differ from each other. B) require the same amount of audit work. C) be the same for each account audited. D) require the same level of unanticipated misstatements.
42) ______
43) The estimate for sampling error results because the auditor has sampled only a portion of the population. Sampling error represents the A) minimum misstatements in accounts not audited. B) maximum misstatements in the audited accounts.
43) ______
C) maximum misstatements in accounts not audited. D) minimum misstatements in the audited accounts.
44) The purpose of allocating planning materiality to balance sheet accounts is to A) assess the appropriate evidence to accumulate for each account on the balance sheet. B) increase the possibility that fraud or illegal activities would be detected by audit procedures. C) assess the appropriate evidence to accumulate for each account on both the balance sheet and income statement. D) reduce the amount of procedures done in the course of the audit.
44) ______
45) If an auditor were to calculate an estimate of the errors by direct projection from the sample to the population, and found $7,000 of net overstatement errors in a sample of $100,000 out of a total population of $900,000, the estimate of errors in the population is A) $63,000. B) $778. C) $77,778. D) $6,300.
45) ______
46) Risk in auditing means that the auditor accepts some level of uncertainty in performing the audit function. An effective auditor will A) perform the audit procedures first and quantitatively set the risk level before forming an opinion and writing the report. B) set the risk level between 5% and 10%. C) take any means available to reduce the risk to the lowest possible level. D) recognize that risks exist and deal with those risks in an appropriate manner.
46) ______
47) When the auditor has the same level of willingness to risk that material errors will exist after the audit is finished for all five cycles, A) a different extent of evidence is needed for various cycles. B) the same amount of evidence will be gathered for each cycle. C) he/she has not followed generally accepted auditing standards. D) the level for each cycle must be no more than 2% so that the entire audit does not exceed 10%.
47) ______
48) When a different extent of evidence is needed for the various cycles, the difference is caused by A) the auditor's need to follow GAAS. B) errors in the client's accounting system. C) the auditor's expectations of errors and assessment of internal control. D) the client's need to achieve an unqualified opinion.
48) ______
49) As the audit progresses and additional information about the client is obtained, the acceptable level of audit risk A) may not be reduced because it would become statistically invalid, but it may be increased. B) may not be increased because it would become statistically invalid, but it may be reduced. C) may not be modified. D) may be modified.
49) ______
50) In order to reduce assessed control risk, the auditor could A) conduct more extensive tests of controls. B) conduct more extensive substantive procedures. C) conduct more extensive substantive procedures and obtain management's certification with regards to the effectiveness of internal controls. D) conduct more extensive tests of controls if the client has effective controls.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Discuss each of the five steps in applying materiality in an audit, and identify the audit phase(s) in which each step is performed. B) Discuss the three main factors that affect an auditor's preliminary judgment about materiality.
52) A) Discuss how auditors use the audit risk model when planning an audit. B) Describe the audit risk model and each of its components.
53) A) There are several factors that affect an audit firm's business risk, and therefore audit risk. Discuss three of these factors. B) There are several factors the auditor should consider when assessing inherent risk. Discuss four of these factors, and for each factor, explain the factor's effect on the auditor's assessment of inherent risk.
54) Below are four situations that involve the audit risk model as it is used for planning audit evidence requirements in the audit of inventory. For each situation, calculate planned detection risk. SITUATION 1
2
3
4
Audit risk
1%
10%
10%
5%
Inherent risk
100%
100%
50%
20%
Control risk
100%
100%
40%
30%
Detection risk
________
________
________
________
55) In practice, auditors rarely assign numerical probabilities to inherent risk, control risk, or audit risk. It is more common to assess these risks as high, medium, or low. For each of the four situations below, fill in the blanks for detection risk and the amount of evidence you would plan to gather ("planned evidence") using the terms high, medium, or low. SITUATION 1
2
3
4
Audit risk DetectionLow risk
________ Low
________ High
________ High
________
Planned High Inherent risk evidence
Low ________
Low ________
Low ________
_______
High
Low
Control risk
Medium
Low
56) Lauralye Leasing Limited (LLL) provides lease financing to companies and individuals for equipment other than automobiles. Leases on commercial signs make up 50% of total leases, computer and telecommunications equipment are 30% and restaurant equipment makes up most of the remainder. LLL's customers arrange to buy new equipment from equipment dealers, then contact LLL to arrange lease financing. LLL was founded over thirty years ago by Laura and Al Ye. It is now run by Mr. and Mrs. Ye's daughter, Betsy, who is the President of LLL. LLL owns a small building downtown, where the offices of the business are located. Unused office space is rented out to other commercial tenants. Betsy was a classmate of yours at York University, and you have kept loosely in touch over the years. This year, she moved the audit to your firm (a local firm with five partners), deciding that the firm her parents had hired many years ago did not really understand her business' needs. LLL has a small loan that is used to cover blips in working capital. The company has two salespeople. Most loans are received from stores throughout the city, with whom LLL has standing agreements. If customers require financing, they fill in an application at the store, which is faxed to LLL for approval. LLL will reply within two business days. The company has been profitable for many years. There are no extraordinary items in the current year's financial statements. Selected financial information is as follows: Current assets Long term assets Short term liabilities Shareholders' equity Revenue Expenses Income before tax (and before bonus)
$9,910,000 $46,500,000 $30,700,000 $25,710,000 $10,200,000 $5,600,000 $4,600,000
Required: A)
Which base would you use to calculate materiality? Why?
B)
Calculate materiality. Choose a specific number, and explain why you chose that amount.
57) Your firm has been appointed as the auditor of Bush Mining Inc. (BMI), a company that runs small mining operations in remote areas of northern Canada, primarily in surface mines. You have been assigned the job of audit senior for BMI. BMI's operations are subject to provincial and federal laws and regulations. These laws and regulations have become stricter in recent years and some of BMI's older mines may be in violation of environmental laws. Surface mining produces tailings (toxic wastes that are dangerous to animal and plant life). These tailings are either further processed and buried or retained in tailings ponds. BMI is required to restore the mining property to a safe condition after a mine is exhausted. BMI has programs in place to monitor and
control waterways. pollutant s that are Required: released to the air A) What factors would affect the business risk of BMI? Based upon your assessment of BMI's business risk, would you adjust audit risk? Why or why not? and to local B) What is your preliminary assessment of audit risk? Justify your answer.
58) Gorgon Corp is a large producer of bread and baked goods. Gorgon is a medium size company operating in the Toronto area and currently has 2% of the market share for baked goods producers in his region. Gorgon has been in business for 5 years and his business has managed to grow their revenues by 10% each year. Gorgon has also managed to be profitable since their third year of operation. However, Gorgon Corp indicated that growth is becoming more difficult with large national and international competitors that can offer lower cost good. The food industry is very price sensitive, which is why they had to reduce their price to be able to compete. Although this price reduction helped them compete, it reduced their gross margin by 5% in the past year. To help finance the company, Gorgon took a loan from the bank for $15,000,000 when the company started. Gorgon only had to pay the interest portion for the first 5 years, but they will have to start making principal payments in the current year in addition to the interest payments. Gorgon has requested the audit services of your firm and the partner asked you to evaluate the risk of financial failure for Gorgon Corp.
59) GreenGrow Limited is a local landscaping company that does household and commercial landscaping. Primarily, they help business select plants and manage the plants. They also have regular maintenance contracts such as watering, weeding, and mowing. In the winter, they have some contracts for managing the indoor plants of shopping malls, and do snow clearing to help boost that low income season. Joey, the majority shareholder of GreenGrow is ecstatic. He has managed to come in as the low bidder for a new type of contract. He bid on the construction of a track for the track and field area of a local university. A piece of land on the north end of the university is being cleared and GreenGrow will be leveling the land and placing a bed of crushed stone for the track. Joey has just the right person to be in charge. Jack has previous experience working as an assistant on a road crew and knows how to use the surveying equipment needed to keep the track level. This is a big contract, and will increase revenues by one third! Required: Assess inherent risk for revenue for GreenGrow Limited.
60) Big Box Distribution Company (see also question 59) has an in-house information systems department of 50 people. The company generally does its own programming, although some software was acquired as a software package. In addition, a software package was purchased for customer relationship management, which will be modified by the programming staff. Procedures for implementing programs vary by department. All major changes are approved by the Management Information Systems steering committee. The committee is also given a list of the maintenance changes that are planned in the coming year. Some departments request that the data processing department
handle and want to do their own testing. testing, Requirements are generally prepared in writing, although small maintenance changes may be handled while verbally. other users are Required: rather Assess inherent risk associated with program changes at Big Box. picky
1) D 2) B 3) C 4) C 5) D 6) A 7) A 8) C 9) C 10) B 11) C 12) B 13) C 14) A 15) A 16) C 17) C 18) A 19) B 20) A 21) D 22) C 23) D 24) C 25) B 26) A
27) B 28) D 29) D 30) B 31) C 32) A 33) D 34) C 35) C 36) D 37) D 38) A 39) B 40) C 41) C 42) A 43) C 44) C 45) A 46) D 47) A 48) C 49) D 50) D 51) A) Step 1. Set planning materiality. This is the combined amount of misstatements in the financial statements that would be considered material. This decision is made in the planning stage of the audit. Step 2. Allocate planning materiality to segments (not commonly done). In this step, some auditors allocate the
preli performed in the audit planning stage. mina Step 3. Estimate total misstatement in segment. In this step, the auditor projects the sample results to the population. ry An allowance for sampling risk is also calculated. This would be performed after the substantive tests for each judg account are completed. ment Step 4. Estimate the combined misstatement. In this step, the projected errors for each account are added, along with abou total sampling error, to calculate the combined misstatement. This would be performed after all substantive tests t have been completed. mate Step 5. Compare combined estimated misstatement with preliminary or revised judgment about materiality. If the combined rialit estimated misstatement is less than or equal to the judgment about materiality, then the auditor concludes the y to financial statements are fairly presented. This would be performed after all substantive tests have been completed, the in the final review stage of the audit. bala nce B) The three main factors that affect an auditor's judgment about materiality are: sheet ∙ Materiality is a relative rather than an absolute concept. A misstatement of a given size might be material for a small acco company, whereas the same dollar misstatement could be immaterial for a larger one. unts. ∙ Bases are needed for evaluating materiality. Since materiality is relative, it is necessary to have bases for This establishing whether misstatements are material. Net income before taxes is normally the most commonly used alloc base, but other possible bases include total assets, revenue, gross profit, and owners' equity. ation ∙ Qualitative factors also affect materiality. Certain types of misstatements are likely to be more important to users is than others, even if the dollar amounts are the same, such as misstatements involving irregularities. 52) A) The audit risk model is used primarily for planning purposes in deciding how much evidence to accumulate in each cycle. The auditor decides an acceptable level of audit risk, assesses inherent risk and control risk, and then uses the relationship depicted in the following model to determine an appropriate level for detection risk:
PDR = B)
.
The planning form of the audit risk model is stated as follows:
PDR where: PDR AR IR CR
= = = = =
. planned detection risk audit risk inherent risk control risk
Detection risk is a measure of the risk that audit evidence for an account will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. Detection risk determines the amount of substantive evidence that the auditor plans to accumulate. Audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. It is influenced primarily by the degree to which external users will rely on the statements, the likelihood that a client will have financial difficulties after the audit report is issued, and the auditor's evaluation of management's integrity. Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements in an account before considering the effectiveness of internal control. Control risk is a measure of the auditor's assessment of the likelihood that misstatements exceeding a tolerable amount in an account will not be prevented or detected by the client's internal controls.
53) A) Business risk and audit risk are affected by: ∙ The degree to which external users will rely on the statements. For large, publicly-held clients, business risk is greater, and acceptable audit risk will be less, than for small, privately held clients, ceteris paribus. ∙ The likelihood that a client will have financial difficulties after the audit report is issued. Business risk is greater, and acceptable audit risk will be lower, when the client is experiencing financial difficulties. ∙ The auditor's evaluation of management's integrity. Business risk is greater, and acceptable audit risk will be lower, when the client's management has questionable integrity. B) Factors the auditor should consider when assessing inherent risk include: ∙ Nature of the client's business. When auditing inventory, inherent risk would be greater for high-tech clients than for a steel fabricator. ∙ Nature of Data Processing Systems: Customized systems are more prone to error, as are systems with complex configurations. ∙ Integrity of management. If an auditor has some concerns about the integrity of members of management, the auditor's assessment of inherent risk will increase. ∙ Client motivation. If management has a strong incentive to "window-dress," the auditor's assessment of inherent risk will increase. ∙ Results of previous audits. If the auditor has uncovered many misstatements in the client's previous financial statements, the current year's assessed inherent risk will increase. ∙ Initial vs. repeat engagement. Most auditors set a high inherent risk in the first year of an audit and reduce it in subsequent years as appropriate. ∙ Related parties. Inherent risk is higher when there are transactions between related parties. ∙ Nonroutine transactions. Since unusual transactions have a higher likelihood of being recorded incorrectly by the client, inherent risk for these transactions is higher than for normal, routine transactions. ∙ Judgment required to correctly record account balances and transactions. Since accounts and transactions that require estimates and judgments have a higher likelihood of being handled incorrectly, inherent risk for these accounts and transactions is higher than for items that require little judgment. ∙ Susceptibility to misappropriation. If cash, inventory, or marketable securities are not closely controlled, the risk that employees may convert these assets to personal use is increased, which increases inherent risk for the accounts. ∙ Makeup of the population. Overdue accounts receivable are associated with higher inherent risk than current receivables. 54) 1. 1%; 2. 10%; 3. 50%; 4. 83.3% 55) 1. 2. 3. 4.
low, high medium, medium medium, medium high, low
56) A) Normally, net income before income taxes and bonus would be used to calculate materiality. The company has been profitable for many years, and there is no need to consider other bases. Gross profit applies more to companies that sell products or have direct costs associated with products. Total assets, equity and revenue are used as bases if net income fluctuates or if the company is experiencing losses. B) The range applied to net income is 5% to 10%, which would result in a materiality range of $230,000 to $460,000. The company is a private company, with the shareholders and the bank as users. Due to the few users, we would likely go towards the larger end of this range, i.e. $460,000. 57) A) The factors that affect business risk also affect audit risk. Each factor is discussed in turn: Reliance on statements by external users: BMI likely has shareholders, financial institution and regulatory agencies (such as environmental agencies and Canada Revenue Agency) using the financial statements.
Likeli probably has fluctuating profits, depending upon metal commodity prices. Also, if there are heavy fines or hood environmental problems, this increases the risk of financial failure. of finan Management's integrity: There are no indicators of management integrity problems. However, management cial probably has a bias towards not disclosing environmental violations. failur Based upon the above factors, I would lower audit risk because of the likely volatility of the business and the e: The potential for exposure with respect to environmental matters. com pany B) I would assess audit risk as low, due to factors discussed in (a). 58) The risk of financial failure can be broken down in the following category: - Liquidity position: Although there is no indication that Gorgon had liquidity problems in the current year, with the principal repayments for the upcoming year combined with the reduced gross margin, there is a possibility that Gorgon will have liquidity problems in the coming year. - Profits in the previous year: The profits decreased, but Gorgon is still profitable. - Method of financing growth: Gorgon currently has a large outstanding loan with the bank. This makes it riskier as the loan is repayable and the creditor could push Gorgon into bankruptcy if they failed to make a payment. - Nature of client's operations: The baked goods business appears to be very competitive and price sensitive, this makes it increasingly difficult for Gorgon to compete and to achieve economies of scales. Not being able to compete with the large players could push Gorgon into bankruptcy. Further the baked goods business has a high risk of obsolescence for their inventory. This can also be considered as failure to predict demand properly could also significantly affect the profitability of Gorgon.
59) I would assess inherent risk for revenue for GreenGrow Limited as high. Reasons: ∙ Income in the winter season is volatile, depending upon snowfall. ∙ There is a new contract for a track which is expected to comprise 30% of income. GreenGrow has never done this kind of work, and may not be able to complete the contract in a timely manner. ∙ The above is a non-routine transaction which may be recorded incorrectly; we will need to determine that the costs and revenues are properly matched in this contract, which will require different accounting methods than maintenance and landscaping revenues. 60) Inherent risks for programming errors are high. This means that there could be incorrect or unauthorized program changes, particularly for those departments where the information systems department handles all of the testing. Reasoning: The following behaviours increase the risks of unauthorized or incorrect program changes: ∙ Maintenance changes do not require independent approval (this means that anyone can initiate a program change). ∙ Maintenance changes may be made without a written request or may not be documented (same as above, it also means that program change may be made without being documented or tested). ∙ Customized systems are in use; customized systems are used by only one business, i.e. Big Box, and tend to have less testing and documentation than package systems, meaning that there is a greater likelihood of program
error .
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) An effective audit is one that 1) _______ A) does not contain errors of a dollar amount higher than 5% of the net income of the company. B) is completed on time and within budget. C) ensure that there are no errors contained in the financial statements. D) reduces the audit risk to the targeted level.
2) An important reason for adequately planning the audit engagement is to A) keep audit risk as low as possible. B) enable the auditor to obtain sufficient appropriate audit evidence. C) properly design the contents of the engagement letter. D) help decide whether the engagement should be accepted.
2) _______
3) A measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued is the A) statistical risk. B) financial risk. C) inherent risk. D) audit risk.
3) _______
4) A measure of the auditor's assessment of the likelihood that there are material misstatements in a segment before considering the effectiveness of internal controls is A) control risk. B) audit risk. C) statistical risk. D) inherent risk.
4) _______
5) Investigation of new clients and reevaluation of existing ones is an essential part of deciding A) statistical risk. B) acceptable audit risk. C) financial risk. D) inherent risk.
5) _______
6) When the auditor decides that lower audit risk on an audit is appropriate, then A) less extensive review of the working papers is required. B) less evidence is required to decrease audit assurance. C) inherent risk will also need to be modified to compensate. D) the engagement may require more qualified staff.
6) _______
7) The purpose of developing a client risk profile is to assist the auditor in A) developing the pertinent audit procedures for tests of internal controls. B) locating related parties that need to be disclosed. C) assessing the client's business risk. D) deciding whether fraud or illegal acts have taken place.
7) _______
8) It is important for the auditor to obtain a good understanding of the industry of the client to develop a client risk profile. If the auditor is looking at a high technology software company, a risk specific to the industry would be A) the high risk of defective products.
8) _______
B) the volatility in the stock market with regards to high technology company's stock. C) the high risk of obsolescence of their inventory. D) the high risk of poor governance and management oversight as high technology companies normally grow with multiple acquisitions.
9) GAAP requires financial instruments to be recorded at fair market value. This can result in complex calculations and valuations when a market for the financial instrument does not exist. Krammer LLP, a PA firm turned down the mandate for Scotia Capital, an investment company due to the complexities and risks around valuation of the various financial instruments Scotia Capital holds and their lack of experience in the valuation area. Krammer LLP turned down the client based on the A) management and governance as management's valuation of the investment cannot be relied upon. B) specific requirements to evaluate whether the client's financial statements are in accordance with GAAP. C) operational and reporting structure. D) lack of internal controls over valuation at Scotia Capital.
9) _______
10) In order to assess if the company is a going concern, the auditor can calculate the ________ during the planning and compare with previous years and successful companies in the industry. A) inventory turnover ratio B) accounts receivable turnover ratio C) gross margin ratio D) debt to equity ratio
10) ______
11) In order to understand the client's business and industry, the auditor can calculate the ________ during the planning and compare with industry averages. A) key ratios B) gross margin C) debt to equity D) interest coverage ratio
11) ______
12) After discovering that a related-party transaction exists, the auditor should be aware that the A) transaction is assumed to be outside the ordinary course of business. B) substance of the transaction could be significantly different from its form. C) financial statements should recognize the legal form of the transaction rather than its substance. D) adequacy of disclosure of the transaction is secondary to its legal form.
12) ______
13) An auditor searching for related-party transactions should obtain an understanding of each subsidiary's relationship to the total entity because A) the business structure may be deliberately designed to obscure related party transactions. B) this may reveal whether particular transactions would have taken place if the parties had not been related. C) intercompany transactions may have been consummated on terms equivalent to arm's-length transactions. D) this may permit the audit of intercompany account balances to be performed as of concurrent dates.
13) ______
14) Mario, the owner of Clayton's ice cream, is giving Steve, the manager of the audit, a private tour
of
the
producti 14) on facilities. By doing the tour, Steve will A) be better able to identify control risks. B) be able to gather audit evidence. C) understand the client's business and operations better. D) Steve should not be taking a tour alone with the owner as this could compromise his independence.
___ ___
15) The least effective method of identifying related parties would be A) a review of the purchases and sales journals for the period under audit. B) an inquiry of management. C) a review of filings with regulatory bodies. D) an examination of shareholders' listings to identify principal shareholders.
15) ______
16) Simon owns a clothing store, Simonello. Simonello recently purchased a material amount fabrics from Simonique Inc., a textile company also owned by Simon. With regards to this transaction, the auditors should A) qualify the audit report as this puts into question management's integrity. B) inspect the textile received in the warehouse to ensure that the amount sent equals the amount ordered. C) request a confirmation from Simonique that the transaction took place. D) ensure that the transaction is disclosed in the financial statements.
16) ______
17) The auditor will obtain a copy of the client's articles of incorporation (if applicable) and retain a copy in the permanent file. Important information in the articles of incorporation includes A) the interest rates that are being received on long term notes invested. B) voting rights of each class of shares issued by the company. C) the interest rates currently being paid for bonds that have been issued. D) which shares have been redeemed by the company in the current year.
17) ______
18) An effective board of directors helps ensure that the company takes only appropriate risks. The audit committee can A) reduce the likelihood of financial statement errors by helping management in the preparation of the financial statements and related notes. B) reduce the likelihood of overly aggressive accounting through oversight of financial reporting. C) reduce the likelihood of financial statement errors by helping management of the company with complex financial reporting issues. D) reduce the likelihood of fraud and financial statement errors through oversight of the entity level controls.
18) ______
19) Brandon is working on the audit of Michum Inc. In accordance to CAS 550 (related parties),
Bra ndon
had provided by Michum. Brandon should obtained a manage ment confirma tion of all related-p arty transacti on. When auditing the purchasi ng cycle of Michum, Brandon found that they had purchase d for over $500,000 of merchan dise from Elite Crust Inc, a company that is owned by the CEO's brother. The $500,000 purchase is a material amount and it was not included in the confirma tion
19) ______
A) inform the audit committee B) reduce materiality to increase the likelihood of discovering other undisclosed related party transactions. C) discuss this issue with the management of Michum. D) qualify the audit report.
20) Which of the following would you expect to find in a corporation's bylaws? A) the date of incorporation B) the types of business activities that the corporation is authorized to conduct C) the rules and procedures adopted by the shareholders of the corporation D) the kinds and amounts of capital stock authorized
20) ______
21) The official record of the meetings of the board of directors and shareholders is contained in the corporate A) license. B) charter. C) minutes. D) bylaws.
21) ______
22) An auditor should examine minutes of board of directors' meetings A) on a test basis. B) through the date of the financial statements. C) through the date of his report. D) only at the beginning of the audit.
22) ______
23) In a well run business with a corporate code of ethics that is demonstrated and enforced by management, the auditor will decide that A) inherent and control risks can be reduced. B) there is an increased risk of fraud or illegal activities. C) there is a need for more detailed documentation in the working papers. D) inherent and control risks need to be increased.
23) ______
24) Frontenac Construction is a construction company and in the initial planning phase of the audit, you identified that they have many contracts with severe non-performance clauses if any of the current constructions are not completed on the dates set in the contracts over the next three years. As the auditor, you would set the inherent risk for sales and penalties as A) low. B) moderate. C) high. D) cannot determine until more procedures are performed.
24) ______
25) It is important that the policies, procedures and key decisions of senior management, board of directors and audit committee be considered when developing a client risk profile because A) they have the most incentive to engage in earnings management as their bonus is often tied to company performance. B) it is required by GAAP. C) they have a pervasive effect on the company. D) they influence the most important decisions for the company.
25) ______
26) A client's performance measurement system includes key performance indicators that management uses to A) measure progress toward its objectives. B) compare its performance with prior period. C) prepare the financial statements. D) measure its profitability.
26) ______
27) The auditor has decided to collect more evidence and review the engagement more carefully than usual. This is necessary because A) the auditor has decided that a higher audit risk on the audit is appropriate. B) inherent risks at the engagement have decreased from the prior year. C) control risks at the engagement have decreased from the prior year. D) the auditor has decided that a lower audit risk on the audit is appropriate.
27) ______
28) The Sarbanes-Oxley Act requires management to certify that it has informed the auditor and audit committee of any A) significant deficiencies in internal controls. B) related party transactions. C) significant deficiencies in entity level controls. D) specific business or industry risk.
28) ______
29) Anna performed a trend analysis of accounts receivable balances and computed the days to collect AR ratio. When she compared the results of her analysis with the industry averages, she found the results were unusually low compared the industry norm. Anna can conclude that A) the integrity of the company's management is questionable. B) they will not be able to rely on internal controls for accounts receivable for audit purposes. C) the accounts receivable balance is wrong. D) the accounts receivable has an increased risk of misstatement.
29) ______
30) The working papers are A) the property of client. B) the primary means of documenting that an adequate audit was conducted in accordance with GAAS. C) used primarily as a basis for the partners to review and reward the work of the managers, seniors, and staff. D) the property of the auditor although prepared by the client.
30) ______
31) During the course of an audit engagement an auditor prepares and accumulates audit working papers. The primary purpose of the audit working papers is to A) support the auditor's opinion. B) support the underlying concepts included in the preparation of the basic financial statements. C) provide a point of reference for future audit engagements. D) aid the auditor in adequately planning the work.
31) ______
32) Which one of the following items included in the audit working papers provides an important basis for documenting the planning process of the audit? A) copies of a bond indenture agreement B) conclusions on client risk analysis C) an index to the way that the lead schedules are organized D) formulae for the ratio analyses conducted at the audit
32) ______
33) The audit working papers serve as a record of the evidence accumulated and the results of the test. This helps to demonstrate that the audit was A) completed using Canadian generally accepted auditing principles. B) organized effectively with no mistakes in calculations. C) properly kept confidential; information was held secure. D) conducted in accordance with Canadian generally accepted auditing standards.
33) ______
34) The new Canadian Auditing Standards require the auditor to complete their audit working papers within ________ days of the audit report date. A) 90 B) 183 C) 60 D) 45
34) ______
35) The audit of Simcoe Transports inc was completed three months ago and the PA firm proceeded to the file freeze in accordance with the Canadian Audit Standards. If the audit firm receives additional information related to the audit but the information does not affect the audit conclusions, the information should be A) separately identified and added at the front of the audit file. B) added to the audit file in the section to which it pertains. C) added to the audit file and request that the reviewing partner reviews the new information. D) disregarded as it the file freeze was already done.
35) ______
36) The working papers contain data useful for evaluating the adequacy of the audit scope and the fairness of the financial statements. This helps the auditor to conclude whether A) inherent risks were set as low as possible. B) the current files properly contain copies of client contracts and agreements. C) control risks were accurately identified and tested. D) an unqualified audit report can be issued.
36) ______
37) An important aspect of audit firm quality control is documented in working paper files. Audit quality control documented in such files includes A) second partner rotation policies. B) effective supervisory review. C) qualifications of tax specialists. D) training programs conducted.
37) ______
38) Permanent files contain all the data A) about the current audit and financial statements. B) of a historical or continuing nature about the client. C) of a historical or continuing nature pertinent to the current audit. D) about the most recent audits.
38) ______
39) Which of the following groups details from the auditor's working trial balance by classifying and summarizing similar or related items? A) account analyses B) control accounts C) lead schedules D) supporting schedules
39) ______
40) The permanent file section of the working papers that is kept for each audit client most likely contains A) a schedule of time spent on the engagement by each individual auditor. B) correspondence with the client's legal counsel concerning pending litigation. C) narrative description of the client's internal controls. D) review notes pertaining to questions and comments regarding the audit work performed.
40) ______
41) Your firm uses automated working paper software to import the general ledger account numbers and totals into a predefined format called the A) working trial balance. B) permanent file. C) reclassification entry. D) analytical review schedule.
41) ______
42) Frosten Inc. did not properly assess the inventory obsolescence which therefore resulted in their inventory balance being overstated. In this case, the auditor can A) suggest a reversing entry. B) suggest an adjusting entry. C) suggest a reclassification entry. D) include a reservation specific to the inventory balance in the auditor's report.
42) ______
43) When an adjusting entry has to be made A) management should do the adjusting entry because they have the primary responsibility for the fair presentation of the financial statements. B) management should do the adjusting entry because the auditor does not have access to the accounting system. C) the auditor should do the adjusting entry because it is required by the new Canadian Auditing Standards. D) the auditor should do the adjusting entry because they understand the adjustment better.
43) ______
44) The purpose of a reclassification entry is to present accounting information properly, even when the general ledger account balances are correct. For example, if there is a $50,000 credit balance for one customer in accounts receivable, the overall general ledger balance is still correct, even though this credit balance is an accounts payable. If the reclassification entry is posted to the general ledger accounts on December 31 to transfer this amount to accounts payable, then on January 1, the company will need to A) repay the customer the credit balance. B) send the customer a statement. C) post a reversing entry. D) set up a master file entry in the accounts payable system.
44) ______
45) An example of a reclassification entry would be an entry A) to increase the income tax liability account when it was discovered that client would be
45) ______
subject to a
higher tax rate than originally estimated. B) to reduce inventory when client failed to write down its obsolete raw materials. C) to change material credit balances in accounts receivable accounts to accounts payable accounts. D) to increase the allowance for doubtful accounts when it was discovered that a customer had filed for bankruptcy protection.
46) Reclassification entries may be recorded in the A) cash receipts journal. B) general journal. C) sales journal. D) financial statements but not in the general ledger.
46) ______
47) The largest portion of the auditor's working papers are the A) working trial balance. B) lead schedules. C) adjusting and reclassification entries. D) supporting schedules.
47) ______
48) Renaldo compared receiving reports to sales documents, checking to see that the sales invoice date matched the shipping date, and that quantities invoiced matched quantities shipped. On his working paper, he said that he vouched invoices. What else should his working paper include with respect to the audit procedure conducted? A) results of analytical review procedures on the aging of accounts receivable B) employee number and wage rate of the employees he spoke to C) a statement that the information will be held confidential D) details of tests conducted, with results, noting errors
48) ______
49) The working papers prepared during the engagement are the property of A) the client. B) the auditor, but do not include the working papers prepared by the client for the auditor. C) the auditor, even including those prepared by the client for the auditor. D) the auditor and client jointly.
49) ______
50) Ordinarily, the working papers can be provided to someone else only with the express permission of the client. This is the case even if the papers are A) subpoenaed by a court. B) requested as evidence in a provincial institute disciplinary hearing. C) used as a part of a provincial institute practice inspection. D) transferred as a result of a public accountant selling his/her practice to another public accounting firm.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) The Canadian Auditing Standards state the the auditor must develop an audit plan. List and explain the components that must be included in the auditor's plan.
52) What is the purpose of developing a client risk profile? List the steps involved in developing a client risk
profile.
53) Black Rock Limited is a marble and tile outlet that has a large outdoor area as well as an indoor showroom for a variety of rock, tile and marble. It is July and your firm has just been appointed auditors for the September year end audit. The previous firm of auditors had conducted review engagements. The company's bank has asked for audited financial statements for the current year end. Required: A) What is the purpose of obtaining knowledge of the client's industry and business environment? Identify at least three procedures that you could undertake in this area. B) What is the purpose of obtaining knowledge of the client's business? Identify at least three procedures that you could undertake in this area.
54) Knowledge of the client's industry can be obtained in different ways. Discuss some of the ways that this knowledge can be obtained.
55) Juniper Berry is a private company, operating in the fruits and vegetable industry and is located in the Niagara region. In their main St-Catharines plant, they receive the picked berries and proceed to sort, package and also make some related products such as jams, cookies and pies. Your firm has recently been hired as the auditor of Juniper Berry. The partner in charge of the audit has asked you to write a memo explaining why it is important to gain understanding of the business operations and processes of Juniper Berry and also to list some suggested procedures to be performed in the process of understanding the business operations and processes. To assist you with your memo, the partner provided you with some notes he took at a recent meeting with the management of Juniper Berry. - Juniper Berry (JB) sells and manufactures a wide range of products. From fresh to frozen berries, to jam, cookies and pies. Fresh and Frozen berries make up most of the revenues of JB. - JB sells mostly to grocery stores directly. Their frozen berries however are packaged with the Mondo Grocers logo as they have an exclusive contract to sell all of their frozen berry production to Mondo. - In 2007, JB installed a high tech scale system where the berries received from the various farms are weighted when they are delivered and the amount to be paid to the farmer is calculated and recorded immediately. The system automatically records the inventory and the central system also issues a check for the amount calculated by the scale. JB is very proud to be technologically advanced as it allowed them to cut some jobs and be more cost efficient. - Given that most of the packaging and processing of berries into derived products is automated, the capital assets represent a significant portion of the balance sheet and also required JB to obtain large bank loan in 2007 when the plant upgrade took place.
56) Your preliminary discussion with European Real Estate Management (EREM) Corporation indicated that the company was owned by three Swedish individuals who sold limited liability partnerships in shopping malls, office buildings and large residential apartment buildings to European investors. Often, a single shopping mall was broken up into several limited liability partnerships to make the ownership pieces small enough to sell easily. In some cases, these partnership units were sold to European companies, who diversified and bought units in several buildings. Other units were purchased by individuals. If a property looked particularly
promisin purchased units or advised their wives and family members to purchase units. g, the owners Required: of EREM occasion Explain why it is important for the auditor to identify related party transactions. Why are related party transactions a high risk area for the EREM audit? ally
57) A) One step in the planning phase of an audit is to obtain information about the client's legal obligations. Identify the three types of legal documents and records that auditors examine to obtain this information. B) Discuss the audit-relevant information contained in each of these three types of documents that an auditor should be aware of early in the audit.
58) Blarney Focus Inc., a manufacturer of coloured sunglasses, has had steadily increasing losses since its inception of 2002. Management feels that they will be able to improve profits by retooling to handle coloured contact lenses, which are all the rage. The owners of the company have exhausted all of their personal financial resources, having placed loans upon their personal assets, such as their homes, and liquidating their investments. They are hoping to obtain a large bank loan to cover the purchase of new equipment to manufacture coloured contact lenses, about $300,000. Blarney's banker is anxiously awaiting the audited financial statements to see if the results of the current year end are any better than the previous two years' results. Required: Identify your thoughts with respect to your assessment of audit risk and inherent risk for the overall business. How would this assessment affect the extent of audit testing and the audit process?
59) White Top Telephones is the largest telephone distributor in the province, distributing wired and wireless phones, as well as cellular phones. Management always seems to be in a rush, and difficult to approach. Unfortunately, this attitude has permeated down to all of the staff, and everyone seems to be hurrying about, doing what needs to be done. Sometimes, it seems as if they don't even have time for the customers, moving on to the next task. Yet everything seems to get done. The company's web site has a lengthy privacy policy statement indicating that customers are number one, and that all data are kept secure. Required: Explain the importance of the control environment and corporate governance structure. During what phases of the risk assessment and planning process would the control environment and corporate governance structure be documented and assessed?
60) Identify the characteristics that working papers should have. For each characteristic, briefly explain why it is important.
1) D 2) B 3) D 4) D 5) B 6) D 7) C 8) C 9) B 10) D 11) A 12) B 13) B 14) C 15) A 16) D 17) B 18) B 19) A 20) C 21) C 22) C 23) A 24) C 25) C 26) A
27) D 28) A 29) D 30) B 31) A 32) B 33) D 34) C 35) A 36) D 37) B 38) C 39) C 40) C 41) A 42) B 43) A 44) C 45) C 46) D 47) D 48) D 49) C 50) D 51) - the nature, timing, and extent of audit procedures for the purpose of risk assessment. - the nature, timing, and extent of additional audit procedures, linked to the individual audit assertions. - any other audit procedures that are needed for the audit to be conducted in accordance with CASs.
52) The client risk profile allows the auditor to assess the client's business risk, and provides the information needed to effectively plan the audit. The steps involved in developing the client risk profile are: ∙ obtain knowledge of industry and business environment ∙ obtain knowledge of client's business ∙ assess control environment and corporate governance process ∙ assess risks of fraud ∙ decide on need for outside specialists ∙ determine audit risk ∙ determine inherent risk ∙ calculate materiality 53) A) The three main reasons for obtaining a good understanding of the client's industry are: ∙ to identify any unique industry accounting requirements ∙ to identify risks in the industry that may affect the assessment of audit risk for the client ∙ to identify inherent risks that are typically common to all clients in this industry Methods of obtaining an understanding of the industry and business environment include: ∙ discussions with the previous auditor ∙ discussions with client personnel and internal auditor (if present) ∙ review of industry database at the accounting firm ∙ review of industry trade magazines B) Knowledge about the client that differentiates it from the industry will help the auditor more effectively assess audit risk, inherent risk, and be useful in designing analytical procedures. Methods of gathering knowledge of the client's business include: ∙ review of permanent files ∙ tour of the client's facilities ∙ review of prior financial statements and annual reports ∙ review of information with respect to related party transactions ∙ review of articles of incorporation, bylaws, and corporate minutes 54) - discussion with the auditor who was in charge of the audit in the prior year. - discuss with other auditors in the firm who currently work on similar engagement. - conferences with the client's personnel. - consult with an industry specialist. 55) a) Knowledge about the client's business is important since it will help the auditor more effectively assess audit risk and inherent risk, and will also be useful in designing analytical procedures. b) The following are suggested procedures that could be done at JB to gain an understanding of the business operations and processes. Note that the student's answer could be different and still be valid. - perform an analysis of the sales breakdown by product to understand what product is more significant to JB. The audit procedures should be more extensive for the line of products that are more important. - perform an analysis of the total sales to Mondo compared to total sales. Evaluate if there is a dependence on Mondo as a customer and how this impacts the business risk. - perform a tour of the plant to observe the scale and how the fruits are weighted to better understand the process and see if there are any signs of impairment or defective assets. - Since JB has highly automated process that affect the financial statements (purchases and cash disbursements are
auto cally calculated), discuss the process with management and review documentation with regards to the system and mati its implementation. 56) It is assumed that all transactions in the financial statements take place at arms length. If they do not take place at arms length, then it is critical that the related party transactions be disclosed in the notes to the financial statements so that the user can take this into account when reviewing the financial statements. If disclosure did not occur, then management could manipulate net income when related parties are involved and the user of the financial statements could make poor decisions due to biased information. Transactions with related parties must be disclosed in the financial statements if they are material. This is a high risk area for the EREM audit, because it appears that there are a variety of potentially complex transactions among many individuals and corporations that are related. This relationship may be familial (i.e. among family members) or based upon being able to exert influence. The auditor will need to carefully audit this area, and request management to provide a detailed breakdown of common ownership, including the ownership of the foreign companies, to see if the foreign companies are also related parties. 57) A) Documents and records that auditors examine to obtain information about the client's legal obligations include: ∙ the client's articles of incorporation and bylaws ∙ minutes of meetings of the board of directors and shareholders ∙ contracts B) Articles of incorporation and bylaws. This includes the amounts of capital stock the corporation is authorized to issue, preferences and conditions for dividends, and information concerning voting rights of each class of stock. The bylaws specify such things as the fiscal year of the corporation, the frequency of shareholder meetings, the method of voting for directors, and the duties and powers of the corporate officers. Minutes of meetings. There are two categories of audit-relevant information contained in minutes: authorizations and discussions by the board of directors affecting inherent risk. Common authorizations in the minutes include compensation of officers, new contacts and agreements, acquisitions of property, loans, and dividend payments. Contracts. The auditor should examine contracts early in the engagement to gain a better perspective of the organization and to become familiar with potential problem areas. Contracts will also be examined during the tests of individual audit areas. 58) Audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. Given that the bank is waiting for the statements to possibly issue a bank loan, and that the company has not been doing very well, the auditor should aim for a low risk of error. When the auditor decides that there is a lower audit risk on an engagement, then: ∙ More evidence is required. ∙ The engagement may require more experienced staff. ∙ The engagement will be reviewed more carefully than usual. Inherent risk is a measure of the auditor's assessment of the likelihood that there are material misstatements before considering the effectiveness of the internal controls. Since management has an incentive to overstate profits (they would like to obtain the bank loan), there is a bias that increases inherent risk, i.e. there is a greater likelihood of error. When the auditor concludes that inherent risk is higher, it reinforces the impact that would follow from having a
lowe r audit risk (the three items listed above). 59) In a well run business with a corporate code of ethics that is demonstrated and enforced by management, the auditor will conclude that inherent and control risks are reduced. Where management does not pay attention to the ethical environment of the business, or even condones poor business practices, the risks are increased. Corporate governance processes would be assessed initially in the preplanning phase, as part of the assessment of management integrity. It would also be considered when gathering knowledge of the client's business. Specific documentation of the formal control environment and corporate governance processes, such as extent of involvement of the Board of Directors and the Audit Committee also take place. The governance processes are also considered when the auditor assesses risks of fraud, audit risk, inherent risk and control risk. Throughout the audit, the auditor would also monitor discussions with the client and the results of audit tests to determine whether the governance processes are effective. 60) - properly identified: to clearly reference what the audit paper pertains to. This is helpful in the process of file review. - indexed and cross-referenced: helps in organizing and filling. Also indicates where is the source or support for a given item. - indicate the audit work performed: serves as evidence and support that work was performed by the auditor. - include sufficient information: serves as evidence and support that work was performed by the auditor. Could also be helpful if the procedure had to be re-done as part of a file review. -conclusions should be plainly stated: states the auditor's conclusion for the given procedure or segment. Serves as support and evidence.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A system of internal control consists of policies and procedures designed to provide 1) _______ management with A) assurance that fraud will be prevented or detected. B) assurance that the firm's resources will be used in the optimal way. C) reasonable assurance that fraud will be prevented or detected. D) reasonable assurance that the company achieves its objectives.
2) Management's objectives with respect to internal control include A) ensuring that all policies and procedures are clearly documented to reduce employee training costs. B) having reasonable assurance that the financial statements are in accordance with GAAP. C) preventing fraud and illegal activities at all costs. D) providing reasonable assurance that the goals and objectives important to the entity have been met.
2) _______
3) Management safeguards assets by A) requiring the external auditors to do surprise audits. B) having management sign a management representation letter. C) having the internal auditors conduct periodic counts of physical assets. D) controlling access and by comparison of physical items to records.
3) _______
4) Carrie is the manager of the Bay Street Pharmacy. Carrie is considering implementing a security tag system to reduce the losses related to stolen goods at their store. The system Carrie is looking at currently costs $60,000 and is expected to be effective for 5 years. In order to justify the implementation of the security tag system, average theft per year should be at least A) $12,000. B) $60,000. C) theft should be prevented at all costs. D) $1,000.
4) _______
5) Which one of the following controls would be of concern to management, but not to the auditor? Controls over the A) entry of payroll wage rates into the computer systems. B) distribution of promotional information to present and potential clients. C) cost of inventory items as recorded in the perpetual inventory system. D) collection of accounts receivable amounts.
5) _______
6) To comply with the second examination standard, the auditor need not be concerned with all areas of internal control that apply to management. The auditor's primary concerns are with the system's ability to A) provide reliable data and safeguard assets. B) prevent and detect fraud and error. C) promote efficiency and encourage adherence to policy. D) maintain reliable control systems.
6) _______
7) The accuracy of the results of the accounting system (account balances) is heavily dependent upon A) the knowledge and skills of the auditor. B) the training provided to the personnel. C) the adequacy of the entity level controls. D) the accuracy of the inputs and processing (transactions).
7) _______
8) Which of the following best describes the inherent limitations that should be recognized by an auditor when considering the potential effectiveness of an accounting system? A) Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against irregularities perpetrated by management. B) The benefits expected to be derived from effective accounting system usually do not exceed the costs of such control. C) The competence and integrity of client personnel provides an environment conducive to accounting control and provides assurance that effective control will be achieved. D) Procedures whose effectiveness depends on segregation of duties can be circumvented by collusion.
8) _______
9) Internal controls can never be regarded as completely effective. Even if systems personnel could design an ideal system, its effectiveness depends on the A) adequacy of the computer system. B) competency and dependability of the people using it. C) proper implementation by management. D) ability of the internal audit staff to maintain it.
9) _______
10) An act of two or more employees to misstate records is called A) defalcation. B) malfeasance. C) collusion.
10) ______ D) felony.
11) It is important for the public accountant to consider the competence of the audit clients' employees because their competence bears directly and importantly upon the A) achievement of the objectives of the system of internal control. B) comparison of recorded accountability with assets. C) cost/benefit relationship of internal controls. D) timing of the tests to be performed.
11) ______
12) The essence of an effectively controlled organization lies in the A) attitude of its employees. B) effectiveness of its auditor. C) effectiveness of its internal auditor. D) attitude of its management.
12) ______
13) The control environment consists of actions, policies and procedures that A) are recorded on the web site, for example, access policies to data. B) govern access to particular applications, such as how employees use passwords to change master file payroll rates. C) reflect the overall attitudes of top management, the directors and the owners of an entity about control and its importance.
13) ______
D) help implement the ethical attitudes at the organization, such as a computer usage policy.
14) The board of directors is essential for effective corporate governance because it has ultimate responsibility to A) assist management in the preparation of the financial statements. B) test internal controls and ensure they are working properly. C) provide a report to the auditor confirming that internal controls are working properly. D) make sure management implements proper internal control and financial reporting processes.
14) ______
15) To help with corporate governance and a positive "tone at the top," the board of directors and its committees, such as the audit committee, should A) follow the policies and procedures approved by management. B) rubber stamp the financial statements once per year. C) take an active role in running the company. D) consist of all members of executive management.
15) ______
16) A well-designed organizational structure at an entity A) has the internal audit department report to the Chief Financial Officer. B) requires that wage rates are recorded and tracked by the human resources department. C) has operations and programming personnel tasks combined. D) clearly defines authority and responsibility assignments.
16) ______
17) The methods that management uses to supervise the entity's activities are called A) management's operating style. B) personnel practices. C) management control methods. D) methods of assigning authority and responsibility.
17) ______
18) FiddleWare Limited uses application software to handle the processing of its transactions. An important control that management should implement with respect to information systems is the A) tracking of routine program maintenance changes. B) use of a formal systems development methodology. C) evaluation of potential new systems against organizational objectives. D) use of appropriate checkpoints and milestones during development.
18) ______
19) External auditor Mary Smith may not rely on the work of internal auditor Ray Jones unless A) Jones is supervised by Smith. B) Jones is certified (CA, CGA or CMA). C) Jones is independent of the client. D) Smith obtains evidence that supports the competence, integrity, and objectivity of Jones.
19) ______
20) The first step for management in the risk assessment process is to identify factors that may increase risk, for example failure to meet prior objectives. Then, management will
20) ______
A) develop specific actions to reduce the risk to an acceptable level. B) assess the likelihood of the risk occurring. C) estimate the significance of that risk. D) make sure that procedures are developed to eliminate the risk.
21) Management assesses risks as a part of designing and operating internal controls to minimize fraud and errors. Auditors assess risks to A) make sure that the company will continue to operate over the next year. B) fully implement the audit risk model. C) enable them to assess the completeness of internal controls. D) decide the evidence needed in the audit.
21) ______
22) An example of general computer control systems that provide reasonable assurance of authorization of systems is: A) organization and management controls B) operations and information systems support C) application system control procedures D) systems, acquisition, development and maintenance controls
22) ______
23) The operational responsibility and the recording of transactions are normally kept separate A) to ensure unbiased information is recorded. B) to centralize activities in order to be more cost efficient. C) because operational personnel rarely has the necessary accounting skills to record transactions. D) to avoid unauthorized transactions.
23) ______
24) Proper segregation of functional responsibilities in an effective internal control system calls for segregation of the functions of A) authorization, payment, and recording. B) custody, execution, and reporting. C) authorization, execution, and payment. D) authorization, recording, and custody.
24) ______
25) Why is it important to separate systems development (or acquisition) and program maintenance activities from accounting? A) This allows accounting to reconcile transaction totals to transaction details. B) Custody of media is important to help ensure ongoing operations. C) Lack of separation could result in unauthorized changes to programs and systems. D) Accounting personnel have the expertise to evaluate program changes that have been implemented.
25) ______
26) Which of the following duties would indicate a weakness in internal controls? A) The custodianship of cash is the responsibility of the treasurer's function. B) The custodianship of buildings and equipment is the responsibility of the controller's function. C) The internal auditor reports to the board of directors. D) The accounting function is under the controller.
26) ______
27) Which one of the following is an example of a general authorization? A) The highest credit limit allowed for accounts receivable is $50,000. B) Each supervisory wage rate must be approved by the executive manager. C) Grocery supervisors approve each transaction reversal over five dollars. D) ABC Company has a credit limit of $25,000.
27) ______
28) Which one of the following is an example of a specific authorization? A) The computer systems automatically reorder inventory when quantities fall below the economic order quantity. B) The highest credit limit allowed for accounts receivable customers is $100,000. C) Grocery sales clerks may approve returns of goods less than ten dollars in value. D) Each sales transaction that exceeds the credit limit of a customer must be approved by the controller.
28) ______
29) The most important type of protective measure for safeguarding assets and records is A) adequate segregation of duties among personnel. B) the use of physical precautions. C) adequate documentation. D) proper authorization of transactions.
29) ______
30) An essential characteristic of the persons performing internal check procedures is A) an analytical and inquisitive mind. B) a thorough knowledge of accounting. C) independence from the original data preparer. D) all of the above.
30) ______
31) Kim has accepted a position as the internal auditor for Oporto Corp. In order for Kim to be effective in her new functions, Kim should A) report directly to the audit committee. B) be independent from the operating department. C) be independent from the accounting department. D) all of the above.
31) ______
32) A major control available in a small company, which might not be feasible in a large company, is A) a voucher system. B) the owner-manager's personal interest and close relationship with the personnel. C) a wider segregation of duties. D) fewer transactions to process.
32) ______
33) Effective internal control in a small company that has an insufficient number of employees to permit proper division of responsibilities can best be enhanced by A) employment of temporary personnel to aid in the segregation of duties. B) engaging a public accountant to perform monthly "write-up" work. C) direct participation by the owner of the business in the record-keeping activities of the business.
33) ______
D) delegation of full, clear-cut responsibility to each employee for the functions assigned to each.
34) Understanding components of internal control and assessing the level of control risk are primarily used by the auditor to A) modify the initial assessments of inherent risk and preliminary judgments about materiality levels. B) determine whether procedures and records concerning the safeguarding of assets are reliable. C) ascertain whether the opportunities to allow any person to both perpetrate and conceal frauds are minimized. D) design effective tests of the financial statement balances for each audit assertion.
34) ______
35) When the auditor attempts to determine the operation of the accounting system by tracing one or a few transactions through the accounting system, this is referred to as A) tracing. B) tests of controls. C) vouching. D) a walk-through.
35) ______
36) Once an understanding of internal controls is obtained that is sufficient for audit planning, then the auditor must first assess A) whether the financial statements are auditable. B) the level of control risk to use. C) whether a lower level of control risk could be supported. D) the level of control risk supported by the understanding obtained.
36) ______
37) Control risk is a measure of the auditor's expectation that internal controls A) will detect and correct material misstatements. B) will neither prevent material misstatements nor detect and correct them. C) will prevent material misstatements from occurring. D) will either prevent material misstatements or detect and correct them.
37) ______
38) When planning the audit, the auditor's decision on the appropriate assessed level of control risk to use is A) determined by using actuarial tables. B) an economic issue, trading off the costs of testing controls against the cost of testing balances. C) calculated by using the audit risk model. D) calculated by using a standard formula.
38) ______
39) The procedures to test effectiveness of control policies and procedures in support of a reduced assessed control risk are called A) analytical tests. B) tests of details of balances. C) tests of controls. D) a walk-through.
39) ______
40) Narratives, flowcharts, and internal control questionnaires are three commonly used methods of
40) ______
A) documenting the auditor's understanding of client's organizational structure. B) designing the audit manual and procedures. C) testing internal controls. D) documenting the auditor's understanding of internal controls.
41) Paul is in the process of performing procedures to obtain the necessary understanding of the client's internal controls. As part of this process, Paul received the client's narrative and flowcharts and the internal control questionnaire from the client. Paul can use this information from the client A) if the entity level controls and tone at the top were found to be effective. B) as long as any subsequent reliance on controls is adequately substantiated with testing. C) Paul should not use this information since it was prepared by management who may be biased. D) if there has not been any significant change in the internal controls since the prior year.
41) ______
42) When a compensating control exists, a weakness in the system A) could cause a material loss, so it must be tested using substantive procedures. B) is reduced but not removed; therefore, it is still of concern to the auditor. C) is magnified and must be removed from the sampling process and examined in its entirety. D) is no longer a concern because the potential for misstatement has been sufficiently reduced.
42) ______
43) When the auditor identifies opportunities for the client to make operational improvements in the internal control system, it will be communicated to the client's audit committee in the A) reportable conditions letter. B) management letter. C) engagement letter. D) audit report.
43) ______
44) A secondary objective of the auditor's study and evaluation of internal control is that the study and evaluation provide A) a basis for constructive suggestions concerning improvements in internal control. B) an assurance that the records and documents have been maintained in accordance with existing company policies and procedures. C) a basis for the determination of the resultant extent of the tests to which auditing procedures are to be restricted. D) a basis for reliance on the accounting system.
44) ______
45) The auditor's primary concern about the development and implementation of the client's systems and procedures is ensuring that A) employees in the systems development group are properly trained. B) the organizational structure of the systems development department defines the lines of responsibilities and authority. C) issues such as the client's policy on ethical and social issues are considered. D) programs throughout the year were adequately controlled.
45) ______
46) Ideally, tests of controls should be applied to controls A) at each quarterly interim period. B) for the entire period under audit. C) at the balance sheet date. D) at the beginning of the fiscal period.
46) ______
47) A procedure that would most likely be used by an auditor in performing tests of control procedures that involve segregation of functions and that leave no transaction trail is A) inspection. B) reperformance. C) reconciliation. D) observation.
47) ______
48) Each key control that the auditor intends to rely on must be supported by sufficient A) reperformance procedures. B) analytical review procedures. C) tests of details of balances. D) tests of controls.
48) ______
49) After considering a client's internal controls, an auditor has concluded that it is well designed and is functioning as intended. Under these circumstances, the auditor would most likely A) determine whether transactions are recorded to permit preparation of financial statements in accordance with generally accepted accounting principles. B) use a combined audit approach that includes tests of controls and substantive tests. C) perform tests of controls to the extent outlined in the audit program. D) determine the control procedures that should prevent or detect errors and irregularities.
49) ______
50) The reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily A) inverse. B) equal. C) parallel. D) direct.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Describe the three broad objectives of management when designing an effective system of internal control. B) Describe the aspect of internal control with which auditors are primarily concerned.
52) A) Describe the three key concepts (assumptions) in the study of internal control. B) Describe three inherent limitations of internal control.
53) A) The Coso internal control components comprise five elements. Discuss each of these elements. B) Custody of assets and reconciliation should be separated to contribute to strong internal control. List the general categories of activities that should be separated.
54) A) Discuss what is meant by the term "control environment" and identify four control environment subcomponents that the auditor should consider. B) List the steps that management follows in assessing risks relevant to the preparation of financial statements in conformity with GAAP. C) How does the auditor obtain knowledge about management's risk assessment process?
D)
management's risk assessment process differs from the auditor's risk assessment process. Expl ain how E) What is the relationship between management's risk assessment process and audit evidence?
55) A) List the three types of general computer control systems. B) Adequate segregation of duties is an important control procedure. Discuss the general guidelines for segregation of duties to prevent both intentional and unintentional misstatements that are of significance to auditors. C) Adequate documents and records are important for effective internal control. Five principles dictate the proper design and use of documents and records. One principle is that documents and records should be prenumbered consecutively to facilitate control over missing documents, and to aid in locating documents when they are needed at a later date. Discuss each of the other four principles of adequate documents and records.
56) A) Step one in the auditor's study and evaluation of internal control is obtain understanding of internal control for audit planning purposes. List each of the remaining steps. B) Once the auditor has an understanding of internal control, two assessments are made. List each assessment that must be made prior to testing controls. C) Describe five common procedures an auditor can use to obtain an understanding of internal control design.
57) Dimple Leather is a chain of retail stores that sells leather clothing and accessories across Canada. Each store has point of sale equipment that is linked to a local server. At night, local accounting information is transmitted to the head office computer and any updates to prices or other adjustments are transferred to the local office. Required: Define the control environment. List the components of the control environment. For each component, provide an example of a control that might exist at Dimple Leather.
58) Porterville, Ontario, is the home of the largest leather tanning operation in Canada. Hides from various animals are stretched and treated, then cut into shapes for shipment to wholesalers. Computer assisted operations are important in maintaining temperature, humidity, and proper mix proportions in chemical solutions used for the tanning process. Computer assistance has helped improve the quality of the tanning process, as well as provide a safer environment for employees. Computer operations and backup is supported by the warehouse manager, Joe. Individual hides are tagged with a bar code and tracked for quality control purposes. The HomeTown Tanning Company uses a centralized microcomputer based system for its manufacturing and accounting operations. The two owners of the company are active in the business, and approve all new hardware and software acquisitions. The controller is responsible for network upgrades as well as maintaining passwords and user identification codes on the network. Accounting transactions are entered by accounting staff, although the controller has the ability to review and correct transactions.
Required List the five categories of functions that need to be separated from each other. Does HomeTown Tanning : have these functions separated? For any functions that are not separated, indicate the potential impact upon controls and upon the audit.
59) Joan is the owner of a small manufacturing company. In prior years, your firm has conducted a review engagement of the company. However, this year, Joan obtained a loan from the federal business development bank, and is required to have an audit on her financial statements. When you started asking about controls and procedures at the company, Joan got pretty upset. "All you need to be concerned about is the numbers! Why are you asking all of these questions? It takes too much time away from my staff to answer these questions! Just check the numbers and let us get on with our work!" You calmed her down a bit, and reminded her about the general discussion that occurred with the engagement letter. You invited her for coffee to briefly explain the following items: 1. 2. 3. 4.
Why auditors are concerned about internal controls Why auditors are required to be concerned about internal controls What you need to do to understand internal controls What you will do once you have documented your understanding of internal controls
Required: Explain what you would say to Joan.
60) You have just finished documenting your understanding of cycle controls at an audit engagement. Required: A) Explain how you will identify the controls that will be tested. B) What process will you follow for weakness in internal controls?
1) D 2) D 3) D 4) A 5) B 6) D 7) D 8) D 9) B 10) C 11) A 12) D 13) C 14) D 15) C 16) D 17) C 18) C 19) D 20) C 21) D 22) D 23) A 24) D 25) C 26) B
27) A 28) D 29) B 30) C 31) D 32) B 33) C 34) D 35) D 36) A 37) B 38) B 39) C 40) D 41) B 42) D 43) B 44) A 45) D 46) B 47) D 48) D 49) B 50) A 51) A) Management typically has the following three broad objectives when designing an internal control system: ∙ Reliability of financial reporting ∙ Efficiency and effectiveness of operations
∙
ol that auditors are primarily concerned with is maintaining reliable control systems.
Com plian ce with laws and regul ation s B) T he aspe ct of inter nal contr 52) A) The three concepts which underlie the study of internal control are: ∙ It is management's responsibility to establish and maintain internal controls. ∙ Reasonable but not absolute assurance should be provided because an ideal system cannot be justified on a cost/benefit basis. ∙ Even the ideal internal control system has inherent limitations because of employee carelessness, lack of understanding, or management override. B) The effectiveness of internal controls depends on the competency and dependability of the people using it. Inherent limitations of internal control include: ∙ Employee carelessness ∙ Lack of understanding ∙ Management override ∙ Collusion 53) A) Five elements of internal control are: ∙ The control environment: The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management about control and its importance to the company. ∙ Risk assessment: Management's identification and analysis of risks relevant to the preparation of financial statements in conformity with GAAP ∙ Control activities: Control activities include the control environment (discussed above) and also include: general control systems and procedures, and application systems (or accounting systems). ∙ Information and communication: Includes the process to initiate, record, process and report the entity's transactions and to maintain accountability for the related assets. ∙ Monitoring: Management's ongoing and periodic assessment of the quality of internal control performance to determine that controls are operating as intended and modified when needed B) ∙ ∙ ∙ ∙ ∙
The six general categories of activities are: Custody of assets. Recording or data entry of transactions. Systems development/acquisition and maintenance. Computer operations. Reconciliation.
∙
Authorization of transactions and activities. 54) A) The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about control and its importance to the entity. Subcomponents include: ∙ Management philosophy and operating style ∙ The board of directors and audit committee ∙ Organizational structure ∙ Methods of assigning authority and responsibility ∙ Management control methods ∙ Systems development methodology ∙ Management reaction to external influences ∙ Human resource policies and practices ∙ Internal audit B) ∙ ∙ ∙ ∙
Management's steps include: Identify factors that may increase risk. Estimate the significance of risks. Assess the likelihood that risks would occur. Develop specific actions that need to be taken to reduce the risk to an acceptable level.
C) ∙ ∙ ∙ ∙
The auditor: Determines how management identifies risk relevant to financial reporting Evaluates the significance of these risks Evaluates the likelihood of the risks occurring Decides whether actions (not already undertaken by management) are needed to address the risks
D) Management's risk assessment process is focused upon the identification and analysis of risks relevant to the preparation of financial statements in conformity with GAAP. Management assesses risks as a part of designing and operating internal controls to minimize errors and fraud. Auditors assess risks to decide the evidence needed in the audit. E) There is an inverse relationship: if management effectively assesses and responds to risks, the auditor will typically accumulate less evidence than when management fails to identify or respond to significant risks. 55) A) The three types of general computer control systems are: ∙ Organization and management controls. ∙ Systems acquisition, development and maintenance controls. ∙ Operations and information systems support. B) ∙ ∙ ∙ ∙ ∙ ∙
The general guidelines are: Custody of assets should be separated from accounting. Operational responsibility should be separated from recording or data entry of transactions. Separation of systems development or acquisition and maintenance from accounting. Separation of computer operations from programming and accounting. Separation of reconciliation from data entry. Proper authorization of transactions and activities.
C) ∙ ∙ ∙
Documents and records should be: Prepared at the time a transaction takes place, or as soon thereafter as possible. Pre-numbered or automatically numbered. Sufficiently simple to ensure that they are clearly understood.
∙
gned for multiple use whenever possible, to minimize the number of different forms. ∙ Constructed in a manner that encourages correct preparation, such as providing a degree of internal check Desi within the form or record. 56) A) The remaining steps are: ∙ Evaluate the design effectiveness of controls. ∙ Assess control risk. ∙ Identify and assess risk of material misstatement. ∙ Design tests of control. ∙ Test controls ∙ Evaluate results of tests of controls. B) The assessments are: ∙ Assess whether the financial statements are auditable. ∙ Consider design effectiveness of controls. C) The five procedures used to obtain an understanding of the client's internal control design are: ∙ Update and evaluate the auditor's previous experience with the client company. ∙ Make inquiries of client personnel. ∙ Read the client's policy and systems manuals. ∙ Examine documents and records. ∙ Observe activities and operations at the client's place of business. 57) Definition: The control environment consists of the actions, policies and procedures that reflect the overall attitudes of top management, the directors, and the owners of an entity about control and its importance to the entity. Components of the control environment with an example: (Note that many examples are possible; the following are illustrative examples.) Management philosophy and operating style: Management of Dimple Leather should illustrate ethical behaviour, and have an ethical statement available on their web site. The Board of Directors and the Audit Committee: The Audit Committee should be active in its involvement with management and the auditors, following up to determine why management letter points have not been acted upon. Organizational structure: The organizational structure should support adequate segregation of duties, illustrated in an organization chart and written job descriptions. Methods of assigning authority and responsibility: Management should have clear policies on software copyright and information systems usage that are monitored and enforced. Management control methods: Passwords should be required to access all accounting information systems, with clear policies on allocation of user identification codes and password change. Systems development methodology: User approval should be required for all maintenance program changes. Management reaction to external influences: The company should monitor price and design changes in the industry, and respond accordingly. Human resource policies and practices: Employees should be interviewed and references checked prior to hiring. Internal audit: Internal audit should submit a plan of audits to be conducted, that is in accordance with perceived
risks of error. 58) 1. Separation of custody of assets from accounting: Yes. Warehousing and manufacturing operations are separate from the accounting department. 2.
Separation of operational responsibility from recording or data entry of transactions: Yes. Same as #1.
3. Separation of systems development or acquisition and maintenance from accounting: Yes. The owners approve new systems. The owners are not in the accounting department. 4.
Separation of computer operations from programming and accounting:
Yes for backup and recovery. The warehouse manager is responsible for computer operations (backup), which is separate from accounting. No for password control and security. The controller is responsible for maintaining security passwords, and is also involved in accounting. The impact of this upon the audit is that the controller could record erroneous transactions and hide this fact since she has access to the whole system. The auditor will need to look for compensating controls (such as increased owner involvement). 5. Separation of reconciliation from data entry: No. It is not stated who is responsible for reconciliation. However, all individuals in the accounting department, including the controller, have data entry capability. This means that one or more of these individuals could enter incorrect or incomplete information, and hide the fact. The auditor will need to look for compensating controls (such as increased owner involvement), or may need to increase the amounts of tests of details. 59) 1. Auditors are concerned about internal controls because management uses internal controls to help ensure that business operations run in accordance with the goals and objectives of the company. The internal controls are also used to reduce the risk of fraud and illegal acts, and to help prevent and detect errors in the financial statements. 2. Auditors have rules, called generally accepted auditing standards (GAAS) that require them to understand and document internal controls so that they can plan the audit. It helps auditors to know that internal controls are in place to help prevent and detect errors, fraud and illegal acts. 3. Interviews, walkthroughs and documentation examination will be used to document internal controls so that they can be evaluated for each major transaction cycle and audit objective (such as completeness and accuracy). This is done for control environment, general controls and procedures, accounting systems and control procedures. 4. Once the internal controls have been documented, I will decide whether it is cheaper to test internal controls or to simply do tests of details ("looking at the numbers"). Overall, enough evidence needs to be gathered to provide a high level of assurance on the financial statements. 60) A) First, the controls will be organized by transaction-related audit objectives. Then, the controls will be considered as to their importance and quality. Those controls that are well designed and are most important for satisfying the transaction-related audit objectives will be considered for testing. B) After identifying the controls that are present for transaction-related audit objectives, we will be able to see which audit objectives do not have controls. The absence of controls for a transaction-related audit objective is defined as a weakness. Then, the potential misstatement that could occur for each of these absences is identified. We would discuss with the client whether any compensating controls exist for each weakness. If yes, then the compensating control would be considered for testing. The weakness should be noted in a letter issued to management and the audit committee.
I f there are no com pens ating contr ols for weak areas , then addit ional subst antiv e testi ng may need to be desig ned for those audit objec tives.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The audit committee is composed of board members who preferably have 1) _______ A) worked at the company in the past. B) expertise in the industry. C) been board members for a long time. D) financial expertise.
2) The board members approving organizational and business strategies should have expertise in A) strategic planning and the specific industry. B) human resources. C) financial accounting and risk management. D) financial accounting.
2) _______
3) In 2011, many companies will be adopting IFRS. To deal with this change, the board of directors should A) assist management and the financial reporting department in applying the new standards. B) select an external consultant to oversee the IFRS implementation. C) prepare summaries for management to explain how current accounting policies will be affected by IFRS. D) implement a subcommittee to oversee the transition process.
3) _______
4) A major difference between Canada and the United States is that management's evaluation of internal controls in Canada A) can be done for a period different than the period being audited. B) does not need to be done every year. C) does not need to be audited by external auditors. D) does not include entity level controls.
4) _______
5) The information systems steering committee's role is A) providing support to employees using the IT system. B) implementing a new computer systems. C) overseeing the IT and make recommendations to the board of directors. D) selecting the company's chief information officer.
5) _______
6) The Canadian Public Company National Policy Requirements indicate that a majority of directors on the board should be independent. Independent is defined as A) absence of a direct material relationship with the company. B) currently not holding a full time position at the company. C) currently not holding a management position at the company. D) absence of a direct or indirect material relationship with the company.
6) _______
7) What type of organization would a law firm is most likely be? A) Public B) Adhocracy C) Bureaucracy D) Entrepreneurial structure
7) _______
8) Effective corporate governance can encourage a corporate culture to be A) risk seeking. B) risk averse. C) risk tolerant.
8) _______ D) risk aware.
9) You are auditing the objective setting component of corporate governance. An appropriate auditing technique would be A) inspect the code of conduct of the company. B) observe a board of director meeting. C) inquire with employees to assess if they are aware of the risk tolerance of the company. D) inspect board minutes and supporting document to justify risk tolerance objectives.
9) _______
10) What component of the integrated framework being audited by the auditor if he is inspecting board ERM training programs, board minutes and supporting documents justifying the selection of the ERM framework and the the code of ethics? A) Objective setting B) Risk assessment C) Event identification D) Internal environment
10) ______
11) Coreen Cakes is a small chain of bakeries. Coreen Cakes wants to implement a new sophisticated point of sale system at all of their locations. Proper IT governance suggests that Coreen Cakes should consider A) what type of systems are used in their industry. B) if the employees are receptive to a new point of sale system. C) if the point of sale system will significantly improve the speed and accuracy of sales recorded. D) the costs and benefits of the point of sale system.
11) ______
12) Jenny is the IT support manager at CMH. Jenny is considered to be a super-user at CMH since she can circumvent normal controls. In order to address the risk of super-users, management should A) ensure that the super-user is familiar with the code of conduct of the company. B) establish effective compensating controls. C) remove the super-user. D) update the background check on the super-user on a yearly basis.
12) ______
13) Bravo Design had IMB consulting design a custom software to record the job costs and sales in progress. What acquisition process did Bravo design follow? A) In-house development B) Outsourcing C) Turnkey software development D) Systems acquisition
13) ______
14) Examining the cost-benefit for thoroughness and reasonableness is an audit test related to which phase of the system acquisition process? A) Development and system testing B) Investigation C) On-going maintenance D) Requirements analysis and initial design
14) ______
15) Examining the processes used for "emergency" changes that brought the systems down is an
aud it test
related 15) to which phase of the system acquisiti on process? A) Conversion, implementation and post-implementation review B) Development and system testing C) On-going maintenance D) Requirements analysis and initial design
___ ___
16) At Greenforce Inc, each system user is given their own access code. This is done to enforce A) authorization. B) segregation of duties. C) optimal usage of the system. D) accountability.
16) ______
17) You are trying to convince your boss to acquire a custom software for the company. One of the main advantage you would indicate is that the custom software would A) begin to be implemented right away. B) not require in-house technical analysis and programming personnel. C) allow the company to conduct operations in its own unique way. D) have minimal annual costs.
17) ______
18) Mellon Bowles is a large investment company with multiple branches in Canada. Each month, the head office of Mellon Bowles in Toronto updates the information in the system about the portfolio prices and investment performance. Exception reports are also printed and differences between the different locations are reviewed and a follow up is performed. This is an example of a company reducing the risk of A) unauthorized access to head office programs and data by the branches. B) inaccurate or unauthorized programs at one or more locations. C) inconsistent data processing in multiple locations. D) incomplete or inaccurate transmissions from one location to another.
18) ______
19) To prevent data from being copied or intercepted during data communications, the company should A) create multiple levels of passwords for system users. B) encrypt confidential data. C) install firewalls. D) ensure proper segregation of duties exist.
19) ______
20) A firewall is a software or hardware that A) restricts users from accessing certain modules of the computer system. B) restricts access to and from internal sites. C) protects the system from viruses. D) scrambles the data so that it cannot be intercepted.
20) ______
21) It is important for the auditor to be aware of the existence of a database management system since it affects A) organization and management controls. B) operations and information systems support. C) systems acquisition, development and maintenance controls. D) all areas of general controls.
21) ______
22) Enterprise resource planning systems are complex integrated computer systems based upon pre-defined relational databases. Since there is heavy integration of data, which type of controls will have greater importance? A) Entity level controls B) Controls over accuracy of data C) Controls over input of information D) Controls over output of information
22) ______
23) When Ylang Corporation purchased their new computer system, they contacted multiple vendors and reviewed the various proposals to ensure that the proposed technology was appropriate for the company's need and that the cost of the new system was reasonable. This situation demonstrates that Ylang has good A) IT governance. B) enterprise risk management. C) corporate governance. D) general information systems controls.
23) ______
24) For an auditor to consider placing reliance upon either computer-assisted or fully automated controls, the auditor must have reasonable assurance over the effectiveness of A) enterprise risk management. B) general computer controls. C) corporate governance. D) system acquisition controls.
24) ______
25) Magenta Inc. requires that all software packages be tested prior to the signature of the contract and acceptance of the software. This will result in A) automated controls that can be relied upon. B) properly trained system users. C) system implementation being cancelled until conflicts are resolved. D) proper approval from the board of director.
25) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 26) For each of the following situation, indicate which type of organization structure would be most appropriate and provide support for your answer. A) Luongo Jazz is a small company that consists of one band and 2 DJs that provide services for weddings and corporate events. Roberto Luongo is the drummer of the band and is also the owner of Luongo Jazz. Luongo normally attends 2 to 4 events per week. Roberto manages the company from his house and is in charge of booking the events for the band and DJs. B) Corsico Inc. is a small insurance company with 3 branches located in rural regions. Each branch is managed by a director and relies on their sales people to design and sell insurance packages to various individuals in the region. Due to competition from the large national offices, the sales people need to quickly adapt to the needs and demands of the locals.
C) Royal large bank. They have over 1000 locations across Canada and provide a wide range of banking, investment Cardigan and insurance services to their clients. RCB is a public company with over 12,000,000 shareholders. The Bank is a head office of the RCB is located in Vancouver.
27) When performing an audit, the auditor must consider the design and operating effectiveness with respect to corporate governance. List five questions that the auditor could ask:
28) The acquisition process of an information system can be broken down in five phases. Identify and briefly describe each phase.
29) Ulico Consulting is a consulting company with 8 offices across Canada. Ulico specializes in IT consulting to design unique information technology solutions for a variety of clients in different sectors. Ulico specializes in the design of software, but does not provide any services for IT support and maintenance to their clients. With over 300 employees, Ulico needs to upgrade their own accounting and payroll software. Ulico is considering custom or packaged software. Discuss the advantages and disadvantages of both options for Ulico:
30) For an auditor to consider placing reliance upon either a computer-assisted or fully automated controls, the auditor must have reasonable assurance that general controls over the computerized portion of the controls are effective. More specifically, identify what controls must be particularly effective and briefly explain the reason.
1) D 2) A 3) D 4) C 5) C 6) D 7) B 8) D 9) D 10) D 11) D 12) B 13) C 14) B 15) C 16) B 17) C 18) C 19) B 20) B 21) D 22) C 23) A 24) B 25) A 26) A) Entrepreneurial: Luongo Jazz is a small company that is managed by the owner. They have no external
inves mal decision making processes are most appropriate. tors. Give B) Adhocracy: The company is still relatively small and might not benefit from a formal bureaucratic structure. n the Further, due to the nature of the business and need for the local branches to react quickly to compete with the natu national competitors, having an adhocracy is more appropriate. re of the C) Bureaucratic organization structure: Given the size of the company and the need to account to the millions of busi shareholders, a bureaucratic structure would be most appropriate. The multiple levels of management and ness, standard products and services would be needed to ensure some consistency across the thousands of locations. infor This would also enable clear corporate governance. 27) 1. Is there sufficient expertise on the board and on the management team to address weaknesses in organizational strategies? 2. Do implementations of strategies effectively consider key components of the strategy? 3. Does management regularly review monitoring reports and take appropriate remedial actions? 4. Do the board and its committees take an active role in running the company, not simply rubber-stamp management's activities? 5. Have management and the board of directors dealt effectively with past crises? 6. Do human resource policies and other resourcing policies provide sufficient resources to implement strategies? 7. Does the audit committee meet with the auditors, both external and internal and support them in their activities? 28) 1. Investigation: It is determined whether the proposed system should actually be obtained. 2. Requirements analysis and initial design: It is necessary to identify and document the overall functionality and purpose of the proposed system. 3. Development and system testing: Specific functionality of the new system is identified and developed/acquired and tested. 4. Conversion, implementation, and post-implementation review: Data is converted from the old to the new system, live running of the system commences, and the system is evaluated to determine whether it satisfies the entity's needs. 5. Ongoing maintenance: Changes to the system are made as necessary. 29) Advantages of Custom Software: - System will be tailored to meet the company's exact needs. - The company conducts operations in its own unique way - this could be applicable to Ulico since they have many different consulting projects which may require specific revenue recognition or job costing functions. - Ulico would have the in-house expertise to design the custom software as they have many IT consultants. Advantages of Package Software: - Less costly than custom programing, since software will be used for support functions of Ulico, might be preferable to save money in this area. - Implementation can commence immediately after the package has been selected. - Risk of system error and incorrect choice can be reduced by testing the software before purchase is made. - Many packages are likely to be available since Ulico needs the software for basic areas such as accounting and payroll. This is a common need among companies and although Ulico's business is different, function such as the payroll processing are likely standard. - Annual maintenance cost will be lower - since Ulico does not provide IT support to their own client, they could rely on the software company to provide them with IT support and avoid the need to create an in-house support team. Disadvantages of Custom Software: - Very costly to develop. - Lengthy program development times are common. - Rigorous testing of the program is required to ensure that the system is error free.
to design the in-house system would prevent them from working on other consulting mandates and would Usin therefore reduce the revenues of Ulico. g the IT Disadvantages of Package Software: cons - The package may not be the perfect "fit" for Ulico's needs. ultan - Package evaluation process is costly and time-consuming. ts of - In-house resources may be insufficient to resolve problems with the system use or operations - will have to rely on Ulico external party. 30) Program change controls: to ensure that program were adequately controlled and to provide assurance that there were no unauthorized program changes. Access controls: to prevent unauthorized access to programs and data and to document access and establish accountability.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In the context of the audit of financial statements, fraud is defined as 1) _______ A) using inappropriate assumptions in the development of a financial forecast. B) an intentional misrepresentation of a fact in the books of accounts and the financial statements. C) an overstatement of the likelihood of profits in the coming year in the annual report accompanying the financial statements. D) a deliberate error in marketing information sent to clients.
2) Due to the financial crisis which resulted in lower revenues and net income for the current period, Edward decided to defer some expenditures with regards to repairing the central production facility to the following year where revenues are expected to increase. What type of earnings management is Edward engaging in? A) Income maximization B) Big bath C) Income smoothing D) Income minimization
2) _______
3) Bailey, a student working as a cashier at the Fairplex cinema, would charge a full price of adult admission to adults, but would record the sale of a student ticket. Bailey had arranged for Carmen, the door attendant, to allow the adult customers to go in with student tickets. Bailey and Carmen would split the extra money at the end of the day. Bailey and Carmen committed A) misappropriation of assets fraud. B) management corruption. C) fraudulent financial reporting. D) procurement fraud.
3) _______
4) Inadequate disclosure in the financial statements is an example of A) hiding related party transactions from regulatory authorities. B) income smoothing. C) earnings management. D) fraudulent financial reporting.
4) _______
5) One of the most common techniques used by management to misstate financial statement information is: A) inadequate disclosure of contingent liabilities. B) improper revenue recognition. C) excessive write down of inventory. D) an increased bad debt allowance.
5) _______
6) Procurement fraud is the manipulation of the contracting (purchasing) process. Procurement fraud results in the company A) paying more for goods or services than it should. B) using automated information systems to hide actual amounts spent. C) having inadequate supporting documents for costs incurred. D) having contractors conduct work who are not qualified to do the job.
6) _______
7) The opportunity to have an employee commit fraud is greater in an company where A) significant judgement and estimates are involved in the preparation of financial statements. B) fraud has been committed in the past. C) management has set very high net income targets for employee bonuses. D) employees are disgruntled after the employee benefit package was reduced.
7) _______
8) Three conditions for fraud are referred to as the "fraud triangle." One of the sides of this triangle is incentives or pressures. The other two sides are: A) the need to maintain stock prices and meet debt repayment obligations B) opportunities, attitudes or rationalizations C) opportunities, a desire to meet debt repayment obligations D) attitudes or rationalizations, the need to maintain stock prices
8) _______
9) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of a management incentives or pressures risk factor? A) There has been significant turnover in the accounting department in the last year. B) Management and the auditors disagree upon how to value a large contract in progress. C) There is only one board member who understands financial statements, and she has suffered a heart attack. D) Customer demand for a new product line was significantly less than expected.
9) _______
10) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of a management opportunities risk factor? A) The chief executive officer owns forty percent of the outstanding share capital. B) New accounting standards provide three different methods for valuing financial instruments. C) Two major competitors have gone bankrupt as margins decline in the industry. D) The company has lost a major account and income is falling.
10) ______
11) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of a management attitudes/rationalization risk factor? A) Two senior management personnel are verbally abusive, threatening staff when sales targets are missed. B) A new product being sold has a wide variance in the warranty costs incurred when it is returned for repair. C) The financial results show that there is a danger of debt to equity targets being missed. D) There is uncertainty about the quality of the raw materials that are being purchased.
11) ______
12) Which of the following is a factor that relates to incentives or pressures to commit fraudulent financial reporting? A) Management's practice of making overly aggressive forecasts. B) High turnover of accounting, internal audit and information technology staff. C) Significant accounting estimates involving subjective judgments. D) Excessive pressure for management to meet debt repayment requirements.
12) ______
13) Which of the following is a factor that relates to attitudes or rationalization to commit fraudulent
fina ncial
reporting 13) ? A) High turnover of accounting, internal audit and information technology staff. B) Management's practice of making overly aggressive forecasts. C) Significant accounting estimates involving subjective judgments. D) Excessive pressure for management to meet debt repayment requirements.
___ ___
14) Which of the following is a factor that relates to incentives to misappropriate assets? A) High turnover of accounting, internal audit and information technology staff. B) Significant accounting estimates involving subjective judgments. C) Significant personal financial obligations. D) Management's practice of making overly aggressive forecasts.
14) ______
15) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of an opportunities risk factor? A) The company has announced that it will be laying off 20% of its work force over the next three months. B) Two employees have significant debts due to a gambling addiction. C) Due to cost cutting measures, the company has delayed promotions of all personnel for at least one year. D) Job applicants are hired based upon a fifteen minute interview with the general manager.
15) ______
16) Fraud risk factors are examples of factors that increase the risk of fraud. Which of the following is an example of an attitudes/rationalization risk factor? A) Several employees work through their vacations, taking cash instead. B) Inventory of computer supplies is stacked in the warehouse, which is accessible to all employees. C) Cash is deposited once a week, and left in the cash drawer at other times. D) Frequent errors in the batched transactions in the accounting area are ignored.
16) ______
17) Professional skepticism is best described as an attitude of the auditor that A) requires that all statements made by management be supported with corroborative documentation. B) requires the auditor to search for fraud and illegal acts. C) allows the auditor to assume management honesty when conducting audit tests. D) neither assumes management is dishonest nor assumes unquestioned honesty.
17) ______
18) Research indicates that the most effective way to prevent and deter fraud is to implement programs and controls that are A) based on core values of the company. B) targeted towards upper management as they have significant influence in the company. C) focused on providing up to date technical training to employees. D) focused on cash transactions.
18) ______
19) Which of the following is responsible for implementing corporate governance and control procedures to minimize fraud?
19) ______
A) Management C) Auditors
B) Accounting employees D) Audit committee members
20) The most effective way to prevent and deter fraud is to A) implement programs and controls that are based on core values embraced by the company. B) terminate employees who are suspected of committing fraud. C) hire highly ethical employees. D) communicate expectations to all employees on an annual basis.
20) ______
21) A management tone that helps prevent fraud and error is one that is focused on A) honesty and integrity. B) supporting all decisions with written documentation. C) ensuring that tax regulations are followed. D) satisfying regulatory requirements.
21) ______
22) In addition to an honest and ethical management, what type of document can provide more specific guidance about permitted and prohibited behaviour? A) discussions to improve employee morale B) a corporate code of conduct C) commissions for attracting new clients D) providing bonuses based upon profit
22) ______
23) When an employee discovers activities within their organization that may be indicative of fraud, the employee should report this matter to A) the corporate controller. B) the audit committee. C) an anonymous hotline. D) the external auditor.
23) ______
24) Fraud awareness training should be A) extensive and include details for all functional areas. B) broad and all-encompassing. C) specifically related to the employee's job responsibility. D) focused on communicating ethical values.
24) ______
25) To help reinforce the corporate code of conduct policies and help deter employees from committing fraud, employees should be asked to A) communicate with suppliers and customers in writing. B) list all of the shares that they own in competing companies. C) confirm their responsibilities annually in writing. D) keep their passwords and user ID access codes private.
25) ______
26) An important beginning step in effective fraud oversight is the recognition that A) internal auditors are a crucial tool in preventing and detecting fraud and error. B) almost any employee is capable of committing a dishonest act under the right circumstances. C) every dollar spent in preventing fraud is saved among frauds that did not occur. D) documenting fraud risks will guarantee that fraud is detected quickly.
26) ______
27) Who is responsible for designing and implementing programs and controls to mitigate fraud risks? A) audit committee B) management C) senior accounting officer D) internal audit
27) ______
28) Java Bean Inc has installed a sophisticated sales and shipping computer system. When Java Bean receives an order by fax or e-mail, an employee enters the purchase order in the system. If the purchase order combined with the current customer balance of unpaid invoices to Java Bean exceeds their credit limit, the system rejects the order. This is an example of A) detective control. B) preventive control. C) entity level control. D) fraud control.
28) ______
29) Management of the Xylon Jewellery store has determined that theft of diamond rings is a high risk area. Accordingly, they have designed new control procedures that involve counting inventory every day and using locked display cases. Periodically, management should A) rotate selected inventory out of the locked display cases. B) change the locks on the display cases and issue new keys. C) evaluate whether these controls are being followed and are operating effectively. D) deliberately remove inventory to see if staff detect that it is missing.
29) ______
30) Internal auditors assist in deterring fraud by examining and evaluating internal controls that reduce fraud risk. They assist in fraud detection by A) independently evaluating the competence of middle and senior management. B) performing audit procedures to search for fraudulent financial reporting and misappropriation of assets. C) preparing fictitious transactions to see if they are detected by internal controls. D) being a clear voice in the discussions with the audit committee about fraud risks.
30) ______
31) One method of effectively implementing the attitude of professional skepticism is by maintaining A) a questioning mind. B) good quality senses (sight, hearing). C) using interrogative interview skills. D) a high level of suspicion.
31) ______
32) Critical evaluation of audit evidence requires that representations of management to the auditor A) should be disclosed to the audit committee. B) be discussed with the audit partner. C) are not necessary. D) be supported by corroborating evidence.
32) ______
33) The evaluation of design effectiveness of controls in mitigating fraud risk is performed by the auditor in which audit phase? A) Audit plan B) Preplanning C) Client risk profile D) Test of controls
33) ______
34) The CICA Handbook requires that audit team members have regular meetings. With respect to fraud and error, one of the purposes of these discussions is to A) conduct statistical analyses with respect to frauds that have occurred at all clients. B) share insights into the susceptibility of the entity to fraud and error. C) clarify to the audit committee the procedures that will be used to detect illegal acts. D) design forensic audit procedures to help detect fraud.
34) ______
35) The audit committee's role with respect to fraud and error includes A) designing internal control procedures to prevent and detect fraud and error. B) reporting actual frauds to the local securities and exchange commission. C) overseeing management's fraud risk assessment and response processes. D) quantifying the effect of fraud upon the financial statements.
35) ______
36) The risk assessment with respect to fraud and error is A) documented in the permanent file and carried forward from one audit to the next. B) determined at the beginning of the engagement and incorporated into the audit risk model for the planning phase of the audit only. C) assessed throughout the audit with respect to any new information that is obtained. D) prepared by the partner of the engagement in consultation with the audit committee.
36) ______
37) One of the questions that the auditor can ask of the internal auditor with respect to fraud and error is whether A) the audit risk model is used in designing their testing. B) an assertion based approach is being used for testing. C) they have designed any new internal control systems. D) management has responded satisfactorily to their findings.
37) ______
38) The auditor asked the controller about procedures with respect to receiving, and was told that all materials are received using prenumbered internal receiving reports. The receiving clerk, however, stated that prenumbered receiving reports are used only for goods received without waybills. The auditor should A) tell the receiving clerk that he is not following proper procedures. B) obtain additional evidence to resolve the inconsistency. C) tell the controller that his understanding about internal controls are wrong. D) find out whether the receiving clerk is new and is missing training on procedures.
38) ______
39) Jose is the owner-manager of a small distribution company. Jose is careful about hiring and training personnel, and has close contacts with suppliers and customers. The company is doing well, and all documentation is clear and well organized. There is no audit committee. With respect to fraud and error A) a qualification of the audit report will be required due to an absence of internal controls. B) the auditor will need to be careful to recommend the formation of an audit committee in his management letter. C) the auditor will need to be suspicious because there are very few employees. D) the owner-manager appears to be providing effective oversight.
39) ______
40) When the auditor conducts a risk assessment and determines that several fraud risk factors are present, the auditor should A) perform only substantive tests (no control tests). B) report the risk factors in a letter to the audit committee. C) consider these factors when assessing the risks of fraud. D) qualify the audit report due to the high risk of potential misstatement.
40) ______
41) When conducting analytical review, the specific accounts that are required to be carefully assessed due to the potential for fraudulent financial reporting are A) current assets. B) revenue. C) administrative expenses. D) equity.
41) ______
42) The audit client that you are working on has been identified as having a high risk of misstatement due to fraud. In assigning audit staff to the engagement, which is the most appropriate allocation? Assign to the engagement A) staff that are familiar with this industry and the way that it works. B) newly qualified accountants familiar with current auditing standards. C) more experienced personnel. D) staff that were on the engagement last year, as they are familiar with the client.
42) ______
43) CAS 240 requires auditors to incorporate unpredictability in the audit plan. The reason for this requirement is due to A) perpetrators being knowledgeable about the audit procedures. B) risk that fraud would be committed in a non-significant account. C) companies continually changing. D) making the auditing profession more fun.
43) ______
44) Why is it important that the auditor examine journal entries and other adjustments for evidence of possible misstatements due to fraud at every client? A) Lack of segregation of duties makes journal entries a vulnerable point. B) Errors are more likely to occur when recording recurring entries. C) Automatic entries posted from computerized systems could be in error. D) Fraudulent financial reporting is often implemented by means of adjustments.
44) ______
45) General Upcity Contracting has recorded revenue on some of its contracts prematurely without recording the related costs of sales. How will this be indicated by analytical review? There will be a(n) A) increase in administrative expenses. B) increase in gross margin. C) decrease in gross margin. D) decrease in administrative expenses.
45) ______
46) When a client generates fictitious revenues to make analytical procedures results, such as gross margin, similar to the prior year, what technique might help to detect such a manipulation? A) Compare gross margins over a period of years and to subsidiary companies. B) Review authorizations for prices charged for revenues. C) Conduct tests of controls over recording of revenues. D) Compare client data to industry performance.
46) ______
47) What is the best way to prevent misappropriation of sales and related cash receipts? A) regular credit checks on employees to ensure that they are not in debt B) segregation of duties, which minimizes opportunity C) cash flow analysis with comparison to revenues D) analytical procedures and other comparisons
47) ______
48) One method of improving earnings by means of fraudulent financial reporting is by overstating inventory. Analytical procedures can signal inventory overstatement by identifying A) overstatement of cost of goods sold and overstatement of gross margin. B) understatement of cost of goods sold and understatement of gross margin. C) understatement of cost of goods sold and overstatement of gross margin. D) overstatement of cost of goods sold and understatement of gross margin.
48) ______
49) One method of executing fraud in the acquisition and payment cycle occurs when the employee steals a cheque to a legitimate vendor. The purchases information is then resubmitted for payment to the vendor. Such fraud can be prevented by A) requiring that all contract purchases be subject to a bidding process. B) cancelling supporting documents to prevent their reuse. C) having all accounts payable cheques signed by two people. D) allowing payments to be made to authorized vendors only.
49) ______
50) When fraud is suspected, what should the auditor do before discussing the matter with management? A) Inform the audit committee. B) Consult the authorities so that undercover officers can be involved. C) Gather additional information to determine whether fraud actually exists. D) Contact the local securities exchange commission.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Define fraud and distinguish between the two main categories of fraud. B) List and briefly describe the three conditions for fraud arising from fraudulent financial reporting and misappropriation of assets as described in Section 5135.
52) Explain professional skepticism and the need for maintaining professional skepticism during an audit.
53) A) List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting. B) List and briefly describe examples of risk factors for each condition of fraud for misappropriation of assets.
54) A) Describe the sources of information gathered to assess fraud risks.
B)
What matters related to their consideration of fraud must auditors discuss with the audit team and document according to CAS 240?
55) Management and the board of directors are responsible for setting the "tone at the top." What is meant by "tone at the top"?
56) You are having a discussion with the owner of a medium-sized company about possibly becoming the auditor for the company. As part of the conversation the owner says, "I believe it is important to have an audit every year. In addition to satisfying my bank, I pay good money for preventing and detecting fraud. My accounting systems and the people I have working for me can handle the operations really well, but having the auditor there once a year is a great deterrent!" Required: Respond to the owner. Be sure to address the responsibility of both the auditor and the client in preventing or detecting fraud.
57) You have been assigned as the auditor in charge of one of your firm's high-technology audits. Cobalt Systems Limited designs and sells computer monitors. The company is working on new flat screen systems that are low cost enough that they can be hung in the living room to have a full wall size television. The company management is really excited. Although production bugs have not yet fully been worked out, they have promised televisions to several dealers to be shipped within the next production year. Accordingly, they have started taking deposits on these orders. Projected net income for the year is up fourfold from the prior year due to the flat screen computer screens that have already started shipping this month. Only two years ago the company had losses, but this year they expect to have $42 million in net income. Stock prices are going through the roof, from a penny stock to a current price of over $30. With the new flat screen technology, management is targeting a stock price of close to $100 by the end of the year. That will be a great time to float a new stock issue and retire the company's huge $250 million bank loan. Cobalt has five senior management, all of whom own at least 4% of the stock of the company, and have stock options as part of their remuneration. They also receive a bonus based upon income before taxes. Required: Assess the risk of financial statement fraud at Cobalt Systems Limited. Justify your answer.
58) You are responsible for the audit of YellowFolio Limited (YL), a company that sells computers that are painted a distinctive yellow colour. Many companies are taking advantage of the special trade-in offers that YL provides, and trading up to current computers. Accordingly, YL has many one and two year computers that it is selling. A hot market for these products is Africa and Southeast Asia, where they cannot seem to get enough computers, and they are ready to pay good money for older models. Analytical review indicated that marketing expenses were thirty times larger than the prior year. Detailed analysis of the marketing expense account revealed several internal memos listing consulting fees that were paid to numerous Swiss bank accounts. When you queried management, you were told that these individuals had provided marketing consulting assistance for companies in Africa and Southeast Asia. These consultants enabled the sale of computer equipment to the military government of several countries. Required:
What on has been buried in the marketing expense? Is fraud involved here? type of transacti What are your responsibilities?
59) As part of the audit of the administrative expense accounts, you requested a computer assisted audit technique to list all transactions over $150,000 (which amounts to about 75% of materiality). Last year this test was done, and turned up only two transactions, both of which were in the repairs and maintenance account. This year, to your surprise, there was one transaction of $168,000 in the miscellaneous expense account. The controller was rather sheepish about it. She said that when she went on vacation she had left several signed cheques with the chief accountant without filling in a payee. The chief accountant had made the cheques out to the maximum that would be covered by the balance in the bank account that day, and had disappeared with the money. The cheques were supposed to be for suppliers that were coming in to pick up the cheques because the payables were running a bit late. The police had been called, but the chief accountant, who had been working for the company for only three months by that time, had disappeared and could not be located. Senior management had told the controller that she would have to work without a chief accountant to recover the funds that had been lost by means of the fraud. Required: What impact does the above situation have on fraud risks for this client? Are there any other effects on the audit?
60) Dorothy is the assistant manager of Charline's boutique. Charline's boutique is a trendy, upper scale clothing and accessories boutique. Charline, Dorothy's boss, is very demanding and often loses her temper with her employees. Dorothy often feels that she is alone to run the boutique while Charline socializes with the clients and travels to jet set destinations. Given that Charline is often going on vacation, Dorothy was not able to take vacation for more than 3 days in a row for the past 2 years. Due to the fact that the boutique is really small, Dorothy is often left on her own to perform all of the administrative tasks including record keeping, ordering clothing and managing the sales at the store. Dorothy often works 60 hours per week while her contract stipulates that she should only be working 40 hours. Dorothy has complained about the extra hours and the fact that she was not paid overtime to Charline. Dorothy also indicated to Charline that she has been the assistant manager for 3 years and had not gotten a raise since she received the promotion. In response to the complaint, Charline gave Dorothy a $600 pair of Manola shoes from the boutique as a compensation for all of her extra work. Last week, Charline discovered that Dorothy had stolen $20,000 from the boutique. Dorothy would return goods that were not sold to the suppliers and keep the money that was returned. For financial reporting purposes, Dorothy would decrease the inventory and record a loss for obsolescence of inventory or an expense with regards to in-store theft. Required: Describe the incentives/pressures, opportunities and rationalization present in the above scenario that led to the fraud committed by Dorothy.
1) B 2) C 3) A 4) D 5) B 6) A 7) A 8) B 9) D 10) B 11) D 12) D 13) B 14) C 15) D 16) D 17) D 18) A 19) A 20) A 21) A 22) B 23) C 24) C 25) C 26) B
27) B 28) B 29) C 30) B 31) A 32) D 33) A 34) B 35) C 36) C 37) D 38) B 39) D 40) C 41) B 42) C 43) A 44) D 45) B 46) D 47) B 48) C 49) B 50) C 51) A) In the context of financial statement auditing, fraud is defined as an intentional misstatement of the financial statements.
The nt financial reporting and misappropriation of assets. Fraudulent financial reporting is an intentional misstatement two or omission of amounts or disclosures with the intent to deceive users of the financial statement. Misappropriation main of assets involve theft of an entity's assets. categ ories B) of ∙ Incentives/pressures: Management or other employees have incentives or pressures to commit fraud. frau ∙ Opportunities: Circumstances provide opportunities for management or employees to commit fraud. d are ∙ Attitudes/rationalization: An attitude, character, or set of ethical values exists that allows management or frau employees to intentionally commit a dishonest act, or they are in an environment that imposes sufficient pressure dule that causes them to rationalize committing a dishonest act. 52) Section 5090 states that, in exercising professional skepticism, an auditor "neither assumes that management is dishonest nor assumes unquestioned honesty." Auditors need to maintain their skepticism and a questioning mind throughout the audit so that they can identify fraud risk and critically evaluate audit evidence. 53) A) Incentives/Pressures: 1. Financial stability or profitability is threatened by economic, industry, or entity operating conditions. 2. Excessive pressure for management to meet debt repayment or other debt covenant requirements. 3. Management or the board of directors' personal net worth is materially threatened by the entity's financial performance. Opportunities: 1. Significant accounting estimates involve subjective judgments or uncertainties that are difficult to verify. 2. Ineffective board of director or audit committee oversight over financial reporting. 3. High turnover or ineffective accounting, internal audit, or information technology staff. Attitudes/Rationalization: 1. Inappropriate or ineffective support of the entity's ethics and values. 2. Known history of violations of laws and regulations. 3. Management's disregard for the financial reporting process. B) Incentives/Pressures: 1. Personal financial obligations create pressure for those with access to cash or other assets susceptible to theft to misappropriate those assets. 2. Adverse relationships between management and employees with access to assets susceptible to theft motivate employees to misappropriate those assets. Opportunities: 1. Presence of large amounts of cash on hand or inventory items that are small, of high value, or in high demand. 2. Inadequate internal control over assets. Attitudes/Rationalization: 1. Disregard for the need to monitor misappropriations of assets. 2. Disregard for internal controls or failing to correct control deficiencies. 54) A) When the auditor is assessing fraud risks the following information sources should be considered: ∙ Information obtained from communications among audit team members about their knowledge of the company and its industry, including how and where the company's financial statements might be susceptible to material misstatements due to fraud. ∙ Responses to auditor inquiries of management about their views of the risks of fraud and about existing programs and controls to address specific identified fraud risks. ∙ Specific risk factors in fraudulent financial reporting or misappropriation of assets. ∙ Analytical procedures results obtained during planning that indicate possible implausible or unexpected analytical relationships. ∙ Knowledge obtained through other procedures such as client acceptance and retention decisions, interim review of financial statements, and consideration of inherent and control risks. B) ∙ How and where the audit team believes the entity's financial statements might be susceptible material misstatement due to fraud. ∙ How management could perpetrate and conceal fraudulent financial reporting.
to
∙
could be misappropriated. ∙ What circumstances exist that might be indicative of earnings management that could lead to How fraudulent financial reporting. asset ∙ What known external and internal factors affecting the entity might s of ∙ create an inventive or pressure for management to commit fraud the ∙ provide the opportunity for fraud to be perpetrated; or entit ∙ indicate a culture or environment that enables management to rationalize fraudulent acts. y ∙ How the auditor might respond to the susceptibility of material misstatements due to fraud. 55) Management cannot act one way and expect others in the company to behave differently. Through its actions and communications, management can show that dishonest or unethical behaviour are not tolerated, even if the results benefit the company. Statements by management about the absolute need to meet operating and financial targets create undue pressures that may lead employees to commit fraud to achieve them. In contrast, statements indicating management's desire to aggressively pursue entity's goals and targets while at the same time requiring honest and ethical actions to achieve those goals clearly indicates to employees that integrity is a requirement. Whichever course management pursues, its actions establish the "tone at the top." 56) Auditor: The auditor's responsibility is to provide assurance with respect to the reasonableness of the financial statements in the context of materiality. If fraud or error are material, then such detection would be within reasonable responsibility of the auditor. However, since the auditor conducts sampling and does not look at every transaction, even material fraud may not be detected. Since fraud is often deliberately concealed, the auditor may not detect material fraud, and most engagement letters clearly stipulate that detection of fraud is not the auditor's responsibility. The auditor should clearly indicate in the engagement letter that fraud detection is not their responsibility, and discuss with the client to ensure that he understands. If the auditor suspects fraud, then he has an obligation to conduct further auditing techniques to confirm or dispel. If fraud is found, then the matter will be brought to the attention of management as well as the audit committee. The auditor is now required to ask the audit committee if they are aware of any fraud taking place in the organization. Management: Management has the responsibility to design, implement and monitor effective control systems, including those systems that are to prevent fraud and error. Management also has the responsibility to discuss with the auditor the risks of fraud or error in the financial statements, and disclose to the auditor any fraud or error that management is aware of. Please note: This material was also covered in earlier chapters. 57) The risk of financial statement fraud at Cobalt Systems Limited is high, for the following reasons: Management incentives/pressures: Management has several reasons to want to overstate earnings: • All senior management own shares and stock options in the company, so if share prices rise, they could benefit. • All senior management are remunerated based upon bonuses based upon net income, so increased net income means more money in their pockets. • There is an incentive to overstate net income as the company wants to issue more stock later in the year. This would mean that they could receive more capital. • There is pressure to repay a large bank loan. • Shareholder expectations would likely be for increasing profits.
Because of the new product and uncertainty about how well the product will do, management may manipulate Man research and development costs or costs or revenues associated with the new product. age ment Management attitudes/rationalization: oppo Management is engaging in extremely risky behaviour in taking orders for a new product that cannot yet be rtuni produced. It is possible that risks could also be taken in other aspects of the business. ties: 58) Type of transaction in the marketing expense: It seems that the payments to the Swiss bank accounts may be bribes, which would make them illegal acts. Is it fraud? Fraud involves an intention to deceive. Clearly, if they are listed in the supporting documents as consultant's fees, when they were in fact, bribes, there is intent to deceive, which could categorize these transactions as fraudulent. Auditor responsibilities: Additional work needs to be completed to confirm or dispel this possibility. It may be necessary to discuss with higher levels of management or with the audit committee (especially as this casts a negative light on management integrity). Other parts of the audit may need to be re-assessed if it is confirmed that there has been management deceit involved. Depending upon the significance of the amounts to the financial statements, and the potential consequences (if they are bribes), the auditor may wish to consult with a lawyer or consider withdrawing from the engagement. The representation letter from management should clearly require them to say that they are not aware of any illegal actions. 59) Fraud risks: This client seems to be rife with opportunities for fraud: ∙ The controller left unsigned cheques with an employee who had only been there for three months. It also indicates problems with respect to attitudes towards risk factors: ∙ It is possible that employee screening was not adequately done, if it is not possible to track down the chief accountant. ∙ Management seems to have a poor attitude towards internal controls (particularly the controller), including the indication that the chief accountant position will not be replaced. Other effects on the audit: ∙ The control environment needs to be reassessed: are there other problem areas? E.g. why is accounts payable running so tight that suppliers are actually coming to pick up cheques (may mean additional cutoff testing or going concern testing is necessary)? ∙ There may be other examples of the consequences of poor controls or other fraudulent transactions, so the level of substantive testing may need to be increased. ∙ Inquiry of staff of management may help narrow down the areas where this testing needs to be done. ∙ We need to confirm that higher levels of management and the audit committee are aware of this fraud. ∙ We should re-evaluate management's processes for preventing and detecting fraud. 60) Incentives / pressures: In this case, there were no significant external pressures or performance targets that led Dorothy to commit the fraud. Dorothy performed the fraud to benefit directly from the money given by the suppliers when the goods were returned. The incentives for Dorothy were personal and to benefit from the money she would be able to use as she wanted, probably to compensate her for a low salary and extra hours worked. Dorothy may have had some personal financial commitment that were not satisfied with her current salary. This
led ation of the store. This resulted in improper segregation of duties and gave Dorothy the opportunity to create and her conceal fraud. Further, since Dorothy never took long vacation, no one replacing her would be able to detect the to anomalies in the clothing returned. This ensured that Dorothy's fraud remained undiscovered for a while. seek addit Rationalization: Dorothy definitely appears to be overworked and underappreciated. This situation can make ional Dorothy rationalize taking the $20,000 by saying that this money is to compensate her for all of her hard work and sour overtime. The $600 pair of shoes she received was hardly a fair compensation for all of her work. It is possible ces also that working in an expensive boutique and seeing Charline travel and take a lot of vacation makes Dorothy less of remorseful about taking money from the boutique and Charline. cash. Oppo rtuni ties: Since Char line's bouti que is rathe r small and Char line appe ars to be more conc erne d with trave lling and socia lizin g, Doro thy was left alone to run most of the admi nistr
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Risk assessment and audit planning is the first phase of the audit process. At the end of this 1) _______ phase, the auditor should have a(n) A) audit plan and specific audit program for the entire audit. B) final assessment of all components of the audit risk model. C) completed letter of representation from management. D) assessment of the results of control testing for each transaction-related audit objective.
2) Planning activities can be carried out at the overall audit level, the cycle level, for individual accounts, or for individual transaction-related or balance-related audit objectives. Which of the following activities are carried out at the levels of the individual account and balance-related audit objectives? A) Design tests of details of balances. B) Assess inherent risk. C) Design substantive analytical D) Assess planned control risk. procedures.
2) _______
3) Audit risk is assessed at which level of the audit? A) account C) cycle
3) _______ B) overall audit D) transaction-related audit objective
4) Risks of fraud are assessed at which level(s) of the audit? A) balance-related audit objectives only B) cycle, account and transaction-related audit objectives C) overall audit, cycle and account D) overall audit, transaction-related audit objectives
4) _______
5) Internal control weaknesses are assessed for A) the overall audit and transaction-related audit objectives. B) transaction-related audit objectives. C) individual account balances. D) balance-related audit objectives.
5) _______
6) The preliminary judgment about materiality is set for A) each cycle or segment. B) cycles and accounts. C) the overall audit. D) transaction-related audit objectives.
6) _______
7) A substantive procedure is used to A) obtain an understanding of internal controls. B) analyze the account balance to see if there are potential errors. C) assess the likelihood of material misstatement in the financial statements. D) quantify the amount of potential error in an account or transaction stream.
7) _______
8) If the auditor is not using tests of control, then A) tests of detail must be used. B) the auditor will have to qualify the audit opinion. C) analytical procedures must be used. D) tests of design of internal controls must at least be used.
8) _______
9) Which combination of the types of evidence would be used for both obtaining an understanding of internal controls and for testing the controls? A) making inquiries of client personnel and examining documents, records, and reports B) observing control-related activities and reperforming client procedures C) calculating gross profit and comparing to actual costs D) examining documents, records, and reports, and observing control-related activities
9) _______
10) Which of the following ultimately determines the specific audit procedures necessary to provide an auditor with a reasonable basis for the expression of an opinion? A) the auditor's judgment B) generally accepted auditing standards C) the auditor's working papers D) the audit program
10) ______
11) When the auditor identifies an area of the accounting system with missing controls (i.e., a weakness), this would lead to a modification of the audit program in that area that would A) increase the amount of tests of controls. B) increase the reliance on tests of controls. C) eliminate the need for a test of controls. D) cause the issuance of a qualified or adverse opinion.
11) ______
12) Eleonar is observing a sample of "Code of Conduct acknowledgement form" that must be signed by all employees to indicate that they have read and understood the company's code of conduct. Eleonar is ensuring that they have been signed by the employee. Eleonar is performing A) a test of controls. B) a procedure to obtain an understanding of internal controls. C) a substantive procedure. D) an analytical procedure.
12) ______
13) The auditor selects several transactions in each functional area and traces them through the entire accounting system, paying special attention to evidence about whether or not the control features are in operation. This is an example of A) a substantive test. B) a sequence test. C) a functional test. D) a test of controls.
13) ______
14) The purpose of tests of controls is to provide reasonable assurance that the A) entity has complied with disclosure requirements of generally accepted accounting principles. B) accounting treatment of transactions and balances is valid and proper. C) entity has complied with requirements of quality control. D) accounting control procedures are operating as intended.
14) ______
15) Tests of controls are directed toward the control's A) efficiency. C) effectiveness.
15) ______ B) cost benefit ratio. D) efficiency and effectiveness.
16) After finishing the procedures to obtain an understanding of internal control in an audit engagement, the auditor should perform tests of controls on A) a random sample of the controls that were reviewed. B) those controls in which material weaknesses were identified. C) those controls that have a material effect upon the financial statement balances. D) those controls that the auditor plans to rely upon.
16) ______
17) A procedure designed to test for dollar errors or irregularities directly affecting the correctness of financial statement balances is a A) definition of dollar-unit sampling. B) substantive test. C) analytical test. D) test of controls.
17) ______
18) Tests to determine whether the accounting transactions have been properly authorized, correctly recorded and summarized in the journals, and correctly posted to subsidiary ledgers and the general ledger are A) tests of controls. B) direct tests. C) analytical procedures. D) substantive tests of balances.
18) ______
19) Which of the following audit tests would be regarded as a "test of controls"? Test of the A) signatures on cancelled cheques to board of director's authorizations B) specific items making up the balance in a given general ledger account C) inventory pricing to vendors' invoices D) additions to capital assets
19) ______
20) Which of the following is ordinarily designed to detect possible material dollar errors on the financial statements? A) tests of controls B) computer controls C) analytical review D) post-audit working paper review
20) ______
21) If no material fluctuations are found using analytical procedures and the auditor concludes that differences should not have occurred, A) other tests may be reduced. B) it will not be necessary to perform tests of details of balances. C) it will be necessary to increase the tests of controls. D) it will be necessary to increase the tests of details of balances.
21) ______
22) Analytical procedures are considered to be a planning procedure and A) substantive tests. B) statistical processes. C) tests of controls.
22) ______
D) helpful procedures not possessing the validity of other tests available to the auditor.
23) Donna sees a large variation in the gross margin percentage as a result of analytical procedures she performed. A) Donna cannot rely on the company's internal controls. B) The financial statements contain an error. C) Donna should perform more tests. D) Donna should document this difference.
23) ______
24) The auditor verifies the summarizing, accuracy, and posting of entries by performing A) analytical procedures. B) procedures to gain an understanding of internal control. C) tests of controls. D) dual-purpose tests
24) ______
25) In the context of an audit of financial statements, substantive tests are audit procedures that A) will increase proportionately with the auditor's reliance on internal control. B) may be eliminated under certain conditions. C) may be either direct tests of financial balances, or analytical tests. D) are designed to discover significant subsequent events.
25) ______
26) After completing the procedures to obtain an understanding of internal control, the auditor decides not to assess control risk at less than the maximum. Documentation may be limited to the auditor's A) basis for concluding that errors and irregularities will be prevented. B) understanding of internal control. C) reasons for deciding not to test controls. D) completed internal control questionnaire.
26) ______
27) Which of the following audit tests is usually the least costly to perform? A) tests of controls B) analytical procedures C) confirmations D) tests of balances
27) ______
28) Performance of tests of controls provide evidence in support of the specific controls that contribute to the auditor's assessed control risk (where it is reduced below 100%). Also, when dual-purpose tests are used, evidence is obtained in support of A) monetary correctness of transactions. B) statistical ratios to assist analytical review. C) the nature of illegal acts that occurred. D) the quantitative effects of fraud risks.
28) ______
29) Which of the following audit tests is usually the most costly to perform? A) tests of controls B) tests of details of balances C) procedures to obtain an understanding of internal control
29) ______
D) analytical procedures
30) Symco Inc has a policy that all cash disbursements of $2,000 or more must be approved by the treasurer. While performing a test of controls on a sample of disbursements, Craig discovered that the assistant controller had authorized a cash disbursement of $3,500 while the treasurer was on vacation. This control deviation is significant only if A) the amount of the deviation identified is larger than the planning materiality and no compensating control exists. B) the amount of the deviation identified is larger than the planning materiality. C) it occurred with sufficient frequency to cause the auditor to believe there may be material dollar misstatements in the statements. D) it is determined that the assistant controller is not qualified to approve cash disbursements of this size.
30) ______
31) After completing tests of key controls, the auditor should review the results and consider whether A) sufficient knowledge has been obtained about the entity's entire internal control structure. B) the audit evidence obtained from the study of internal controls can provide a reasonable basis for an opinion. C) the planned degree of reliance on internal controls is justified. D) further study of internal controls is likely to justify any restriction of tests of details of balances.
31) ______
32) The auditor has conducted tests of controls of the write off of accounts receivable and found two exceptions. These exceptions are A) confirmation that controls are not functioning as designed throughout the year. B) indications that employee training is required in the accounting area. C) information about the quantity of the dollar error in accounts receivable. D) an indication of the likelihood of errors or fraud and other irregularities.
32) ______
33) The auditor has completed analyzing the results of tests of details of the accounts receivable ending balance. Errors totaling $25,000 were found. These exceptions are A) financial statement misstatements. B) probably cut-off errors that can be explained. C) an indication of potential errors in the ending balance. D) indications that the credit limit is being incorrectly applied.
33) ______
34) Control risk has been assessed at 100% for your client. What audit approach will you follow? A A) reliance on tests of controls and tests of details B) reliance on analytical review and tests of controls C) combined approach D) substantive approach
34) ______
35) PA has designed an audit approach where she places maximum possible reliance on controls. This means that she will be A) be following a combined audit approach.
35) ______
B) using analytical review and tests of controls. C) conducting only tests of controls. D) setting control risk at 100%.
36) The highest cost audit will be incurred when the auditor expects that the internal control system would A) be very sophisticated, and the tests of controls confirmed this. B) have few effective controls, but client's personnel were well-trained and knowledgeable. C) be effective, but the auditor found extensive control test deviations. D) have few effective controls, and tests of balances found many errors.
36) ______
37) There will be heavy emphasis on tests of controls when A) controls are ineffective and assessed control risk is high. B) the auditor is doing a "fraud audit." C) controls are effective and assessed control risk is low. D) it is a first-year audit.
37) ______
38) A listing of all the things which the auditor will use to gather sufficient appropriate evidence for a particular transaction cycle is the A) audit program. B) audit procedure. C) audit plan. D) audit risk model.
38) ______
39) When does the auditor normally conduct tests of controls? A) prior to the finalization of the audit risk model B) after the completion of all analytical review C) prior to the preparation of the client risk analysis D) prior to the completion of the tests of details
39) ______
40) Analytical procedures are mandatory during which phases of the audit? A) planning and completion B) planning and tests of details C) tests of controls and tests of details D) tests of details and completion
40) ______
41) Choosing the appropriate analytical procedures requires the auditor to use A) professional judgment. B) the standards developed by the auditor's firm. C) computer assisted audit techniques. D) automated working paper software.
41) ______
42) Last year the materiality for the client was $590,000. This year it is $400,000. All things being equal, how will the change in materiality affect the extent of tests of details? A) increase B) no effect as the tests of controls will be increased C) no effect as the tests of controls will be decreased D) decrease
42) ______
43) Julianne is performing an analysis of the bad debt expense as a percentage of total sales. When performing the analytical procedure, it is important that Julianne A) has concluded that the AR balance is free from material misstatement. B) can rely on the internal controls of the AR process. C) has an expectation of the result that should be obtained. D) has requested permission from the client.
43) ______
44) Cimco Forest is a client of your PA firm that has requested that the audit of their financial statements be completed 25 days after their year end. Given the time constraint, the auditor A) should increase the size of the audit team. B) should change the audit program to include more tests of controls and less tests of details as they are more time consuming. C) can perform audit procedures at an interim date and roll forward the interim balances to year end. D) should not accept Cimco as a client.
44) ______
45) Tests of details are designed based upon planned results of analytical review and planned results of tests of controls. Should the planned results differ materially from the actual results of analytical review and tests of controls then A) audit risk will be revised. B) inherent risk will be revised. C) the planned audit program will require revision. D) tests of controls will not be considered for overall risk assessment processes.
45) ______
46) Standard audit program can dramatically increase A) quality audit evidence. B) the amount of work that can be delegated to more junior staff members. C) audit efficiency. D) communication between the audit team.
46) ______
47) Transaction-related audit objectives have a direct relationship to balance-related audit objectives. The transaction-related audit objective of occurrence is related to which balance-related audit objective? A) detail tie-in B) accuracy C) cutoff D) existence or completeness
47) ______
48) Transaction-related audit objectives have a direct relationship to balance-related audit objectives. The transaction-related audit objective of timing is related to which balance-related audit objective? A) existence B) accuracy C) measurement D) cutoff
48) ______
49) Transaction-related audit objectives have a direct relationship to balance-related audit objectives. The transaction-related audit objective of posting and summarization is related to which balance-related audit objective? A) cutoff B) detail tie-in C) accuracy D) completeness
49) ______
50) Even when all transaction-related audit objectives are met, the following balance-related audit objectives are still tested with primarily tests of details: A) realizable value, detail tie-in, classification B) presentation and disclosure, accuracy, detail tie-in C) realizable value, rights and obligations, presentation and disclosure D) rights and obligations, detail tie-in, cut-off
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Describe the five types of audit tests used to determine whether financial statements are fairly stated. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk. B) There are five types of audit procedures that relate to the auditor's understanding of internal control. One type of procedure is "Update and evaluate the auditor's previous experience with the entity." Identify (1) the remaining four types of procedures related to understanding internal control, and (2) the four types of procedures that are used to test controls.
52) Discuss the purposes of tests of controls and tests of details of balances. Give an example of each.
53) A) There are seven types of audit evidence: inspection, confirmation, recalculation, observation, inquiries of the client, reperformance, and analytical procedures. For each of the following types of audit tests, indicate the type(s) of evidence that can be obtained through the test: (1) tests of controls, (2) analytical procedures, and (3) tests of details of balances. B) Contrast the circumstances in which the auditor would choose not to test controls with those in which he or she would perform tests of controls. C) Types of audit tests include tests of controls, analytical procedures, and tests of details of balances. Please rank the preceding three types of tests from least costly to most costly.
54) List the nine balance-related audit objectives in the verification of the ending balance in accounts receivable, and provide one specific useful audit procedure for each of the objectives.
55) Greenvale Construction Limited was started by four brothers who lived in the Toronto area. Over time, the brothers have moved to different parts of the country. They decided it was a good idea to keep the company, and organize their work as separate divisions as part of the same company. There are now three divisions, one for each of the brothers who are actively involved in construction. The fourth brother, Ted, is responsible for accounting and record keeping. Ted went back to school and completed an accounting designation, and now has three employees in the accounting area. Each of the brothers has moved on to specialize in a different kind of construction work. In Toronto, it is mainly new home construction. In Edmonton, the work is primarily renovations of large homes and small commercial enterprises, while in Halifax, the work is completely commercial on mid-to-large projects. All of the brothers prefer to subcontract their work rather than hiring full time construction employees, although some of the subcontract relationships have lasted over fifteen years now. Required:
Explain would do to document your understanding of internal control for Greenvale. Identify potential risk areas what you where you would need to focus additional attention.
56) You are conducting the audit of a medium-sized company that has a chief accountant and three employees. Segregation of duties is excellent, with jobs allocated to provide maximum levels of controls. Segregation is supported by accounting software with user identification and password that limits functions to the appropriate job. Required: A) What type of audit approach would you recommend? Why? B) How would your answer change if the accounting department was organized on a job sharing basis so that all employees did some of every task to keep the work more interesting? Why?
57) "This is really confusing! I've sat in on three audit planning meetings so far, and each one has gone differently. I've been responsible for the sales section each time. Sure the risks are all different, but in the first one I'm supposed to do flowcharts and detailed narrative for the sales systems, in the second one I'm supposed to use the firm's computerized system to answer detailed questions, and in the last one the partner only wants a brief description of the system in narrative form — no more than one page, he said." Required: Explain why it may be necessary to do different types of documentation to support an understanding of internal controls, in the context of risks and evidence mix.
58) Jane is a sole practitioner operating out of a local office. She is part of a regional group of firms, and occasionally does a small audit, with the assistance of one staff person. Using automated working paper software, she runs a standard set of analytical review calculations for each audit, then puts them in the working paper file. She does not look at the analytical review process again. Since most of her audit clients have no internal controls, she then calculates materiality, and conducts a substantive audit. She prefers to do more substantive testing rather than having to do all kinds of work with internal controls. Required: What is wrong with Jane's audit approach?
59) Samru has been assigned the sales cycle as part of an audit team. He will be evaluating several key controls in the sales cycle and conducting tests of detail for accounts receivable. Samru has been told to look at 15 customers with respect to the credit limit approval process (a test of control). Then, he has been told to use dual purpose tests for the rest of his testing. Required: Explain the relationship between tests of controls, dual purpose tests and tests of details.
60) You are a senior at a PA firm and this is your junior's first day. He would like you to explain to him what
are the types of audit tests that should be performed over the course of an audit to obtain sufficient and appropriate different audit evidence. Further, please indicate to which component of audit risk the type of test is linked.
1) A 2) C 3) B 4) C 5) A 6) C 7) D 8) A 9) A 10) A 11) C 12) A 13) D 14) D 15) C 16) D 17) B 18) A 19) A 20) C 21) A 22) A 23) C 24) D 25) C 26) C
27) B 28) A 29) B 30) C 31) C 32) D 33) A 34) D 35) A 36) C 37) C 38) A 39) D 40) A 41) A 42) A 43) C 44) C 45) C 46) C 47) D 48) D 49) B 50) C 51) A) The five types of audit tests used to determine whether financial statements are fairly stated are: procedures to obtain an understanding of internal control, tests of controls, risk assessment procedures, analytical procedures, and tests of details of balances. Analytical procedures and tests of details of balances are substantive tests, whereas
proc ding of internal control and tests of controls are used to reduce assessed control risk. edur es to B) The remaining four types of procedures related to understanding internal control are: make enquiries of client obtai personnel, read clients' policy and systems manuals, examine documents and records, and observe entity activities n an and operations. The four types of procedures that are used to test controls are: make inquiries of appropriate client unde personnel, examine documents records, and reports, observe control-related activities, and reperform client rstan procedures. 52) The purpose of tests of controls is to determine the effectiveness of both the design and operations of specific internal controls. For example, the auditor might observe for a month whether statements are mailed to all customers. The purpose of tests of details of balances is to detect material misstatements at the assertion level. The confirmation of accounts receivable is an example. 53) A) 1. Tests of controls. Recalculation, observation, inquiries of the client, inspection, reperformance. 2. Analytical procedures. Inquiries of the client, analytical procedures. 3. Tests of details of balances. Inspection, confirmation, recalculation, inquiries of the client, reperformance. B) If the auditor believes that controls have not been operating effectively during the period under audit, or that it would not be cost-effective to test controls, then he or she would choose not to test controls. In contrast, if the auditor believes that controls have been operating effectively during the period under audit, and that it would be cost-effective to test controls, the auditor will perform tests of controls. C) The least expensive type of audit test is analytical procedures, followed by tests of controls, and tests of details of balances. 54) The nine balance-related audit objectives are: ∙ Detail tie-in. Obtain an aged list of accounts receivable, foot the schedule, and trace total to general ledger. Also trace individual accounts to the master file. ∙ Existence. Obtain direct confirmation of accounts receivable. ∙ Completeness. Obtain an analysis of the allowance for doubtful accounts and examine authorization for write-offs. ∙ Accuracy. Obtain direct confirmation of accounts receivable. ∙ Classification. Review lists of balances for credit balances and for notes receivable due after one year. ∙ Cutoff. Determine that proper cutoff procedures were applied at the balance sheet date to ensure that sales, cash receipts, and credit memos have been recorded in the proper period. ∙ Valuation. Analyze the AFDA % as a function of sales and compare to industry and prior years. ∙ Rights. Review receivables for any that have been assigned or discounted. ∙ Presentation and disclosure. Review list of balances for amounts due from related parties or employees. 55) Update and evaluate the auditor's previous experience with Greenvale: ∙ Review the prior year audit file. ∙ Identify any risk areas from the prior year's audit that would likely be risk areas this year. Make enquiries of client personnel: ∙ Discuss with Ted whether there have been any changes in procedures. ∙ Review last year's management letter to determine if there have been any recommendations that were (or were not) followed up by the client. ∙ Walk through the descriptions of internal control with Ted and his staff to see if there have been any changes in procedures. ∙ Contact each of the brothers in the other locations and inquire with respect to their changes in procedures.
have been any changes to accounting systems in use. Read ∙ If so, review the supporting documentation for any issues relevant to the audit. the ∙ Ask if there are any policy documents that have changed from the prior year and if so, review these. clien t's Examine documents and records: polic ∙ Select a sample of transactions and walk them through the system descriptions updated with the client. y and Observe entity activities and operations: Observe accounting staff activities while on premises. syste ∙ ms man Potential risk areas: Since transactions are sent from other locations to the Toronto head office, there could be cut-off errors, or uals: ∙ transactions could be sent late. ∙ ∙ Segregation of duties at each of the locations would not exist, since there is essentially only one employee: each of the brothers has the ability to override controls. Ask Procedures and controls for each of the construction divisions may be different: need to consider them Ted ∙ whet separately. Need to consider issues like inventory of materials, whether it is material, and whether an accountant in Halifax her ∙ there or Edmonton should be involved in counting these materials. 56) A) I would recommend a combined audit approach, as tests of controls cost less than tests of detail. By relying on internal controls, where possible, the overall cost of the audit can be minimized. B) A substantive audit approach will be required, and control risk will need to be set at 100%, since it will be difficult to rely upon internal controls when there is no segregation of duties. 57) It is likely that for both the first and second audit, the auditor will be relying upon internal controls and conducting a combined audit. To enable reliance, internal controls need to be thoroughly documented, so that assessments of control risk can be prepared for each account and for each transaction-related audit objective. It is possible that the client where flowcharts are to be prepared manually is a smaller client, and the number of possible key controls is small. Where there are a larger number of possible controls, it is more effective to use automated techniques, so that the assistance of the software can be used to help ensure that each audit assertion has been properly considered for each material account, or where there is a risk of material misstatement for the account. The last client, where only a brief one page description is required, is probably an owner-managed client where the primary control is exercised by the owner-manager. In that case, there will be few other key controls, as lack of segregation of duties in a small business means that controls executed by individual accounting employees may not be effective. 58) First of all, Jane is violating generally accepted audit standards. She is also not conducting an effective audit: ∙ She is not gathering sufficient information about internal controls to assess control risks and design her tests. ∙ Analytical procedures are required to be conducted during the planning and completion phases of the audit, not just the planning phase. ∙ The purpose of analytical review is to target subsequent audit work — analytical procedures work does not seem to be linked to the rest of the audit. ∙ Her audit is not linked to a risk analysis process (she does not seem to be considering inherent or control risks, nor even planning in the context of a targeted audit risk). ∙ Materiality does not seem to be used as an effective planning tool, but rather as a method of selecting tests of details. ∙ Jane does not seem to be actively considering the risks of fraud or illegal acts. 59) The purpose of tests of controls is to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions. The results of the tests will help the auditor assess the effectiveness of
inter functioning as designed, and the auditor places reliance on the internal controls, all things being equal, this will nal result in the need to conduct fewer tests of details. contr ols. Substantive tests (tests of detail and analytical procedures) are designed to test for dollar amounts of errors or fraud and other irregularities directly affecting the correctness of financial statement balances. If inter Dual-purpose tests are tests that provide evidence of whether or not the controls being tested were operating nal effectively during the period and whether there are misstatements in the data produced by the accounting systems. contr ols The use of dual-purpose tests combines an internal control test and a test of detail into one test, saving costs during are the audit. 60) The types of audit tests are: Risk assessment, procedures to obtain an understanding of internal controls, tests of controls, analytical procedures and tests of detail balances. Risk assessment is linked to the inherent risk. Procedures to obtain an understanding of internal controls and tests of controls are linked to the control risk. Analytical procedures and tests of details of balances are linked the the detection risk.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A sample in which the characteristics of the sample are the same as those of the population is 1) _______ a(n) A) representative sample. B) random sample. C) attribute sample. D) variables sample.
2) Nonsampling errors occur when audit tests do not uncover existing exceptions in the A) planning stage. B) financial statements. C) population. D) sample.
2) _______
3) One of the causes of nonsampling error is A) the use of inappropriate or ineffective audit procedures. B) failure to draw a representative sample. C) failure to draw a random sample. D) the use of attribute sampling instead of variables sampling.
3) _______
4) One of the ways to eliminate nonsampling risk is through A) controls which ensure that the sample drawn is random and representative. B) proper supervision and instruction of the client's employees. C) the use of attribute sampling rather than variables sampling. D) proper supervision and instruction of the audit team.
4) _______
5) Sampling risk (sampling error) is an inherent part of sampling that results from A) testing less than the entire population. B) weaknesses in client's internal control system. C) failure to recognize exceptions. D) inappropriate audit procedures.
5) _______
6) One of the ways to reduce sampling risk is to A) use an appropriate method of selecting sample items from the population. B) provide proper supervision and instruction of the audit team. C) use variables sampling rather than attribute sampling. D) carefully design the audit procedures to be used.
6) _______
7) An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods A) afford greater assurance than a nonstatistical sample of equal size. B) can more easily convert the sample into a dual-purpose test useful for substantive testing. C) eliminate the need to use judgment in determining appropriate sample sizes. D) provide an objective basis for quantitatively evaluating sample risks.
7) _______
8) The professional standards indicate that
8) _______
A) non-statistical methods should only be used if statistical method of sampling is too costly to use. B) it is equally acceptable to use either statistical or non-statistical sampling methods. C) it is preferable to use non-statistical sampling method instead of statistical sampling method. D) it is preferable to use statistical sampling method instead of non-statistical sampling method.
9) An example of judgmental sampling is A) proportionate-to-size sample selection. C) block sampling.
9) _______ B) systematic sample selection. D) simple random sample selection.
10) Carrie found an error in the sample she tested from the population of AR over 90 days. The error found by Carrie should be extrapolated to the population of A) all past due AR. B) AR over 90 days. C) Carrie should perform more tests. D) all AR.
10) ______
11) A common use of block testing is testing A) valuation. B) existense.
11) ______ C) cut-off.
D) authorization.
12) Which of the following statements is a valid criticism of the use of non-statistical sampling methods? A) Nonstatistical sampling does not differ substantially from statistical sampling methods. B) The cost of performing random selection or testing often exceeds the benefits. C) Conclusions may be drawn in more precise ways when using statistical sampling methods. D) Many audit tests, such as footing of journals, must be performed outside a statistical sampling context.
12) ______
13) An underlying feature of random-based selection of items is that each A) item in the population be randomly ordered. B) item in the population should have an opportunity to be selected. C) stratum of the population be given equal representation in the sample. D) item must be systematically selected using replacement.
13) ______
14) When the auditor goes through a population and selects items for the sample without regard to their size, source, or other distinguishing characteristics, it is called A) block selection. B) systematic selection. C) haphazard selection. D) statistical selection.
14) ______
15) When the auditor intends to evaluate a sample statistically, the only acceptable selection method is A) block selection. B) haphazard selection. C) probabilistic selection. D) judgmental selection.
15) ______
16) The process which requires the calculation of an interval and then selects the items based on the sizer of the interval is A) computerized selection. B) statistical sampling. C) systematic selection. D) random selection.
16) ______
17) In systematic selection, population size is divided by the number of sample items desired in order to determine the A) interval. B) computed upper exception rate. C) mean. D) tolerable exception rate.
17) ______
18) When systematic sample selection is used, the first item is selected and all other items are selected automatically. If the characteristic of interest is no distributed randomly in the population, the systematic selection creates the possibility of A) selecting mostly larger dollar items. B) judgmental intervention in the process. C) abnormal frequency distribution. D) bias.
18) ______
19) In performing a review of his client's cash disbursements, a public accountant uses systematic sampling with a random start. The primary disadvantage of systematic sampling is that population items A) may occur in a systematic pattern, thus negating the randomness of the sample. B) may occur twice in the sample. C) must be replaced in the population after sampling to permit valid statistical inference. D) must be reordered in a systematic pattern before the sample can be drawn.
19) ______
20) Which of the following best describes what the auditor means by the rate of occurrence in the attribute sampling plan? A) the frequency with which a certain characteristic occurs within a population B) the dollar range within which the true population total can be expected to fall C) the degree of confidence that the sample is representative of the population D) the number of errors that can reasonably be expected to be found in a population
20) ______
21) The most common method used for performing statistical tests of controls is A) random selection of samples. B) judgment sampling. C) attribute sampling. D) variables sampling.
21) ______
22) A statistical method used to estimate the proportion of items in a population containing a characteristic of interest is A) population-proportional-to-size sampling. B) attribute sampling. C) estimation sampling. D) variables sampling.
22) ______
23) A method of sampling in which all the items in the population are divided into two or more subpopulations is A) attribute sampling. B) variables sampling.
23) ______
C) divisible sampling.
D) stratified sampling.
24) A public accountant examining inventory may appropriately apply sampling for attributes in order to estimate the A) physical quantity of inventory items. B) average price of inventory items. C) dollar value of inventory. D) percentage of slow-moving inventory items.
24) ______
25) If an auditor, planning to use statistical sampling, is concerned with the number of a client's sales invoices that contain mathematical errors, the auditor would most likely utilize A) sampling for variables. B) stratified random sampling. C) sampling for attributes. D) random sampling with replacement.
25) ______
26) Attribute sampling would be an appropriate method to use on which one of the following procedures in an audit program? A) Review sales transactions for large and unreasonable amounts. B) Review the aged schedule of accounts receivable to determine if amounts receivable from officers are included. C) Examine a sample of duplicate sales invoices for credit approval by the credit manager. D) Observe whether the duties of the accounts receivable clerk are separate from handling cash.
26) ______
27) Which of the following is a disadvantage of the monetary-unit sampling method? A) It always gives the statistical conclusion as a dollar amount. B) Computer assistance is needed to select dollar-unit samples from large populations. C) Currency can be used as the sampling unit. D) It automatically increases the likelihood of selecting high dollar items from the population being audited.
27) ______
28) Maha is testing the population of sales invoice of Tecca Corp. The total sales for the year are $140,000,000. The total number of invoices for the year is 70,000 and the average sales per invoice is $2,000. If Maha uses monetary unit sampling instead of physical sampling, an invoice of $1,000 has A) more chance of being selected. B) less chance of being selected. C) equal chance of being selected. D) no possibility of being selected since it is not material.
28) ______
29) Which of the following would be designed to estimate a numerical measurement of a population, such as a dollar value? A) sampling for attribute B) numerical sampling C) discovery sampling D) monetary unit sampling
29) ______
30) Auditors make extensive use of variables sampling in performing
30) ______
A) tests of details of balances. C) understanding of the business.
B) tests of controls. D) analytical procedures.
31) The overall objectives of the audit test must be stated in terms of A) the transaction cycle being tested. B) the anticipated results. C) the risk addressed and the anticipated results. D) the risks addressed and the transaction cycle being tested.
31) ______
32) The exception rate the auditor will permit in the population and still be willing to use the assessed level of control risk is called the A) estimated population exception rate. B) tolerable exception rate. C) acceptable risk of overreliance. D) sample exception rate.
32) ______
33) Establishing the tolerable exception rate (TER) requires A) a computer program. B) random number tables. C) professional judgment. D) statistical frequency probability tables.
33) ______
34) The tolerable exception rate (TER) has a significant effect on sample size. The relationship of TER to sample size is A) direct (larger TER = larger sample). B) not determinable. C) variable (sometimes larger, sometimes smaller). D) inverse (larger TER = smaller sample).
34) ______
35) The acceptable risk of assessing control risk too low (ARACR) has a significant effect on sample size. The relationship of ARACR to sample size is A) direct (larger ARACR = larger sample). B) variable (sometimes larger, sometimes smaller). C) not determinable. D) inverse (larger ARACR = smaller sample).
35) ______
36) In statistical terms, acceptable risk of assessing control risk too low (ARACR) corresponds with A) sampling risk. B) inherent risk. C) nonsampling risk. D) control risk.
36) ______
37) If the result obtained from a particular sample will be critical (that is, the auditor would not be able to render an unqualified opinion unless every item in the population was examined), which of the following is the most important to the auditor? A) size of the population B) acceptable risk of assessing control risk too low C) tolerable exception rate D) estimated population exception rate
37) ______
38) If the auditor decides to assess control risk at the maximum level, tests of controls are A) increased in number. B) not performed. C) unchanged from prior planned settings. D) reduced in number.
38) ______
39) In attribute sampling, an advance estimate of the expected population exception rate is necessary to plan the appropriate sample size. The relationship of expected population exception rate (EPER) to sample size is A) inverse (small EPER = large sample). B) a variable (sometimes small, sometimes large) dependent on other factors present. C) indeterminate. D) direct (small EPER = small sample).
39) ______
40) If all other factors specified in a sampling plan remain constant, changing the estimated population exception rate from 2% to 4% would cause the required sample size to A) increase. B) decrease. C) become indeterminate. D) remain the same.
40) ______
41) Of the four factors which determine the initial sample size (population size, tolerable exception rate, acceptable risk of assessing control risk too low, and expected population exception rate), which combination of two factors has the greatest effect on sample size? A) tolerable exception rate minus expected population exception rate B) acceptable risk of overreliance minus tolerable exception rate C) expected population exception rate plus acceptable risk of overreliance D) population size times expected population exception rate
41) ______
42) The auditor cannot expect meaningful results from using audit sampling unless the audit procedures are applied A) timely. B) steadily. C) randomly. D) carefully.
42) ______
43) The sample exception rate equals A) the number of exceptions in the population divided by the sample size. B) the number of exceptions in the sample divided by the sample size. C) the number of items in the population multiplied by the number of exceptions in the sample. D) the number of exceptions in the population divided by the population size.
43) ______
44) In estimating the population misstatement, the first step in projecting from the sample to the population is to A) make a point estimate. B) revise the upper error bound. C) calculate the precision interval. D) determine the population mean.
44) ______
45) Helen found that the expense reports were not properly approved while the senior accounts payable clerk was on vacation in July. Helen decided to perform a test of control on the authorization of expense reports for all the months except for July which she will test substantively. Helen is allowed to do this because
45) ______
A) compensating controls exist in the payroll reconciliation process. B) the authorized expense reports for July are not material. C) the authorization for the month of July are not representative of the population as a whole. D) it would not be cost beneficial to test the entire population substantively.
46) The point estimate, by itself, is not an adequate measure of the population misstatement because of A) population biases. B) control risk. C) audit risk. D) sampling error.
46) ______
47) The final step in the evaluation of the audit results is the decision to A) project the point estimate. B) determine the acceptability of the population. C) determine the error in each sample. D) determine sampling error and calculate the estimated total population error.
47) ______
48) When the computed upper exception rate is greater than the tolerable exception rate, it is necessary for the auditor to take specific action. Which of the following courses of action would be most difficult to defend if the auditor is ever subject to review by a court? A) Revise and relax the tolerable exception rate (TER) or the acceptable risk of assessing control risk too low (ARACR). B) Revise the assessed control risk. C) Expand the sample size. D) Write a letter to management.
48) ______
49) An increase in the sample size has the effect of decreasing the sampling error if the A) actual sample exception rate increases. B) number of exceptions in the sample does not increase. C) actual sample exception rate does not increase. D) number of exceptions in the sample increases.
49) ______
50) An auditor who uses statistical sampling for attribute in testing internal controls should increase the assessed level of control risk when the A) sample rate of exception plus the allowance for sampling risk exceeds the tolerable exception rate. B) sample rate of exception plus the allowance for sampling risk equals the tolerable exception rate. C) tolerable exception rate less the allowance for sampling risk exceeds the sample rate of deviation. D) sample rate of exception is less than the expected rate of exception used in planning the sample.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Discuss what is meant by "sampling error." B) Discuss what is meant by "nonsampling error."
uss two causes of nonsampling error. Also discuss ways the auditor can control nonsampling risk. C) Disc D) Discuss two ways the auditor can control sampling risk.
52) A) Describe the differences between statistical and nonstatistical sampling in terms of (1) the sample selection methods used, and (2) measurement (quantification) of sampling risk. B) Describe each of the three types of sample selection methods commonly associated with nonstatistical audit sampling. C) Directed sample selection is the selection of each item in the sample based on some judgment criteria established by the auditor. Describe three commonly used criteria.
53) A) Describe each of the four types of sample selection methods commonly associated with statistical audit sampling. B) Explain the difference between sampling with replacement and without replacement. Which method is more common in audit practice? C) Explain the steps involved in systematic sampling.
54) A) There are 14 steps to audit sampling, divided into three sections: plan the sample and select the sample, perform the audit procedures, and evaluate the results. Discuss each of the steps that comprise the "plan the sample" section.
55) Identify each of the seven factors that influence sample size for nonstatistical tests of details of balances and state whether each factor is directly or inversely related to sample size.
56) Discuss each of the possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount.
57) You are working on the testing of internal controls over price changes in the inventory system. You completed the controls testing to determine whether all price changes were approved by the senior accountant, by reference to master file change forms. In order to place reliance on this control, your audit supervisor has decided that the error rate in the population should be less than 1%. When you calculated your sample size, you used a confidence level of 90% and predicted an error rate in the population of less than one percent. Based on these decisions, you examined 150 inventory price master file change forms. In your testing, you uncovered two deviations. Based on these results, you calculate that the actual error rate in the population could be as high as 2.33 %. Required: A) What actions are available to you regarding your planned reliance on the master file change controls? B) What are the advantages and disadvantages of each action?
C) How would you decide which action to take?
58) Kyle is performing a test of detail using a non-statistical sample. A) Can Kyle formally measure sampling error? B) What should Kyle consider in determining the sampling error?
59) You have recently been hired as an audit trainee with an internal audit department. Your first assignment will be will be to select the sample for a test of new capital assets acquired over the last two years. Your review of the internal audit files indicates that the last time this work was done the sample to be tested was selected on a judgmental nonstatistical basis. However, based on your university audit course, you believe the work offers good potential for the use of statistical sampling techniques. You know that you will have to be able to explain and justify your opinion to the internal audit manager. Required: Both statistical sampling as well as nonstatistical or judgmental sampling have advantages and disadvantages. Briefly state two advantages and two disadvantages of statistical sampling and one advantage and one disadvantage of nonstatistical sampling.
60) You have just been given the approval to conduct statistical sampling for the audit of capital assets acquisitions. Previously, this work was completed using a judgmental sample. Required: Explain the key areas where decisions need to be made when conducting audit work using a statistical sample.
1) A 2) D 3) A 4) D 5) A 6) A 7) D 8) B 9) C 10) B 11) C 12) C 13) B 14) C 15) C 16) C 17) A 18) D 19) A 20) A 21) C 22) B 23) D 24) D 25) C 26) C
27) B 28) B 29) D 30) A 31) D 32) B 33) C 34) D 35) D 36) A 37) B 38) B 39) D 40) A 41) A 42) D 43) B 44) A 45) C 46) D 47) B 48) A 49) C 50) A 51) A) Sampling error occurs when the sample is not representative of the population; that is, the characteristics of interest in the sample are not the same as those in the population.
B)
when audit tests do not uncover existing exceptions in the sample.
Nons C) The two causes of nonsampling error are (1) the auditor's failure to recognize exceptions and (2) inappropriate ampl or ineffective audit procedures. The auditor can control nonsampling risk through careful design of audit ing procedures, and through proper instruction, supervision, and review. error occu D) Two ways the auditor can control sampling risk are (1) adjust sample size and (2) use an appropriate method of rs selecting sample items from the population. 52) A) Nonstatistical sampling differs from statistical sampling in that nonprobabilistic sampling can be used for the former but not the latter. In addition, sampling risk can be quantified when using statistical sampling, but not when using nonstatistical sampling. B) Three types of sample selection methods commonly associated with nonstatistical audit sampling are: ∙ Directed sample selection. Each item in the sample is selected on the basis of some judgmental criteria established by the auditor. ∙ Block sample selection. Several items in the population are selected in sequence. ∙ Haphazard sample selection. Sample items are selected from the population without regard to their size, source, or other distinguishing characteristics. C) Commonly-used criteria used in directed sample selection are: ∙ Items most likely to contain misstatements; e.g., unusual or complex transactions, overdue receivables. ∙ Items containing selected population characteristics, such as transactions selected from each month during the year or from each location. ∙ Large dollar coverage in which the auditor focuses on selecting the relatively large items in the population for testing. 53) A) Four types of sample selection methods commonly associated with statistical audit sampling are: ∙ Simple random sample selection. Every possible combination of elements in the population has an equal chance of constituting the sample. ∙ Systematic sample selection. A probabilistic method of sampling in which the auditor calculates an interval (the population size divided by the number of sample items desired), and selects the items for the sample based on the size of the interval and a randomly selected number between zero and the interval size. ∙ Probability proportional to size sample selection. The probability of selecting any individual population item is proportional to its recorded amount. ∙ Stratified sample selection. A probabilistic method of sampling in which the population is divided into subpopulations, and subsamples are taken from each of the subpopulations. B) In replacement sampling, an element in the population can be included in the sample more than once, whereas in nonreplacement sampling, an element can be included only once. Nonreplacement sampling is more common in audit practice. C) In systematic selection, the auditor calculates an interval (the population size divided by the number of sample items desired) called the selection, or skip, interval. The auditor then randomly selects a number between zero and the interval size. This number is the starting point for the sample selection; i.e., the document or transaction corresponding to the random number constitutes the first item in the sample. The second sample item is the document or transaction corresponding to the sum of the random number and the interval; the third item is determined by adding the interval to the second number, the fourth item is determined by adding the interval to the third number, and so on. 54) A) The steps that comprise the "plan the sample" section in attribute sampling are: 1. State the objectives of the audit test. Typically, in attribute sampling, the overall objective is to test the application
of 2. Decide if audit sampling applies. Audit procedures involving documentation normally can be performed using contr sampling, whereas procedures involving observation, inquiry of the client, and analytical procedures are not suited ols to audit sampling. and 3. Define attribute and exception or error conditions. In this step, the auditor carefully defines the attribute of interest deter and the conditions that constitute exceptions or errors. mine 4. Define the population. The population is the body of data about which the auditor wished to generalize, from whet which the sample must be drawn. her 5. Define the sampling unit. In attribute sampling, the sampling unit is normally a document, identified by trans document numbers, or a transaction recorded in a journal. actio 6. Specify tolerable exception rate or specify materiality. This is the exception rate that the auditor will permit in the ns population and still be willing to rely on internal controls. conta 7. Specify acceptable risk of assessing control risk too low. This is the risk that the auditor is willing to take of accepting in a control as effective when the true population exception rate is greater than the tolerable exception rate. mon 8. Estimate the population exception rate. This is the exception rate the auditor expects to find in the population etary before testing begins. misst 9. Determine the initial sample size. The initial sample size is determined from tables, based on values for the atem tolerable exception rate, acceptable risk of assessing control risk too low, and the estimated exception rate. ents. 10. Select the sample: The auditor selects the items from the population to be included in the sample. 55) - Control risk. Control risk is directly related to sample size; as control risk increases, sample size also increases. - Risk for other substantive tests related to the same assertion. Directly related to sample size, as these risks increase, sample size also increases. - Acceptable audit risk. Inversely related to sample size; as AAR increases, sample size decreases. - Tolerable misstatement. Inversely related; as tolerable misstatement increases, sample size decreases. -Inherent risk. Directly related; as inherent risk increases, sample size also increases. - Expected size and frequency of misstatements. Directly related; as the size and frequency of expected misstatements increases, sample size also increases. - Number of items in the population. Directly related, but has only a minor effect on the sample size. 56) The possible courses of action the auditor can take when he or she has concluded that the population is misstated by more than a tolerable amount are: ∙ Take no action until tests of other audit areas are completed. If offsetting misstatements are found in other parts of the audit, the auditor may conclude that the population is acceptable. ∙ Perform expanded audit tests in specific areas. Increase the sample size. As sample size increases, sampling error is reduced if the rate of misstatements in the expanded sample, their dollar amount, and their direction are similar to those in the original sample. This may result in the population being acceptable. ∙ Adjust the account balance. In some circumstances, if the client corrects the misstatements discovered by the auditor, the book value of the account may become acceptable. ∙ Request the client to correct the entire population. ∙ Refuse to give an unqualified opinion. If none of the prior courses of action result in an acceptable population, the auditor will have to issue either a qualified or an adverse opinion. 57) The problem here is that the actual error rate in the population is higher than expected, too high to place reliance upon the control. A), B) Potential action
Advantages
Disadvantages Difficult to justify (particularly Revise the TER This would allow the from a quality control (tolerable error rate) auditor to rely upon the perspective). The amount of from 1% to a higher population, but likely with reliance on the control will have number a lower level of assurance. to be less, resulting in the need
to do additional additional substantive tests of details. tests. C) In order to decide on which action to take,There the audit should: may staff also be errors in the ∙ First consult The withestimated the engagement senior, supervisor or manager. error in the additional items tested, ∙ Carefully investigate thewill errors to determine whether they arelarger representative (for example, if they occurred population decrease IF resulting in an even while the senior there accountant on in holiday; perhaps only that period would require additional substantive Expand the sample are nowas errors the estimated error forholiday the tests). size additional items sampled. population. ∙ Carefully check see that the sample was selected properly andlooking is representative. Thistoaction is most This will require either ∙ Compare thesupportable costs of the and alternative approaches. for and relying upon a Consider how much time isgood left to complete the audit. control (if Revise∙ assessed demonstrates use of compensating control risk
judgment.
available) or conducting
58) A) No, Kyle cannot formally measure the sampling error if non-statistical sampling is used. B) Kyle must subjectively consider the possibility that the true population misstatement aggregated with other misstatements exceeds materiality. This includes consideration for: - the difference between the point estimate and materiality - the extent to which items in the population have been audited 100% - whether misstatements tend to be offsetting or in only one direction - the amounts of individual misstatements - sample size 59) Advantages of statistical sampling: ∙ ∙ ∙
Results are more defensible. Can quantify the impact of errors or exceptions. Enables more pragmatic and objective recommendations to management.
Disadvantages of statistical sampling: ∙ ∙ ∙ ∙
May be more time consuming. Requires a higher level of expertise or more experienced staff. Often requires the use of CAATs (computer assisted audit techniques). Often need additional training or expertise to use and interpret the results.
Advantage of nonstatistical sampling: ∙ ∙ ∙
Can be designed to be just as useful as statistical sampling. Can focus work on high dollar errors (where there might be a greater potential for error). Less costly/less time required to implement.
Disadvantages of nonstatistical sampling: ∙ ∙
Cannot extrapolate the results across the population with as much confidence. Cannot quantify sampling risk.
60) Decisions are made or professional judgment used in the following areas: ∙ ∙ ∙ ∙ ∙
Planning the sample (i.e. where sampling will be used in the engagement; where the sample will be taken from). Determining which statistical sampling method to use. Conducting the sample selection process. Performing the audit tests. Evaluating the results of the audit tests.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The overall objective in the audit of the sales and collection cycle is to evaluate whether 1) _______ A) the sales account and the accounts receivable account are presented fairly in accordance with generally accepted accounting principles. B) the account balances affected by the cycle are fairly presented in accordance with generally accepted accounting principles. C) the sales account and the accounts receivable account are free of material errors. D) the sales account and the accounts receivable account are free of errors.
2) For the most part, the evidence gathered during the audit of the sales and collection cycle can be subjectively combined with the other parts of the audit A) after the conclusion of both the cash cycle and the sales and collection cycle. B) only after the audit of the sales and collection cycle is concluded. C) as the evidence accumulation process proceeds. D) only when all fieldwork processes of the engagement are completed.
2) _______
3) Which of the following data elements would be included in the customer master file as semi-permanent information? A) transaction amount B) credit limit C) amount paid D) transaction date
3) _______
4) The sales and collection cycle ends with A) the creation of an AR. B) the customer agreeing to purchase the good. C) the receipt of cash. D) the transfer of goods.
4) _______
5) What information would be considered semi-permanent as well as transaction information? A) Customer credit limit B) Transaction amount C) Current balance outstanding D) Customer number or code
5) _______
6) Which of the following controls pertains to audit trails in the batch processing of sales transactions? A) audit trail is available in electronic form B) the focus is on preventing incorrect transactions C) groups of documents are totalled D) remittance advice information is matched to sales invoice numbers
6) _______
7) What is the primary focus with respect to error detection and correction for the online processing of sales transactions? A) account for numeric sequencing of input documents B) prevent the entering of incorrect transactions C) trace daily sales totals from the journals to the general ledger
7) _______
D) reject groups of transactions when one transaction is in error
8) Decentralization of data entry functions to departments can result in individual users performing traditionally incompatible functions. What control helps compensate for this lack of segregation? A) comparison of data entry totals to batch control totals B) checking for invalid customer numbers and reasonableness of dates C) independent preparation and review of exception reports D) automatic document sequencing by application software
8) _______
9) Before goods are shipped on account, a properly authorized person must A) prepare the sales invoice. B) approve credit. C) approve the journal entry. D) verify that the unit price is accurate.
9) _______
10) Poor controls over credit limit approval or in changing the credit limit in the master file may result in A) incomplete sales records. B) excessive bad debts and uncollectible account receivables. C) financial statement errors for sales and AR accounts. D) confused and frustrated customers.
10) ______
11) Most companies recognize sales when A) the merchandise is received by the customer. B) the merchandise is shipped. C) a customer order is received. D) cash is received on account.
11) ______
12) A document prepared to initiate shipment of the goods sold is the A) sales order. B) customer C) sales invoice. order.
12) ______ D) bill of lading.
13) A document sent to each customer showing his or her beginning accounts receivable balance and the amount and date of each sale, cash payment received, credit memo issued, and the ending balance is the A) accounts receivable subsidiary ledger. B) remittance advice. C) monthly statement. D) sales invoice.
13) ______
14) The document which is used to permit the immediate deposit of cash and to improve the control over the custody of assets is the A) credit memo. B) cash receipts journal. C) sales invoice. D) remittance advice.
14) ______
15) Zhang corporation returned $6,000 of defective goods to Meli Inc. Meli has a strict policy of no cash refund. Meli should
15) ______
A) write off the AR. B) wait until Zhang places their next order to record the AR. C) not adjust their accounting records since $6,000 is not material for Meli. D) issue a credit memo to Zhang.
16) Proper accounting requires that an account receivable must be charged off by the client when A) the client company concludes that an amount is no longer collectible. B) a collection agency cannot inspire the customer to pay the debt. C) the account is at least six months old. D) the customer files for bankruptcy.
16) ______
17) The total of the individual account balances in the accounts receivable master file equals the A) total sales less the total cash received for the period. B) balance of the accounts receivable account in the general ledger. C) total sales for the period. D) balance of the sales account in the general ledger.
17) ______
18) Which of the following control weaknesses could result in problems with collectability of accounts receivable? A) Unauthorized individuals can establish or change credit limits. B) Cash receipts are matched to the customer accounts rather than against specific invoices. C) Matching shipping documents to sales records is done weekly. D) When there is one error in a batch of transactions, the whole batch is rejected.
18) ______
19) The information systems audit specialist on your audit team has indicated that the general controls over program changes are excellent for all application cycles. What impact does this have upon your audit of sales invoice processing? A) The auditor can place reliance upon the programs performing sales calculations. B) There could be problems with the accuracy of calculations for sales taxes and goods and excise taxes. C) Tests of controls should be omitted; only substantive tests may be conducted. D) Generalized audit software should be used to select a sample of sales transactions for control testing.
19) ______
20) The information systems audit specialist on your audit team has indicated that the general controls over program changes are inadequate for all application cycles. What impact does this have upon your audit of sales invoice processing? A) Unauthorized access to information recorded in the master files is likely. B) It is likely that calculations, such as extensions, are performed consistently and accurately throughout the year. C) The auditor could potentially rely upon only manual controls. D) Only interdependent controls should be considered for control testing.
20) ______
21) One of the key internal controls to prevent invalid transactions in the sales and collection cycle is A) to account for the integrity of the numerical sequence of sales orders. B) to include the sales price list of all products in the computer files.
21) ______
C) to have the bank reconciliation done by someone who is independent of the treasury function. D) to include a list of customer numbers in the computer files.
22) Which of the following is an example of a key internal control for an online system that would help ensure that recorded sales are for the amount of goods shipped and are correctly billed and recorded? A) Shipping details are automatically used as the invoicing source. B) Shipping documents are matched to invoices. C) Shipping documents are prenumbered and accounted for. D) Transactions are summarized daily for posting to the general ledger.
22) ______
23) Which of the following key controls helps ensure that sales transactions are classified to the correct account? A) Computer checks for gaps in shipping document numbers. B) Posting is done automatically to the sales account based upon periodic totals. C) Invoices are prepared using prices and terms from the customer master file. D) Management reviews sales reports regularly for reasonableness.
23) ______
24) Procedures requiring billing and recording of sales on a daily basis are performed as close to the time of occurrence as possible. This control pertains to which transaction-related audit objective? A) completeness B) posting and summarization C) classification D) timing
24) ______
25) Which of the following control procedures may prevent the failure to bill customers for some shipments? A) Each sales order should be approved by authorized personnel. B) Each sales invoice should be supported by a shipping document. C) Sales journal entries should be reconciled to daily sales summaries. D) Each shipment should be supported by a prenumbered sales invoice that is accounted for.
25) ______
26) Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? The cashier A) makes the daily deposit at a local bank. B) endorses the cheques. C) prepares the daily deposit. D) posts the receipts to the accounts receivable subsidiary ledger cards.
26) ______
27) After the auditor has identified the key internal controls and weaknesses and assessed control risk, it is appropriate to decide whether A) tests of controls will be reduced sufficiently to justify the cost of performing substantive tests. B) substantive tests will be reduced sufficiently to justify the cost of performing tests of controls. C) tests of controls will be increased sufficiently to justify the cost of performing substantive tests.
27) ______
D) substantive tests will be increased sufficiently to justify the cost of performing tests of controls.
28) For each control on which the auditor plans to rely to reduce assessed control risk, he or she must A) quantitatively determine the effect on sampling error. B) report all weaknesses in the management letter. C) ensure that the test applies to several different transaction audit objectives. D) design one or more tests of controls to verify its effectiveness.
28) ______
29) Certain internal controls satisfy more than one objective. It is desirable to A) consider the objectives that can be tested. B) consider only the controls that satisfy the more than one objective. C) consider each objective separately. D) consider the objectives together.
29) ______
30) Tamra is performing a test of control consisting of looking at the numerical sequence of credit memos issued by the company. Tamra is performing a block test by looking for any missing number in the sequence. This test will provide evidence of A) completeness. B) existence and completeness. C) accuracy and completeness. D) existence and accuracy.
30) ______
31) The appropriate test of controls for separation of duties is A) documentation. B) observation. C) examination.
31) ______ D) confirmation.
32) Which one of the following audit procedures is a dual-purpose test? A) Examine subsequent cash receipts to determine the dollar amount of the cut-off error in accounts receivable. B) Examine credit limit changes for authorization. C) Calculate the accuracy of the accounts receivable aging. D) Conduct analytical review to determine the reasonableness of the bad debt allowance.
32) ______
33) To test for recorded sales for which there were no actual shipments, the auditor traces from the A) sales journal to the accounts receivable subsidiary ledger. B) bill of lading to the supporting customer order and sales order. C) bill of lading to the sales journal. D) sales journal to the shipping documents.
33) ______
34) An effective procedure to test for unbilled shipments is to trace from the A) sales journal to the shipping documents. B) sales journal to the general ledger sales account. C) sales journal to the accounts receivable ledger. D) shipping documents to the sales journal.
34) ______
35) Which of the following procedures would ordinarily be expected to best reveal unrecorded sales at the balance sheet date? A) Apply gross profit rates to inventory disposed of during the period. B) Trace payments received subsequent to the balance sheet date. C) Send accounts receivable confirmation requests. D) Compare shipping documents with sales invoices.
35) ______
36) The auditor traces items from the source documents to the journals in order to satisfy the A) valuation objective. B) completeness objective. C) ownership objective. D) validity objective.
36) ______
37) The auditor traces items from the journals back to the source documents in order to satisfy the A) ownership objective. B) valuation objective. C) completeness objective. D) validity objective.
37) ______
38) To determine that sales are accurately recorded, the unit prices on the duplicate sales invoices are normally compared with A) the original invoices. B) an approved price list. C) the amounts posted to the customer's account in the accounts receivable master file. D) the amounts recorded in the sales journal for that transaction.
38) ______
39) It is common to test sales for proper classification as part of testing for A) completeness. B) cutoff. C) accuracy.
39) ______ D) valuation.
40) An auditor selects a sample from the file of shipping documents to determine whether invoices were prepared. This test is performed to satisfy the audit objective of A) existence. B) completeness. C) control. D) accuracy.
40) ______
41) It is important that sales be billed and recorded in the journal as soon as possible after A) credit is approved and it is verified that there is enough inventory to fill the order. B) the order is received. C) the order is received and credit is approved. D) shipment takes place.
41) ______
42) Interdependent controls require A) that the person performing the test is independent from the process. B) that the control is programmed and works independently. C) that the internal audit department of the client be involved. D) that programmed and manual components satisfy an audit objective.
42) ______
43) An example of an interdependent control is A) the controller regularly updates the accounting policies of the firm to provide a reference for the accounting employees. The manager tests the employees on the updates to ensure
43) ______
they are up to date. B) the accounting system is protected by having each user have their own password and user profile. C) the client's system rejects a purchase order for a client that would make him exceed his allowed credit limit. The system automatically sends a response to the client. D) the client's system produces an exception report for all journal entries entered outside of normal office hours. The controller reviews this report weekly for any anomalies.
44) What is one of the advantages of converting procedures from a design to a performance format? A) Will ensure compliance with the Canadian Auditing Standards B) Eliminate of duplicate procedures C) Help the auditor select the procedures to be performed D) Obtain audit evidence of better quality
44) ______
45) The most difficult type of cash defalcation for the auditor to detect is that which occurs A) out of the balance kept in a cash register. B) after cash is recorded but before it goes to the bank. C) before the cash is recorded. D) in amounts under $100.
45) ______
46) Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? A) understating the cash receipts journal B) overstating the accounts receivable control account C) understating the sales journal D) overstating the accounts receivable subsidiary ledger
46) ______
47) The emphasis for the audit of sales return and allowances if often placed on testing the existence of recorded transactions. However, the most important objective to consider is A) accuracy. B) completeness. C) cut-off. D) valuation.
47) ______
48) The defalcation process, which postpones entries for the collection of accounts receivable to conceal an existing cash shortage, is referred to as A) lapping. B) cooking the books. C) computer fraud. D) kiting.
48) ______
49) An audit procedure which compares the name, amount, and dates shown on remittance advices with cash receipts journal entries and with related duplicate deposit slips would be effective in detecting A) sales without proper credit authorization. B) lapping. C) kiting. D) illicit write-offs of customers as uncollectible accounts.
49) ______
50) Which of the following internal control procedures will most likely prevent the concealment of a
cas h
shortage 50) resulting from the improper write-off of a trade account receivabl e? Write-off s must be A) approved by the cashier who is in a position to know if the accounts receivable have, in fact, been collected. B) authorized by company field sales employees who are in a position to determine the financial standing of the customers. C) supported by an aging schedule showing that only receivables overdue several months have been written off. D) approved by a responsible officer after review of credit department recommendations and supporting evidence.
___ ___
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) Outline the key areas that the auditor would review as part of general controls.
52) A) Discuss the four business functions that result in sales transactions in a typical sales and collection cycle and, for each function, state the key documents and records involved. B) State the five classes of transactions that comprise the sales and collection cycle. C) The sales and collections cycle is comprised of eight business functions. The first four functions result in sales transactions. Discuss each of the remaining four business functions that occur after sales transactions, and identify the key documents and records involved in each of those four functions.
53) A) State the six specific transaction-related audit objectives for sales and describe one common test of controls for each objective. B) Describe three tests of controls commonly used to test the accuracy objective for sales.
54) A)
Describe each of the six key control activities for sales.
B) When assessing planned control risk for sales, the auditor is concerned about proper authorization at three key points. Discuss each of these three points. C) When testing the existence objective for sales, the auditor is concerned with the possibility of three types of misstatements. One type is sales being including in the journal for which no shipment was made. Discuss the other two types of misstatements.
55) A) State the six specific transaction-related audit objectives for cash receipts and describe one common test
of objective. controls for each B) Discuss what is meant by proof of cash receipts and explain its purpose.
56) During your lunch, your audit team went to a local mall, in the food court, since they needed to be quick today. You dropped off a photofinishing film at a film developer, saying that you would pick it up after work that day. After telling you that she preferred using her digital camera to using regular film, your supervisor said, "Next week, you are going to be working at a client that just happens to be a group of photography stores. Tell me, what controls do you think should be programmed into the cash register to help ensure that sales transactions are accurate and complete?" Required: Answer your supervisor's question.
57) You are the audit senior responsible for a large photofinishing centre and camera store. The store uses automated cash registers tied to inventory (also known as point of sale devices). The point of sale devices take advantage of automated procedures and controls that can be programmed, to reduce errors and improve controls over completeness of transactions. Required: Provide examples of interdependent controls that should be used to complement the programmed controls.
58) Office Design Inc. (ODI) has been your audit client for five years. ODI designs and sells office furniture, such as desks, cabinets, and couches used in reception areas. ODI has sales in Canada and the U.S., with five distribution locations, where furniture is available to prospective purchasers to try out before purchasing. These locations are in Toronto, Montreal, Halifax, New York and Chicago. The company uses custom designed software for its order processing and sales, kept current by one of the five information systems personnel. The Vice President Finance is new. Executive management is paid based upon a salary and a bonus based upon the annual net income of ODI. Unfortunately, the accounting staff at head office (Montreal) has been downsized from ten people to six due to a recent slowdown in sales. Your review of the aged accounts receivable trial balance revealed that one third of the accounts have been outstanding for more than one year. ODI's profits have declined substantially from last year. The line of credit and bank loans are at their maximum, and the company is considering selling its U.S. operations to provide cash flow. Prior year working papers revealed few errors and that you considered management integrity to be good. However, due to segregation issues, you did not rely on the internal controls in the prior year. Required: A) What issues in corporate governance and in the control environment affect your assessment of internal controls for revenue? How does this affect the decision to conduct substantive testing (i.e. exclusion of tests of controls)? B) What is the likely assessment of computer general controls? How does this affect the type of audit testing conducted at ODI?
59) Chong Manufacturing Limited (CML) is a small manufacturer that supplies parts to the automotive industry. CML deals primarily with second tier companies, and does not deal with the car manufacturers directly. Last year, CML was required to implement EDI (electronic data interchange), otherwise two of its major customers would have taken their business elsewhere. The installation was provided by Simon's Computer Company, a local computer store with expertise in EDI. One of CML's customers, Delta Parts Limited, also sent a purchasing agent to CML to help train staff at CML in the use of EDI and to walk through the first few transactions with CML accounting personnel to ensure that they could use the system effectively. A typical EDI sale is processed as follows: Delta sends a purchase order to CML, which is received via the internet into an EDI in-basket. CML empties the EDI in-basket using its EDI software every hour, and the EDI software edits the purchase order for completeness and obvious errors. If there are no problems, then the purchase order is printed out and used by CML to process the order. Once the order has been processed, CML prepares its shipping documentation and invoice using its normal packaged accounting software. The shipping document and the electronic invoice are transferred to the EDI software and placed in an EDI out-basket. Accounting staff transmit the contents of the EDI out-basket to their customer (e.g. Delta). Once Delta receives the electronic shipping documents and electronic invoices, it will transfer the funds electronically to CML's bank account to pay for the goods delivered. This means that CML receives payment much faster than when invoices were mailed to customers. Required: A) What is the impact of the new EDI system on the audit engagement? B) List some controls that should be included in the new EDI system.
60) Gonzo is an on-line dating agency. Gonzo has been in business for 5 years and has been able to reach revenues of $1 million last year. Given their recent expansion, Gonzo's shareholders have required that the company's financial statements be audited for the first time this year. You have been assigned to the audit team for this mandate. The senior manager asked you to review the process description for the sales of Gonzo. The manager asked you to identify the controls in place that could be tested and used for the audit and also, any controls that might be missing. Briefly explain the impact on the audit. Gonzo's CEO provided you with the following description of their processes and activities for the past year: Sales Gonzo's web-site is operational 24 hours per day. All of the sales for Gonzo are done on-line when the customer opens a profile. A customer will pay $50 to open a profile and will then pay $10 per month to keep his profile active. Most customers pay on-line with their credit cards and the sale is automatically recorded in the sales ledger of Gonzo at the time of payment. Gonzo also had a promotion for the last 3 months of the year. If the customer wanted to subscribe for one year, they could pay $100 upfront to keep their profile active for the full year instead of paying $10 each month for 12 months. This proved to be a popular sales tactic as customers enjoyed the $20 savings. Web-Site Security In the past year, one hacker managed to intrude the web-site and steal the credit card information of 25 Gonzo customers. To ensure quality of customer service, Gonzo reimbursed a total of $10,000 to the customers to compensate them for the amounts that were stolen as a result of the intrusion on their web-site.
Since Box performs monthly updates to the security features and monitors any intrusion attempt. Gonzo did not then, have a problem since. Gonzo hired a Collection and Reconciliation third As most of the sales are done by credit card, Gonzo receives the money from large credit card companies on party, a by-weekly basis. Mindster Box, to When the money is received from the credit card company, Jo-Ann, the accounting manager of Gonzo, update reconciles the detail of the payments received by the credit card company to the sales ledger of Gonzo. the Jo-Ann has often complained that this is nearly impossible to do since the accounting system of Gonzo keeps security track of the payment by the on-line user name which is often very different from the actual name of the features person as stated on the detailed report provided by the credit card company. of their web-site. Jo-Ann therefore mostly relies on the statement of the credit card company to record and adjust revenues Mindster reported by Gonzo.
1) B 2) C 3) B 4) C 5) D 6) C 7) B 8) C 9) B 10) B 11) B 12) D 13) C 14) D 15) D 16) A 17) B 18) A 19) A 20) C 21) D 22) A 23) B 24) D 25) D 26) D
27) B 28) D 29) C 30) B 31) B 32) A 33) D 34) D 35) D 36) B 37) D 38) B 39) C 40) B 41) D 42) D 43) D 44) B 45) C 46) C 47) B 48) A 49) B 50) D 51) The key areas that the auditor would review as part of general controls are: ∙ Organization structure and job responsibilities within the data processing department. ∙ Program change controls.
∙
security. ∙ Documentation of programs and operations.
Physi cal acces s and secur ity. ∙ L ogical acces s and 52) A) The four business functions that result in sales transactions, and related documents and records, are: ∙ Processing customer orders. Key documents include customer order and sales order. ∙ Granting credit. Customer order or sales order. ∙ Shipping goods. Shipping document (bill of lading). ∙ Billing customers and recording sales. Sales invoice, sales journal, summary sales report, accounts receivable master file, accounts receivable trial balance, and monthly statements. B) ∙ ∙ ∙ ∙ ∙
The five classes of transactions that comprise the sales and collection cycle are: Sales (cash and sales on account) Cash receipts Sales returns and allowances Charge-off of uncollectible accounts Bad debt expense
C) The four business functions that occur after sales transactions, and related key documents and records, are: ∙ Processing and recording cash receipts. Key documents and records include remittance advice, prelisting of cash receipts, and cash receipts journal. ∙ Processing and recording sales returns and allowances. Credit memo, sales returns and allowances journal. ∙ Charging off uncollectible accounts receivable. Uncollectible account authorization form. ∙ Providing for bad debts. 53) A) ∙ Recorded sales are for shipments actually made to nonfictitious customers (existence). Trace sales journal entries to copies of sales orders, sales invoices, and shipping documents. ∙ Existing sales transactions are recorded (completeness). Trace shipping documents to sales invoices and sales journal entries and accounts receivable master file. ∙ Recorded sales are for the amount of goods shipped and are correctly billed and recorded (accuracy). Trace entries in sales journal to sales invoices. ∙ Sales transactions are properly classified (classification). Examine documents supporting sales transactions for proper classification. ∙ Sales are recorded on the correct dates (timing). Compare dates of recorded sales transactions with dates on shipping records. ∙ Sales transactions are updated correctly to the customer master file, and the posting to the general ledger summed these transactions correctly: Compare customer mater file totals with general ledger balance on a monthly basis. Investigate any differences. B) (Note: Answers will vary beyond the three examples below.) Three tests of controls commonly used to test the accuracy objective for sales include: ∙ Recompute information on sales invoices (re-foot and re-extend the invoice).
∙
e entries in sales journal to sales invoices, comparing invoice total with amount recorded in journal. ∙ Trace details on sales invoices (description, price per unit, quantity) to shipping documents, approved price Trac lists, and customers' orders. 54) A) The six key control activities for sales are: ∙ Adequate separation of duties. For example, persons responsible for inputting sales and cash receipts transactions should not have access to cash. ∙ Proper authorization. Credit should be properly authorized before a sale takes place, goods should be shipped only after proper authorization, and prices should be authorized. ∙ Adequate documents and recordkeeping procedures. ∙ Prenumbered documents that are accounted for periodically. ∙ Mailing monthly statements to customers. ∙ Internal verification procedures. An independent person should periodically check the processing and recording of sales transactions. B) Credit should be properly authorized before a sale takes place; goods should be shipped only after proper authorization; and prices, base terms, freight, and discounts should be properly authorized. C) The auditor is also concerned with the possibility of (1) shipments being made to nonexistent customers and recorded as sales, and (2) sales being recorded more than once. 55) A) The six specific transaction-related audit objectives for sales and one common tests of controls are: ∙ Recorded cash receipts are for funds actually received by the company (existence). Trace from cash receipts journal to bank statements. ∙ Cash received is recorded in the cash receipts journal (completeness). Trace from remittance advices or prelisting to cash receipts journal. ∙ Cash receipts are deposited and recorded at the amounts received (accuracy). Proof of cash receipts. ∙ Cash receipts transactions are properly classified (classification). Examine documents supporting cash receipts for proper classification. ∙ Cash receipts are recorded on the correct dates (timing). Compare dates of deposits with dates in the cash receipts journal and prelisting of cash receipts. ∙ Cash receipts are properly included in the accounts receivable master file and are correctly summarized (posting and summarization). Foot journals and trace postings to general ledger and accounts receivable master file. B) A proof of cash receipts is an audit procedure in which the total cash receipts recorded in the cash receipts journal for a given period are reconciled with the actual deposits made to the bank during the same period. The purpose of a proof of cash receipts is to determine whether all recorded cash receipts have been deposited in the bank account. It can also identify unrecorded deposits. 56) Check digits and validity checks: for example, the cash register could check for valid store clerk user identification codes, and valid transaction codes (e.g. film type and processing type), as well as for valid inventory transaction codes (for items sold). Automatic retrieval of information: if information is scanned (such as product UPC code), the cash register should automatically retrieve price information from the master files. Limit checks: There should be maximum numbers for items (e.g. 10 for film, 1 for large items such as expensive cameras). Automatic calculations: Extensions, totals, should be automatic, as should be calculations of sales tax and gst. The cash register system probably also keeps totals of each payment method daily (such as cash, credit card, debit card). Field checks: Required fields must be entered, or the transaction will not be completed (e.g. quantity, price,
pay
ment method).
57) [Note, see question 55 in testbank for examples of programmed controls that could be present in cash registers or point of sale devices.] Error follow up: Any errors (such as rejected transactions or rejected user access attempts) should be recorded by the computer systems and reviewed by a supervisor. The supervisor should ensure that errors are followed up. Exception reports (such as high dollar transactions or negative inventory) should be reviewed by management regularly. Reconciliation: Totals per the point of sale device by each cash receipt type should be reconciled to the cash register drawer daily (i.e. cash, credit card, debit card). Credit card and debit card deposits should be reconciled to the bank statement. Cash should be deposited daily and agreed to the duplicate deposit slip. Bank statements should be reconciled to the balance per general ledger in the cash account. 58) A) Senior executives are motivated to overstate revenue as they are remunerated based upon net income (alternatively, they could also understate expenses, such as bad debt expense). This also would motivate them to understate the bad debt allowance, which would increase revenue. Particularly due to the decrease in staff, it would be easier for senior management to override internal controls. This would motivate the auditor to increase substantive testing. Customized programming is more complex and error prone than software packages. Particularly with a small information systems group, it is less likely that there would be controls over program changes, meaning that auditors would need to look for compensating manual controls over revenue and are less likely to be able to rely on automated controls. This takes us back to senior management potential to override such manual controls, again supporting the need for increased substantive testing rather than tests of controls. B) With a small information systems group (only five people), it is less likely that there is adequate segregation of duties in key information systems areas. Program change controls are likely difficult to rely upon (see part A) due to the complexity of customized systems rather than packaged systems. Physical access and security is not mentioned, but could be a problem if some information systems support activities are handled by accounting personnel. Finally, documentation of programs and operations tends to be less when there are customized systems and fewer personnel. This would lead the auditor to place limited reliance upon general controls, resulting in the need to conduct increased substantive testing. [Note: This case is a good example for students to understand why it is still necessary to document internal controls, even though they may decide not to conduct tests of controls. Identification of weaknesses helps the auditor design substantive tests.] 59) A) Since it is a new sub-system, we will need to obtain an understanding of it and document the system so that we can design our audit tests. If the system is complex, we may need to request the assistance of information systems specialist staff on the audit engagement. It does not appear that there is any transaction data in the new EDI system, but there is likely some master file information, such as customer information and part information. Any information set up in the new system needs to be tested to ensure that it was prepared accurately. It may be necessary to use computer-assisted audit testing if transactions are kept in only electronic format rather than printed (i.e. shipping documents and invoices). If we choose to rely on the edits performed by the EDI system, then we will need to test these edits (e.g. data being
acce identification codes and passwords to use the system. pted Passwords should be difficult to guess and changed periodically. in the prop Users should be limited to the functions that they need to perform their job. er form The system should have automatic acknowledgements to confirm that transactions have been sent and received. at). Input edits should be specific to the company, e.g. size of part numbers, looking for missed information, adequate edits on dates. B) Adequate help screens or other documentation should exist to use the system properly. User s Staff who use the system should be properly trained. shou ld Logs should be used to identify errors or exceptions and printed off regularly. requi re Accounting personnel should follow up on errors and exceptions on a timely basis (e.g. daily). user 60) Controls in place & Audit Implications 1. Automated recording of sales by the system: A test of control can be done to compare the number of sales and total amount of sales recorded by the system to the number of sales and total amount of sales recorded by the credit card company. A sample of days could be selected. 2. Third party security updates: This control was not in place for the entire year, but can help increase assurance with regards to the security and accuracy of sales recorded by the system for the period where it was in place. If the system is secure, we will be able to place more reliance on the system during our audit. To do this, we could inquire about the experience and knowledge of Mindster Box. A review of their monthly updates could also be done to ensure that they were performed and were appropriate. 3. Third party report of sales: Gonzo has access to the sales recorded by the credit card company. This is good evidence as it comes from an independent third party. Since the internal records from the system might not be reliable for the full year, we could obtain a report from the credit card company attesting to the proper functioning of their internal control in order to use their reports as audit evidence. Control Weaknesses & Audit Implications 1. Upfront revenue recognition issue: With the promotion of upfront monthly fees for the last 3 months of the year, combined with the fact that the system records revenues when the customer pays on-line, it is possible that the revenues are overstated as the current year's revenue include monthly membership fees that relate to the following year. There was no indication by Gonzo that a review with regards to the cut-off of revenues was performed. This will be an area of concern for the audit. 2. Web-site intrusion: It appears that the security over the web-site of Gonzo was not working as well as they had expected, at least for a portion of the year. This will increase the risk of the audit as there might have been other undetected intrusions which could result in financial statement errors or further liability for Gonzo. This should be considered in the audit planing and assessment of the audit risk. 3. Gonzo's system does not keep track of the sales by customer name. This makes the reconciliation done by Jo-Ann not very useful. Gonzo should consider changing their system so that the sale is recorded by the name the customer enters as the <name on the credit card> rather than their user name for the web-site. At that point, the control of the sales reconciliation could be used in the audit.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Tests of details of balances relate to 1) _______ A) inherent risk. B) control risk. C) planned detection risk. D) substantive risk.
2) Victor is performing a test of control to determine that the system correctly classifies the AR in the aging of accounts receivable. Victor is concerned with what aspect of the internal controls? A) Cut-off B) Existence of AR. C) Defalcation of assets D) Allowance for doubtful accounts
2) _______
3) Audit risk is assessed for A) various accounts and objectives, and the sum is then assigned to the financial statements as a whole. B) the financial statements as a whole and then allocated to various accounts. C) various accounts but not for the financial statements as a whole. D) the financial statements as a whole and is not usually allocated to various accounts or objectives.
3) _______
4) The two primary classes of transactions in the sales and collection cycle are A) sales and cash receipts. B) sales and sales discounts. C) sales and sales returns. D) sales and accounts receivable.
4) _______
5) For sales, the occurrence transaction-related audit objective affects the existence balance-related audit objective. For cash receipts, the occurrence transaction-related audit objective affects which balance-related audit objective? A) cut-off B) valuation C) completeness D) existence
5) _______
6) In the planning phase, Denis conducted an analytical procedure to compare the AFDA balance to the AR balance. In the prior years, the AFDA/AR was between 2.5% to 3.5%. This year, the number is 1.25%. What should Denis do? A) Change the assessed inherent risk B) Document this difference and continue with audit work to see if this is pervasive bias of management C) Conduct additional testing to justify the lower bad debt D) Advise management that they should increase the AFDA provision
6) _______
7) In the sales and collection cycle, the results of the tests of controls determine A) the extent to which planned detection risk is satisfied for each accounts receivable objective. B) whether positive or negative confirmations should be used for this engagement. C) if tests of details of balances need to be performed. D) whether assessed control risk for sales and cash receipts needs to be revised.
7) _______
8) Comparing bad debt expense as a percentage of gross sales with previous years will detect what kind of possible misstatement? A) uncollectible accounts receivable that have not been provided for B) understatement of sales and accounts receivable C) overstatement of sales and accounts receivable D) understatement of allowance for uncollectible accounts
8) _______
9) Comparison of individual customer balances over a statement amount with previous years will detect what type of possible misstatement? A) overstatement or understatement of allowance for uncollectible accounts B) misstatement in gross profit and bad debt expense C) misstatements in accounts receivable and related income statement accounts D) overstatement or understatement of bad debt expense
9) _______
10) Stefano is performing a review of the accounts receivable for large and unusual amounts. Of the following accounts receivable, Stefano should pay special attention to an account receivable A) for a large dollar amount. B) recorded close to year end. C) from a related party. D) that is recurring.
10) ______
11) Analytical procedures are substantive tests and, if the results of the analytical procedures are favourable, they will A) reduce the analytical procedures. B) reduce the extent of tests of controls. C) reduce all of the other tests. D) reduce the extent of tests of details of balances.
11) ______
12) The most important test of details of balances for accounts receivable is A) recalculation of the aged receivables and uncollectible accounts. B) tracing from shipping documents to journals to the accounts receivable ledger. C) confirmations. D) tracing credit memos for returned merchandise to receiving room reports.
12) ______
13) Tests of details of balances mainly focus on A) income statement accounts. B) income and statement of cash flow accounts. C) statement of cash flows. D) balance sheet accounts.
13) ______
14) The most important test of details of balances to determine the existence of recorded accounts receivable is A) tracing sales entries to shipping documents. B) tracing sales returns entries to credit memos issued and receiving room reports. C) confirming customers' balances. D) tracing the credits in accounts receivable to bank deposits.
14) ______
15) The understatement of sales and accounts receivable is best uncovered by A) reconciling the accounts receivable general ledger account with the schedule of accounts receivable. B) testing transactions for shipments made but not recorded. C) reviewing the aged trial balance. D) confirming receivables.
15) ______
16) If accounts receivable accounts with credit balances are significant, they should be A) corrected by making adjusting entries. B) reclassified as accounts payable. C) moved to the debit side. D) written off.
16) ______
17) A common way to evaluate the adequacy of the bad debt allowance is to A) examine carefully the noncurrent accounts on the aged trial balance to determine which ones have not been paid subsequent to the balance sheet date. B) examine the program logic that is used to prepare the aged trial balance and to monitor the implementation of credit policies. C) review the results of tests of controls that are concerned with the client's credit policy. D) send positive confirmations to all accounts with balances over 90 days based upon the aged trial balance.
17) ______
18) There are two pitfalls in evaluating the accounts receivable bad debt allowance by reviewing individual noncurrent balances. It is difficult to compare the results of the current year with those of the previous years on such an unstructured basis. Also A) credit policies may have changed. B) current accounts are ignored. C) incorrect prices charged are not D) shipping cutoff may be a problem. detected.
18) ______
19) The client's estimate of the total amount of receivables which are uncollectible is represented by A) the accounts with credit balances in the accounts receivable subsidiary ledger. B) the allowance for uncollectible accounts. C) footnote disclosure in the financial statements. D) the bad debts expense account on the income statement.
19) ______
20) Most tests of accounts receivable and the allowance for uncollectible accounts are based on A) the results of confirmations. B) the results of analytical procedures. C) the general ledger balance of each account. D) the aged trial balance.
20) ______
21) Glee Inc. is a manufacturer of musical instruments and their year end is September 30th. Copa Loca, a local music school, has purchased some instruments from Glee, but was not satisfied with the quality and returned the goods to Glee during the last week of September. Being very busy with year end, Glee received the goods from Copa Loca on September 30th, but only processed the returned merchandised and cancelled the AR in October. This represents a A) cut-off misstatement. B) presentation misstatement.
21) ______
C) classification misstatement.
D) significant misstatement.
22) The criterion used by most clients for determining when a sale takes place is when A) cash is exchanged. B) title passes. C) the goods are shipped. D) the costs are incurred.
22) ______
23) When the client's internal control structure is adequate, the cutoff can usually be verified by A) confirmation of the receivable for the last recorded sale. B) inquiries of the controller. C) the client's representation letter. D) obtaining the last shipping document number of the year and comparing it with current and subsequent period recorded sales.
23) ______
24) Generally accepted accounting principles require that material sales returns and allowances be A) recorded in the period when the credit memo is issued. B) recorded as a debit to the sales account. C) matched with related sales. D) recorded in the period when the merchandise is returned.
24) ______
25) For audit purposes, a proper cut-off of sales returns and allowances is more important than a proper cash cut-off because A) a cash cut-off does not affect earnings. B) the accounts receivable balance is normally more significant than the cash balance. C) the cash cut-off can be easily be verified with a bank confirmation. D) none of the above. The cash cut-off is as important.
25) ______
26) Celebra sold some goods to Frankfurt Corp. Frankfurt sent a check to Celebra to pay for the goods on December 24th. Celebra received the check on January 4th. At December 31st, Celebra still showed an AR from Frankfurt while Frankfurt no longer had an account payable to Celebra. This situation represents a A) error in presentation. B) cut-off error. C) lack of communication between the two companies. D) timing difference.
26) ______
27) If the internal controls for recording sales returns and allowances are evaluated as ineffective, A) all sales returns must be traced to supporting documentation. B) all sales returns must be confirmed with the customer. C) a larger sample is needed to verify cutoff. D) sampling is not appropriate.
27) ______
28) It is easy to test for a cash receipts cutoff error by A) tracing recorded cash receipts to bank deposits on the bank statement of a different period. B) observing the counting of cash at the balance sheet date. C) reconciling the bank statement.
28) ______
D) performing a four-column proof-of-cash.
29) A client's public accountant learns that collections of accounts receivable during the first ten days of January 2006 were entered as debits to cash and credits to accounts receivable as of December 31, 2005. The effect generally will be to A) overstate the current ratio with no effect on working capital at December 31, 2005. B) overstate both working capital and the current ratio at December 31, 2005. C) overstate working capital with no effect on the current ratio at December 31, 2005. D) leave both working capital and the current ratio unchanged at December 31, 2005.
29) ______
30) Trade accounts receivable should not include A) past-due accounts receivable. B) related party accounts receivable. C) accounts receivable of clients entitled to receive discounts. D) accounts receivables denominated in foreign currencies.
30) ______
31) Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide evidence concerning the A) ownership of the balances confirmed. B) existence of the balances confirmed. C) internal control over balances confirmed. D) collectability of the balances confirmed.
31) ______
32) Confirmation is most likely to be a relevant form of evidence with regard to assertions about accounts receivable when the auditor has concerns about the accounts receivable's A) classification. B) valuation. C) completeness. D) existence.
32) ______
33) The primary purpose of accounts receivable confirmation is to satisfy the A) existence, accuracy, and cutoff B) existence and cutoff objectives. objectives. C) existence objective. D) accuracy and cutoff objectives.
33) ______
34) Communication addressed to the debtor requesting him or her to confirm whether the balance as stated on the communication is correct or incorrect is a A) positive confirmation. B) negative confirmation. C) dunning letter. D) bank confirmation.
34) ______
35) The use of the positive (as opposed to the negative) form of receivables confirmation is indicated when A) a large number of small balances are involved. B) accounts receivable consists of current balances only. C) internal control surrounding accounts receivable is considered to be effective. D) there is reason to believe that a substantial number of accounts may be in dispute.
35) ______
36) The auditor obtains corroborating audit evidence for accounts receivable by using positive or negative confirmation requests. Under which of the following circumstances might the negative
for of the m account
s 36) receivabl e confirma tion be useful? A) Client records include a large number of relatively small balances. B) A substantial number of accounts are in dispute. C) The auditor believes that recipients of the requests are unlikely to give them consideration. D) Internal control over accounts receivable is ineffective.
___ ___
37) Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because A) the auditor cannot infer that all nonrespondents have verified their account information. B) some recipients may report incorrect balances that require extensive follow-up. C) negative confirmations do not produce evidential matter that is statistically quantifiable. D) a majority of recipients usually lack the willingness to respond objectively.
37) ______
38) Beltrand, CA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent property taxes. The internal controls at the municipality are weak. To determine the existence of the accounts receivable balances at the balance sheet date, Beltrand would most likely A) examine evidence of subsequent cash receipts. B) send negative confirmation request. C) send positive confirmation requests. D) inspect the internal records such as copies of the tax invoices that were mailed to the residents.
38) ______
39) A positive confirmation is more reliable evidence than a negative confirmation because A) follow-up procedures can be performed if a response is not received from the debtor. B) fewer confirmations can be sent out. C) the auditor has a document which can be used in court. D) the debtor's lack of response indicates agreement with the stated balance.
39) ______
40) Which one of the following circumstances would indicate that positive confirmations should be used on this engagement? A) The internal control over accounts receivable is good. B) The auditor is unaware of disputed or inaccurate accounts. C) A significant portion of the total accounts receivable balance is represented by a small number of accounts with large balances. D) The recipients are mostly businesses rather than individuals.
40) ______
41) The most reliable evidence from confirmations is obtained when they are sent A) at various times throughout the year to the same group in the sample, so that the sample will not have a time bias. B) several months before the year-end, so the auditor will have adequate time to perform alternate procedures if they are required.
41) ______
C) as close to the balance sheet date as possible. D) at various times throughout the year to different sections of the sample, so that the entire sample is representative of account balances scattered throughout the year.
42) After the items for confirmation have been selected, the auditor must maintain control of the confirmations until A) the sealed envelopes are provided to client's personnel to be mailed. B) the responses are received by the client with the return mail. C) the names are provided to client's personnel to type the envelopes. D) they are returned by the debtor to the auditor.
42) ______
43) When positive confirmations have been used, it is normally desirable to account for unconfirmed balances with alternative procedures, A) only if the amounts are large. B) if it does not increase the audit firm's costs. C) even if the amounts are small. D) only if the amounts are material.
43) ______
44) An auditor should perform alternative procedures to substantiate the existence of accounts receivable when A) no reply to a positive confirmation request is received. B) collectability of the accounts receivable is in doubt. C) no reply to a negative confirmation request is received. D) pledging of the accounts receivable is probable.
44) ______
45) Positive accounts receivable confirmations were circularized, and there were many differences where the client stated that payment had already been made. In addition to the possibility of a cash receipts cutoff misstatement, this type of reported difference could be an indication of A) sampling errors in the confirmation process. B) problems with client assignment of credit limits. C) lapping or theft of cash. D) a large number of goods returned after the year end.
45) ______
46) Positive accounts receivable confirmations were circularized, and there were many differences where the client stated that the goods had not been received as of the date of the confirmation. In addition to the possibility that the goods were not received by the client, this type of reported difference could be an indication of A) a cutoff misstatement. B) improper recording of sales allowances. C) timing differences with respect to recording sales returns. D) theft of cash or lapping.
46) ______
47) In monetary-unit sampling, the values of the estimated likely maximum misstatements are referred to as the A) precision intervals. B) misstatement bounds. C) confidence intervals. D) point estimates.
47) ______
48) In the absence of convincing information to the contrary, most auditors believe it is desirable to assume an overall percent of error in those items containing an error of A) between 5% and 10% error for both overstatements and understatements. B) 100% error for both overstatements and understatements. C) 10% error for both overstatements and understatements. D) 20% for overstatement errors and 200% for understatement errors.
48) ______
49) When errors are found, a common assumption in practice is to assume A) that the population errors are larger than the sample errors. B) that the population errors are smaller than the sample errors. C) that the actual sample errors are representative of the population errors. D) a 100% assumption for all errors.
49) ______
50) Whenever a statistical method is used, a decision rule determines whether the population is acceptable. The decision rule for dollar-unit sampling is "Accept the conclusion that the book value is not misstated by a material amount if A) the overstatement tolerable misstatement amount falls between the lower and upper error bound." B) both the lower and upper error bound falls between the understatement and overstatement tolerable misstatement amounts." C) the upper error bound falls between the understatement and overstatement tolerable misstatement amounts." D) both the understatement and overstatement tolerable misstatement amounts fall between the upper and lower error bound."
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) State the eight specific balance-related audit objectives as applied to accounts receivable.
52) You are the auditor of Foundry Inc., a company that manufactures chocolate bars and assorted candies. The description of the sales and collection cycle for Foundry is as follow: Clients & Credit Limits Foundy has 50 clients as they mostly sell to grocery store's central purchasing department or distributors. For each customer, Foundry performs a credit check prior to setting the credit limit for the client. The credit limit is reviewed each year. In the past year, the credit limits were increased by 10%. This is due to the growth in product lines of Foundy and increased demand from customers. This also came at the same time the CEO of Foundry set the objective of growing the company's revenue by 25% over the next 2 years. Increasing the credit limit has helped Foundry move towards that objective. Recording of AR The AR system of Foundry is highly automated. When a purchase order is received, it is entered into the system and sent to the warehouse. When the warehouse ships the good to the client, the warehouse manager prepares the shipping document and enters it in the system. At this point, the sale and corresponding AR are recorded. It is to be noted that Foundry has three warehouses and only one manager.
Therefor all shipping documents for the week even if the goods are not scheduled to leave for another 3 or 5 days. e, when This eliminates the need for him to go back to the plant everyday. the manager Allowance for Doubtful Accounts is at a The allowance for doubtful accounts is calculated by the controller by taking a percentage of the total sales warehou for the month. The controller has been taking 3% of total sales. The estimate has not been revised in the se, he current year, but it has always been sufficient to pay for any write-off incurred. will try to Required: For each of the three areas discussed above, identify the risk areas and the most likely approve misstatements for Foundry.
53) Discuss three examples of analytical procedures an auditor might perform while auditing the sales and collection cycle. Also discuss the potential misstatement(s) that may be revealed by each analytical procedure.
54) A) Discuss the alternative procedures an auditor can perform to test the existence objective for accounts receivable when customers do not respond to confirmation requests. B) Discuss the audit procedures performed when testing the detail tie-in objective for accounts receivable, and explain why this objective is ordinarily tested before any other objectives for accounts receivable.
55) A) An auditor is concerned that accounts receivable may be understated due to sales to customers that have been omitted from the sales journal and from the accounts receivable master file. Describe the procedure(s) the auditor should perform in these circumstances. B) Describe how the auditor tests the classification objective for accounts receivable.
56) A) Assuming the client's internal controls are adequate, describe how the auditor can verify proper cutoff of sales transactions. B) Describe how the auditor tests the rights objective for accounts receivable.
57) A) Describe the differences between positive and negative confirmations. Which type is more reliable? B) Discuss the advantages and disadvantages of using negative accounts receivable confirmations rather than positive confirmations. C) Discuss the circumstances in which it is acceptable to use negative confirmation requests. D) The auditor's decision regarding the type of accounts receivable confirmation to use involves a continuum, starting with using no confirmations in some circumstances, to using only negatives, to using both positives and negatives, to using only positives. Discuss the primary factors affecting this decision.
58) You are conducting an audit and have obtained the following figures with respect to sales and accounts receivable:
ccounts receivable 2 $ 3,343,000 $ 2,694,000 Allowance for doubtful accounts 0 212,150 207,660 Sales 0 25,640,000 24,630,000 6 Required: 2 A) What are the audit implications of these 0 figures? 0 B) Identify key audit steps that you would5 perform for any of the above accounts. A
59) You are the auditor for GreenAcres, a non-profit home for homeless elderly. GreenAcres has a December 31 year end. It receives government funding, and also relies upon donations for revenue. GreenAcres has a major funding drive in November, when it collects pledges by means of activities at a garage sale, a walkathon, and fall bake sale events in the community. During late February you had a meeting with Ellen Famous, the President of GreenAcres, at the organization's premises. Ellen reviews and approves bank statements and is the second and final cheque signer. Two other accounting staff have the following responsibilities: ∙ Paul approves pledge write-offs (which normally average about 15%), opens the mail, endorses cheques received in the mail, prepares and delivers bank deposits, and posts transactions into the accounting system. ∙ Diana, a retired bookkeeper, volunteers about 10 hours per week to reconcile the bank account, review journal entries posted to the general ledger, and prepare payroll and accounts payable transactions for processing. Ellen normally reviews pledge write-offs, but was very busy in February, so she took a look while you were there. To her surprise, she found that about 40% of the pledges had been written off. She asked Diana to investigate, and Diana found that most of the write-offs had actually been paid Required: A) What are possible causes of the inconsistency with the pledge write-offs? B) What are the weaknesses in internal control that could allow the excess write-offs to occur? Provide recommendations for improvement. C) Identify audit procedures that you would complete to quantify any potential misstatement with respect to the pledges receivable balance as at December 31.
60) Following are three different situations with respect to the audit of accounts receivable and sales. For each, specify the evidence mix that you would use (tests of control, substantive tests, type of confirmation/timing), and explain why. A) The client is in a volatile industry, selling products that can quickly become technically obsolete. Total accounts receivable is $65 million, with a bad debt allowance of $7 million. The company has recently laid off three accounting staff to save money. B) A small company has 45 different customers, with balances ranging from $500 to $25,000 per customer. There is one accountant on staff, and a professional accountant comes in once per week for three hours to review the work and prepare journal entries. Bad debts are rare, as the owner is actively involved in accounts receivable collection.
C) Big ion has fifty staff in the accounting department, a sophisticated software package, and about $250 million in Departm accounts receivable. The corporation manages the department store credit cards. About 100,000 credit card ent Store customers have balances less than $300 on their accounts, while the balances for the remaining customers Finance range up to a maximum of $5,000. Corporat
1) C 2) D 3) D 4) A 5) C 6) C 7) D 8) A 9) C 10) C 11) D 12) C 13) D 14) C 15) B 16) B 17) A 18) B 19) B 20) D 21) A 22) C 23) D 24) C 25) A 26) D
27) C 28) A 29) D 30) B 31) B 32) D 33) A 34) A 35) D 36) A 37) A 38) C 39) A 40) C 41) C 42) D 43) C 44) A 45) C 46) A 47) B 48) B 49) C 50) B 51) The nine specific balance-related audit objectives as applied to accounts receivable are: ∙ Accounts receivable in the aged trial balance agree with related customer master file amounts, and the total is correctly added and agrees with the general ledger (detail tie-in).
∙
exist (existence). ∙ Existing accounts receivable are included (completeness). Reco ∙ Accounts receivable are accurate (accuracy). rded ∙ Accounts receivable are properly classified (classification). acco ∙ Cutoff for accounts receivable is correct (cutoff). unts ∙ Accounts receivable is stated at realizable value (valuation). recei ∙ The client has rights to accounts receivable (rights & obligations). vable ∙ Accounts receivable presentation and disclosures are proper (presentation and disclosure). 52) Clients and Credit Limits - Risk is mitigated because Foundry does not have a large number of client. - However, risk increased in the current year as the credit balances have been increased. Since all credit limits were increased by 10%, it is probable that some clients did not deserve such an increase and, as a result, increases the likelihood that AR will not be collected. - The information that the CEO is setting an aggressive goal for growth also places more pressure on management to increase sales and AR as a result. This increases overall audit risk and should be considered in the audit. Recording AR - The timing of the recording appears to be risky as there is a possibility that AR and sales are recorded in the incorrect period. By approving the shipping documents ahead of time and inputting them in the system, a sale and AR are recorded on the day of the approval before the goods are shipped and the risks and rewards of the goods were transferred to the client. Depending on the amount of transactions approved in the days prior to year end, this increases the risk that sales and AR contain a material misstatement. Allowance for doubtful account - The valuation of the AR could result in a misstatement. Valuation requires professional judgement to determine if the balance is sufficient or if it is too large. In the case of Foundry, the risk appears to be high as there was no formal review of the percentage done this year. Given that the credit limits were increased this year is an indication that a review should have been performed. Further, the fact that the provision has been sufficient for the accounts written off in the prior year is not sufficient to conclude that the process is adequate. Some accounts relating to this period might have to be written off in the following period or it could also be that the current provision is too high. 53) Analytical procedures applicable to the audit of the sales and collection cycle, and possible misstatements, include: ANALYTICAL PROCEDURE
POSSIBLE MISSTATEMENT
Compare gross margin percentage with Overstatement or understatement of previous years. sales and accounts receivable. Compare sales by month over time.
Overstatement or understatement of sales and accounts receivable.
Compare sales returns and allowances as a percentage of gross sales with previous years.
Overstatement or understatement of sales returns and allowances and accounts receivable.
Compare individual customer balances over a stated amount with previous years.
Misstatements in accounts receivable and related income statement accounts.
Compare bad debt expense as a percentage of gross sales with previous
Uncollectible accounts receivable that have not been provided for.
years. previous years.
and bad debt expense.
Compare Compare number allowance of days that for uncollectible accounts Overstatement Overstatement or understatement or understatement of of receivable accounts are outstanding as a percentage withof accountsallowance allowance for uncollectible for uncollectible accounts accounts previous receivable years. with previous years. and bad and debt badexpense. debt expense. Compare aging categories as a percentage of accounts receivable with
Overstatement or understatement of allowance for uncollectible accounts
54) A) For any positive confirmation not returned, the auditor can examine the following to verify the existence of individual sales transactions making up the ending balance in accounts receivable: ∙ Subsequent cash receipts evidence of the receipt of cash subsequent to the confirmation date includes examining remittance advices and entries in the cash receipts records. ∙ Duplicate sales invoices. ∙ Shipping documents. ∙ Correspondence between the customer and the client. B) When testing the detail tie-in objective for accounts receivable, the total column and the columns depicting the aging on the aged trial balance are footed, and the total is compared to the general ledger. In addition, a sample of individual balances on the aged trial balance should be traced to supporting documents to verify the customer's name, balance, and proper aging. These tests are ordinarily done before any other tests to assure the auditor that the population being tested agrees with the general ledger and accounts receivable master file. 55) A) The understatement of sales and accounts receivable is best uncovered by substantive tests of transactions for shipments made but not recorded by tracing from a sample of shipping documents (bills of lading) to the sales journal to verify that each shipment has been recorded. B) The classification objective is tested by reviewing the aged trial balance for material amounts receivable from affiliates, officers, directors, or other related parties. If notes receivable or accounts that should not be classified as a current asset are included with the regular accounts, these should also be segregated. Finally, if credit balances in accounts receivable are significant, it is appropriate to reclassify them as accounts payable. 56) A) Assuming the client's internal controls are adequate, the auditor can verify proper cutoff of sales transactions by obtaining the shipping document number for the last shipment made at the end of the period and comparing this number with current and subsequent period recorded sales. B) The auditor can test the rights objective for accounts receivable by reviewing the client's minutes, discussions with the client, confirmation with banks, and the examination of correspondence files to determine whether accounts receivable may have been pledged as collateral, assigned to someone else, factored, or sold. 57) A) A positive confirmation requests the recipient to respond regardless of whether the balance as stated on the confirmation is correct or incorrect. In contrast, a negative confirmation requests the recipient to respond only if the balance as stated on the confirmation is incorrect. Positive confirmations are more reliable because the auditor can perform follow-up procedures if a response is not received from the customer. B) The primary advantage of negative confirmations is that they are less expensive than positive confirmations because there are no second requests and no follow-up of nonresponses. The primary disadvantage of negative confirmations is that they are less reliable than positive confirmations because a nonresponse must be regarded as a correct response, even though the debtor may have ignored the confirmation request. C) It is acceptable to use negative confirmation requests only when all of the following circumstances are present: ∙ Accounts receivable is made up of a large number of small accounts.
∙
sed control risk and inherent risk is low. ∙ There is no reason to believe that the recipients of the confirmations are unlikely to give them consideration.
Com bine D) The primary factors affecting the decision regarding the type of confirmation to use are the materiality of total d accounts receivable, the number and size of individual accounts, control risk, inherent risk, the effectiveness of asses confirmations as audit evidence, and the availability of other audit evidence. 58) A) Accounts receivable has increased substantially over the prior year, where there has been only a small increase in sales. This could indicate that there is an increase in uncollectible accounts. Also, accounts receivable has increased substantially, but there has been only a small increase in the allowance for doubtful accounts. This could mean that there is an increased risk of misstatement in the allowance for doubtful accounts. B) Additional work should be performed on the allowance for doubtful accounts. The following techniques are suggested: ∙ Test the accuracy of the aged trial balance. ∙ Review the aged trial balance for unusually old amounts. ∙ Review the older amounts in the aged trial balance (perhaps over 90 days) for large amounts or for customers that have not made any payments. ∙ Test subsequent receipts after year end. ∙ Confirm old and large accounts receivable amounts. 59) A) The inconsistency could be due to either fraud (Paul stealing the funds) or error, i.e. too many accounts written off. B) Paul controls the cash and cheques received, deposits the funds into the bank and records the amounts in the accounting system. He has control over the physical assets (the cheques and cash) and the accounting records. He could receive a cheque, deposit in his own account, and write it off. Recommendations for improvement: ∙ Write-offs should be approved by Ellen (as she is independent of the custody of the assets and of accounting). ∙ Mail should be opened by an independent individual, perhaps a volunteer. ∙ Cheques should be restrictively endorsed by the mail opener (stamped with the GreenAcres stamp). ∙ Custody of the cash and cheques should be separated from the accounting — perhaps Ellen could take these amounts to the bank. ∙ Bank deposit amounts should be agreed to the accounting records (cash receipts listing). C) In the absence of a suspicion of fraud, the auditor would likely limit testing of pledges to testing of subsequent cash receipts and tracing of unpaid amounts to either a pledges receivable register or to a write-off listing. With the suspicion of fraud, the auditor might consider extended procedures such as confirmation with individual donors with respect to the amount of their pledges and whether these amounts have been paid or not (similar to positive confirmations of accounts receivable). 60) A) It is likely that internal controls are poor, due to the reduction in accounting staff. Accordingly, substantive tests would be increased, particularly of the bad debt allowance, which is high (more than 10% of total accounts receivable). Positive confirmations would be used, since it is likely that the amounts due to individual customers could be large. Due to the lack of internal controls, confirmations would need to be sent at year end. B) Since the owner is actively involved in accounts receivable, the likelihood of misstatement from the accounting staff is low. However, the potential for management override (and collection of cash for personal use) is high. Thus, there would be no reliance on internal controls, and substantive tests only would be conducted. Positive confirmations of larger balances would be sent as of the year end date.
C)
rmations would likely be used, as the amounts are all small, particularly for the 100,000 accounts that are less than S $300.
ince there are likel y excel lent inter nal contr ols, a com bine d audit appr oach can be used (inte rnal contr ols testi ng and subst antiv e tests) . Conf irmat ions coul d be sent prior to the year end date, if need ed. Nega tive confi
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) From an audit perspective, an imprest bank account at a client can 1) _______ A) increase audit risk. B) require less time for the audit of cash. C) improve client internal controls. D) result in an increase in control risk.
2) A branch bank account is helpful for A) limiting the impact of a fraud. B) empowering the different branches of the company. C) improving internal controls. D) building public relations in local communities and decentralizing operations.
2) _______
3) When are short-term investments that are readily converted to cash included in the cash account in the financial statements? A) When there is little risk of change in value B) When they are under the control of the treasury department C) If they are held in local currencies (i.e. Canadian dollars) D) If interest has been paid up to the year end date
3) _______
4) The general cash account is considered significant in almost all audits A) even when the ending balance is immaterial. B) except those of not-for-profit organizations. C) where the ending balance is material. D) where either the beginning or ending balance is material.
4) _______
5) There is a greater risk of defalcation for cash than for other types of assets because A) most employees have access to cash. B) most other assets must be converted to cash to make them usable. C) it is easier to steal. D) companies usually have weak internal controls surrounding cash.
5) _______
6) Certain types of misstatements that affect cash may be detected in the audit of tests of controls. Which of the following misstatements would be detected in the audit of the sales and collection cycle? A) A defalcation of cash hidden by an unauthorized write off of a bad debt B) Payment to an employee at an incorrect wage rate C) Payment for raw materials that were not received D) Accidental duplicate payment of a vendor's invoice
6) _______
7) Certain types of misstatements that affect cash may be detected in the audit of tests of controls. Which of the following misstatements would be detected in the audit of the acquisition and payment cycle? A) Failure to bill a customer for goods shipped B) Improper reimbursement of an officers' personal expenses
7) _______
C) Paying an employee at the incorrect wage rate D) Billing a customer at the incorrect price
8) Which one of the following misstatements could be detected as part of the tests of a bank reconciliation? A) Exclusion of mortgage interest receivable from the balance sheet B) Deposits recorded as cash receipts at the end of year, but included as outstanding deposits (deposits in transit) C) A defalcation of cash by interception of collections before they are recorded D) Payment of interest to a related party at an incorrect rate
8) _______
9) Which of the following transaction cycles affect the cash in bank account? A) Payroll and personnel; acquisition and payment B) Sales and collection; acquisition and payment C) All cycles D) Sales and collection; payroll and personnel
9) _______
10) Toasted Tomato is a restaurant in Ottawa. You walk by this restaurant frequently and noticed it is usually empty. When you came in to do the audit, you were surprised to see that they had a large cash balance and high sales. Toasted Tomato might A) be engaging in money laundering. B) have a going concern issue. C) have lower business risk than initially anticipated. D) have weak internal controls.
10) ______
11) Which of the following statements best describes the position of cash on the balance sheet at most organizations? It is usually A) highly material. B) immaterial. C) affected by many different capital asset accounts. D) dispersed among many different accounts.
11) ______
12) Sandra is analyzing the cash cycle of her audit client. Which of the following indicator could lead to a liquidity problem? A) Backordered inventory B) High level of inventory C) Inventory on consignment D) Obsolete inventory
12) ______
13) Because cash is the most desirable asset for people to steal, it has a higher A) detection risk. B) control risk. C) inherent risk.
13) ______ D) materiality.
14) Which of the following is the most important internal control in the cash cycle? A) Careful accounting of the continuity of cheques returned from the bank B) Independent receipt of the bank statement from the bank C) Use of two signatures on payroll cheques and payables cheques D) Independent preparation of bank reconciliations
14) ______
15) What is an important benefit of independent preparation of bank reconciliations? A) The best time to carefully serially account for cheques issued B) An opportunity to independently check that cheques have two signatures C) The client being able to check that the bank is processing transactions correctly D) The ability to internally verify cash receipts and disbursements transactions
15) ______
16) What is the best way to prevent potential alteration, deletion or addition of cancelled cheques, duplicate deposit slips or other documents provided with the bank statement? Have the A) bank statements provided to the accounts payable supervisor. B) bank statements provided unopened to an independent reconciler. C) signing officer(s) review the bank reconciliation. D) person responsible for recording cash receipts do the bank reconciliation.
16) ______
17) Which of the following internal procedures is directly related to the tests of controls of transaction cycles? A) Review of month-end interbank transfers for propriety B) Reconciliation of all items causing a difference between the book and bank balance C) Confirmation of the propriety of all bank reconciliation reconciling items D) Examination of cancelled cheques for signature, endorsements and cancellation
17) ______
18) Which of the following internal procedures is part of the internal bank reconciliation control process (rather than being part of the internal controls for a transaction cycle)? A) Comparison of cancelled cheques with the cash disbursements journal by payee B) Accounting for the numerical sequence of cheques, with investigation of missing ones C) Comparison of deposits in the bank with the recorded cash receipts by customer D) Reconciliation of total credits on the bank statement with the totals in the cash receipts journal
18) ______
19) Which of the following is a common analytical procedure that may detect misstatements in cash? A) Calculation of inventory turnover and gross profit B) Comparison of gross sales on a month by month basis with the prior year C) Review of amounts included in the earnings per share calculations D) Comparison of outstanding cheques and deposits in transit with the prior year bank reconciliation
19) ______
20) Bank reconciliations are normally verified on a 100-percent basis. Testing the reasonableness of the cash balance is therefore A) equally important than for other audit areas. B) less important than for most other audit areas. C) less important than for the audit of other assets, but more important than the audit of liabilities. D) more important than for other audit areas.
20) ______
21) Which of the following situations would indicate a susceptibility at the client to the potential of
fraud that
pertains 21) to theft of cash? A) payroll rates being approved by the corporate controller B) lack of segregation of duties between the handling of cash and the recording of cash C) customer master file changes being handled by the controller's executive assistant D) cash disbursements cheques requiring only one authorizing signature
___ ___
22) The starting point for the verification of the balance in the general bank account is to obtain A) the client's cash account from the general ledger. B) a bank reconciliation from the client. C) the client's December bank statement and reconcile it. D) a cutoff bank statement directly from the bank.
22) ______
23) Which balance-related audit objectives are most important for the audit of cash? A) Existence, cut-off, completeness B) Detail tie-in, existence, cut-off C) Existence, accuracy, completeness D) Completeness, presentation and disclosure
23) ______
24) The audit objective to determine that cash in bank is properly presented and disclosed can be met through which of the following tests of details of balances? A) Test for kiting B) Foot the outstanding cheque list and deposits in transit C) Examine minutes, loan agreements, and the bank confirmation for restrictions on the use of cash and compensating balances D) Trace outstanding cheques to subsequent period bank statement
24) ______
25) The test of balances procedure that requires the auditor to trace the book balance on the reconciliation to the general ledger is an attempt to satisfy the audit objective of A) detail tie-in. B) completeness. C) accuracy. D) existence.
25) ______
26) The audit objective of determining that cash in bank as stated on the reconciliation is accurate can be tested by which of the following procedures? A) Trace deposits in transit to subsequent period bank statement B) Receipt and tests of a bank reconciliation C) Prove the bank reconciliation as to additions and subtractions D) Do tests for kiting
26) ______
27) In an effort to satisfy the completeness objective, the auditor could perform which of the following test of details of balance procedures? A) Review financial statements to make sure that material savings accounts and certificates of deposit are disclosed separately B) Prepare a proof of cash C) Trace the book balance on the reconciliation to the general ledger D) Trace outstanding cheques to subsequent period bank statements
27) ______
28) The audit procedure which requires the auditor to record the last cheque number used on the last day of the year and subsequently trace to the outstanding cheques and the cash disbursements journal is performed to satisfy the audit objective of A) cut-off. B) detail tie-in. C) existence. D) completeness.
28) ______
29) During his examination of a January 19, 2006 cutoff bank statement, an auditor noticed that the majority of cheques listed as outstanding at December 31, 2005 had not cleared the bank. This would indicate A) a high probability of kiting. B) that the cash disbursements journal had been held open past December 31, 2005. C) a high probability of lapping. D) that the cash disbursements journal had been closed prior to December 31, 2005.
29) ______
30) A partial-period bank statement and the related cancelled cheques, duplicate deposit slips, and other documents included in bank statements, mailed by the bank directly to the public accounting firm's office, is called A) a four-column proof of cash. B) a bank statement. C) a short-period bank statement. D) a cutoff bank statement.
30) ______
31) The reason for testing the client's bank reconciliation is to verify whether the client's recorded bank balance is the same amount as the actual cash in bank, except for deposits in transit, cheques outstanding, and other reconciling items. The information needed to complete the tests of the reconciliation are provided by the A) journals and ledgers of client for the subsequent year. B) cutoff bank statement. C) cancelled cheques for the year under audit. D) journals and ledgers of client for the year under audit.
31) ______
32) An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily in order to A) verify the cash balance reported on the bank confirmation inquiry form. B) verify reconciling items on the client's bank reconciliation. C) detect kiting. D) detect lapping.
32) ______
33) A major consideration in the audit of the general cash balance is the possibility of fraud. The auditor must extend his or her procedures in the audit of year-end cash to determine the possibility of a material fraud when there are A) large cash receipts and disbursements during the year. B) no imprest accounts used for payroll. C) large cash balances at the end of the year. D) inadequate internal controls.
33) ______
34) What is the purpose of an extended test of the bank reconciliation? To
34) ______
A) compensate for material weaknesses in internal control with respect to segregation of duties B) verify whether all transactions included in the journals for the last month of the year were correctly allocated to the bank reconciliation C) verify whether specific transactions that flowed through the cash account were correctly recorded D) increase detection risk for the audit of cash
35) Under what circumstances would an auditor prepare a proof of cash? When A) an enterprise resource system is in use for processing of cash transactions. B) inherent risk in cash is considered to be low. C) control risk is set at minimum. D) the client has material internal control weaknesses in cash.
35) ______
36) A four-column proof of cash can be performed for A) the last month of the year. B) one or more interim months. C) the entire year. D) any specified time period for which bank statements are available and which the auditor chooses to designate.
36) ______
37) The auditor uses a proof of cash to determine whether A) all recorded cash receipts were deposited and whether all recorded cash disbursements were paid by the bank. B) internal controls over cash have been functioning effectively in the period under audit. C) accounts receivable was properly recorded and whether cash receipts transactions were properly recorded. D) accounts payable was properly recorded and whether cash disbursement transactions were properly recorded.
37) ______
38) What type of audit test is a proof of cash? A) Test of control C) Dual-purpose
38) ______ B) Analytical review D) Test of details
39) On the last day of the fiscal year, the cash disbursements clerk drew a company cheque on bank A and deposited the cheque in the company account in bank B to cover a previous theft of cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by A) examining paid cheques returned with the bank statement of the next account period after year-end. B) examining the composition of deposits in both bank A and B subsequent to year-end. C) comparing the detail of cash receipts as shown by the cash receipts records with the detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year-end. D) preparing from the cash disbursements book a summary of bank transfers for one week prior to and subsequent to year-end.
39) ______
40) The process of transferring money from one bank account to another and improperly recording the transaction in both accounts is A) a scam. B) embezzling. C) lapping. D) kiting.
40) ______
41) What audit objective is associated with the comparison of disbursement and receipt information on a bank transfer schedule to the cash disbursements and cash receipts journals? A) Completeness B) Accuracy C) Occurrence D) Classification
41) ______
42) Testing to ensure that bank transfers are recorded in both the receiving and disbursing banks helps to detect evidence A) that would warrant decreasing control risk to a minimum. B) that increases reliability with respect to the accuracy of the transfer schedule. C) that would reduce inherent risk to a minimum. D) associated with an attempt to conceal a theft of cash.
42) ______
43) On a bank transfer schedule, if a cash disbursement was recorded in the current fiscal year, and the receipt in the subsequent fiscal year, this might be A) the best way to record this type of transaction. B) an attempt to cover a cash shortage. C) an indication of an error in recording information by the bank. D) an indication of increased inherent risk with respect to cash.
43) ______
44) Disbursements on the bank transfer schedule should be correctly included in or excluded from year-end bank reconciliations as outstanding cheques. Understating outstanding cheques on the bank reconciliation indicates A) a cut-off error in the bank account. B) an understatement of the bank balance. C) an increase in inherent risks associated with cash. D) the possibility of kiting.
44) ______
45) In addition to the possibility of kiting, inaccurate handling of bank transfers could result in A) an incorrect balance in the bank loan account. B) a misclassification between cash and accounts receivable. C) an incorrect balance in the accounts receivable account. D) a misclassification between cash and accounts payable.
45) ______
46) When examining the bank reconciliation for the imprest payroll account, it is normal for the only reconciling item to be A) outstanding deposits. B) corrections to payroll amounts. C) bank service charges. D) outstanding cheques.
46) ______
47) Electronic data interchange (EDI) represents the electronic transfer of A) of data between accounting system of the company's entities. B) of information between the bank and the company. C) funds.
47) ______
D) business documents.
48) Stella is auditing the electronic receipts and payments. The extent of her audit work conducted on the bank reconciliation will A) be more extensive than if the company did not engage in electronic receipts and payments. B) depend on the assessed quality of internal controls. C) be significantly diminished if Stella can determine that the receipts and payments come from a reputable bank with proper internal controls. D) be less extensive than if the company did not engage in electronic receipts and payments.
48) ______
49) The most important internal control for petty cash is A) the use of an imprest fund that is the responsibility of one individual. B) accessibility so that cheques won't have to be written for small amounts. C) keeping the amount of cash to a minimum. D) keeping it in a safe or locked drawer.
49) ______
50) Petty cash tests can ordinarily be performed at any time during the year, but as a matter of convenience they are typically done A) on an interim date. B) near the end of the field work. C) on the balance sheet date. D) at the same time as the observation of inventory, since both auditor and client must be present at that time.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Describe each of the major types of cash accounts maintained by business entities. B) Discuss the advantages of using an imprest bank account for payroll transactions.
52) A) "Failure to bill a customer" is an example of an error that results in the failure to receive cash, but would not be discovered as part of the audit of the bank reconciliation. State three other examples of errors or irregularities that result in the improper payment of, or failure to receive, cash, but would not be discovered during the audit of the bank reconciliation. How are these types of misstatements normally uncovered in the audit? B) State three examples of errors or irregularities that normally would be uncovered during the audit of the bank reconciliation.
53) You are the auditor of Brody Grass Inc. The CEO expressed a concern that the audit fees for the year were very high. You then explained that this is largely due to poor internal controls in the cash and transaction cycle and that the audit fees could decrease if better controls were in place. Provide 5 examples of general cash account controls that Brody Grass could implement.
54) A) Discuss the methodology for designing tests of details of balances for cash in the bank.
bank reconciliation by client personnel consists of nine procedures. List these nine bank reconciliation B) An procedures. effective monthly C) Discuss two analytical procedures commonly performed during the audit of the cash account.
55) A) Explain what is meant by a cutoff bank statement and discuss the purpose of the cutoff bank statement in the audit of cash. B) Explain the purpose of testing the client's bank reconciliation and discuss the major audit procedures involved.
56) A) Many auditors prove the subsequent period bank statement if a cutoff statement is not received directly from the bank. Discuss the purpose of proving the subsequent period statement, and explain the audit procedures performed during the proof. B) Discuss the circumstances in which an auditor would prepare a proof of cash.
57) A) Explain what is meant by kiting and discuss how it is performed. B) Discuss how an auditor can test for kiting.
58) Outline the audit procedures that would be performed when testing electronic receipts and payments.
59) Following are situations that an auditor might find by means of tests of controls or tests of details of cash balances for a company with a December year end. A) The accountant did not record or deposit a cash receipt for $50,000 that was received on December 28. Cash is prelisted by the receptionist. B) Cheques prepared up to January 6 were dated December 31 and recorded in the cash disbursements journal. C) A cheque was issued for office supplies that were never received by the client. Required: List a substantive audit procedure that could uncover each of the preceding situations.
60) Serena is the assistant controller of Opus Inc. As a result of a recent expansion the controller has been very busy and delegated the signing authority of the cheques to Serena. Further, due to the cash accountant leaving on maternity leave, Serena was asked to perform the bank reconciliation until they found someone to replace the cash accountant. Serena is a qualified accountant and has been able to handle all of these additional tasks. However, she asked her boss for a raise to compensate her for the additional responsibilities that she currently has. Her boss indicated that this was only temporary and the company could not afford a raise for now.
Serena address. She has been paying this vendor $2,000 for the past 3 months as a means of compensating herself. created a This theft has yet to be discovered by Opus. vendor Required: in the system What audit procedures might with her A) What internal controls are missing to enable the theft to occur?B) detect the theft? home
1) C 2) D 3) A 4) A 5) B 6) A 7) B 8) B 9) C 10) A 11) B 12) D 13) C 14) D 15) D 16) B 17) D 18) D 19) D 20) B 21) B 22) B 23) C 24) C 25) A 26) B
27) B 28) A 29) B 30) D 31) B 32) B 33) D 34) B 35) D 36) D 37) A 38) C 39) A 40) D 41) B 42) D 43) B 44) D 45) D 46) D 47) D 48) B 49) A 50) A 51) A) ∙ General cash account. This is the focal point of cash for most organizations because virtually all cash receipts and disbursements flow through this account.
∙
nal control, many companies establish a separate imprest bank account for making payroll payments to employees. I In such an account, a fixed balance, such as $1,000, is maintained. Immediately before each pay period, one cheque mpre is drawn on the general cash account to deposit the total amount of the net payroll in the imprest payroll account. st ∙ Branch bank account. For a company operating in multiple locations, it is frequently desirable to have a separate payro bank balance at each location. Branch bank accounts are useful for building public relations in local communities ll and permitting the centralization of operations at the branch level. accou ∙ Imprest petty cash fund. This fund is used for small cash transactions that can be paid more conveniently and nt. quickly by cash than by cheque. As a ∙ Cash equivalents. Excess cash accumulated during certain parts of the operating cycle that will be needed in the mea reasonably near future is often invested in short-term, highly liquid cash equivalents such as term deposits, ns of certificates of deposit, and money market funds. impr ovin B) The primary advantages are that the use of an imprest payroll account can (1) improve internal control and (2) g reduce the time needed to reconcile bank accounts. inter 52) A) ∙ Billing a customer at a lower price than called for by company policy. ∙ A defalcation of cash by interception of cash receipts from customers before they are recorded; the account is charged off as a bad debt. ∙ Duplicate payment of a vendor's invoice. ∙ Improper payments of officers' personal expenditures. ∙ Payment for raw materials that were not received. ∙ Payment to an employee for more hours than he or she worked. ∙ Payment of interest to a related party for an amount in excess of the going rate. If these misstatements are to be uncovered in the audit, their discovery must come about through tests of controls. B) ∙ Failure to include a cheque that has not cleared the bank on the outstanding cheque list, even though it has been recorded in the cash disbursements journal. ∙ Cash received by the client subsequent to the balance sheet date but recorded as cash receipts in the current year. ∙ Deposits recorded as cash receipts near the end of the year, deposited in the bank in the same month, and included in the bank reconciliation as a deposit in transit. ∙ Payments on notes payable debited directly to the bank balance by the bank but not entered in the client's records. 53) Note that the list below is not exhaustive and other answers could also be judged acceptable. - adequate segregation of duties between cheque signing, accounts payable function and bank reconciliation. - signing of cheques only by an authorized person - the use of prenumbered cheques - cheques are kept in a secure place where only authorized personnel have access - adequate control of blank and voided cheques - careful review of supporting documentation by the cheque signer before signing - adequate internal verification - bank reconciliation is performed on a timely basis 54) A) 1. Set materiality and assess acceptable audit risk and inherent risk for cash in bank. 2. Assess control risk for cash in bank. 3. Design and perform tests of controls for the sales and collection cycle, acquisition and payment cycle, payroll
and Design and perform analytical procedures for cash in bank balance. pers 5. Design tests of details of cash in bank balance to satisfy balance-related audit objective. Decide appropriate onne audit procedures, sample size, items to select for testing, and timing of tests. l cycle B) , and ∙ Compare cancelled cheques with the cash disbursement journal for date, payee, and account. capit ∙ Examine cancelled cheques for signature, endorsement, and cancellation. al ∙ Compare deposits in the bank with recorded cash receipts for date, customer, and amount. acqui ∙ Account for the numerical sequence of cheques, and investigate missing ones.* Reconcile all items causing a sitio difference between the book and bank balance, and verify their propriety. n ∙ Reconcile total debits on the bank statements with the totals in the cash disbursements journal. and ∙ Reconcile total credits on the bank statements with the totals in the cash receipts journal. repa ∙ Review month-end interbank transfers for propriety and proper recording. yme ∙ Follow up on outstanding cheques and stop-payment notices. nt cycle C) It is common for auditors to compare the ending balance on the bank reconciliation, deposits in transit, . outstanding cheques, and other reconciling items with the prior-year reconciliation. Similarly, auditors normally 4. compare the ending balance in cash with previous months' balances. 55) A) A cutoff bank statement is a partial-period bank statement and the related cancelled cheques, duplicate deposit slips, and other documents included in bank statements, mailed by the bank directly to the public accounting firm's office. The purpose of the cutoff bank statements is to verify the reconciling items on the client's year-end bank reconciliation with evidence that is inaccessible to the client. B) The purpose of testing the client's reconciliation is to verify whether the client's recorded bank balance is the same amount as the actual cash in the bank. Procedures include: ∙ Verify that the client's bank reconciliation is mathematically accurate. ∙ Trace the balance on the cutoff statement to the balance per bank on the bank reconciliation. ∙ Trace cheques included with the cutoff bank statement to the list of outstanding cheques on the bank reconciliation and to the cash disbursement journal. ∙ Investigate all significant cheques included on the outstanding cheque list that have not cleared the bank on the cutoff statement. ∙ Trace deposits in transit to the subsequent bank statement. ∙ Account for other reconciling items on the bank statement and bank reconciliation. 56) A) The purpose of such a proof is to test whether the client's employees have omitted, added, or altered any of the documents accompanying the cutoff statement received from the client. The audit procedures include (1) footing all the cancelled cheques, debit memos, deposits, and credit memos; (2) checking to see that the bank statement balances when the footed totals are used; and (3) reviewing the items included in the footings to make sure that they were cancelled by the bank in the proper period and do not include any erasures or alterations. B) Auditors would prepare a proof of cash when the client has material internal control weakness in cash. 57) A) Kiting is transferring money from one bank to another and improperly recording the transaction to cover a defalcation of cash. Near the balance sheet date a cheque is drawn on one bank account and immediately deposited in a second account for credit before the end of the accounting period. In making this transfer, the embezzler is careful to make sure that the cheque is deposited at a late enough date so that it does not clear the first bank until after the end of the period. If the bank transfer is not recorded until after the balance sheet date, the amount of the transfer is recorded as an asset in both banks. B) To test for kiting, the auditor obtains a schedule of interbank transfers that lists all bank transfers made a few days before and after the balance sheet date, and traces each to the accounting records for proper recording. Specific
item The accuracy of the information on the bank transfer schedule should be verified by reference to the cash s of disbursements and cash receipts journals. inter ∙ The date of the recording of the disbursements and receipts for each transfer must be in the same fiscal year. est ∙ Disbursements on the bank transfer schedule should be correctly included in or excluded from year-end bank inclu reconciliations as outstanding cheques. de: ∙ Receipts on the bank transfer schedule should be correctly included in or excluded from year-end bank ∙ reconciliations as deposits in transit. 58) Procedures would include: ∙ Agreeing electronic payments to an authorized schedule of such payments by date, payee account number and amount. ∙ Reviewing the authorized schedule of payments and controls over its preparation. ∙ Tracing deposits to the client's POS system records. 59) A) Trace the prelisting of cash to the cash receipts records or to the bank deposit. B) Examine the bank cancellation date for cheques included in the bank cut-off statement or included with the January bank reconciliation. C) Compare cash disbursements to invoices and receiving reports or other proof of delivery. 60) A) Poor segregation of duties is the main cause. By allowing Serena to have access to the cheques and authority to sign them in addition to being responsible to reconcile the bank account, this gives Serena the opportunity to steal and cover up the theft. Authorization of the checks should remain with the controller while Serena performs the reconciliation. Further, it appears that Serena had access to the vendor creation function of the system. This could be an indication of poor computer controls. There should also be an authorization or review of any new vendors created. B) - testing the reconciliation performed by Serena - A review of all new vendors created - Computer assisted procedure where a scan of vendors similar to employee names or addresses is performed - A review of recurring payments - Test a sample of payments to ensure that they were approved by authorized person. - Careful review of supporting documentation for payments selected.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Payroll and personnel costs at ABC Manufacturing are a major expense. This means that 1) _______ improper allocation or misclassification of labour costs could result in A) a net effect that is negligible when costing inventory. B) incorrect payment of payroll to employees. C) quality control problems with respect to the production of finished products. D) a material misstatement of net income.
2) The payroll and personnel cycle is the transaction cycle that begins with A) hiring of personnel. B) the creation of the employee profile in the payroll master file. C) the employee performing work for the company. D) processing the payment to the employees.
2) _______
3) The employees included in the payroll and personnel cycle include A) straight salary employees. B) sales people paid by commission. C) employee receiving a bonus. D) all of the above.
3) _______
4) In auditing payroll, which of the following procedures will take the least amount of auditor time? A) analytical procedures B) tests of details of balances C) confirmations D) tests of controls
4) _______
5) In most audits, the amounts of the balance sheet accounts related to payroll are A) large on the liability side but small on the asset side. B) large and require substantial effort to audit. C) significantly larger than the related accounts on the income statement. D) small and can be verified with ease.
5) _______
6) Which of the following describes the class of transactions associated with payroll? A) Write-off of damaged inventory dropped by employees B) Posting of costs allocated to inventory C) Payment of withholding taxes and benefits D) Payment of employee services
6) _______
7) Which of the following best describes proper internal control over payroll? A) The payment of cash to employees should be replaced with payment by cheques. B) The duties of hiring, payroll computation, and payment to employees should be segregated. C) The preparation of the payroll must be under the control of the personnel department. D) The confidentiality of employee payroll data should be carefully protected to prevent fraud.
7) _______
8) Ricky recently got an internal transfer from payroll analyst to assistant regional manager of the production. An employee at the production facility came to see Ricky since he was not paid on the last payroll cheque for the overtime he had done. Ricky apologized for this mistake and logged into the payroll system to modify the next paycheck for the employee to ensure that he would be paid for the additional hours. A) The company did not properly complete the access rights approval form. B) Ricky did not do anything wrong since the employee had worked the hours. C) The company did not properly check employee background when they hired Ricky. D) The company did not properly complete the access rights change form.
8) _______
9) The file for recording each payroll transaction for each employee and maintaining total employee wages paid for the year to date is the A) payroll transaction file. B) payroll master file. C) payroll journal. D) job time ticket.
9) _______
10) The total of the individual employee earnings in the payroll master file equals the A) total of the cheques drawn to employees for payroll. B) total balance of gross payroll in general ledger accounts. C) total gross pay for the current week's payroll. D) total gross payroll plus the total contributed by the employer for payroll taxes.
10) ______
11) Which of the following controls best prevents employees from checking in for more than one employee? The use of A) time cards stored in a wall rack B) placing the punch clock in full view of the receptionist C) a personalized swipe card D) numerically controlled punch-in cards
11) ______
12) After the payroll cheque is cashed and returned to the company from the bank, it is referred to as a A) cancelled cheque. B) completed transaction. C) void cheque. D) cashiered cheque.
12) ______
13) To minimize the opportunity for fraud, unclaimed salary cheques should be A) left with the employee's supervisor. B) held for the employee in the personnel department. C) immediately returned for redeposit. D) kept in the payroll department.
13) ______
14) George records the payroll and hands out the time cards. Ann distributes the cheques. The assistant controller handles unclaimed cheques and the controller completes the payroll bank reconciliation. Who should be signing the payroll cheques? A) Ann B) Controller C) Assistant controller D) George
14) ______
15) When labour is a material factor in inventory valuation, the auditor should place special emphasis on testing the internal controls concerning A) authorization of wage rates. B) completeness of recorded transactions. C) proper classification of transactions. D) fictitious employees.
15) ______
16) A form issued for each employee summarizing the earnings record for the calendar year is the A) rate authorization form. B) T-4 form. C) summary payroll report. D) payroll master file.
16) ______
17) The careful and timely preparation of all payroll withholdings and employers' portion is necessary to avoid penalties and criminal charges. The most important control in the timely preparation of these returns is A) a well-defined set of policies that indicate when each form must be filed. B) independent verification of computer output by a competent individual. C) computerized preparation of tax returns. D) a Gantt chart.
17) ______
18) General controls must be evaluated and their impact considered upon the payroll and personnel transaction cycle because A) automated techniques are normally used to prepare and post payroll transactions. B) the best way to test payroll transactions is usually by using generalized audit software. C) there are frequently weaknesses in internal controls in the payroll cycle. D) the best way to test payroll transactions is usually by using test data.
18) ______
19) Which of the following type of test is most important for the audit of payroll? A) Analytical review B) Internal control C) Test of detail D) Substantive test
19) ______
20) When examining payroll transactions, an auditor is primarily concerned with the possibility of A) misfootings of employee time records. B) excess withholding of amounts required to be withheld. C) overpayments and unauthorized payments. D) posting of gross payroll amounts to incorrect salary expense accounts.
20) ______
21) To test whether the client has fulfilled its legal obligation in submitting payments for all payroll withholdings, the auditor must first A) trace these payments to the imprest payroll account. B) know the dates when tax payments are due. C) contact client's independent legal counsel. D) determine the client's requirements for submitting the payments.
21) ______
22) Tracing selected items from the payroll register to employee time cards that have been approved by supervisory personnel provides evidence that A) only bona fide employees worked and their pay was properly computed.
22) ______
B) payroll cheques were signed by an appropriate officer independent of the payroll preparation process. C) employees worked the number of hours for which their pay was computed. D) internal controls relating to payroll disbursements were operating effectively.
23) Which of the following is a test of controls? A) Examine time cards for indication of supervisor approval B) Examine cancelled cheques for proper endorsement C) Review the payroll journal, general ledger, and payroll earnings records for large or unusual amounts D) Compare cancelled cheques with payroll journal for name, amount, and date
23) ______
24) Which of the following is a substantive test of transactions? A) Reconcile the disbursements in the payroll journal with the disbursements on the payroll bank statement B) Account for a sequence of payroll cheques C) Examine printouts of transactions rejected by the computer as having invalid employee numbers D) Review personnel policies
24) ______
25) Which of the following internal controls helps ensure that recorded payroll payments are for work actually performed by existing employees? A) Procedures require recording transactions as soon as possible B) Internal verification of payroll file contents C) Independent preparation of payroll bank reconciliation D) Only valid employees from the computer data files are accepted for processing
25) ______
26) Which of the following internal control tests would assist in satisfying the occurrence transaction-related audit objective for payroll? A) Prove the payroll bank reconciliation B) Examine payroll records for evidence of approval C) Account for a sequence of payroll cheques D) Review chart of accounts
26) ______
27) "Recorded payroll payments are for work actually performed by existing employees" is the control objective of A) accuracy. B) authorization. C) completeness. D) occurrence.
27) ______
28) "Existing payroll transactions are recorded" is the control objective of A) completeness. B) existence. C) authorization.
28) ______ D) accuracy.
29) Which of the following internal controls would help ensure that existing payroll transactions are recorded? A) Time records are approved by supervisors B) Comparison of payroll master file totals with general ledger control account
29) ______
C) Time clock is used to record time D) Independent preparation of payroll bank reconciliation
30) Which of the following tests of controls would pertain to whether existing payroll transactions are recorded? A) Foot payroll journal and trace details to general ledger B) Compare cancelled cheques with payroll journal details C) Conduct gap testing for a sequence of payroll cheques D) Compare cancelled cheques with payroll records
30) ______
31) "Recorded payroll transactions are for the amount of time actually worked and at the proper pay rate; withholdings are properly calculated" relates to which control objective? A) Authorization B) Accuracy C) Completeness D) Existence
31) ______
32) Which of the following internal controls would assist in ensuring that recorded payroll transactions are for the amount of time actually worked and at the proper pay rate, and that withholdings are properly calculated? A) Separation of duties between personnel, timekeeping, and payroll disbursements B) Comparison of batch totals with computer summary reports C) Adequate personnel files D) Comparison of payroll master file with payroll general ledger totals
32) ______
33) Which of the following internal control tests would be used in assessing that recorded payroll transactions are for the amount of time actually worked and at the proper pay rate, and that withholdings are properly calculated? A) Foot payroll journal and trace to general ledger B) Prove the bank reconciliation C) Review the payroll journal for large or unusual amounts D) Recompute gross pay
33) ______
34) Which of the following internal control tests would help to assess whether payroll transactions were properly classified? A) Test clerical accuracy by footing the payroll journal B) Review time records and job records, tracing to labour distribution C) Recompute net pay and gross pay D) Reconcile the disbursements in the payroll journal with the payroll bank statement
34) ______
35) Which of the following internal control tests would help to assess whether payroll transactions were recorded on the correct dates? A) Recompute hours worked from pay records B) Compare cancelled cheques with payroll journal for name, amount, and date C) Compare date on cheque with date the cheque cleared the bank D) Compare cancelled cheques with personnel records
35) ______
36) A weak internal control system allows a foreman to clock in daily for a fictitious employee and
to
approv
e the 36) time card at the end of the payroll period. This fraud would be detected if other controls were in place, such as having an indepen dent party A) foot the payroll journal and trace postings to the general ledger and the payroll master file. B) recompute hours worked from time cards. C) distribute paycheques. D) compare the date of the recorded cheque in the payroll journal with the date on the cancelled cheques and time cards.
___ ___
37) When the employees are paid automatically by bank deposits to the employees' accounts, in an effort to identify potential fraud, the auditor can look for A) cancelled cheques. B) duplicated bank account numbers. C) unusual employee names. D) duplicated name.
37) ______
38) The auditor should review the preparation of at least one of each type of payroll tax form the client is responsible for filing, as a part of the auditor's responsibility for A) doing tests of controls. B) understanding internal controls. C) doing analytical procedures. D) doing tests of balances.
38) ______
39) A procedure in which each employee must pick up and sign for his or her cheque in the presence of a supervisor and the auditor is A) an inexpensive way to uncover payroll "ghosts." B) a payroll roll call. C) a surprise payroll payoff. D) a payroll queue.
39) ______
40) Because of the lack of available evidence, it is usually difficult for an auditor to discover if an employee records more time on his or her time card than actually worked. One procedure is A) to reconcile the total hours paid this period with a previous period. B) to reconcile the total hours worked according to the summary payroll report with the total
40) ______
hours worked as recorded on the time card for the period. C) to reconcile the total hours worked this period with a previous period. D) to reconcile the total hours paid according to the payroll records with an independent record of the total hours worked, such as those maintained by production control.
41) Otto decided to outsource the payroll function to Magna Plus. From the purpose of an assurance engagement, Magna is a A) user entity. B) human resource company. C) payroll company. D) service organization.
41) ______
42) Otto decided to outsource the payroll function to Magna Plus. For the purpose of the audit engagement, the auditor A) will not be able to rely on Magna Plus' reports as a source of information. B) will not have to perform tests of details for the payroll cycle. C) may rely upon Magna Plus' reports as a source of information. D) must test the internal controls at Magna Plus.
42) ______
43) Otto decided to outsource the payroll function to Magna Plus. The controller of Otto should still A) review the payroll journal and compare the total hours worked with the payroll time records. B) review and authorize each individual payments to employees. C) inquire with the manager of Magna Plus if they suspect any unusual transaction. D) recalculate the payroll and its remittance to ensure accuracy.
43) ______
44) The correct cutoff and valuation of accrued salaries and wages A) depends on company policy, consistently followed. B) is to compute an approximate proportion of the wages that were earned in the current period and use that amount as the accrual. C) allows the client to choose between a and b above each year. D) is to calculate the exact hours of pay that were earned in the current period and paid in a subsequent period.
44) ______
45) Once the auditor has determined the company's policy for accruing wages and knows it is consistent with that of previous years, the appropriate audit procedure to test for cutoff and accuracy is to A) confirm the amount with employees. B) compare the ledger balance with the journal and the T-4 form. C) compare the recorded accrued wages with the amount approved in the minutes of the Board. D) recalculate the client's accruals.
45) ______
46) The auditor's primary concern in testing payroll liabilities is to make sure that A) salaries of officers have not been misclassified as wages. B) expense has not been overstated, thus reducing profits. C) employees' T-4 slips are accurate.
46) ______
D) there are no understated or omitted accruals.
47) Verification of the legitimacy of year-end unpaid bonuses to officers and employees can be accomplished by comparing the recorded accrual to the amount A) paid in the subsequent period. B) used in the prior period. C) in the expense account. D) authorized in the minutes of the board of directors.
47) ______
48) The most important consideration in evaluating the fairness of the amounts accrued for vacation pay, sick pay, and other benefits is A) the amount expended to date in the current period. B) the actual expense incurred for the prior period. C) the consistent accrual of these liabilities relative to those of the preceding year. D) the profitability of the client which will enable these liabilities to be met.
48) ______
49) An audit procedure which reconciles total payroll expense in the general ledger with the employee withholdings and benefits remittance forms and the T-4 slips is seldom successful in discovering errors because A) accounting principles used by companies may be different than those required on the tax return. B) the auditor expects that these will be different totals. C) misstatements, if any, are likely to be in both sets of records. D) the financial statements cover a year, but the withholdings and benefits remittance forms must be filed quarterly.
49) ______
50) When auditing the payroll and personnel cycle, the auditor should verify the officers' compensation because A) officers' compensation is likely more significant. B) some officers may be in a position to pay themselves more than the authorized amounts. C) some officers may have complex compensation packages. D) officers are more likely to commit fraud.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Discuss three important differences between the payroll and personnel cycle and other cycles in a typical audit. B) Describe each of the four business functions in a typical payroll and personnel cycle. C) Describe each of the primary documents and records used in the timekeeping and payroll preparation function in the payroll and personnel cycle. D) Discuss each of the primary documents and records used in the (1) payment of payroll function, and (2) preparation of employee withholdings and benefits remittance forms function in the payroll and personnel cycle.
52) A) There are several internal controls in the personnel and employment function that are important from an audit perspective. For example, there should be an adequate investigation of the competence and trustworthiness of new employees. Discuss other internal controls in the personnel and employment function that are important from an audit perspective. B) There are several key internal controls over the timekeeping and payroll preparation function that should be present. For example, adequate control over the time on employees' time cards includes the use of a time clock or other method of making certain that employees are paid for the number of hours they worked. Discuss other key internal controls over the timekeeping and payroll preparation function. C) There are several key internal controls over the payment of payroll function that should be present. For example, the payroll should be distributed by someone who is not involved in the other payroll functions. Discuss other key internal controls over the payment of payroll function.
53) Even though the tests of controls are the most important part of testing payroll, many auditors spend little time in this area. In many audits, there is a minimal risk of material misstatements, even though payroll is frequently a significant part of total expenses. Explain the reasons the auditors have for justifying this position.
54) State the six specific transactions-related audit objectives as related to payroll, and for each objective, state one common test of controls that can be used to test the objective.
55) Discuss the two most common ways in which employees can defraud a company in the payroll area.
56) A) Describe an audit procedure to test for the issuance of payroll cheques to individuals who do not work for the company (nonexistent employees). B) Discuss the procedures involved in, and the purpose of, a surprise payroll payoff.
57) The WhirlyGig Factory Ltd. manufactures WhirlyGigs of many different sizes and types. The company employs 55 employees, all paid on an hourly basis. Employees fill in time sheets and hand them in every Monday to the payroll clerk, Pamela. For factory employees, the time sheet shows the hours worked by product job number, and indicates if the job has been completed. The payroll clerk tracks the hours worked by job, and when a job is complete, compares the totals to the estimate made by the owner, Faruq. A bonus is paid for actual hours paid less than the estimated amount. Every Wednesday, Pamela prepares the cheques and gives them to Faruq for signing. Pamela then staples the cheques to the payroll stubs. Pamela hands out the office cheques and gives the other cheques to the factory supervisor for distribution. Required: A) Identify control weaknesses and their impact, and provide recommendations for improvement. B) What is the impact of the control weaknesses upon your audit approach?
58) Joan has been the payroll supervisor at York Distribution Company (YDC) for ten years. She has never missed a payroll and Farah, the owner of the company is delighted with her conscientiousness and knowledge. This is particularly important, as Farah spends a lot of time on the road drumming up new business, and needs competent personnel back at the office. There are two accounting personnel at the office, a receptionist, five shipping and receiving personnel, and thirty sales people employed by YDC. Office and shipping/receiving personnel are paid a salary, while the sales people are paid a monthly base salary plus a percentage of their sales, calculated quarterly. The base salary is low, at $20,000, with a 2% commission, calculated based upon sales less any bad debts written off related to their customers. Joan prints off the sales by customer every month, and uses this information to calculate commission. She then prepares the payroll cheques and gives them to Farah, who signs them and gives them to the sales staff at the monthly sales meeting. The cheques are written against a payroll imprest bank account, kept at a balance of $1,000. This account is not reconciled, as the staff are very overworked with the increasing volume of business handled by the company. Required: A) Identify control weaknesses and their impact, and provide recommendations for improvement. B) What is the impact of the control weaknesses upon your audit approach?
59) You have been working on the audit of Big Insurance Company for several years now. There are about 5,000 employees working at the company in various positions. Your audit partner has indicated that this year, the firm will be implementing computer assisted audit techniques (CAATs), using generalized audit software. The information systems audit specialist will be assisting the audit team with the implementation of these tests. She wants you to provide a draft list of CAATs that could assist with the coming year's audit of payroll. The company uses mainframe computing systems. You need to assume that the typical payroll information is available on computer files, i.e. employee number, employee name, social insurance number, department code, payment type code (salaried or hourly), time worked, wage rate, gross pay, deductions (by type), net pay, and cheque number. Required: Prepare a list of potential computer assisted audit techniques that could be prepared for the payroll audit. Identify the audit objective to which they relate, and indicate if any manual procedures are required to supplement the suggested CAAT.
60) You have been working on the audit of Ballistic Defence Company for several years now. There are about 15,000 employees working at the company in various positions. Recently, the company contracted for a new customized payroll system, which is to be implemented next month. You have been asked to assess the acceptance testing plan that is being prepared by accounting staff. In particular, they want you to help assess controls that will improve the accuracy of information entered into the new computer system. The company uses mainframe computing systems. You need to assume that the typical payroll information is available on computer files, i.e. employee number, employee name, social insurance number, department code, payment type code (salaried or hourly), time worked, wage rate, gross pay, deductions (by type), net pay, and cheque number. Required:
Identify that should be conducted by the company's accounting staff with respect to accuracy before accepting the the tests software.
1) D 2) A 3) D 4) B 5) D 6) D 7) B 8) D 9) B 10) B 11) C 12) A 13) C 14) B 15) C 16) B 17) A 18) A 19) B 20) C 21) D 22) C 23) A 24) A 25) D 26) B
27) D 28) A 29) D 30) C 31) B 32) B 33) D 34) B 35) C 36) C 37) B 38) B 39) C 40) D 41) D 42) C 43) A 44) A 45) D 46) D 47) D 48) C 49) C 50) B 51) A) Three important differences between the payroll and personnel cycle and other cycles in a typical audit are: ∙ There is only one class of transactions for payroll, whereas most cycles include at least two classes of transactions.
∙
ive for almost all companies, even small ones. This is primarily due to severe federal and provincial penalties for I errors in withholding and paying payroll taxes and employee morale problems if employees are not paid or are n the underpaid. payr oll B) The four business functions in a typical payroll and personnel cycle are: cycle ∙ Personnel and employment. This department provides an independent source for interviewing and hiring , qualified personnel. This department is also an independent source of records for the internal verification of wage trans information. actio ∙ Timekeeping and payroll preparation. This function includes the preparation of time cards by employees; the ns summarization and calculation of gross pay, deductions, and net pay; the preparation of payroll cheques; and the are preparation of payroll records. far ∙ Access rights management. This function involves determining which functions within a particular information more system the employee is to have access to. signi ∙ Preparation of T-4s and Employee withholdings and benefits remittance forms. This function involves the preparation fican and mailing of forms and payments to the various levels of government for the payment of withheld taxes and the t employer's portion of employee benefits. than relat C) The primary documents and records used in the timekeeping and payroll preparation function are: ed ∙ Time card. The time card is used to indicate the time the employee started and stopped working each day and bala the number of hours the employee worked. nce ∙ Job time ticket. This document indicates jobs on which a factory employee worked during a given time period. sheet This form is used only when an employee works on different jobs or in different departments. acco ∙ Summary payroll report. This report summarizes payroll for a period. unts. ∙ Payroll journal. This journal is used to record payroll cheques. ∙ ∙ Payroll master file. This file contains each payroll transaction for each employee, along with total employee I wages paid for the year to date. ntern ∙ Payroll transaction and history files. Includes information on each pay given to employees. al contr D) The primary documents and records used in the payment of payroll function and the preparation of payroll tax ols returns and payment of taxes function are: over ∙ Payroll cheque. This is a cheque written to the employee for services performed. payr ∙ T-4 form. This form is issued for each employee summarizing the earnings record for the calendar year. oll ∙ Employee withholdings and benefits remittance forms. These are tax forms submitted to local, state, and federal units are of government for the payment of withheld taxes and the employer's tax. effect 52) A) From an audit perspective, the most important internal controls in personnel involve formal methods of informing the timekeeping and payroll preparation personnel of new employees, the authorization of initial and periodic changes in pay rates, and the termination date of employees no longer working for the company. As part of these controls, segregation of duties is extremely important. No individual with access to time cards, payroll records, or cheques should also be permitted access to personnel records. B) Internal controls over the timekeeping and payroll preparation function should include controls to prevent anyone from clocking in for several employees or submitting a fraudulent time card. The summarization and calculation of the payroll can be controlled by well-defined policies for the payroll department, separation of duties to provide automatic cross-cheques, reconciliation of payroll hours with independent production records, and independent internal verification of all important data. Controls over the preparation of payroll cheques include preventing those responsible for preparing the cheques from having access to time cards, signing or distributing cheques, or independently verifying payroll output. In addition, the cheques should be prenumbered and verified through independent bank reconciliation procedures. C) Controls over payroll cheques should include limiting the authorization for signing the cheques to a responsible employee who does not have access to timekeeping or the preparation of the payroll, and the immediate return of
uncl cheques for redeposit. If a cheque-signing machine is used to replace a manual signature, the machine must be aime carefully controlled. An imprest payroll account can be used to prevent the payment of unauthorized payroll d transactions. 53) There are three reasons: 1) employees are likely to complain to management if they are underpaid 2) all payroll transactions are typically uniform and uncomplicated 3) payroll transactions are extensively audited by federal and provincial governments 54) The six transactions-related audit objectives as related to payroll, and one common substantive test of transactions that can be used to test the objective, are as follows: ∙ Recorded payroll payments are for work actually performed by existing employees (occurrence). Compare cancelled cheques with payroll journal for name, amount, and date. ∙ Existing payroll transactions are recorded (completeness). Reconcile the disbursements in the payroll journal with the disbursements on the payroll bank statement. ∙ Recorded payroll transactions are for the amount of time actually worked and at the proper pay rate; withholdings are properly calculated (accuracy). Compare cancelled cheque with payroll journal for amount. ∙ Payroll transactions are properly classified (classification). Compare classification with chart of accounts or procedures manual. ∙ Payroll transactions are recorded on the correct dates (timing). Compare date on cheque with date the cheque cleared the bank. ∙ Payroll transactions are properly included in the payroll master file and transaction files: they are properly summarized (posting and summarization). Test clerical accuracy by footing the payroll journal and tracing postings to the general ledger and the payroll master file. 55) The two most common ways in which employees can defraud a company in the payroll area are (1) employees report more time than was actually worked (fraudulent hours) and (2) the issuance of payroll cheques to individuals who do not work for the company (nonexistent employees). 56) A) A test for nonexistent employees is to trace selected transactions recorded in the payroll journal to the personnel department to determine whether the employees were actually employed during the payroll period. B) A surprise payroll payoff is a procedure in which each employee must pick up and sign for his or her cheque in the presence of a supervisor and the auditor. Any cheques that are not claimed are subject to an extensive investigation to determine whether an unclaimed cheque is fraudulent. The purpose is to test for nonexistent employees; i.e., the issuance of payroll cheques to individuals who do not work for the company. 57) A) (1) Weakness: There is inadequate segregation of duties: the payroll clerk maintains payroll information, calculates payroll, and distributes the signed cheques. Impact: The payroll clerk could prepare inaccurate payrolls (e.g. for the wrong wage rate or for the wrong number of hours) and it would not be detected. Recommendation: Cheques should be distributed by Faruq. Someone should be assigned to independently verify payroll information entered (wage rates and hours worked). (2) Weakness: There is no authorization of payroll. Faruq signs the cheques without reference to time sheets. Implication: Employees could be entering hours that were not worked. Also, they could be allocating hours worked to the wrong jobs, so that they receive bonuses to which they are not entitled. Recommendation: Time sheets should be approved daily by the factory supervisor. Time sheets should be
sub cheques to Faruq. mitte B) The impact of the weaknesses is that we may be unable to rely upon internal controls in the payroll area: payroll d with could be inaccurate or allocated to the wrong accounts. Control risk needs to be increased and substantive testing of the payroll will need to be conducted. 58) A) (1) Weakness: There is inadequate segregation of duties: the payroll supervisor prepares and calculates the commission wages and also decides on the amount to be paid (by doing the calculation). Impact: There could be errors in the calculation, particularly with respect to taking account of customer write offs. The payroll supervisor could be taking funds. Recommendation: The sales wages calculation should be approved by Farah prior to wage calculations. The payroll bank should be reconciled by someone other than the payroll supervisor. (2) Weakness: There is no check on the payroll supervisor's work. Impact: She could be making deliberate errors or could have unauthorized personnel on the payroll. Recommendation: An independent payroll should be prepared (perhaps by another accounting staff person or by an independent accountant), paying particular attention to wage rates and information pertaining to the existence of employees. Farah could check calculations on a test basis. Farah needs to ensure that the payroll clerk takes appropriate vacation time. She should train another person to do this job. B) The impact of the weaknesses is that we may be unable to rely upon internal controls in the payroll area: payroll could be inaccurate or allocated to the wrong accounts. Control risk needs to be increased and substantive testing of payroll will need to be conducted. 59) [Note, this is a sample of CAATs. Other tests could also be included.] Occurrence: CAAT: Select an attribute statistical sampling. Manual: Numerous tests could be conducted, such as comparison to approved wage rates, or review of cancelled cheques for proper endorsement. Accuracy: CAAT: Recalculate the deductions (e.g. income tax), recompute net pay (gross pay minus deductions), foot the payroll and agree to payroll journal (gross pay, withholdings, net pay). Manual: Agree calculated totals to payroll journal and general ledger postings, review tax rates and compare to authorized tax tables, compare wage rate to authorized personnel files. Completeness: CAAT: Check numeric sequence of payroll cheques and print a gap listing, identify duplicate payroll numbers for a pay, or duplicate cheque numbers for a pay. Manual: Inquire about any missing numbers, and follow up on any duplicated numbers.
ion/presentation: Add up payroll by department. Class ificat Manual: Compare to payroll journal and general ledger postings. 60) There are two major areas where accuracy is important: (1) when entering information and (2) when performing calculations or postings. For both purposes, staff should prepare test data, and list their expected results before actually doing their tests. (1) Entering information: ∙ The system should accept only valid employee numbers (i.e. reject invalid ones). ∙ Duplicate employee numbers should be rejected. ∙ Dates should be reasonable or generated automatically. ∙ Payroll rates should be automatically pulled from the master file (upon entering these into the master file, there should be reasonableness checks). ∙ Hours entered should be subject to reasonableness checks. ∙ Social insurance numbers should be checked with respect to the built in check digit. ∙ Only valid information should be accepted (e.g. department codes). (2) Performing calculations: ∙ The company should calculate a payroll under the old system and resubmit the same information to the new systems and check whether the calculations are performed the same. ∙ Any differences should be investigated.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) It usually takes more time to audit the acquisition and payment cycle than any other cycle 1) _______ because A) there is a greater possibility of fraud in these transactions. B) of the large number of accounts affected. C) internal controls in this area are usually weakest. D) there is a greater likelihood of lawsuits against the auditor relating to these accounts.
2) The major balance sheet account in the acquisition and payment cycle is A) purchases. B) accounts payable. C) merchandise inventory. D) common stock.
2) _______
3) A document identifying the description, supplier, quantity, and related information for goods and services the company intends to purchase is the A) purchase requisition. B) purchase order. C) purchases catalogue. D) receiving report.
3) _______
4) The purchase order, usually in writing, is a legal document that is A) an acceptance of a vendor's catalogue offer to sell. B) a binding agreement between client and vendor. C) not enforceable if it is not in writing. D) an offer to buy.
4) _______
5) The point at which most companies first recognize the acquisition and related liability on their records is when the A) receiving report is completed. B) vendor's invoice is paid. C) purchase requisition is completed. D) purchase order is completed.
5) _______
6) An important control in the accounts payable and information systems departments is to require that those personnel who record acquisitions do not have access to A) lists of vendors' names and addresses. B) the accounts payable master file. C) vendors' price lists. D) cash, marketable securities, and other assets.
6) _______
7) When processing and recording cash disbursements, it is important to have a method of cancelling the supporting documents to prevent their reuse as support for another cheque at a later time. A common method is to A) transfer possession of the documents to a bank vault such as a safety deposit box. B) shred the documents so they can't be reused. C) write the cheque number on the supporting documents. D) move the documents to a permanent off-site facility such as a warehouse.
7) _______
8) Since the audit of accounts payable generally takes a considerable amount of audit time, effective internal controls, properly tested, can significantly reduce audit costs by reducing A) tests of controls. B) tests of details of balances. C) analytical procedures. D) confirmations.
8) _______
9) Internal controls which are likely to prevent the client from including as a business expense those transactions that primarily benefit management or other employees rather than the entity being audited satisfy the control objective that A) acquisitions are correctly classified. B) acquisitions are correctly valued. C) existing acquisitions are recorded. D) recorded acquisitions are for goods and services received.
9) _______
10) An auditor learns that his client has paid a vendor twice for the same shipment, once based upon the original invoice and once based upon the monthly statement. A control procedure that should have prevented this duplicate payment is A) attachment of the receiving report to the disbursement report. B) prenumbering of receiving reports. C) use of a limit or reasonableness test. D) prenumbering of disbursement vouchers.
10) ______
11) The internal control objective to determine that "existing acquisition transactions are recorded" satisfies the objective of A) accuracy. B) classification. C) completeness. D) occurrence.
11) ______
12) The internal control which requires that "purchase orders, receiving reports, and vouchers are prenumbered and accounted for" satisfies the objective of A) accuracy. B) completeness. C) classification. D) occurrence.
12) ______
13) The control test which requires the auditor to "compare recorded transactions in the acquisitions journal with the vendor's invoice, receiving report, and other supporting documentation" satisfies the objective of A) classification. B) accuracy. C) completeness. D) occurrence.
13) ______
14) Because of the importance of tests of controls for acquisitions and cash disbursements, it is common in this audit area to use A) variables sampling. B) probability-proportional-to-size sampling. C) block sampling. D) attributes sampling.
14) ______
15) Because many of the types of errors and irregularities that may be found in the acquisition and payment cycle represent a misstatement of earnings and are of significant concern to the auditor, the tolerable exception rate selected by the auditor will be
15) ______
A) average.
B) 15% or less.
C) low.
D) high.
16) The internal control which requires "adequate segregation of duties between accounts payable and custody of signed cheques" satisfies the objective of A) accuracy. B) posting and summarization. C) completeness. D) occurrence.
16) ______
17) The internal control which requires "examination of supporting documentation before signing of cheques by an authorized person" satisfies the objective of A) posting and summarization. B) accuracy. C) completeness. D) occurrence.
17) ______
18) The internal control which requires a "monthly preparation of a bank reconciliation by an independent person" satisfies the objective of A) completeness. B) occurrence. C) accuracy. D) posting and summarization.
18) ______
19) The test of transactions which requires "reconcile recorded cash disbursements with the cash disbursements on the bank statement" satisfies the objective of A) posting and summarization. B) completeness. C) accuracy. D) occurrence.
19) ______
20) The test of transactions which requires "recompute cash discounts" satisfies the objective of A) occurrence. B) accuracy. C) completeness. D) posting and summarization.
20) ______
21) Comparing expenses to prior years is an effective analytical procedure for accounts payable because expenses from year to year are A) dynamic. B) erratic. C) variable. D) relatively stable.
21) ______
22) The analytical procedure which requires the auditor to "review the list of accounts payable for unusual or non-vendor payables" would have the best chance of discovering which possible error? A) Classification error for non-trade liabilities B) Invalid accounts or misstatements C) Unrecorded accounts or misstatements D) Misstatement of accounts payable and expenses
22) ______
23) The main focus taken by the auditor in verifying liability balances is on the discovery of A) overstated or extraneous liabilities. B) overstated liabilities. C) understated or omitted liabilities. D) understated liabilities.
23) ______
24) The test of details of balances procedure to "review the list of accounts payable and master file for related parties, notes, or other interest-bearing liabilities" satisfies the objective of A) existence. B) completeness. C) detail tie-in. D) classification.
24) ______
25) The purpose of the audit procedure to "examine underlying documentation for subsequent cash disbursements" is to A) uncover cash disbursements recorded in a subsequent accounting period which should be recorded in this period. B) find the documentation relating to a cash disbursement. C) uncover payments made in a subsequent accounting period that represent liabilities at the balance sheet date. D) uncover liabilities on the balance sheet which should not have been recorded until a subsequent period.
25) ______
26) The purpose of the audit procedure to "trace receiving reports issued before year-end to related vendors' invoices" is to determine that all A) merchandise was received. B) merchandise received is included in accounts payable. C) merchandise received is included in inventory. D) invoices have been paid.
26) ______
27) In determining that the accounts payable cutoff is correct, it is essential that the cutoff tests be coordinated with the A) cash count. B) tests on long-term liabilities. C) confirmation of accounts payable. D) observation of inventory.
27) ______
28) An inventory acquisition is received late in the afternoon of December 31 after the physical inventory is completed. If the acquisition is included in accounts payable and purchases, but excluded from inventory, the result A) is an understatement of net earnings. B) is indeterminable from the information given. C) is an overstatement of net earnings. D) does not affect earnings.
28) ______
29) When an acquisition is on an FOB origin basis, the inventory and related accounts payable must be recorded in the current period if the goods were A) both shipped and received prior to the balance sheet date. B) received prior to the balance sheet date. C) shipped prior to the balance sheet date. D) paid for.
29) ______
30) Auditor confirmation of accounts payable balances at the balance sheet date may be unnecessary because A) there is likely to be other reliable external evidence available to support the balances. B) correspondence with the audit client's lawyer will reveal all legal action by vendors for nonpayment.
30) ______
C) accounts payable balances at the balance sheet date may not be paid before the audit is completed. D) this is a duplication of cutoff tests.
31) A set of records for each piece of equipment that includes descriptive information, date of acquisition, original cost, current year amortization, and accumulated amortization is A) the file of purchase requisitions. B) the acquisitions journal. C) the amortization schedule. D) the capital asset master file.
31) ______
32) The starting point for the verification of current-year acquisitions of manufacturing equipment is normally A) the manufacturing equipment account in the general ledger. B) the purchase requisitions file. C) the acquisitions journal. D) a client schedule of all acquisitions recorded during the year.
32) ______
33) When verifying current-year additions to manufacturing equipment, the two major objectives for this part of the audit are A) rights and existence. B) detail tie-in and cutoff. C) accuracy and classification. D) disclosure and completeness.
33) ______
34) It is normal for the auditor to verify large and unusual transactions for the entire year as well as a representative sample of typical additions. The extent of verification depends on the auditor's A) sampling selection methodology used. B) understanding of the nature of internal controls. C) availability of client resources to pull supporting documentation. D) assessed control risk and materiality of additions.
34) ______
35) A test of detail of balances for manufacturing equipment additions includes tracing the individual acquisitions to the data files for amounts and descriptions. What is the balance-related audit objective associated with this test? A) Existence B) Classification C) Detail tie-in D) Accuracy
35) ______
36) Which one of the following tests of details of balances for manufacturing equipment additions addresses the balance-related audit objective of ownership? A) Foot the acquisitions journal. B) Examine vendor's invoices. C) Physically examine assets. D) Review lease and rental agreements.
36) ______
37) The tests of details of balances procedure which requires the auditor to physically examine assets satisfies the audit objective of A) existence. B) cutoff. C) classification. D) completeness.
37) ______
38) The tests of details of balances procedure for manufacturing equipment which requires the auditor to examine vendors' invoices of closely related accounts such as repairs and maintenance
to over unc items
that 38) should be manufact uring equipme nt would satisfy the audit objective of A) detail tie-in.
___ ___
B) completeness.
C) accuracy.
D) existence.
39) A normal audit procedure is to analyze the current year's repairs and maintenance accounts to provide evidence in support of the audit proposition that A) expenditures for capital assets have been recorded in the proper period. B) non-capitalizable expenditures have been properly expensed. C) capital expenditures have been properly authorized. D) expenditures for capital assets have been capitalized.
39) ______
40) Which of the following is a customary audit procedure for the verification of the legal ownership of real property? A) Examination of deeds and title guaranty policies on hand B) Examination of correspondence with the corporate counsel concerning acquisition matters C) Examination of ownership documents registered and on file at a public hall of records D) Examination of corporate minutes and resolutions concerning the approval to acquire capital assets
40) ______
41) When an asset is sold or disposed of without having been traded in for a replacement asset, the valuation of the transaction can be verified by examining the related A) purchase order and merchandise inventory listing. B) sales invoice and merchandise inventory listing. C) purchase order and property master file. D) sales invoice and property master file.
41) ______
42) In rare cases, the auditor may believe it is necessary that a complete physical inventory of capital assets be taken to make sure they actually exist. If a physical inventory is taken, the auditor normally A) requires client to take the inventory and provide documentation to the auditor. B) observes the count. C) takes the inventory. D) requires that it be done by an outside, independent third party.
42) ______
43) Ordinarily, it is unnecessary to test the valuation of capital assets recorded in prior periods because A) it will not affect the current valuations. B) the emphasis of the audit is on the income statement items, not the balance sheet items.
43) ______
C) the related amortization calculations for the current period are more important. D) they were verified in previous audits.
44) The most important objective for amortization expense is proper A) disclosure. B) accuracy. C) cutoff.
44) ______ D) classification.
45) Which of the following tests of the prepaid insurance schedule pertain to the accuracy objective? A) verifying the allocation of the premium to unexpired insurance B) reviewing insurance policies for other claimants, such as mortgage holders C) ensuring correct allocation between current and long-term assets D) classifying the debits based upon the type of asset covered
45) ______
46) Estimated unpaid obligations for services or benefits that have been received prior to the balance sheet date are classified as A) miscellaneous assets. B) accrued liabilities. C) accounts payable. D) deferred charges.
46) ______
47) A typical analytical procedure for operations is to compare individual manufacturing expenses divided by total manufacturing expenses with previous years. What type of potential misstatement does this procedure detect? Misstatement of A) cost of goods sold and inventory B) insurance expense or other administrative expenses C) individual manufacturing expenses and related balance sheet accounts D) commission expense or other sales expenses
47) ______
48) Which of the following analytical procedures might highlight a possible overstatement or understatement of a balance in an expense account? Compare A) individual expenses with previous year. B) inventory turnover ratio with previous year. C) individual asset and liability balances with previous year. D) gross margin percentage with previous year.
48) ______
49) Expense accounts analysis is closely related to tests of controls. The major difference is A) the degree of concentration on an individual account. B) that one emphasizes transactions and the other emphasizes amounts. C) the difference in the types of underlying documentation which is examined. D) the use or nonuse of cutoff tests.
49) ______
50) The two most important audit procedures for allocations are A) substantive tests and enquiry. B) tests of controls and tests of details of balances. C) tests of controls and confirmations. D) tests for reasonableness using analytical procedures and recalculation.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) A) Discuss each of the four business functions that comprise the acquisition and payment cycle. B) Discuss the key documents used in processing purchase orders and receiving goods and services functions in the acquisitions and payment cycle. C) Discuss the key documents and records used in the recognizing the liability function in the acquisitions and payment cycle.
52) State each of the six specific transaction-related audit objectives for acquisitions and, for each objective, describe one common test of transactions.
53) State each of the six specific transaction-related audit objectives for cash disbursements and, for each objective, describe one common test of transactions.
54) Discuss the three types of tests that need to be performed by the auditor when auditing a client's data conversion process.
55) State each of the eight specific balance-related audit objectives for accounts payable and, for each objective, describe one common test of details of balances.
56) Describe the audit procedures typically used to test for out-of-period liabilities (also referred to as the search for unrecorded accounts payable).
57) State each of the seven specific balance-related audit objectives for manufacturing equipment additions and, for each objective, describe one common test of details of balances.
58) Discuss the key internal controls related to the disposal of manufacturing equipment.
59) Discuss the key internal controls over existing capital assets that affect the auditor's extent of testing of capital assets acquired in prior years.
60) A) Discuss the key internal controls for prepaid insurance that affect the auditor's extent of testing of the prepaid insurance account. B) Describe the types of information that should be included in the schedule of prepaid insurance that is used by the auditor as the basis for auditing prepaid insurance. C) The auditor may decide to rely upon analytical review for the audit of the prepaid insurance. Indicate if this is an acceptable practice and why. Also, provide four examples of analytical review procedures that an auditor could use for the prepaid insurance.
1) B 2) B 3) B 4) D 5) A 6) D 7) C 8) B 9) D 10) A 11) C 12) B 13) B 14) D 15) C 16) D 17) D 18) C 19) B 20) B 21) D 22) A 23) C 24) D 25) C 26) B
27) D 28) A 29) C 30) A 31) D 32) D 33) C 34) D 35) C 36) B 37) A 38) B 39) D 40) A 41) D 42) B 43) D 44) B 45) A 46) B 47) C 48) A 49) A 50) D 51) A) The four business functions that comprise the acquisition and payment cycle are: ∙ Processing purchase orders. This function involves the preparation of a purchase requisition and a purchase order to acquire goods and services.
∙
the date received, and other relevant data. ∙ Recognizing the liability. In most companies, the liability for acquisitions is recognized when the goods and Recei services are received; in other companies, it is deferred until the vendor's invoice is received. ving ∙ Processing and recording cash disbursements. This function involves the signing and mailing of the cheque for goods payment of the acquisition and recording of the cash disbursement in the cash disbursements journal. and servic B) The key documents and files used in the processing purchase orders and receiving goods and services functions es. in the acquisitions and payment cycle are: Whe ∙ Purchase requisition. This is a request by an authorized employee to the purchasing department to place an order n for inventory and other items used by an entity. good ∙ Purchase order. This is prepared by the purchasing department indicating the description, quantity, and related s are information for goods and services that the company intends to purchase. recei ∙ Vendor master file. This file sums individual acquisitions, cash disbursements, and acquisition returns and ved, allowances for each vendor. a ∙ Purchase order transaction file. As purchase commitments are made, transaction details are recorded in this file. recei ving C) The key documents and records used in the recognizing the liability function in the acquisitions and payment repo cycle are: rt is ∙ Acquisition journal. Acquisition transactions are recorded in this journal. prep ∙ Summary acquisitions report. This is a computer-generated document that summarizes acquisitions for a period. ared ∙ Vendor's invoice. This document, sent by the vendor, indicates the description and quantity of goods and that services received, price including freight, cash discount terms, and date of the billing. indic ∙ Debit memo. This document is used to indicate a reduction in the amount owed to a vendor because of returned ates goods or an allowance granted. the ∙ Vendor transaction file. This file indicates the details of the vendor's invoice and debit memo details from descr accounts payable. iptio ∙ Voucher. This document is used to establish a formal means of recording and controlling acquisitions. n of ∙ Vendor master file. This file sums individual acquisitions, cash disbursements, and acquisition returns and good allowances for each vendor. s, the ∙ Accounts payable trial balance. This is a listing of the amount owed to each vendor or for each invoice or voucher quan at a point in time. tity ∙ Vendor's statement. This is a statement prepared monthly by the vendor indicating the beginning balance, recei acquisitions, returns and allowances, payments to the vendor, and ending balance. ved, 52) The six specific transaction-related audit objectives for acquisitions, along with one common substantive test of transactions, are: ∙ Recorded acquisitions are for goods and services received, consistent with the best interests of the client (occurrence). Examine underlying documents for reasonableness and authenticity. ∙ Existing acquisition transactions are recorded (completeness). Trace from a file of receiving reports to the acquisitions journal. ∙ Recorded acquisition transactions are accurate (accuracy). Recompute the clerical accuracy on the vendor's invoice, including discounts and freight. ∙ Acquisition transactions are properly classified (classification). Compare classification with chart of accounts by reference to vendors' invoices. ∙ Acquisition transactions are recorded on the correct dates (timing). Compare dates of receiving reports and vendors' invoices with dates in the acquisitions journal. ∙ Acquisition transactions are properly included in the vendor and inventory master files, and are properly summarized (posting and summarization). Test clerical accuracy by footing the journals and tracing postings to general ledger, and to accounts payable and inventory master files. 53) The six specific transaction-related audit objectives for cash disbursements, along with one substantive test of transactions, are:
∙
es actually received (occurrence). Examine cancelled cheque for authorized signature, proper endorsement, and cancellation by the bank. Recor ∙ Existing cash disbursement transactions are recorded (completeness). Reconcile recorded cash disbursements with the ded cash disbursements on the bank statement (proof of cash disbursements). cash ∙ Recorded cash disbursement transactions are accurate (accuracy). Recompute cash discounts. disbu ∙ Cash disbursement transactions are properly classified (classification). Compare classification with chart of accounts rseme by reference to vendors' invoices and acquisitions journal. nts ∙ Cash disbursement transactions are recorded on the correct dates (timing). Compare dates on cancelled cheques with are the bank cancellation date. for ∙ Cash disbursement transactions are properly included in the vendor master file and are properly summarized (posting and goods summarization). Test clerical accuracy by footing journals and tracing postings to general ledger and accounts and payable master file. servic 54) The three types of tests are: ∙ Comparisons of details from the new system to the old system. This ensures that the new system contains accurate and authorized information. ∙ Comparisons of details from the old system to the new system. This ensures that the new system contains accurate and complete information. ∙ Cut-off testing. This ensures that the new system includes the proper transactions. 55) The eight specific balance-related audit objectives for accounts payable and common tests of details of balances are: ∙ Accounts payable in the accounts payable list agree with the related master file, and the total is correctly added and agrees with the general ledger (detail tie-in). Trace individual vendors' invoices to transaction file for names and amounts. ∙ Accounts payable in the accounts payable list exist (existence). Confirm accounts payable, emphasizing large and unusual amounts. ∙ Existing accounts payable are in the accounts payable list (completeness). Perform out-of-period liability tests. ∙ Accounts payable in the accounts payable list are accurate (accuracy). Trace from accounts payable list to vendors' invoices and statements for amounts. ∙ Accounts payable in the accounts payable list are properly classified (classification). Review the list and master file for related parties, notes or other interest-bearing liabilities, long-term payables, and debit balances. ∙ Transactions in the acquisition and payment cycle are recorded in the proper period (cutoff). Perform out-of-period liability tests. ∙ The company has an obligation to pay the liabilities included in accounts payable (obligations). Examine vendors' statements and confirm accounts payable. ∙ Accounts in the acquisition and payment cycle are properly presented and disclosed (presentation and disclosure). Review financial statements to make sure material related parties, long-term, and interest-bearing liabilities are segregated. 56) The audit procedures typically used to test for out-of-period liabilities are: ∙ Examine underlying documentation for subsequent cash disbursement. ∙ Examine underlying documentation for bills not paid several weeks after the year-end. ∙ Trace receiving reports issued before year-end to related vendors' invoices. ∙ Trace vendors' statements that show a balance due to the accounts payable trial balance. ∙ Send confirmations to vendors with which the client does business, including zero balance confirmations. 57) ∙ Current-year acquisitions in the acquisitions schedule agree with related data file amounts, and the total agrees with the general ledger (detail tie-in). Foot the acquisitions schedule. ∙ Current-year acquisitions as listed exist (existence). Physically examine assets. ∙ Existing acquisitions are recorded (completeness). Examine vendors' invoices of closely related accounts such as repairs and maintenance to uncover items that should be manufacturing equipment. ∙ Current-year acquisitions as listed are accurate (accuracy). Examine vendors' invoices. ∙ Current-year acquisitions as listed are properly classified (classification). Examine rent and lease expense for capital leases.
∙
nt-year acquisitions are recorded in the proper period (cutoff). Review transactions near the balance sheet date for proper period. Curre ∙ The client has rights to current-year acquisitions (rights). Examine vendors' invoices. 58) The most important internal control over the disposal of manufacturing equipment is the existence of a formal method to inform management of the sale, trade-in, abandonment, or theft of recorded machinery and equipment. Another important control to protect assets from unauthorized disposal is a provision for authorization for the sale or other disposal of manufacturing equipment. Finally, there should be adequate internal verification of recorded disposals to make sure that assets are correctly removed from the accounting records. 59) Important controls include the use of a master file for individual capital assets, adequate physical controls over assets that are easily movable, assignment of identification numbers to each plant asset, and periodic physical count of capital assets and their reconciliation by accounting personnel. A formal method of informing the accounting department of all disposals of capital assets is also an important control over the balance of assets carried forward into the current year. 60) A) Important controls include proper authorization for new insurance policies and payment of insurance premiums consistent with the client's payment procedures. A record of insurance policies in force and the due date of each policy is an essential control to make sure that the company has adequate insurance at all times. The control should include a provision for periodic review of the adequacy of the insurance coverage by an independent qualified person. The detailed records of the information in the insurance register should be verified by someone independent of the person preparing them. A closely related control is the use of monthly standard journal entries for insurance expense. B) The schedule should include each insurance policy in force, policy number, insurance coverage for each policy, premium amount, premium period, insurance expense for the year, and prepaid insurance at the end of the year. C) Relying mostly on analytical procedures in the audit of prepaid insurance can be acceptable because the opening and closing balances are frequently immaterial. Further, few transactions are debited and credited to the balance during the year and they are simple to understand. Analytical procedures can therefore help identify any potential significant misstatements. Examples of analytical procedures include: - Compare total prepaid insurance and insurance expense with those of previous years. - Compute the ratio of prepaid insurance to insurance expense and compare to those of previous years. - Compare the individual insurance policy coverage on the schedule obtained from the client with the preceding year's schedule as a test of the elimination of certain policies of a change in insurance coverage. - Compare the computed prepaid insurance balance for the current year on a policy-by-policy basis with that of the preceding year as a test of an error in calculation. - Review the insurance coverage listed on the prepaid insurance schedule with an appropriate client official or insurance broker for adequacy of coverage.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Ken is auditing Brooks, a jewelry company. The audit of the jewels will be complex because 1) _______ A) the jewels and precious stones are very small and harder to count. B) there is a higher likelihood of theft when it comes to jewels and precious stones inventory. C) the client might not grant access to the auditor to see the precious stones and jewels. D) the value of the precious stones and jewels will be hard to determine.
2) The inventory and warehousing cycle can be thought of as comprising two separate but closely related systems, one involving the actual physical flow of goods, and the other the A) prevention of waste, obsolescence, and theft. B) storing of the goods. C) related costs. D) internal control over those goods.
2) _______
3) The form used to request the purchasing department to place orders for inventory items is the A) materials requisition. B) bill of lading. C) purchase order. D) purchase requisition.
3) _______
4) The controls over purchase requisitions and the related purchase orders are evaluated and tested as part of the A) inventory and warehousing cycle. B) capital acquisitions cycle. C) acquisitions and payments cycle. D) payroll and personnel cycle.
4) _______
5) Materials received by the company should be A) recorded in the inventory master file at the market value on the day they are received. B) inspected for quantity and quality. C) recorded as a cost of good sold. D) inspected for quantity.
5) _______
6) Receipt of ordered materials by the receiving department will generate the completion of a form called the A) materials requisition. B) inventory acquisition summary. C) bill of lading. D) receiving report.
6) _______
7) In any company involved in manufacturing, adequate cost accounting controls are necessary to indicate the relative profitability of the various products for management planning and control and to A) determine variances from budgets. B) value inventories for audit verification. C) value inventories for financial statement purposes. D) determine variances from standards.
7) _______
8) Master files, worksheets, and reports that accumulate material, labour, and overhead as the costs are incurred are A) accounting systems. B) cost accounting records. C) storeroom documents. D) finished goods inventory records.
8) _______
9) The main difference between job cost and process cost systems is that A) one accumulates costs by individual jobs and the other by particular processes. B) one emphasizes costs accumulated in completed products and the other emphasizes costs associated with work-in-process. C) one emphasizes costs adding value to the product and the other emphasizes costs incurred because of waste, scrap, and obsolescence. D) one accumulates costs by materials issued and the other by labour incurred.
9) _______
10) Shipping of completed goods is an integral part of the A) acquisitions and payments cycle. B) sales and collections cycle. C) inventory and warehousing cycle. D) payroll and personnel cycle.
10) ______
11) A well-designed computerized system of perpetual inventory data files includes information about the A) unit costs of inventory purchased, sold, and on hand. B) units and unit costs of inventory purchased, sold, and on hand. C) units of inventory purchased, sold, and on hand. D) units of raw materials, work-in-process, and finished goods.
11) ______
12) Finished goods cost include raw materials, direct labour and allocation of A) gross margin. B) manufacturing overhead and administrative costs. C) profit margin. D) manufacturing overhead.
12) ______
13) The bias in recording inventory would be toward A) understatement. C) overstatement.
13) ______ B) increasing share price. D) income smoothing.
14) The auditor evaluates the internal transfer of assets and costs during the A) payroll and personnel cycle. B) sales and collection cycle. C) acquisition and payments cycle. D) inventory and warehousing cycle.
14) ______
15) The overall objective in the audit of the inventory and warehousing cycle is to determine that A) inventory and cost of goods sold are fairly stated on the financial statements. B) gross profit and inventory are fairly presented on the financial statements. C) inventory items on the balance sheet are neither fraudulent nor materially in error. D) costs of goods sold and gross profit are correctly stated on the income statement.
15) ______
16) When labour is a significant part of inventory, verifying the proper accounting of these costs should be tested in the A) cash cycle. B) payroll and personnel cycle. C) inventory and warehousing cycle. D) acquisitions and payments cycle.
16) ______
17) The auditor must verify whether the physical counts were correctly summarized, the inventory quantities and prices were correctly extended, and the extended inventory was correctly footed. These tests are called A) compilation tests. B) mechanical tests. C) price tests. D) cost tests.
17) ______
18) The costs used to value the physical inventory must be tested to determine whether the client has correctly followed an inventory method that is in accordance with GAAP and is consistent with previous years. The audit procedures used to verify these costs are referred to as A) price tests. B) cost tests. C) compilation tests. D) consistency tests.
18) ______
19) The audit tests to verify that the client is using a generally accepted inventory method and to verify that physical counts were correctly summarized are performed as part of the A) sales and collection cycle. B) acquisitions and payments cycle. C) inventory and warehousing cycle. D) payroll and personnel cycle.
19) ______
20) Cost accounting controls are those related to the physical inventory and the consequent costs from the point at which A) raw materials are requisitioned until the finished product is completely manufactured. B) raw materials are requisitioned until the finished product is sent to storage. C) materials are ordered for purchase until the finished product is sold. D) the customer's order is received until the finished product is shipped.
20) ______
21) To protect the inventory, Globus Corp wants to assign the custody of inventory to a specific responsible individual. Globus can accomplish this by requesting A) a designated employee to authorize movement of inventory. B) have restricted access to the production facility. C) employees to have photo id cards. D) have frequent inventory count.
21) ______
22) The existence of adequate inventory cost records aid management in A) costing inventory. B) pricing. C) controlling costs. D) all of the above.
22) ______
23) The auditor's tests of the adequacy of the physical controls over raw materials, work-in-process, and finished goods must be restricted to A) documentation and observation. B) documentation and inquiry. C) observation and inquiry. D) documentation and confirmation.
23) ______
24) It is frequently possible to test the physical inventory prior to the balance sheet date when A) there are accurate perpetual inventory master files. B) year-end sales are small. C) client counts inventory at interim dates. D) the internal control system is no better at year-end than at an earlier point in time.
24) ______
25) Tests of the perpetual inventory master files for the purpose of reducing the tests of physical inventory or changing their timing are done through the use of A) observation. B) confirmation. C) inquiry. D) documentation.
25) ______
26) Naomi is verifying the inventory cost records. A major difficulty for Naomi in this process is A) evaluating the impact of the management bias on the inventory cost records. B) selecting a sample to be tested. C) determining the reasonableness of cost allocations. D) completing the work on time given the large number of items normally included in inventory cost records.
26) ______
27) Which one of the following analytical procedures would be most helpful in alerting the auditor to the possibility of obsolete inventory? Comparing A) gross margin percentage with previous years B) inventory turnover costs with previous years C) current year manufacturing costs with previous years D) unit costs of inventory with previous years
27) ______
28) To detect an overstatement or understatement of inventory and cost of goods sold, the auditor may perform an analytical procedure such as comparing A) extended inventory value with previous years. B) current year manufacturing costs with previous years. C) gross margin percentage with previous years. D) inventory turnover with previous years.
28) ______
29) The CAS require that audit procedures for inventory include that the auditor A) must be present at the count and review the methods followed in the determination of quantities and values. B) must be present at the count and must receive adequate documentation from client regarding the effectiveness of inventory-taking. C) must count the inventory. D) need not be present at the count but must review the methods followed in the determination of quantities and values.
29) ______
30) If the auditor is appointed after the year end of the client, the auditor A) should qualify the audit opinion for the inventory balance and cost of sales. B) should do an inventory count as soon as he is appointed. C) will inquire with management of the company about the inventory count performed at year end.
30) ______
D) could attend a current perpetual inventory count and roll backward with the records.
31) When a physical count of inventory is permitted at an interim date, the auditor observes it at that time, and also tests the perpetuals for transactions A) which are a representative sample of the period under audit. B) from the date of the count to the end of the audit field work. C) throughout the year. D) from the date of the count to year-end.
31) ______
32) Obtaining an adequate understanding of the client's business is important in physical observation of inventory because A) it will help the auditor in assessing the risk of theft of inventory. B) it is required by GAAP. C) inventory is normally a significant item. D) inventory varies significantly for different companies.
32) ______
33) A public accountant observes his client's physical inventory count on December 31. There are eight inventory-taking teams, and a tag system is used. The public accountant's observation normally may be expected to result in detection of which of the following inventory errors: A) The inventory takers forgot to count all the items in one room of the warehouse. B) An error is made in the count of one inventory item. C) The inventory omits items on consignment to wholesalers. D) Some of the items included in the inventory had been received on consignment.
33) ______
34) When there are no perpetual inventory files and the inventory is material, A) the auditor will have to perform the inventory count and valuation instead of client. B) a complete physical inventory must be taken by client near year-end. C) the auditor is relieved of responsibility for observing inventory counts, but still must do test counts. D) an audit cannot be performed so the auditor must issue a denial of opinion.
34) ______
35) Sample size in physical observation of inventory is A) difficult to specify because the emphasis is on observing client's procedures. B) determined using attributes sampling. C) determined using dollar-unit sampling. D) determined using variables sampling.
35) ______
36) The most important part of the observation of inventory is determining whether A) the inventory-takers are qualified. B) obsolete inventory has been identified. C) the counts are accurate. D) the physical count is being taken in accordance with the client's instructions.
36) ______
37) A useful starting point for becoming familiar with the client's inventory is for the auditor to A) obtain and review industry ratios.
37) ______
B) read client's Accounting Manual. C) review accounting theory covering special problems, such as gas and oil accounting, or lease-purchase agreements. D) tour the client's facility.
38) A common inventory observation procedure is to select a random sample of tag numbers and identify the tag with that number attached to the actual inventory. The audit objective being achieved by this procedure is A) inventory is classified correctly (classification). B) existing inventory is counted and tagged (completeness). C) inventory as recorded on tags exists (existence). D) inventory is counted accurately (accuracy).
38) ______
39) The test of details of balance procedure which requires the auditor to account for unused inventory tag numbers to make sure none have been omitted is an attempt to satisfy the objective of A) completeness. B) accuracy. C) detail tie-in. D) existence.
39) ______
40) When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that A) no goods observed during the physical count are pledged or sold. B) no goods held on consignment for customers are included in the inventory balance. C) all goods owned at year-end are included in the inventory balance. D) all goods purchased before year-end are received before the physical inventory count.
40) ______
41) From which of the following evidence-gathering audit procedures would an auditor obtain most assurance concerning the existence of inventories? A) observation of physical inventory counts B) confirmation of inventories in a public warehouse C) auditor's recomputation of inventory extensions D) written inventory representations from management
41) ______
42) A common inventory observation procedure is to enquire as to inventory in other locations. The audit objective being achieved by this procedure is A) inventory as recorded exists. B) inventory is classified correctly. C) inventory is counted accurately. D) existing inventory is counted and tagged.
42) ______
43) An inventory observation procedure which compares physical counts with the perpetual inventory master file is an attempt to satisfy the audit objective of A) existence. B) accuracy. C) classification. D) completeness.
43) ______
44) A common inventory observation procedure is to record in the working papers for subsequent follow-up the last shipping document number used at year-end. The audit objective being achieved by this procedure is
44) ______
A) information is obtained to make sure sales and inventory purchases are recorded in the proper period. B) inventory as recorded exists. C) existing inventory is counted and tagged. D) tags are accounted for to make sure none is missing.
45) A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is A) rights. B) cutoff. C) valuation. D) classification.
45) ______
46) Controls which provide a means of ensuring that the physical counts are properly summarized, priced at the same amount as the unit records, correctly extended and totalled, and included in the general ledger at the proper amount are known as A) pricing internal controls. B) count quantity internal controls. C) compilation internal controls. D) standard cost records.
46) ______
47) The test of details of balance procedure which requires the auditor to perform tests of lower-of-cost-or-market, selling price, and obsolescence is an attempt to satisfy the objective of A) valuation. B) existence. C) completeness. D) accuracy.
47) ______
48) The test of details of balance procedure which requires the auditor to review contracts with suppliers and customers and inquire of management for the possibility of the inclusion of consigned or other non-owned inventory is an attempt to satisfy the objective of A) completeness. B) realizable value. C) existence. D) rights and obligations.
48) ______
49) Assume that the client's valuation of an inventory item is $10 per unit for 1,000 units, using FIFO. If the most recent acquisition of inventory was for 600 units at $10 per unit and the immediately preceding acquisition was for 700 units at $9 per unit, the inventory item is in error and it is A) understated $300. B) overstated $700. C) overstated $400. D) understated $400.
49) ______
50) Most of the audit testing in the storage of finished goods as well as the shipment of merchandise takes place during the testing of the A) sales and collection cycle. B) inventory and warehousing cycle. C) acquisition and payments cycle. D) payroll and personnel cycle.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) The audit of inventory is often the most complex and time consuming part of the audit. Discuss four of the reasons.
52) State the six functions that make up the inventory and warehousing cycle and, for each function, identify the
related
documents and/or records that would be used by a manufacturing company.
53) Discuss the main difference between a job cost system and a process cost system.
54) The audit of the inventory and warehousing cycle consists of five parts. State the five parts and, for each part, identify the cycle in which that part is tested by the auditor.
55) Identify three analytical procedures commonly used when auditing accounts in the inventory and warehousing cycle.
56) Discuss the methodology for designing tests of details of balances for inventory.
57) A) Discuss the key control procedures relating to the client's physical count of inventory. B) State the primary determinants of the amount of time needed to perform the physical observation of inventory.
58) State five specific balance-related audit objectives for physical inventory observation and, for each objective, describe one common test of details of balances related to that objective.
59) A) State five specific balance-related audit objectives for inventory pricing and compilation and, for each objective, describe one common test of details of balances related to that objective. B) Explain why the audit of work-in-process and finished goods inventory is generally more complex than the audit of purchased inventory.
60) You are conducting the audit of Files R Us Inc. (FRI), a family-owned business that manufactures a variety of different types of wooden and metal file cabinets. In business for over twenty years, FRI has a reputation for providing high quality products on time or even ahead of schedule. FRI does not sell to the public, but only to fine furniture stores and to a variety of office supply chains. As of the current year end, the company has a total of $6.3 million in assets. Inventory information is as follows: Raw materials (metals and supplies) Raw materials (wood products) Work in progress Finished goods
$
400,000 450,000 1,350,000 250,000 $2,450,000
Finished goods consists of: Material Direct labour Overhead
48% 22 30 100%
imports from Asia and Mexico. To help manage costs, FRI uses a job-order, standard cost system. Standard File costs are assessed quarterly. Each job is costed and compared to standard. Inventory is counted only at the cabinet end of the year. There is no perpetual inventory system. producti Due to problems with raw material quality and new staff, losses have been incurred in the last six on is months of the year. Your review of last year's audit file indicated that there were numerous inventory intensely adjustments required last year. competiti ve, Required: primaril y due to Using the audit risk model, assess the risks associated with the audit of inventory.
1) D 2) C 3) D 4) C 5) B 6) D 7) C 8) B 9) A 10) B 11) B 12) D 13) C 14) D 15) A 16) B 17) A 18) A 19) C 20) B 21) A 22) D 23) C 24) A 25) D 26) C
27) B 28) C 29) A 30) D 31) D 32) D 33) A 34) B 35) A 36) D 37) D 38) C 39) A 40) C 41) A 42) D 43) B 44) A 45) C 46) C 47) A 48) D 49) C 50) A 51) The student should address four of the five reasons provided. Judgement can be used to decide if another reason provided is reasonable. 1. Inventory is generally a major item on the balance sheet and it is often the largest item making up the accounts
inclu inventory items are often in different locations, which makes physical control and counting difficult. Companies ded must have their inventory accessible for the efficient manufacture and sale of the product, but this dispersal creates in significant audit problems. work 3. The diversity of the items in inventories creates difficulties for the auditor. Such items as jewels chemicals and ing electronic parts present problems with observation and valuation. capit 4. The valuation of inventory is difficult due to such factors as obsolescence and the need to allocate manufacturing al. costs to inventory. 2. 5. There are several acceptable inventory valuation methods, but any given client must apply a method consistently The from year to year. 52) The six functions are: ∙ Process purchase orders. Related documents are the purchase requisition and the purchase order. ∙ Receive raw materials. Related documents are the receiving report and the vendor's invoice. ∙ Store raw materials. Related record is the raw materials perpetual inventory master file. ∙ Process the goods. Related documents and records are the raw materials requisition and the cost accounting records. ∙ Store finished goods. Related records are the finished goods perpetual inventory master file and the cost accounting records. ∙ Ship finished goods. Related documents and records are the shipping document, the finished goods perpetual inventory master file, and the cost accounting records. 53) The main difference is that, in a job cost system, costs are accumulated by individual jobs when material is issued and labour costs incurred; whereas, in a process cost system, costs are accumulated by processes, with unit costs for each process assigned to the products passing through the process. 54) The five parts are: ∙ Acquire and record raw materials, labour, and overhead. This is tested during the audits of the acquisition and payment cycle, and the payroll and personnel cycle. ∙ Transfer assets and costs. This is tested in the inventory and warehousing cycle. ∙ Ship goods, and record revenue and costs. This is tested during the audit of the sales and collection cycle. ∙ Physically observe inventory. This is tested in the inventory and warehousing cycle. ∙ Price and compile inventory. This is tested in the inventory and warehousing cycle. 55) Common analytical procedures for the inventory and warehousing cycle include: ∙ Compare gross margin percentage with previous year. ∙ Compare inventory turnover ratio with previous years. ∙ Compare unit costs of inventory with previous years. ∙ Compare extended inventory value with previous years. ∙ Compare current-year manufacturing costs with previous years. 56) The methodology for designing tests of details of balances for inventory is: 1. Set materiality and assess acceptable audit risk and inherent risk for the inventory and warehousing cycle. 2. Assess control risk for several cycles. This risk is assessed for the inventory and warehousing cycle, sales and collection cycle, acquisition and payment cycle, and payroll and personnel cycle. 3. Identify assertions where substantive testing is insufficient, risk of material misstatement and significance. 4. Design and perform tests of controls for several cycles. 5. Design and perform analytical procedures for the inventory and warehousing cycle. 6. Design tests of details of inventory to satisfy balance-related audit objectives. Design sample size, timing of tests, items to select for testing, and audit procedures to be performed. 57) A) The key control procedures relating to the client's physical count of inventory include proper instructions for the physical count, supervision by responsible personnel, independent internal verification of the counts,
inde the physical counts with perpetual inventory master files, and adequate control over count sheets, tags, or pend computerized records. ent reco B) The primary determinants of the amount of time needed to perform the physical observation of inventory are ncilia the adequacy of the internal controls over the physical counts, accuracy of the perpetual inventory master files, total tions dollar amount and type of inventory, number of different significant inventory locations, nature and extent of of misstatements discovered in previous years, and other inherent risk factors. 58) Balance-related audit objectives for physical inventory observation include: ∙ Inventory as recorded on tags exists (existence). Select a random sample of tag numbers and identify the tag with that number attached to the actual inventory. ∙ Existing inventory is counted and tagged and tags are accounted for to make sure none are missing (completeness). Account for all used and unused tags to make sure none are lost or intentionally omitted. ∙ Inventory is counted accurately (accuracy). Record client's counts for subsequent testing. ∙ Inventory is classified correctly on the tags (classification). Examine inventory descriptions on the tags and compare with the actual inventory for raw material, work-in-process, and finished goods. ∙ Information is obtained to make sure sales and inventory purchases are recorded in the proper period (cutoff). Record in the working papers for subsequent follow-up the last shipping document number used at year-end. ∙ Obsolete and unusable inventory items are excluded or noted (valuation). Test for obsolete inventory by inquiry of factory employees and management, and alertness for items that are damaged, rust- or dust-covered, or located in inappropriate places. ∙ The client has rights to inventory recorded on tags (rights and obligations). Inquire as to consignment or customer inventory included on client's premises. 59) A) Balance-related audit objectives for inventory pricing and compilation include: ∙ Inventory on the inventory listing schedule agrees with the physical inventory counts, the extensions are correct, and the total is correctly added and agrees with the general ledger (detail tie-in). Foot the inventory listing schedules. ∙ Inventory items on the inventory listing schedule exist (existence). Trace inventory listed in the schedule to inventory tags and auditor's recorded counts for existence and description. ∙ Existing inventory items are included on the inventory listing schedule (completeness). Account for unused tag numbers shown in the auditor's working papers to make sure no tags have been added. ∙ Inventory items on the inventory listing schedule are accurate (accuracy). Trace inventory listed in the schedule to inventory tags and auditor's recorded counts for quantity and description. ∙ Inventory items on the inventory listing schedule are properly classified (classification). Compare the classification into raw materials, work-in-process, and finished goods by comparing the descriptions on inventory tags and auditor's recorded test counts with the inventory listing schedule. ∙ Inventory items on the inventory listing are stated at realizable value (realizable value). Perform tests of lower-of-cost-or-market, selling price, and obsolescence. ∙ The client has rights to inventory items on the inventory listing schedule (rights). Trace inventory tags identified as non-owned during the physical observation to the inventory listing schedule to make sure these have not been included. ∙ Inventory and related accounts on the inventory and warehousing cycle are properly disclosed (presentation and disclosure). Examine financial statements for proper presentation and disclosure. B) The need to verify the cost of raw materials, direct labour, and manufacturing overhead in pricing work-in-process and finished goods has the effect of making the audit of work-in-process and finished goods inventory more complex than the audit of purchased inventory. 60) Audit Risk: As the company is a private company, we will set audit risk at high. Inherent Risk: Inherent risk is moderate for the following reasons: ∙ Since inventory is 39% of the company's total assets, this increases inherent risk.
∙
rol risk is set as high for the following reasons: I ∙ Losses have occurred for the last six months, indicating potential problems with costing and manufacturing nher management. ent ∙ Poor quality raw materials and new staff have affected the production process (there may be more scrap or risk inventory that needs to be written off). is ∙ There were many inventory adjustments last year, indicating there might also be the need for adjustments this lowe year, suggesting that the inventory control systems may not be functioning effectively. red as Detection Risk: The result is that detection risk will be moderate to low, requiring moderate to high levels of the assurance from substantive tests. As control risk was set as high, a substantive based approach for the audit of com inventory should be used. pany has a repu tatio n for good man ufact urin g pract ices (high quali ty and on time) . ∙ I nher ent risk is incre ased due to the recen t prod uctio n probl ems. Contr ol Risk: Cont
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The normal audit approach for the audit of bonds issued is to 1) _______ A) select a statistical sample of transactions throughout the year. B) verify each transaction taking place in the cycle for the entire year. C) rely upon controls rather than conducting substantive tests. D) examine transactions that occurred near the year end date only.
2) In the audit of the transactions and amounts in the capital acquisitions and repayments cycle, the auditor must ensure that the significant legal requirements affecting the financial statements have been properly fulfilled and A) are adequately disclosed in the financial statements. B) must issue a disclaimer if they haven't been fulfilled. C) any departures from the agreements are made with management's knowledge and consent. D) any violations are reported to the relevant provincial securities commissions.
2) _______
3) A note payable is A) an unsecured legal obligation to a creditor B) a legal obligation to a creditor which may be unsecured or secured by assets. C) a legal obligation to a creditor secured by assets. D) a long-term account payable.
3) _______
4) Notes payable are easy for companies to correctly value and include in the financial statements. This means that with respect to notes payable, inherent risk is A) low. B) not assessed. C) high. D) medium.
4) _______
5) Control risk for notes payable is usually assessed as low. This occurs because internal controls are normally good for notes payable and A) there are a small number of large transactions. B) inclusion in the accounts payable listing helps track the notes. C) interest expense can easily be distinguished from bank service charges. D) creditors would complain if the notes are not paid.
5) _______
6) Caroline is performing the audit of the acquisition and payment cycle. She is currently auditing the payments of interest made during the year. The proper documentation that Caroline should use as supporting evidence of the payment is A) the notes payable subledger. B) a bank reconciliation. C) documentation of her inquiries with management. D) a copy of the note.
6) _______
7) Responsibility for the issuance of new notes should be vested in the A) accounts payable department. B) accounting department. C) purchasing department. D) board of directors.
7) _______
8) Proper authorization for the issuance of notes payable requires that A) responsibility for authorization should lie with the treasurer's function, since the treasurer's department will receive the cash generated. B) responsibility for authorization should lie with the manager who must generate the revenue to repay the loan. C) responsibility for authorizing notes should lie with the manager who will receive the benefits of the loan. D) whenever notes are renewed (refinanced), they should be subject to the same authorization procedures as those used when they were first issued.
8) _______
9) The periodic payments of interest and principal should be controlled as a part of the A) interest and notes/bonds payable cycle. B) sales and collection cycle. C) acquisition and payment cycle. D) capital acquisitions and repayments cycle.
9) _______
10) Notes payable which have been repaid in full should be A) cancelled and retained by an authorized company official. B) destroyed so that they will not be paid again inadvertently. C) cancelled and destroyed. D) cancelled and returned to the creditor.
10) ______
11) During the course of an audit, a public accountant observes that the recorded interest expense seems to be excessive in relation to the balance in the long-term debt account. This observation could lead the auditor to suspect that A) premium on bonds payable is understated. B) long-term debt is overstated. C) discount on bonds payable is overstated. D) long-term debt is understated.
11) ______
12) Tests of details for notes payable interest expense and accrued interest can frequently be eliminated when A) notes are issued by a person independent of the accounting department. B) tests of controls are conducted over authorization and recording procedures. C) the notes payable schedule indicates that all notes have been repaid. D) results of analytical review are favourable.
12) ______
13) Recalculation of an approximate interest expense using the basis of average interests rates and overall monthly notes payable could detect what type of possible misstatement? A) Misstatement of notes payable, interest expense or accrued interest B) Misclassification of a note payable as long term rather than current C) Omission or misstatement of a note payable D) Misstatement of interest expense or accrued interest, or omission of a note payable
13) ______
14) Comparison of individual notes payable outstanding with the prior year could detect what type of possible misstatement? A) Omission or misstatement of a note payable B) Misstatement of interest expense or accrued interest, or omission of a note payable C) Misclassification of a note payable as long term rather than current D) Misstatement of notes payable, interest expense or accrued interest
14) ______
15) Comparison of the total balance in notes payable, interest expense and accrued interest with these accounts in the prior year could detect what type of possible misstatement? A) Misstatement of interest expense or accrued interest, or omission of a note payable B) Omission or misstatement of a note payable C) Misstatement of notes payable, interest expense or accrued interest D) Misclassification of a note payable as long term rather than current
15) ______
16) The normal starting point for the audit of notes payable is A) the assessment of materiality. B) a schedule of notes payable and accrued interest obtained from the client. C) a discussion with management of any new notes payable for the year. D) the minutes of the board of directors.
16) ______
17) The tests of details of balances procedure which requires the auditor to trace the totals of the notes payable list to the general ledger satisfies the objective of A) existence. B) accuracy. C) completeness. D) detail tie-in.
17) ______
18) The audit objective to determine that notes payable in the schedule exist is verified by the tests of balances procedure to A) examine the balance sheet for proper disclosure of noncurrent portions. B) confirm notes payable. C) foot the notes payable list. D) recalculate interest expense.
18) ______
19) The tests of details of balances procedure which requires the auditor to examine corporate minutes for loan approval would satisfy the audit objective of A) existence. B) accuracy. C) completeness. D) detail tie-in.
19) ______
20) The tests of details of balances procedure which requires the auditor to examine notes paid after year-end to determine whether they were liabilities at the balance sheet date is an attempt to satisfy the audit objective of A) completeness. B) existence. C) accuracy. D) classification.
20) ______
21) The audit objective to determine that existing notes payable are included in the notes payable schedule (completeness) is accomplished by the following test of balances procedure. A) Examine duplicate copies of notes for principal and interest rates. B) Trace the individual notes payable on the schedule to the master file. C) Review the bank reconciliation for new notes credited directly to the bank account by the
21) ______
bank. D) Examine balance sheet for disclosure details.
22) The audit objective to determine that notes payable and accrued interest on the notes payable schedule are accurate is accomplished by which of the following test of balances procedure? A) Review the minutes of the board of directors for authorized but unrecorded notes B) Examine duplicate copies of notes for principal and interest rates C) Trace the total of the notes payable schedule to the general ledger D) Review the notes to determine whether any are with related parties or should be accounts payable
22) ______
23) The audit objective requiring that existing notes payable are included in the notes payable schedule (completeness) is satisfied by performing the following audit procedure. A) Obtain confirmations from creditors who have held notes from the client in the past and are not currently included in the notes payable schedule. B) Examine duplicate copies of notes for details. C) Trace the total of the notes payable schedule to the general ledger. D) Review the notes payable schedule to determine whether any are related parties.
23) ______
24) The test of details of balances procedure which requires the auditor to recalculate accrued interest will satisfy the audit objective of A) existence. B) completeness. C) accuracy D) classification.
24) ______
25) The audit objective which requires the auditor to determine that notes payable on the notes payable schedule are properly classified can be tested with the following procedure. A) Review the notes to determine whether any are with related parties. B) Examine notes, minutes, and bank confirmations for restrictions. C) Confirm notes payable. D) Examine corporate minutes for loan approval.
25) ______
26) The audit procedure that requires the auditor to examine notes, minutes, and bank confirmations for restrictions is performed to satisfy the audit objective of A) existence. B) presentation and disclosure. C) accuracy. D) completeness.
26) ______
27) The three most important balance-related audit objectives in notes payable are: A) completeness, accuracy, presentation and disclosure B) accuracy, presentation and disclosure, classification C) classification, accuracy, cutoff D) existence, accuracy, presentation and disclosure
27) ______
28) One of the reasons that the auditor reads debt agreements is to discover whether there are any restrictions on the company, such as restrictions on the payment of dividends. It is important for the auditor to identify such restrictions as A) the auditor can make sure that management is adhering to the restrictions.
28) ______
B) corroborative evidence can then be obtained from management. C) the auditor can include the restrictions in the management representation letter. D) they must be disclosed in the footnotes of the financial statements.
29) For publicly held corporations, the verification of owners' equity is more complex due to the A) problem of having to confirm shares held with many more different individuals. B) need to consider that audit risk will be lower, and different shareholders have different points of view with respect to materiality. C) larger numbers of shareholders and frequent changes in the individuals holding the shares. D) fact that there are many more equity accounts to audit.
29) ______
30) The amount of time spent verifying owners' equity is frequently minimal for closely-held corporations because A) there are few if any transactions during the year for the capital stock accounts, except for earnings and dividends. B) there is no public interest in these companies. C) the few owners all have access to the books so the auditor spends more time on accounts like liabilities, which affect outsiders. D) these companies are so small that it is not necessary to audit the capital section.
30) ______
31) Which of the following is the most important consideration of an auditor when examining the shareholders' equity section of a client's balance sheet? A) Entries in the capital stock account can be traced to a resolution in the minutes of the board of directors' meeting. B) Stock dividends are capitalized at stated value on the dividend declaration date. C) Stock dividends and/or stock splits during the year under audit were approved by the shareholders. D) Changes in the capital stock account are verified by an independent stock transfer agent.
31) ______
32) As part of the audit, the auditor may examine authorization procedures with respect to the issuance of capital stock. In particular, for a public company the auditor would verify that the following details have been authorized: A) privileges, date, price, and effects upon existing bond agreements B) type of equity, number of shares, price, privileges and date C) price, privileges, date, and the common share dividends to be paid in the next year D) type of equity, price, privileges, and intended purchasers
32) ______
33) As part of the audit, the auditor may examine authorization procedures with respect to the repurchase or redemption of capital stock. In particular, for a public company the auditor would verify that the following details have been authorized: A) type of stock, timing, amount to be paid B) type of stock, amount to be paid, effect upon bond sinking funds C) individuals from whom repurchase will be permitted, maximum amount D) general ledger accounts affected, dividends included, amount to be paid
33) ______
34) As part of the audit, the auditor may examine authorization procedures with respect to the
declaration
of 34) dividend s. In particula r, for a public company the auditor would verify that the followin g details have been authoriz ed: A) form (cash or stock), amount, record date, payment date B) form (cash or stock), payment date, number of shareholders to be paid C) whether the payment is for all shareholders or for executives only D) general ledger accounts affected, type of dividends included, amount to be paid
___ ___
35) Round Corporation declared a 100% stock dividend during 2010. In connection with the examination of Round's financial statements, Round's auditor should determine that A) the additional shares issued do not exceed the number of authorized but previously unissued shares. B) shareholders received their additional shares by confirming year-end holdings with them. C) Round's shareholders have authorized the issuance of 100% stock dividends. D) the stock dividend was properly recorded at fair market value.
35) ______
36) Kumar is the internal auditor of Tarragon Inc. Kumar wants to put procedures in place in order to prevent misstatements in owners' equity and ensure proper record keeping. Kumar suggested that management implements well-defined policies for preparing stock certificates and recording capital stock transaction. What else should Kumar recommend? A) Perform a monthly reconciliation of shareholder's equity B) Having all journal entries in the equity account reviewed by the controller C) Independent internal verification of information in the records D) Reconcile the dividend payments with the bank statement
36) ______
37) The board of director has approved the issuance of 400,000 new shares for the upcoming year. They have verified that the new issuance does not exceed the number of authorized shares in the articles of incorporation. What else should the board of auditor verify? A) Compliance with relevant federal and provincial laws B) Impact on the Debt to Equity ratio C) Compliance with industry norm D) Capacity of the firm to pay the dividends on the new shares in the future
37) ______
38) A record of the issuance and repurchase of capital stock for the life of the corporation is maintained in the A) capital stock certificate book. B) capital stock account in the general ledger. C) capital stock subsidiary ledger. D) board of directors' minutes.
38) ______
39) When a dividend is declared by the Board, the source for determining who should receive dividend cheques is the A) stock certificate books. B) corporate directory. C) shareholders' capital stock master file. D) common stock account in the general ledger.
39) ______
40) An important control in the disbursement of cash dividends is A) independent posting of the total dividends paid to the equity general ledger account. B) preparation of dividend cheques by someone who is not responsible for maintaining the capital stock records. C) sequential numbering of each of the cheques issued, either manually or by the computer systems. D) cancellation of the shares after the dividends have been paid.
40) ______
41) Most large corporations employ the services of a stock transfer agent for the purpose of A) maintaining the shareholder records. B) ensuring that stock issuances are complying with federal and provincial laws. C) issuing the shares for the company. D) recording the payment of dividends.
41) ______
42) Which of the following internal control procedures helps to prevent the payment of a larger amount of dividends than was authorized? A) Dual authorized signatures on all dividend cheques B) Use of a separate imprest dividend account C) Daily analysis of the cash bank account (to check remaining cash availability) D) Matching of dividend cheques to share certificates
42) ______
43) It is normal practice to verify all capital stock transactions A) only when the client is small. B) that are in excess of a material amount. C) regardless of the controls in existence, because of their materiality and permanence in the records. D) if there aren't very many during the year.
43) ______
44) If a company employs a capital stock registrar and/or transfer agent, the registrar or agent, or both, should be requested to confirm directly to the auditor the number of shares of each class of stock A) authorized at the balance sheet date.
44) ______
B) authorized, issued, and outstanding during the year. C) surrendered and cancelled during the year. D) issued and outstanding at the balance sheet date.
45) Primary concern in determining whether retained earnings is correctly disclosed on the balance sheet is A) correct calculation of dividend payments for the year. B) whether adjustments to retained earnings have been made correctly. C) whether there are any restrictions on the payment of dividends. D) correct calculation of the net income or loss for the year.
45) ______
46) The transfer agent confirmed to the auditor that the company had 2,500,000 shares outstanding at December 31, 2010. To have assurance over the accuracy of the capital stock, the auditor would multiply 2,500,000 by the A) average market value of the stock for the year. B) par value of the stock. C) stated value of the stock. D) market value of the stock at December 31, 2010.
46) ______
47) Usually dividends are audited A) using attributes sampling. C) on a 100% basis.
47) ______ B) using block sampling. D) using variables sampling.
48) The transfer agent confirmed to the auditor that the company had 2,500,000 shares outstanding at December 31, 2010. To have assurance over the accuracy of the dividend payable, the auditor would multiply 2,500,000 by the A) dividend per share as per the articles of incorporation, even if it was not declared during the year. B) average dividend for the industry. C) dividend per share paid during the year. D) dividend per share declared.
48) ______
49) The emphasis in the audit of dividends is on A) opening dividends payable balance. B) transactions. C) ending equity balance. D) confirming the number of shares outstanding.
49) ______
50) As part of the audit of retained earnings, the auditor should audit the credits to retained earnings for the net income. This procedure should be done at what point in the audit process? A) After the capital stock and dividend accounts have been audited B) At the beginning of the audit during the planning phase C) After all the adjusting entries affecting net earnings have been completed D) As the audit progresses
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) Discuss the four characteristics of the capital acquisition and repayment cycle that make it unique from other cycles.
52) Discuss the overall objectives of the audit of notes payable.
53) Discuss the four key controls over notes payable.
54) Identify three analytical procedures commonly performed for notes payable.
55) State the specific balance-related audit objectives applicable to notes payable and interest and, for each objective, identify one common test of details of balances.
56) Explain why the auditor's verification of owners' equity is more complex for publicly-held corporations than closely-held corporations.
57) Describe the three objectives of the auditor's examination of owners' equity.
58) First Global is a public company. You are currently performing the audit of the owner's equity section and you have been asked to write a short memo about the control weaknesses you have identified and the potential risk attached to the weakness. First Global is a public company since March of the current year as they underwent an IPO during the year. The corporation has been implementing various controls with regards to keeping records of the company, but they are still a growing company, and Sasha, the equity accountant, has been having a tough time learning all the new regulations, keeping the records up to date and ensuring that the dividend payments are made on time. First Global issued 2 classes of shares in the IPO. Class A shares with 10 votes were issued to the Truman family so they could retain control and Class B shares with 1 votes were issued to the general public. When you reviewed the accounting records, you noticed that they contained only one account for capital stocks.
59) Discuss the internal controls related to owners' equity that are of concern to the auditor.
60) State the four most important audit objectives for capital stock and describe how the auditor typically verifies each of the four objectives.
1) B 2) A 3) B 4) A 5) A 6) D 7) D 8) D 9) C 10) A 11) D 12) D 13) D 14) A 15) C 16) B 17) D 18) B 19) A 20) A 21) C 22) B 23) A 24) C 25) A 26) B
27) A 28) D 29) C 30) A 31) A 32) B 33) A 34) A 35) A 36) C 37) A 38) A 39) C 40) B 41) A 42) B 43) C 44) D 45) C 46) C 47) C 48) D 49) B 50) C 51) The four characteristics are: ∙ Relatively few transactions affect the account balances, but each transaction is often highly material in amount. ∙ The exclusion of a single transaction could be material in itself.
∙
is a legal relationship between the client entity and the holder of the stock, bond, or similar ownership document. T ∙ There is a direct relationship between the interest and dividends accounts and debt and equity. here 52) The overall objectives of the audit of notes payable are to determine whether: ∙ The internal controls over notes payable are adequate. ∙ Transactions for principal and interest involving notes payable are properly authorized and recorded as defined by the six transaction-related audit objectives. ∙ The liability for notes payable and the related interest expense and accrued liability are properly stated as defined by eight of the nine balance-related audit objectives (realizable value is excluded). 53) The four key controls over notes payable are: ∙ Proper authorization for the issue of new notes. Responsibility for the issuance of new notes should be vested in the board of directors or high-level management personnel, with signatures of two authorized officials required for all loan agreements. ∙ Adequate controls over the repayment of principal and interest. At the time notes are issued, the accounting department should receive a copy in the same manner in which it receives vendors' invoices and receiving reports. The accounts payable department should automatically issue cheques for the notes when they become due, in the same manner in which it prepares cheques for acquisitions of goods and services. ∙ Proper documents and records. These include the maintenance of subsidiary records and control over blank and paid notes by a responsible person. Paid notes should be cancelled and retained under the custody of an authorized official. ∙ Periodic independent verification. The detailed note records should be reconciled periodically with the general ledger and compared with the note holders' records by an employee who is not responsible for maintaining the detailed records. 54) Some possible analytical procedures for notes payable include: ∙ Recalculate approximate interest expense on the basis of average interest rates and overall monthly notes payable. ∙ Compare individual notes outstanding with the prior year. ∙ Compare total balance in notes payable, interest expense, and accrued interest with prior year. 55) ∙ Notes payable in the notes payable schedule agree with the client's notes payable register or master file (detail tie-in). Foot the notes payable list for notes payable and accrued interest. ∙ Notes payable in the schedule exist (existence). Confirm notes payable. ∙ Existing notes payable are included in the notes payable schedule (completeness). Examine notes paid after year-end to determine whether they were liabilities at the balance sheet date. ∙ Notes payable and accrued interest in the schedule are accurate (accuracy). Examine duplicate copies of notes for principal and interest rates. ∙ Notes payable in the schedule are properly classified (classification). Review notes to determine whether any are related party notes or accounts payable. ∙ Notes payable are included in the proper period (cutoff). Examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date. ∙ The company has an obligation to pay the notes payable (rights and obligations). Examine notes to determine whether the company has obligations for payment. ∙ Notes payable interest expense and accrued interest are properly presented and disclosed (presentation and disclosure). Examine balance sheet for proper presentation and disclosure of noncurrent portions, related parties, assets pledged as security for notes, and restrictions resulting from notes payable. 56) For publicly-held corporations, the verification of owners' equity is more complex due to the larger numbers of shareholders and frequent changes in the individuals holding the stock.
57) 1. The internal controls over capital stock and related dividends are adequate. 2. Owners' equity transactions are recorded properly as defined by the six transaction-related audit objectives 3. Owners' equity balance are properly presented and disclosed as defined by the balance related audit objectives for owners' equity accounts. 58) I have noticed the following control weaknesses at First Global 1 - Improper segregation of duties: Sasha is in charge of record keeping and also the cash disbursement for dividends. These functions should be separated as this increases the risk of fraud and the possibility that Sasha would create and conceal a fraud. 2 - Potential lack of knowledge from equity accountant: - The company is now public and it appears that Sasha does not have extended knowledge or experience about regulations and laws governing the corporations. Non compliance with laws and regulations could result in penalties or fines for First Global. This increases the risk for First Global and also means that the auditor will have to perform additional procedures and reviews. - Sasha classified all the common shares in the same capital stock account. This will result in improper presentation and note disclosure in the financial statements. This could be caused by the lack of training or knowledge of Sasha or lack of management review of the work done by Sasha. Additional procedures will have to be performed to ensure that proper disclosure is done. Judgement should be used to determine is variation of the above answer are acceptable. 59) ∙ Proper authorization of transactions. Material transactions should be approved by the board of directors, including issuance of capital stock, repurchase of capital stock, and declaration of dividends. ∙ Proper recordkeeping and segregation of duties. This should include well-defined policies for preparing stock certificates and recording capital stock transactions, and independent internal verification of information in the records. Many companies use a stock certificate book and a shareholders' capital stock master file to improve control over capital stock transactions. ∙ Independent registrar and stock transfer agent. An independent registrar acts as a control to prevent the improper issue of stock certificates. A stock transfer agent acts as a control over the stock records. 60) The four most important audit objectives for capital stock are: ∙ Existing capital stock transactions are recorded (completeness). Confirm with the registrar or transfer agent whether any capital stock transactions occurred. ∙ Recorded capital stock transactions exist and are accurately recorded (occurrence and accuracy). Existence can be tested by examining the minutes of the board of directors' meetings for proper authorization. Accuracy can be tested by confirming the amount with the transfer agent and tracing the amount of the recorded capital stock transactions to the cash receipts journal. ∙ Capital stock is accurately recorded (accuracy). The ending balance in the capital stock account is verified by first determining, via confirmation from the transfer agent, the number of shares outstanding at the balance sheet date. ∙ Capital stock is properly presented and disclosed (presentation and disclosure). Using the corporate charter, the minutes of board of directors' meeting and the auditor's analysis of capital stock transactions, the auditor should determine that there is a proper description of each class of stock. The proper presentation and disclosure of stock options, stock warrants, and convertible securities should also be verified by examining legal documents or other evidence of the provisions of these agreements.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is a required condition for a contingent liability to exist? 1) _______ A) The liability resulted from an existing condition. B) The amount of the future payment is known. C) There is a potential liability to an employee of the client. D) The outcome has been resolved by a current event.
2) What situation represents a contingent liability for a company? A) A hotel chain was found guilty by a judge for not refunding customers with on-line reservations. The hotel chain will have to pay $50,000 to various customers in the following year. B) A restaurant received a $10,000 claim from a customer for emotional damages as a result of poor service. The legal counsel of the restaurant indicated that the claim was not supported and there was less than a 5% chance that the restaurant would have to pay. C) A bike company learned that a racer using their bike was seriously injured in an accident on December 30th, 2010, as the front wheel of the bike was released in a curb as a result of a manufacturing defect. The company has not received a claim at December 31st, 2010 but management expects to receive a claim. D) A candy company's monthly production requires 1,000 kg of chocolate. The company entered into a contract with a chocolate producer to purchase 6,000 kg of chocolate over the next six months at the market price.
2) _______
3) When the proper disclosure in the financial statements of material contingencies is through footnotes, the footnote should describe the nature of the contingency to the extent it is known and A) the steps client has taken to ensure that it doesn't recur. B) the opinion of legal counsel or management as to the expected outcome. C) the auditor's opinion as to the expected outcome. D) an estimate of the amount or a statement that the amount cannot be estimated.
3) _______
4) If the amount of a probable loss on a contingent liability is not determinable, the liability should be A) disclosed in the auditor's report but not disclosed on the financial statements. B) disclosed in footnotes, but not accrued. C) accrued and indicated in the body of the financial statements. D) neither accrued nor disclosed in footnotes.
4) _______
5) If the amount of a probable loss on a contingent liability cannot be estimated, but the event is likely, the liability should be A) disclosed in the auditor's report but not disclosed on the financial statements. B) accrued and indicated in the body of the financial statements. C) disclosed in footnotes, but not accrued. D) neither accrued nor disclosed in footnotes.
5) _______
6) If a potential loss on a contingent liability is likely and the amount of the loss can be reasonably estimated, the liability should be A) disclosed in footnotes, but not accrued. B) neither accrued nor disclosed in footnotes. C) disclosed in the auditor's report but not disclosed on the financial statements. D) accrued and indicated in the body of the financial statements.
6) _______
7) Which of the following scenarios regarding a lawsuit filed against a client by a third party would qualify as a "contingent liability"? A) A lawsuit has been filed and concluded with a third party winning an award of $100,000, but the client hasn't paid yet. B) A lawsuit has been filed but not yet resolved. C) A lawsuit has been filed and concluded with a third party winning an award of $100,000, which the client paid after the balance sheet date but before the statements are issued. D) A lawsuit has been filed and concluded with the client winning.
7) _______
8) If a potential loss on a contingent liability is unlikely and the event will not likely have a significant adverse financial effect, the liability should be A) accrued and indicated in the body of the financial statements. B) neither accrued nor disclosed in footnotes. C) disclosed in footnotes, but not accrued. D) disclosed in the auditor's report but not disclosed on the financial statements.
8) _______
9) The auditor's responsibility with regards to contingent liabilities is to A) prepare note disclosure. B) evaluate the accounting treatment of known contingent liabilities. C) identify the appropriate accounting treatment. D) decide on the appropriate accounting treatment.
9) _______
10) When auditing contingent liabilities, the primary objective at the initial stage of the tests is to determine A) the existence of the liability. B) what constitutes adequate disclosure of the liability. C) the likelihood of the liability. D) the materiality of any liability.
10) ______
11) Which of the following situations represents a commitment? A) A 10 year capital lease for a building B) A futures contract to purchase 10,000 gallons of gas C) A company projecting to purchase 10,000 gallons of gas in the next quarter D) A 10 year operating lease for a building
11) ______
12) Management furnishes the auditor with information concerning litigation, claims, and assessments. Which of the following is the auditor's primary means of initiating action to corroborate such information? A) Request that client lawyers undertake a reconsideration of matters of litigation, claims, and
12) ______
assessments
with which they were consulted during the period under examination. B) Request that client lawyers provide a legal opinion concerning the policies and procedures adopted by management to identify, evaluate, and account for litigation, claims, and assessments. C) Request that client management engage outside lawyers to suggest wording for the text of a footnote explaining the nature and probable outcome of existing litigation, claims, and assessments. D) Request that client management send a letter of inquiry to those lawyers with whom management consulted concerning litigation, claims, and assessments.
13) Which of the following procedures might be useful in discovering a contingent liability for a lawsuit that management is intentionally neglecting to disclose? A) Review current and previous years' Canada Revenue Agency correspondence B) Obtain a letter of representation from management that it is not aware of any undisclosed contingent liabilities C) Analyze legal expense and review invoices and statements from outside legal counsel D) Inquiries (orally and in writing) of management
13) ______
14) An agreement which commits the firm to a set of fixed conditions in the future regardless of what happens to profits or the economy as a whole is a definition of a A) conditional contract. B) contingent liability. C) commitment. D) potentially hazardous agreement.
14) ______
15) What audit approach is used to search for unknown commitments? A) Conduct with substantive tests associated with the cutoff assertion B) Perform as part of the audit of each cycle C) Include with the legal letter sent to lawyers D) Include as part of the search for subsequent events
15) ______
16) There are two categories of lawsuits: an outstanding (or asserted) claim, and a(n) A) disputed claim among several parties. B) possible or unasserted claim. C) settled claim. D) claims that could result in material misstatements.
16) ______
17) The standard letter of confirmation from a client's legal counsel should be prepared on the A) client's stationery and signed by a company official. B) lawyer's stationery and signed by the lawyer. C) plain paper and be unsigned. D) auditor's stationery and signed by an audit partner.
17) ______
18) If a lawyer refuses to provide the auditor with information that is within the lawyer's jurisdiction and may directly affect the fair presentation of financial statements about material existing lawsuits (asserted claims) or unasserted claims, the audit report would have to be A) an adverse opinion. B) modified to reflect the lack of available evidence (ie., scope limitation).
18) ______
C) an unqualified opinion with an explanatory paragraph. D) a qualified opinion.
19) The standard letter of confirmation from client's legal counsel should ask for information about the period of time A) covered by client's financial statements plus the succeeding year. B) covered by client's financial statements. C) approximately up to the date of the auditor's report. D) covered by client's financial statements plus the preceding year.
19) ______
20) The auditor has a responsibility to review transactions and activities occurring after the year-end to determine whether anything occurred that might affect the valuation or disclosure of the statements being audited. The auditing procedures required to verify these transactions are commonly referred to as the review for A) subsequent events. B) contingent liabilities. C) late unusual occurrences. D) subsequent year's transactions.
20) ______
21) The auditor's responsibility for "reviewing the subsequent events" of a client is normally limited to the period of time beginning with the A) balance sheet date and ending with the date of the auditor's report. B) start of the fiscal year under audit and ending with the balance sheet date. C) balance sheet date and ending with the date the registration statement becomes effective. D) start of the fiscal year under audit and ending with the date of the auditor's report
21) ______
22) Whenever subsequent events are used to evaluate the amounts included in the statements, care must be taken to distinguish between conditions that existed at the balance sheet date and those that come into being after the end of the year. The subsequent information should not be incorporated directly into the statements if the conditions causing the change in valuation A) occurred both before and after year-end. B) did not take place until after year-end. C) did take place before year-end. D) are reimbursable through insurance policies.
22) ______
23) The following events all occurred after the balance sheet date (6/30/06) but prior to the auditor's report (9/10/06). Which one would require an adjustment to the account balances as of 6/30/06? A) Client will market a new series of equity securities ($2 million of preferred stock) on 8/1/06. B) Securities costing $30,000 held for temporary investment on 6/30/06 declined in value by one-third when the market took a plunge on 8/15/06. C) Inventory valued at $100,000 on 6/30/06 was destroyed in a fire on 8/1/06. D) Unused equipment on the books at 6/30/06 for $100,000 was disposed of 7/31/06 for $60,000.
23) ______
24) Subsequent events affecting the realization of assets ordinarily will require adjustments of the financial statements under examination because such events typically represent A) the preliminary estimate of losses relating to new events that occurred subsequent to the balance sheet date. B) the culmination of conditions that existed at the balance sheet date.
24) ______
C) the final estimates of losses relating to casualties occurring in the subsequent events period. D) the discovery of new conditions occurring in the subsequent events period.
25) A client has a calendar year-end. Listed below are four events that occurred after December 31. Which one of these subsequent events might result in adjustment of the December 31 financial statements? A) adoption of accelerated depreciation methods B) sale of a major subsidiary C) collection of 90% of the accounts receivable existing at December 31 D) write-off of a substantial portion of inventory as obsolete
25) ______
26) Which of the following material events occurring subsequent to the balance sheet date would require an adjustment to the financial statements before they could be issued? A) settlement of litigation in excess of the recorded liability B) sale of long-term debt or capital stock C) major purchase of a business that is expected to double the sales volume D) loss of a plant as a result of a flood
26) ______
27) A client acquired 25% of its outstanding capital stock after year-end and prior to completion of the auditor's fieldwork. The auditor should A) advise management to adjust the balance sheet to reflect the acquisition. B) disclose the acquisition in the opinion paragraph of the auditor's report. C) advise management to disclose the acquisition in the notes to the financial statements. D) issue pro forma financial statements giving effect to the acquisition as if it had occurred at year-end.
27) ______
28) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures are in category 1? A) Examine subsequent period sales and purchases transactions to determine whether the cutoff is accurate. B) Make inquiries of client regarding contingent liabilities. C) Review journals and ledgers of year 2 to determine the existence of any transaction related to year 1. D) Obtain a letter of representation written by client.
28) ______
29) Inquiries of management are used to help identify subsequent events. To help obtain meaningful answers A) these inquiries must be conducted with the proper client personnel. B) the standard firm checklist should be followed. C) they should be asked after the effective date of the audit report. D) the inquiries should be conducted by senior audit personnel.
29) ______
30) Financial statements subsequent to the year end are reviewed to help identify subsequent events. The statements should be discussed with management to determine whether they are prepared
on same the basis as
the 30) current period statemen ts. An effective comparis on of these financial statemen ts would be against A) results for the same period in the year under audit. B) budgeted results for the same period as the subsequent financial statements. C) expected results, adjusted for any extraordinary items. D) the most recent financial quarter.
___ ___
31) The audit procedures for the subsequent events review can be divided into two categories: (1) procedures normally integrated as a part of the verification of year-end account balances, and (2) those performed specifically for the purpose of discovering subsequent events. Which of the following procedures are in category 2? A) Examine subsequent-period sales and purchases transactions to determine whether the cutoff is accurate. B) Test the collectability of accounts receivable by reviewing subsequent period cash receipts. C) Compare the subsequent period purchase price of inventory with the recorded cost as a test of lower-of-cost-or-market valuation. D) Correspond with lawyers.
31) ______
32) The primary objective of analytical procedures used in the final review stage of an audit is to A) obtain evidence from details tested to corroborate particular assertions. B) assist the auditor in assessing the validity of the conclusions reached. C) identify areas that represent specific risks relevant to the audit. D) satisfy doubts when questions arise about a client's ability to continue in existence.
32) ______
33) Kendra is inquiring about subsequent events with regards to lawsuit and contingent claims. To obtain a meaningful answer, Kendra should hold the enquiry with A) the VP legal of the company. B) the mail clerk. C) the accountant in charge of the legal liability reconciliation. D) the assistant controller.
33) ______
34) CAS 570 - Going Concern, requires that the auditor evaluates management's assessment of the ability of the entity to continue as a going concern based on A) the liquidity and solvency ratios of the firm. B) the evidence collected throughout the audit. C) inquiry with management.
34) ______
D) the opinion of the legal counsel of the company.
35) At the completion of the audit, management is asked to make a written statement that it is not aware of any undisclosed contingent liabilities. This statement would appear in the A) letter of inquiry. B) letter of representation. C) letters testamentary. D) management letter.
35) ______
36) Which of the following auditing procedures is ordinarily performed last? A) Confirming accounts payable B) Obtaining a management representation letter C) Testing of the purchasing function D) Reading of the minutes of the directors' meetings
36) ______
37) Refusal by a client to prepare and sign the representation letter would require a(n) A) adverse opinion or a denial of opinion. B) qualified opinion as to GAAP departure or an adverse opinion. C) unqualified opinion with an explanatory paragraph. D) qualified opinion as to scope limitation or a denial of opinion.
37) ______
38) One of the purposes of a management letter is to A) reduce the amount of audit procedures performed by the auditor. B) reduce the detection risk. C) serve as audit evidence for the accuracy of the contingent liabilities. D) document the responses from management to inquiries about various aspects of the audit.
38) ______
39) A client representation letter is a written statement from a non-independent source and therefore A) cannot be regarded as reliable evidence. B) needs to be confirmed by an outside, independent source such as a financial institution, or law firm. C) can be regarded as reliable evidence only if the auditor finds strong internal controls. D) can be regarded as reliable evidence if the high-level corporate officials who sign it are trustworthy.
39) ______
40) The CAS require the auditor to review the other information in the annual report to ascertain its consistency with the financial statements. If there is a material inconsistency, the client should be requested to change the information. If the client refuses, the auditor should A) issue an unqualified opinion, bill the client, and withdraw from any future engagements. B) issue an adverse opinion. C) issue a qualified opinion. D) consider what further action is warranted.
40) ______
41) After all the audit procedures have been completed, the auditor must decide whether sufficient appropriate audit evidence has been accumulated to warrant the conclusion that the financial statements are A) stated in accordance with the Canadian Auditing Standards.
41) ______
B) a fair representation of the financial performance of the company. C) free from misstatements. D) stated in accordance with the Generally Accepted Accounting Principles.
42) In addition to the financial statements, MD&A (management discussion and analysis) are appended to the financial statements to inform users of management's expectations for the foreseeable future, as well as to provide management's assessment of the financial results. MD&A are prepared primarily because it is A) required so that the company can borrow more funds or sell more shares to the public. B) generally required by securities administrators in Canada. C) an additional piece of evidence used by auditors to assess the financial statements. D) an unbiased view of the prospective future results of the company.
42) ______
43) If, after the accumulation of final evidence and during the evaluation of results, the auditor concludes that sufficient appropriate evidence has not been obtained to draw a conclusion about fairness of the client's representations, there are two choices: A) (1) issue a denial of opinion, or (2) withdraw from the engagement. B) (1) obtain additional information, or (2) issue an adverse opinion. C) (1) obtain additional evidence, or (2) issue a qualified opinion as to scope limitation or a denial of opinion. D) (1) issue a qualified opinion as to scope limitation, or (2) issue a denial of opinion.
43) ______
44) An important part of evaluating whether the financial statements are fairly stated is summarizing the misstatements uncovered in the audit. Whenever the auditor uncovers misstatements that are in themselves material, A) it is necessary to combine individually immaterial misstatements with the material misstatements and make entries to correct the statements. B) no entries need be made but footnote disclosure is required. C) entries should be proposed to the client to correct the statements. D) it is necessary to combine individually immaterial misstatements with the material misstatements and make full disclosure in the footnotes.
44) ______
45) There are often a large number of immaterial errors discovered that do not require an adjustment at the time they are found. How should these errors be dealt with by the auditor? A) The auditor must combine the individually immaterial errors and evaluate whether the combined amount is material. B) Since these items are individually immaterial, the auditor would not recommend adjusting entries to client. C) Since there are a large number of these, the auditor would recommend adjusting entries to client. D) The auditor would never combine these individually immaterial amounts because that would mix apples and oranges.
45) ______
46) The initial review of the working papers prepared by any given auditor is normally done by A) the partner assigned to the audit. B) the immediate supervisor. C) the senior. D) the supervisor or manager.
46) ______
47) CAS 450 requires the auditor to communicate all misstatements to the audit committee A) if the misstatements are material. B) if the misstatements are other than trivial. C) if the misstatements are slightly D) regardless of materiality. material.
47) ______
48) CAS 250 requires the auditor to communicate illegal acts to the audit committee A) if the illegal acts are material. B) if the illegal acts are other than trivial. C) regardless of materiality. D) if the illegal acts are slightly material.
48) ______
49) The auditor is required to report significant deficiencies in internal controls to A) audit committee. B) management and the audit committee. C) management and the person responsible for the cycle in which the deficiency was noted. D) management.
49) ______
50) The management letter A) is required by the CAS whenever there are "reportable conditions." B) spells out to the audit committee the auditor's responsibilities under generally accepted auditing standards. C) must follow the format prescribed by the CICA. D) is optional and is intended to help the client operate its business more effectively.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) State the three conditions required for a contingent liability to exist.
52) Discuss three audit procedures commonly used to search for contingent liabilities.
53) State three lists or requests that should be included in a standard letter of inquiry of client's law firms.
54) State the two primary types of subsequent events that require consideration by management and evaluation by the auditor, and give two examples of each type.
55) Klein Corporation has reported a loss for the 6th year in a row. Klein also has a large bank loan due in the coming year, bringing their current ratio to .60. Further, due to the economic crisis, Klein had to increase their bad debt expense by 4% and also saw their largest client, Forest Prairie filing for bankruptcy. Forest Prairie's purchases made up 18% of the total sales of Klein in the past year. Forest Prairie also had an unpaid balance to Klein at year end. In trying to reduce expenses, Klein has reduced the employee training from 5 days to 1 day. During the year, an employee was seriously injured in the production process when his arm was caught in a press. The employee has filed a lawsuit against Klein for $1,000,000 as he claims that he was not properly trained to use the equipment. The legal proceeding for this case should begin in the next fiscal year. Since Klein has
never lawsuit before, the legal counsel indicated that they were not able to estimate the amount and likelihood that been Klein would have to pay. involved in such Required: Evaluate the going concern situation at Klein and indicate what the auditor would be required to as do under CAS 570.
56) A) Discuss the purposes of performing analytical procedures during the audit completion phase. B) State the two purposes of the client letter of representation.
57) List four specific matters that should be included in a client representation letter.
58) Besides the search for contingent liabilities and the review for subsequent events, the auditor has four important final evidence accumulation responsibilities, all of which are required by current professional auditing standards. Discuss each of these four responsibilities.
59) State the three main reasons why it is essential that working papers be thoroughly reviewed by another member of the audit firm at the completion of the audit.
60) Discuss the purposes of a management letter.
1) A 2) C 3) D 4) B 5) C 6) D 7) B 8) B 9) B 10) A 11) D 12) D 13) C 14) C 15) B 16) B 17) A 18) B 19) C 20) A 21) A 22) B 23) D 24) D 25) D 26) A
27) C 28) A 29) A 30) A 31) D 32) B 33) A 34) B 35) B 36) B 37) D 38) D 39) A 40) D 41) D 42) B 43) C 44) C 45) A 46) B 47) B 48) C 49) B 50) D 51) Three conditions required for a contingent liability to exist are:(1) there is a potential future payment to an outside party or the impairment of some other asset that would result from an existing condition, (2) there is uncertainty about the amount of the future payment or impairment, and (3) the outcome will be resolved by some future event
or
events. 52) (note that students' answers will vary): ∙ Inquire of management (orally and in writing) about the possibility of unrecorded contingencies. ∙ Review current and previous years' Canada Revenue Agency notice of assessment. ∙ Review the minutes of directors' and shareholders' meetings for indications of lawsuits or other contingencies. ∙ Analyze legal expense for the period under audit, and review invoices and statements from legal counsel for indications of contingent liabilities. ∙ Obtain a letter from each major lawyer performing legal services for the client as to the status of pending litigation or other contingent liabilities. ∙ Review working papers for any information that may indicate a potential contingency. ∙ Obtain letters of credit in force as of the balance sheet date and obtain a confirmation of the used and unused balance. ∙ Read contracts, agreements and related correspondence and documents. 53) ∙ A list, prepared by management, of outstanding and possible claims with which the lawyer has had significant involvement. ∙ A description of the nature and current status of each claim and possible claim. ∙ An indication of management's evaluation of the amount and likelihood of loss or gain for each listed claim or possible claim. ∙ A request that the lawyer reply to the client, with a signed copy going to the public accounting firm. 54) ∙ Events that have a direct effect on the financial statements and required adjustment. Examples include declaration of bankruptcy by a customer with an outstanding accounts receivable balance due to deteriorating financial condition; settlement of a litigation at an amount different from the amount recorded on the books. ∙ Events that have no direct effect on the financial statements but for which disclosure is advisable. Examples include a decline in the market value of securities held for temporary investment or resale during the subsequent period; issuance of bonds or equity securities during the subsequent period. 55) It is evident that Klein has a going concern issue due to the following: - Large bank loan due in the coming year which is currently not being covered by their current asset (current ratio is less than 1). This indicates the possibility of Klein being unable to repay the bank and at that point, the bank could push Klein into bankruptcy. - Klein has incurred losses for the past 6 years which indicates their inability to generate cash from their operations. - Klein is expected to have even larger losses in the following year due to poor collectability of accounts receivables and the loss of a major customer. - Possibility of having to pay up to $1,000,000 for the lawsuit by the employee. In response to this evidence and to evaluate how this issue should be included in the auditor's report, the auditor should: - inquire with management and consider the actions they intend to take to repay the bank loan and generate profits in the coming year. - contact the bank to see if they will grant an extension or renegotiate the terms with Klein for the loan that is due in the next year. - inquire if Klein has any other sources of financing to help them repay the debt if the bank is not willing to renegotiate the loan. - consult external counsel or search for similar lawsuits in the industry to determine the amount and likelihood that Klein will have to pay. The auditor will then be able to decide on the seriousness of the going concern issue and decide if an explanatory paragraph in the auditor's report is needed or if the auditor's report need to be further modified.
56) A) Analytical procedures performed during the completion phase are useful as a final review for material misstatements or financial problems not noted during other testing, and to help the auditor take a final objective look at the financial statements. B) The two purposes of the client letter are: ∙ To impress upon management its responsibility for the assertions in the financial statements. ∙ To document the responses from management to inquiries about various aspects of the audit. 57) ∙ Management's acknowledgment of its responsibility for the fair presentation in the statements of financial position, results of operations, and cash flows in accordance with generally accepted accounting principles or an appropriate disclosed basis of accounting. ∙ Availability of all financial records and related data. ∙ Completeness and availability of all minutes of meetings of shareholders, directors, and committees of directors. ∙ Information concerning related-party transactions and related amounts receivable or payable. ∙ Plans or intentions that may affect the carrying value or classification of assets or liabilities. ∙ Disclosure of compensating balances or other arrangements involving restrictions on cash balances, and disclosure of line-of-credit or similar arrangements. 58) ∙ Final analytical procedures performed as a final review for material misstatements or financial problems, and to help the auditor take a final objective look at the financial statements. ∙ Evaluate going concern assumption. ∙ Obtain a client representation letter documenting management's most important oral representations during the audit. ∙ Review additional information to determine if there is an inconsistency between the financial statements and additional information. 59) ∙ ∙ ∙
To evaluate the performance of inexperienced personnel. To make sure that the audit meets the public accounting firm's standard of performance. To counteract the bias that may enter into the auditor's judgment.
60) The purpose of a management letter is to inform the client of the public accountant's recommendations for improving the client's business. The recommendations normally focus on suggestions for more efficient operations.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If a misstatement is immaterial relative to the financial statements of the entity for the current 1) _______ period and is not expected to have a material effect in future periods, it is appropriate to issue A) a qualified opinion. B) an adverse opinion. C) an unqualified opinion. D) a disclaimer of opinion.
2) According to CAS 700, the standard unqualified report's title should be A) Unqualified report of the auditor. B) Independent auditor's report. C) Auditor's report. D) Audited financial statements.
2) _______
3) Under the Canadian Auditing Standards, the introductory paragraph indicates that the auditor has audited the balance sheet, the income statement, the cash flow, a summary of accounting policies and notes and A) the statement of changes in equity. B) the internal controls of the company. C) management's discussion and analysis letter. D) the statements of retained earnings.
3) _______
4) The scope paragraph of the standard unqualified audit report states that the audit is designed to A) conform to generally accepted accounting principles. B) discover all errors and/or irregularities. C) obtain reasonable assurance whether the statements are free of material misstatement. D) discover material errors and/or irregularities.
4) _______
5) In the scope paragraph of the audit report, the use of the term "reasonable assurance" is intended to indicate that A) no material misstatements exist in the statements. B) there is a possibility that immaterial misstatements still exist in the financial statements. C) there is some possibility that material misstatements still exist in the financial statements. D) no misstatements exist in the financial statements.
5) _______
6) Clark Kent is a PA partner at the firm of Kent, Lane and Lang, a limited liability partnership. Kent's firm has just completed the audit of a client with a March 31, 20106, year end. How should the audit report be signed? A) Clark Kent, PA B) Kent, Lane and Lang, PAs C) Kent, Lane and Lang, LLP D) Clark Kent, LLP
6) _______
7) The use of the term "reasonable assurance" is intended to indicate that an audit cannot be expected to A) completely eliminate the possibility that a material error or fraud exists. B) be compliant with the generally accepted accounting principles for every account. C) provide assurance to investors who are using the financial statements for investment decisions.
7) _______
D) consider or search for minor errors.
8) The phrase "in our opinion" indicates that A) the auditor's judgement can be relied upon. B) there may be some information risk associated with the financial statements. C) the auditor performed the audit on a test basis. D) the auditor relied on their knowledge to perform the audit.
8) _______
9) The appropriate date for the audit report for a public company is the one on which the A) board of directors approved the financial statements. B) auditor prepares and delivers the report to the client. C) client's fiscal year ended. D) auditor and client entered into a contract.
9) _______
10) Double dating a report is done when A) the auditor finishes his work later than planned. B) a material event occurs after the date of the auditor's report and before the date the report is issued. C) the parent company and their subsidiaries have different year ends. D) a material event occurs after the date of the auditor's report and affects the period that was audited
10) ______
11) A deviation from the standard unqualified report will cause knowledgeable users of financial statements to recognize that A) the financial statements contain an error. B) the Canadian Auditing Standards were not followed. C) the auditor intends to communicate additional or limiting information. D) the financial statements contain a material error.
11) ______
12) The audit report date is important to users because it indicates the last day A) of the fiscal period. B) on which the financial statements may be filed with the provincial securities commission. C) of the auditor's responsibility for the review of significant events that occurred after the date of the financial statements. D) on which users may institute a lawsuit against either client or auditor.
12) ______
13) If the balance sheet of a company is dated December 31, 2010, the audit report is dated March 6, 2011, and both are released to the public on March 15, 2011, this indicates that the auditor has searched for material unrecorded transactions and events that occurred up to A) March 6, 2011. B) December 31, 2010. C) March 15, 2011. D) December 31, 2011.
13) ______
14) The most common type of audit report contains A) an adverse opinion. C) a qualified opinion.
14) ______ B) an unqualified opinion. D) a disclaimer of opinion.
15) The auditor's report of the Rogers Trump company indicates that the financial statement are fairly presented except for the goodwill balance which does not comply with GAAP. The auditor's report is A) unqualified with explanatory paragraph. B) qualified. C) adverse. D) unqualified.
15) ______
16) The auditor's report of the Samcorp company indicates that the auditor is unable to form an opinion on whether the financial statements of the company are fairly presented. The auditor's report is A) qualified. B) adverse. C) unqualified. D) denial of opinion.
16) ______
17) Beem & Lord, a PA firm, audited the financial statements of Frazer Inc. Since this was a first time audit, Beem & Lord did not audit the comparative financial statements, as this was done by the previous auditor. Beem & Lord should expand their report to include an explanation A) in the opinion paragraph. B) in a paragraph following the opinion paragraph. C) in the scope paragraph. D) in a paragraph following the scope paragraph.
17) ______
18) The "unqualified report with explanatory paragraph" and the "unqualified report with modified wording" A) arise when the financial statements are not quite "presented fairly." B) meet the criteria of a complete audit but with unsatisfactory results. C) meet the criteria of a complete audit with satisfactory results. D) arise as a result of an incomplete audit.
18) ______
19) Black, White and Brown are a national firm of PAs who conduct audits for local, regional, national and international clients. One of their clients with a Canadian head office has a going concern problem, with the result that the wording of the audit report accompanying the financial statements will be different for the Canadian and U.S. security exchange commission filings. How should the PA firm issue the audit report(s)? The PA firm should provide the A) U.S. audit report only to both security exchange filings. B) Canadian audit report only to both security exchange filings. C) U.S. audit report with additional comments providing Canadian information. D) Canadian audit report with additional comments providing U.S. information.
19) ______
20) A company has changed its method of inventory valuation from an unacceptable one to one that complies with generally accepted accounting principles. The auditor's report on the financial statements of the year of the change should include A) a reference to a change in accounting principle in the opinion paragraph. B) an explanatory paragraph explaining the change. C) a justification for making the change and the impact of the change on reported net income. D) no reference to the item assuming that the change has been properly disclosed.
20) ______
21) Assuming the items are material, which of the following requires note disclosure? A) The correction of an error in the prior year's financial statements resulting from a mathematical mistake in capitalizing interest B) The acquisition of a new building C) A change in depreciation method which has no effect on current year's financial statements but is certain to affect future years D) A change in the estimate of provisions for warranty costs
21) ______
22) PA firm has been auditing Big Manufacturing Company (BMC) for several years. Last year, BMC converted their inventory and purchasing systems to a new system effective December 31, the date of the year end. To their horror, the PA firm discovered at the beginning of the current error that there was a cut-off error in the accounts payable system of $25 million dollars LAST YEAR. Neither the client nor the firm had detected that the purchases of December 31 had been omitted from the old computer system transaction processing and had been recorded only in the new computer system, understating last year's expenses. Last year's financial statements have been restated and the error disclosed in the notes to both last year's and this year's financial statements. What type of audit opinion will BMC receive this year? A) Unqualified B) Disclaimer C) Qualified D) Adverse
22) ______
23) When a material uncertainty exists, the auditor must A) issue a qualified opinion. B) first determine the materiality of the item and whether adequate disclosure is included in the financial statements. C) issue a disclaimer of opinion. D) disclose it in the audit report.
23) ______
24) ProForce Inc is facing a large lawsuit from their employees. The contingency is significant and may lead to a going concern issue if ProForce is found guilty. ProForce took the adequate measures, as prescribed by GAAP, to account, disclose and present the contingency in the financial statements. The auditor should A) issue a qualified report. B) add an emphasis-of-matter paragraph after the opinion paragraph. C) deny an audit opinion. D) issue a standard unqualified report.
24) ______
25) When a misstatement in the financial statements would affect a user's decision but the overall statements are still fairly stated, it would be appropriate to issue A) an adverse opinion. B) a qualified opinion. C) a disclaimer of opinion. D) an unqualified opinion.
25) ______
26) The client has presented all required financial statements with the exception of the statement of cash flows. The auditor has completed the audit and is satisfied that everything, with the exception of the missing statement, is presented fairly. As a result, the auditor would likely A) issue a qualified opinion. B) issue either an unqualified or qualified opinion. C) issue an unqualified opinion.
26) ______
D) issue a disclaimer of opinion.
27) As a result of management's refusal to permit the auditor to physically examine inventory, the auditor has not accumulated sufficient evidence to conclude whether financial statements are stated in accordance with GAAP. The auditor must depart from the unqualified audit report because A) the scope of the audit has been restricted by the client. B) the financial statements have not been prepared in accordance with GAAP. C) the auditor has lost independence. D) the scope of the audit has been restricted by circumstances beyond either the client's or auditor's control.
27) ______
28) Three of the following conditions would, by themselves, require the auditor to issue a report other than an unqualified report. Which one would permit a standard unqualified report? A) The financial statements have not been prepared in accordance with generally accepted accounting principles and are misleading B) The auditor is not independent during the fiscal period under audit C) The financial statements show a significant net loss for each of the last three years, including the current fiscal period D) The scope of the auditor's examination has been restricted, although the cause of the restriction was not the client's fault
28) ______
29) A report other than an unqualified report must be issued whenever any of the five conditions requiring a departure from an unqualified report A) exists. B) exists and is material. C) exists, is material, and is within management's control. D) exists, is material, and is within either management's or the auditor's control.
29) ______
30) A qualified opinion is appropriate when the auditor is satisfied that the financial statements are A) fairly stated, even though there is an immaterial exception. B) materially misstated. C) fairly stated. D) fairly stated, but there is a material exception.
30) ______
31) The least severe type of report for disclosing departures from an unqualified report is the A) qualified opinion. B) report on unaudited financial statements. C) adverse opinion. D) disclaimer of opinion.
31) ______
32) When the auditor knows that the financial statements may be misleading because they were not prepared in accordance with generally accepted accounting principles, he or she must issue A) a qualified opinion. B) an adverse opinion. C) a qualified or an adverse opinion, depending on the materiality of the item in question. D) a disclaimer of opinion.
32) ______
33) Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned about the possibility that management is trying to prevent discovery of misstated information. In such cases, which type of report should be issued? A) A qualification of both scope and opinion, whenever materiality is in question B) A disclaimer of opinion, whenever materiality is in question C) A disclaimer of opinion, in all cases D) A qualification of both scope and opinion, in all cases
33) ______
34) The auditor would most likely issue a disclaimer of opinion because of A) the qualification of an opinion by the other auditor of a subsidiary where there is a division of responsibility. B) a client-imposed scope limitation. C) inadequate disclosure of material information. D) the client's failure to present supplementary information.
34) ______
35) A misstatement in the financial statements can be considered material if A) it affects more than one account on the statements. B) it overshadows the financial statements as a whole. C) it affects only one account on the statements. D) knowledge of the misstatement would affect the decision of a reasonable user of the statements.
35) ______
36) When a misstatement in the financial statements exists but is unlikely to affect the decisions of a reasonable user, it would be appropriate to issue A) an unqualified opinion. B) an adverse opinion. C) a qualified opinion. D) a disclaimer of opinion.
36) ______
37) An adverse opinion is issued when the auditor believes A) the overall financial statements are so materially misstated or misleading as a whole that they do not present fairly the financial position or results of operations and changes in financial position. B) some parts of the financial statements are materially misstated or misleading. C) the financial statements will be found to be misleading or misstated, if an adequate investigation is performed. D) the audit firm is not independent.
37) ______
38) Both disclaimers of opinion and adverse opinions are used A) only when the condition is highly material. B) regardless of the client's choice of a non-GAAP accounting method. C) regardless of the auditor's independence. D) whether the condition is material or not.
38) ______
39) If inventory is the largest balance on the financial statements, a large misstatement would be so material that the auditor should issue
39) ______
A) an adverse opinion. C) an unqualified opinion.
B) a disclaimer of opinion. D) a qualified opinion.
40) When determining whether an exception is highly material, the extent to which the exception affects different parts of the financial statements must be considered. This is referred to as A) financial analysis. B) materiality. C) ratio analysis. D) pervasiveness.
40) ______
41) Fractal Software Limited has acquired a 100% subsidiary in Malaysia that produces keyboards and other types of computer hardware. Fractal is refusing to consolidate its financial statements, as this would increase the debt to equity ratio to the point that Fractal would violate its debt agreement. Instead, Fractal would like to record the investment in the Malaysian subsidiary at cost. What type of effect does the non-consolidation have upon the financial statements? A) Immaterial B) Material C) Material and isolated D) Material and pervasive
41) ______
42) Mafah Distribution Limited has requested that the audited financial statements be completed by January 5, five days after the December 31 year end. This means that the auditor will be unable to verify subsequent payments on accounts receivable and will be unable to determine whether accounts payable have been set up correctly. What type of audit report should Mafah receive if the auditor is unable to use alternative procedures for these two audit areas? A) Disclaimer B) Unqualified C) Adverse D) Qualified
42) ______
43) The dollar amount of some misstatements cannot be accurately measured. If, for example, the client was unwilling to disclose an existing lawsuit, the materiality question the auditor must evaluate in such a situation is A) how will it affect management's future decisions. B) does it increase the auditor's exposure to lawsuits. C) what effect will it have on statement users. D) what effect will it have on net income.
43) ______
44) The primary concern in measuring materiality when a client has failed to follow GAAP is usually A) the total dollar error in the accounts involved, compared with some base. B) whether it can materially affect some future period. C) the nature of the item in error. D) measurability of the dollar error.
44) ______
45) Bianca Jones was engaged to conduct the audit of Smilicor Company, a toy distributor, three months after the year end date. Bianca was unable to conduct an audit of opening inventory, but was able to satisfy herself with respect to the opening balances. She was also able to conduct audit procedures for other opening balances, for example, by observing fixed assets. What type of audit opinion would Smilicor receive? A) Qualified B) Disclaimer C) Unqualified D) Adverse
45) ______
46) Dussault & Montgomery, the auditors of Greenwich Corp relied on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of Greenwich. The responsibility for the opinion to issue on the financial statements is the responsibility of A) Dussault & Montgomery. B) Dussault & Montgomery and Groves & Padden C) Groves & Padden. D) Greenwich Corp.
46) ______
47) When Dussault & Montgomery relied on Groves & Padden, another PA firm, to audit the Quebec subsidiaries of one of their audit client, Dussault & Montgomery should A) assess Groves & Padden's professional qualifications. B) send one of their auditors to Quebec to supervise the work being done by Groves & Padden. C) issue a qualified opinion for the financial information pertaining to the Quebec subsidiaries. D) ask Groves & Padden to also sign the auditor's report.
47) ______
48) The use of negative assurances in audit reports of historical financial statements is A) properly located in the opinion paragraph of the unqualified report. B) a help in clarifying the degree of responsibility being assumed by the auditor. C) a violation of the reporting standards. D) encouraged by the Canadian Institute of Chartered Accountants.
48) ______
49) The primary auditor who relies on a secondary auditor A) is responsible for any deficiencies in the secondary auditor's work. B) will never mention the name of the secondary auditor in his or her report. C) has no responsibility for checking the work of the secondary auditor. D) will mention the name of the secondary auditor if he or she decides that an unqualified opinion is appropriate.
49) ______
50) A statement in a report such as "Nothing came to our attention that would lead us to question the fairness of the presentations" is referred to as A) positive assurance. B) a disclaimer of opinion. C) the unqualified opinion. D) negative assurance.
50) ______
51) Your firm audits a large electronics company. Financial statements are provided to investors via email, and are published on the company web site. What is the auditor's responsibility with respect to financial information published on a company web site? The auditor A) should confirm that the proper audit report is provided on the internet web site. B) should make sure that the financial information on the web site matches the audited financial statements. C) may conduct analytical review on the information that is placed on the internet. D) is not required to read the financial information published on the web site.
51) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 52) There are five conditions that must be met before an auditor can issue a standard unqualified report. Please
discuss
each of these five conditions.
53) There are two conditions requiring a departure from an unqualified audit report. Discuss each of these conditions and state the appropriate audit report for each condition.
54) Discuss how materiality affects audit reporting decisions.
55) Presented below is an audit report prepared by Baily, Jacobs, and Thompson, Chartered Accountants. They completed the audit on March 10, 2011, and issued their report to Dalton Corporation on April 3, 2011. List any deficiencies in this report. Do not rewrite the report. Auditor's Report To: President of Dalton Corporation We have audited the financial statements of Dalton Corporation as of December 31, 2010. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted accounting standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. In our opinion, except for the effects of not capitalizing certain lease obligations that should be capitalized in order to conform with generally accepted accounting principles, the financial statements referred to above present accurately the financial position of Dalton Corporation as of December 31, 2010 in accordance with generally accepted accounting principles. Baily, Jacobs, and Thompson, Chartered Accountants Victoria, British Columbia December 31, 2010
56) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary, and give reasons. State your assumptions. A) Queen Lake Construction Ltd. uses an aggressive revenue recognition policy under the percentage of completion method for long-term construction contracts. Your review of this year's contracts indicates that several projects look as if they will be high in revenue for the first two years, and then have negligible earnings for the next three years. B) Maple Manufacturing Limited constructs furniture out of maple wood. The furniture is prized for its
durabilit received a letter from a governmental agency advising that it had been found that the factory was located on y and contaminated land that leached hazardous chemicals into the air. This was a preliminary letter stating that a craftsma full investigation into the health effects was underway. Management stated that everything is OK — the nship. investigation was terminated. However, the lawyer refused to sign the legal letter with respect to several Last lawsuits with respect to employee claims for long term disability due to a nervous disorder that affected year, the employees' ability to work. Neither the investigation nor the lawsuits are disclosed in the notes to the company financial statements.
57) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary, and give reasons. State your assumptions. A) Rosebud Ltd. is a construction company that builds and repairs greenhouses for nurseries. An architect does the design, and three different small construction companies are used to build the greenhouses. You are concerned that some of the projects that span the April year end may result in losses, even though income has been reported in the coming year. Management has refused permission for you to enter construction sites, as they feel that the construction sites will be dangerous without you wearing adequate safety equipment. B) Save our Trees is a charitable organization devoted to maintaining national woodland and green space. Fund raising is handled primarily by means of electronic mail and door to door canvassing by volunteers. Volunteers conducting canvassing provide receipts at the door using prenumbered receipts. Funds raised by email are sent receipts by email.
58) The following are two unrelated situations. For each situation outline possible deviations (if any) from a standard auditor's report that may be necessary, and give reasons. State your assumptions. A) During 2010, your client was sued by a customer who had a serious car accident as a result of scrap metal that had been dumped in the parking lot. The customer drove over the scrap metal, which was imbedded in the tires of her vehicle. The tires blew, and the car went out of control on a major highway. The amount in dispute is $400,000, with estimated legal bills of about $20,000. The client does not wish to disclose the suit in the financial statements. B) During the current year, your client leased a large amount of equipment. As the lease qualifies as a capital lease, the equipment has been recorded as an asset, with the corresponding liabilities recorded on the financial statements. The implicit interest rate in the lease is seven percent. The annual payments due over the terms of the lease have been disclosed in the notes to the financial statements.
59) Your client, Huge Telephone Company (HTC), has been hitting troubled times, due to deregulation. There is competition for local telephone business, long distance telephone business, and the high speed lines provided via the telephone network have not been selling as well as expected. A new quirk is that many large cities are going to provide free wireless services by installing wireless transmitters on telephone polls, and is only offering to pay a pittance for the use of the telephone polls. HTC has been able to remain reasonable profits by cutting staff to a bare minimum and outsourcing many services. However, due to several labour contracts and federal legislation that will increase services, you have doubts about the ability of the company to renew a major bond issue this coming year. Required: How does the above information affect the audit report?
60) Julia is in the process of auditing the legal liability section of the financial statements. The controller indicated that he did not want her to contact their external lawyers and he is refusing to grant her access to the detail of the legal expense for the year and any legal invoices. What should Julia do in this situation? Indicate the steps, in the proper order, that should be taken.
1) C 2) B 3) A 4) C 5) C 6) C 7) A 8) B 9) A 10) B 11) C 12) C 13) A 14) B 15) B 16) D 17) B 18) C 19) D 20) D 21) D 22) A 23) B 24) B 25) B 26) A
27) A 28) C 29) B 30) D 31) A 32) C 33) B 34) B 35) D 36) A 37) A 38) A 39) A 40) D 41) D 42) A 43) C 44) A 45) C 46) A 47) A 48) C 49) A 50) D 51) D 52) The five conditions that justify issuing a standard unqualified report are:
∙
undertaken. ∙ The general standard of GAAS has been followed in all respects on the engagement. An ∙ Sufficient appropriate audit evidence has been accumulated, and the three examination standards have been audit met. enga ∙ All statements–balance sheet, income statement, statement of retained earnings, and statement of cash geme flows–are included in the financial statements, and are presented in accordance with an appropriate disclosed basis nt of accounting, which usually is generally accepted accounting principles. has ∙ There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording been of the report. 53) The two conditions requiring a departure from an unqualified report are: ∙ a scope restriction imposed by the client or by circumstances beyond the auditor's or client's control which prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP. In this condition, the auditor would issue either a qualified scope and opinion report, or a disclaimer of opinion. ∙ the financial statements were not prepared in accordance with generally accepted accounting principles. In this condition, the auditor would issue a qualified opinion if the GAAP violation was moderately material, or an adverse opinion if the GAAP violation was highly material. 54) When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) highly material or pervasive. For conditions involving a GAAP violation, the materiality level of the violation influences whether an unqualified, qualified, or adverse opinion is issued. For conditions involving a scope restriction, the materiality of the restriction influences whether an unqualified report, a qualified scope and opinion report, or a disclaimer of opinion is issued. 55) The audit report contains the following deficiencies: ∙ The report should indicate Independent auditor's report. ∙ The report should be addressed to shareholders or to the company, but not to the president. ∙ The introductory paragraph should list the financial statements that were examined and refer to the accounting policies and explanatory notes. ∙ The introductory paragraph is not describing management's responsibility in sufficient detail. ∙ The scope paragraph should state the audit was conducted in accordance with Canadian generally accepted auditing standards, not generally accepted accounting principles. ∙ The scope paragraph should include the description of what is involved in the audit. ∙ Following the scope paragraph, there should be a reservation paragraph that discusses the GAAP violation. ∙ In the opinion paragraph, the auditor should state that the financial statements present fairly, "not present accurately" ∙ In the opinion paragraph, the phrase" in all material respects" should be included. ∙ The audit report should be dated March 10, 2011. 56) A) It is assumed that the amounts involved are material, but can be isolated to specific accounts. The financial statements are materially misstated (revenue is overstated for the current year), which is a violation of GAAP. Accordingly, a qualified opinion would be issued, disclosing the amounts involved. B) The amounts involved cannot be determined, but it is possible that material amounts could be involved. The company has refused to disclose two potential contingencies in the financial statements, so the financial statements are not in accordance with GAAP. A qualified opinion would be issued, identifying the lawsuit and environmental contingencies. 57) A) It is assumed that the amounts are material and can be quantified. Management is imposing a scope limitation, so that it would be difficult to determine the actual percentage of completion of projects and assess whether
reve fication (scope limitation) is required. If the amounts are so large that they would affect the ability of the company nue to continue as a going concern, then a disclaimer of opinion should be issued. is recor B) With both of these fundraising methods, i.e. door to door canvassing and email requests, it is difficult to ded provide internal controls to ensure that all funds received are deposited and recorded. If the amounts are appr considered to be material, then a qualification will be issued with respect to completeness of revenue (the auditor opria cannot conduct field work to determine completeness, so it is a scope limitation). A qualification will be issued, or if tely. the amounts are considered highly material, then a disclaimer of opinion would be issued, although the latter is unlikely. The qualification or disclaimer would be issued if the auditor cannot conduct alternative procedures to A quali satisfy the completeness objective (e.g. testing of prenumbered tax receipts). 58) A) It is assumed that the amount is material, but can be isolated (i.e. it is a specific amount allocated to an individual account). Since the contingency is not disclosed in the financial statements, there is a GAAP violation. A qualified audit opinion should be issued. If the possibility of loss is high (perhaps according to a legal letter), and the company is not adequately insured, the loss could lead to a possibility of the company not continuing as a going concern. In that event, the amount now has a pervasive effect, and an adverse opinion is required. B) The amounts involved have been correctly recorded and adequately disclosed in the financial statements. The auditor would provide an unqualified audit opinion. 59) If the company cannot renew the bond issue, what will they do? Do they have time to issue shares or obtain alternative forms of financing? What are management's plans? These questions would need to be answered before this uncertainty can be addressed. Then, we would need to find out what is disclosed in the financial statements. Is it clear from the financial statements that the bond issue may not be renewed? Also, is the impact of the non-renewal discussed? If there is adequate disclosure, then HTC will receive an unqualified audit report. If not, then there is a GAAP violation, and the auditor may issue a qualified or adverse opinion, depending upon the materiality and the potential impact upon the company to continue as a going concern. 60) First, Julia should ask management to remove the scope limitation and allow her to contact external lawyers and provide her with the detail of the legal expense for the year. If management refuses to remove the scope limitation, Julia should then communicate with the audit committee and the board of directors to inform them of the scope limitation and the potential impact on the audit. Julia should then evaluate if the restriction to access the legal expense detail and to contact the lawyers is material and pervasive. Given the nature of the legal expenses and future potential liabilities, this is a risky area and the legal liabilities can often be material. Further, if management is preventing the auditor from contacting external lawyers, this could be suspicious. In this case, the impact is likely to be considered material. Julia could resign from the audit engagement. If Julia cannot resign, then Julia would issue a disclaimer of opinion.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) "An engagement where, pursuant to an accountability relationship between two or more parties, 1) _______ a practitioner is engaged to issue a written communication expressing a conclusion concerning a subject matter for which the accountable party is responsible" is the definition of a(n) A) compilation engagement. B) audit engagement. C) assurance engagement. D) review engagement.
2) "An engagement where the practitioner expresses a conclusion on a written assertion about a subject prepared by a party accountable for the assertion, such as management" is the definition of a(n) A) audit engagement. B) assurance engagement. C) review engagement. D) attestation engagement.
2) _______
3) The Federal Auditor General, Sheila Fraser, provides the results of her operational audits to Parliament in Auditor General reports. What type of engagements are these? A) direct reporting B) review engagement C) attest engagement D) compilation engagement
3) _______
4) You have just signed off the audit report on the financial statements of your client. What type of engagement did you complete? A) Direct reporting B) Operational C) Review D) Attest and assurance
4) _______
5) Thermos Inc. is having their financial statements audited by Pilott & Levy, a PA firm. Leon Levy is the auditor in charge of the mandate. The accountable party in this assurance engagement is A) the board of directors of Thermos Inc. B) management of Thermos Inc. C) Pilott & Levy. D) Leon Levy.
5) _______
6) Leon Levy, a partner at the audit firm where you work, asked you to work on the audit of the balance sheet of Geminy Corp. Geminy is not a public company and has not been required to have audited financial statements in the past. This year, due to a new bank loan, their bank requested that audited financial statements be provided. Who are the users in this assurance engagement? A) Management of Geminy Corp B) Shareholders of Geminy Corp C) The bank D) Leon Levy
6) _______
7) Locker Building is a new apartment building in a Vancouver suburb. In order to receive a subsidy from the municipality, they need to prove that they have complied with the city's new rules about "green efficiency". The "green efficiency" rules are a described on the municipality's website and list the requirements a building must meet to be considered green and efficient. Your firm, with the help of an environmental scientist, has been asked to perform a direct report engagement for Locker building. The suitable criteria in this case is
7) _______
A) the auditor's judgement. C) the environmental scientist's judgement.
B) the green efficiency rules. D) the federal environmental laws
8) Larry, CA, is about to begin the audit of the financial statements of Grubert Corp. In order to obtain evidence that management is responsible for the preparation of the financial statements, Larry should A) refer to the auditor's report where management's responsibility is stated. B) proceed with the audit since he has a copy of management's acknowledgement from the prior year's audit. C) request a management acknowledgement letter. D) discuss the responsibility with management.
8) _______
9) For the conduct of an assurance engagement, the practitioner is required to identify or develop criteria to evaluate the subject matter. Identify some characteristics of suitable criteria. A) understandability, completeness, timeliness, free from bias B) completeness, timeliness, free from bias, competent C) reliability, accuracy, neutrality, timeliness D) relevance, reliability, neutrality, understandability, completeness
9) _______
10) In addition to having modifications of wording for the financial statement audit opinion, other types of opinions can have modifications as well. Which one of the following describes a situation where there would be a qualification or disclaimer of opinion for a direct reporting engagement? The A) practitioner conducted alternative procedures where there was a scope limitation. B) subject matter does not conform to the criteria. C) information is not presented fairly. D) practitioner and management disagree about the content of the report.
10) ______
11) What is the purpose of an auditor reporting on the effectiveness of internal control over financial reporting? To A) attest to the effectiveness and efficiency of internal controls at an organization B) state that the controls are in conformity with standards with respect to internal controls C) provide an alternative to the operational audits conducted by internal auditors D) state an opinion on management's assessment of the effectiveness of internal controls
11) ______
12) An engagement for applying specified auditing procedures to financial information other than financial statements provides no assurance. This results in A) only certain audit procedures being conducted for specific information. B) distribution of the report normally being restricted. C) frequent disagreement between auditor and client with respect to results. D) a report that can be readily tailored to any type of engagement.
12) ______
13) Which of the following matters would be addressed in a report on the results of applying specified auditing procedures to financial information other than financial statements? A) An opinion with respect to the quality of the information examined B) The factual results of the procedures
13) ______
C) Provision of negative assurance with respect to the accounts examined D) Explanations of the differences between audit, review and special engagements
14) Which of the following would be required in a compilation? A) Management's acknowledgements for their responsibility with regards to the financial statements B) A confirmation of the auditor's independence C) An understanding between the client and the accountant for the services to be provided D) A formal engagement letter signed by the client
14) ______
15) A review engagement requires what amount of evidence to be accumulated? A) Maximum B) Minimal C) Extensive D) Significant
15) ______
16) Four different engagements that the auditor can complete are: compilation, bookkeeping, audit and review. Rank these engagements with respect to the level of assurance provided from highest assurance level to lowest assurance level. A) audit, review, compilation, bookkeeping B) review, audit, bookkeeping, compilation C) audit, compilation, review, bookkeeping D) review, audit, compilation, bookkeeping
16) ______
17) Performing inquiry, analytical procedures and discussion with the limited objective of assessing whether the information being reported on is plausible within the framework of appropriate criteria, is the definition of a(n) A) review. B) compilation. C) examination. D) audit.
17) ______
18) A review engagement includes A) obtaining an understanding of the internal controls. B) inquiry, analytical procedures and discussion. C) tests of controls or transactions. D) independent confirmation or physical examination.
18) ______
19) Before performing a review of an entity's financial statements, an accountant should A) apply analytical procedures to provide limited assurance that no material modifications should be made to the financial statements. B) inquire whether management has omitted substantially all of the disclosures required by generally accepted accounting principles. C) complete a series of inquiries concerning the entity's procedures for recording, classifying, and summarizing transactions. D) obtain a sufficient level of knowledge of the accounting principles and practices of the industry in which the entity operates.
19) ______
20) As part of the review engagement for a small manufacturing company, which of the following would be a typical review procedure for the sales cycle? A) examination of sales documents to ensure credit approval is documented B) review of internal controls over the granting of credit C) comparison of sales and gross profit to the prior year
20) ______
D) recalculation of the taxes and extensions on a sample of invoices
21) As part of the conduct of a review engagement, which of the following would be a typical procedure used for the assessment of the ending accounts receivable balance? A) use of negative confirmations on all large balances B) detailed examination of all accounts over 120 days to assess the bad debt allowance C) comparison of the age of the accounts receivable to the prior year D) circularization of positive confirmations to all balances exceeding materiality
21) ______
22) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of inventory? A) observation of the warehouse, paying particular attention to dusty and damaged goods B) observation of the inventory count C) discussion with management with respect to the costing method used D) confirmation with customers that are holding consignment inventory with respect to quantity and condition of the inventory
22) ______
23) As part of the conduct of a review engagement, which of the following procedures would be appropriate for assessing the ending value of accounts payable? A) use of negative confirmations to suppliers with material balances B) sending zero balance confirmations to frequently used suppliers C) examination of invoices received after the year end to ensure that they were recorded in the proper period D) comparison of the accounts payable balances by supplier to the prior year
23) ______
24) The statement that "nothing came to our attention which would indicate that these statements are not fairly presented" expresses which of the following? A) piecemeal opinion B) negative assurance C) negative confirmation D) disclaimer of an opinion
24) ______
25) The fact that a client has a material departure for failure to follow GAAP would require the accountant to disclose that fact in a separate reservation paragraph, when the accountant is performing A) a review and an audit. B) a compilation. C) either a compilation or a review. D) neither a compilation nor a review, only an audit.
25) ______
26) An accountant who reviews the financial statements of an entity should issue a report stating that a review A) is substantially more in scope than a compilation. B) provides only limited assurance that the financial statements are fairly presented. C) does not constitute an audit. D) provides negative assurance that the internal control structure is functioning as designed.
26) ______
27) When would the public accountant conduct audit procedures during a review engagement? When A) a higher level of assurance is required for the bank B) required to assess plausibility C) it is a first time review engagement D) junior staff are assigned to the engagement
27) ______
28) When conducting a review engagement, how is materiality calculated? A) in the same manner as an audit engagement B) always as a percentage of net income before income taxes C) the concept of significance is used, rather than the concept of materiality D) materiality is not calculated as a lower level of assurance is being provided
28) ______
29) When is negative assurance used during a review engagement? A) when the criteria associated with a review engagement have not been satisfied B) when the practitioner is unable to set appropriate criteria for the review engagement C) if a qualification is required during the review engagement D) when the standards applicable to a review engagement have been met
29) ______
30) Why is it important for the review engagement report to state that the review is not an audit? A) so that the user does not ask any unnecessary questions about the engagement B) to clarify that only review engagement procedures were used during the engagement C) to help users to be aware that a review provides a lower level of assurance D) to make sure that the public accountant is not sued
30) ______
31) You have just recently joined as a member of your local non-profit housing co-op by moving into the largest unit. The Board of Directors has asked that you handle the review engagement, but you are concerned about independence. What is a practical way for you to stay in the co-op but also perform the review engagement? A) Do a compilation rather than a review engagement. B) Have all the preparation work for the review engagement completed by a Board member. C) Request a bylaw stating that the accountant cannot vote for Board members. D) Include a paragraph in the review engagement report stating that you are not independent.
31) ______
32) Compilation services are intended to enable a public accounting firm to compete with A) bookkeeping firms. B) computer service businesses. C) tax preparation businesses. D) management advisory service firms.
32) ______
33) Richard is performing a compilation engagement. Richard is concerned that the information is A) complete. B) arithmetically correct. C) accurate. D) in accordance with GAAP.
33) ______
34) A compilation presents information, in the form of financial statements, that is the representation of management. The public accountant who prepares the compilation undertakes to express
34) ______
A) no assurance on the statements. C) full assurance on the statements.
B) limited assurance on the statements. D) minimal assurance on the statements.
35) Which of the following techniques would be conducted by a practitioner when conducting a review of compliance with agreements and regulations? A) inquire about how the client monitors its compliance with the provisions B) testing control procedures throughout the year that pertain to the provisions of the agreement C) discussions with client's legal counsel to identify any legal liabilities with respect to potential violations of the agreements D) use of a specialist to ensure that the terms of the agreement are complied with
35) ______
36) Which one of the following engagements would most likely be a compilation engagement? An engagement with respect to financial statements A) for a large public company. B) attached to a personal tax return. C) that accompany future oriented information to obtain financing. D) for a company that has a large bank loan.
36) ______
37) Which one of the following procedures would most likely be conducted by an accountant during a compilation engagement? A) Compare gross profit on a year-by-year basis over the last five years. B) Circularize negative accounts receivable confirmations. C) Assemble and re-calculate the financial statement allocations. D) Enquire of management with respect to the purpose of new capital assets.
37) ______
38) The level of assurance that is provided by the public accountant on a compilation report is A) none. B) low. C) high. D) medium.
38) ______
39) The accountant is working on an engagement with respect to the client's financial statements. Which of the following engagements would omit an assessment of the client's accounting policies' compliance with GAAP? A) Review B) Audit C) Compilation D) Attestation
39) ______
40) Which of the following items includes criteria for accepting a compilation engagement? A) completion of an independence threat analysis, ensuring that there are no threats to independence B) no reason to believe that the financial statements are false or misleading C) evaluation of whether the financial statements are in accordance with GAAP D) completion of a client risk analysis, with the conclusion that risks are low
40) ______
41) A public accounting firm can issue a compilation report A) only if all the partners and the staff in the office performing the engagement are independent. B) only if the partners are independent.
41) ______
C) even if it is not independent. D) if the partners have no material or direct immaterial interest in client.
42) You are a public accountant retained by the manager of a cooperative retirement village to do "write-up work." You are expected to prepare unaudited financial statements with each page marked "unaudited" and accompanied by a disclaimer of opinion stating no audit was made. In performing the work, you discover that there are no invoices to support $25,000 of the manager's claimed disbursements. The manager informs you that all the disbursements are proper. What should you do? A) Obtain further information about the $25,000 unsupported items and withdraw if the situation is not satisfactorily resolved B) Include the unsupported disbursements in the statements since you are not expected to make an audit C) Obtain, from the manager, a written statement that you informed him of the missing invoices and include his assurance that the disbursements are proper D) Submit the expected statements but omit $25,000 of unsupported disbursements
42) ______
43) Which one of the following is a professional standard that must be followed by an accountant when conducting a compilation engagement? A) work being adequately planned and properly executed B) having adequate technical training and proficiency in auditing C) documenting the processes used to compile and record transactions D) obtaining an adequate understanding of the business and its industry
43) ______
44) What is the title of a compilation report? A) Notice to Reader C) Engagement Report
44) ______ B) Criteria Schedule D) Opinion
45) Prospective financial information prepared using assumptions reflecting management's judgment as to the most probable courses of action for the entity is called a(n) A) forecast. B) prospectus. C) projection. D) prospective financial statement.
45) ______
46) Financial information prepared using one or more assumptions (hypotheses) that do not necessarily reflect the most likely course of action in management's judgment is called a(n) A) prospective financial statement. B) prospectus. C) forecast. D) projection.
46) ______
47) An example of special use prospective financial statements refers to use by A) the relevant provincial securities commissions. B) third parties with whom negotiations are being conducted directly. C) any third party. D) internal management only.
47) ______
48) With respect to working on an engagement to examine a financial forecast or projection included
in a prospec
tus or 48) other public offering documen t, the public accounta nt and the client should agree upon A) allocation of the responsibility of creating the assumptions to the public accountant. B) delegation of forecast preparation to the public accountant. C) the period of time to be covered. D) the fact that the forecast may not be prepared in accordance with standards.
___ ___
49) Prior to accepting an engagement to examine a financial forecast or projection included in a prospectus or other public offering document, the public accountant should A) inform the client that the engagement may not detect errors in the client's forecasts. B) ensure that management is willing to disclose all significant assumptions. C) obtain an understanding of the controls over preparation of internal forecasts such as budgets. D) consider the risk profile of the client with respect to management integrity.
49) ______
50) A public accountant has been engaged to conduct an examination of future-oriented financial information. Which of the following procedures would be included in the examination? A) assessment of internal controls over the development of internal future-oriented information, such as budgets B) assessing the plausibility of hypothesis C) creation of assumptions that fit the projected information D) developing the hypotheses with the assistance of management
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) Define "assurance engagements".
52) Define "attest engagements".
53) Define "direct reporting engagements".
54) Outline the three performance standards of CICA Handbook section 5025, "Standards for Assurance Engagements".
55) A financial statement review emphasizes four broad areas, one of which is to "Perform analytical
procedur es." State the other three areas emphasized.
56) Yvan is preparing the audit plan for Share the Wealth, a non-profit organization. Share the Wealth is a large Montreal based organization and receives corporate donations and also has many stores that collect and re-sell jewelry and clothing. The purpose of the organization is to build recreation areas for children in less fortunate areas of the city. Share the Wealth was started by two sisters. One of the sister is still actively involved in the organization, but the other sister has been devoting less time to the organization since she has had triplets. Share the Wealth has a total of 8 stores in the city where individuals can drop off donations and where customers can also purchase the second hand clothing and jewelry. Share the Wealth has a total of 12 employees who work in the different stores across the city. Depending on the schedule and availability, the employees will randomly be assigned to a store for the week. What are some of the important issues that Yvan should consider when performing the audit of Share the Wealth?
57) Describe the professional standards that must be followed when undertaking a compilation engagement as specified by the CICA Handbook.
58) Identify the reporting standards for compilation engagements.
59) Always Quick Manufacturing Limited is a small business that manufactures metal and plastic components for a variety of industries. The bulk of the business is in the computing industry, although the occasional contract is for the automotive industry. Jose, the owner, would like to expand the business so that he can bid on larger contracts. This requires an investment of about $500,000 to finance capital assets and about $300,000 for a working capital loan. Jose has financed the business himself to this point, and has been given some alternatives by the bank. The alternatives pertain to which assets are used as guarantees, and whether Jose also guarantees the loans personally (as he has substantial personal assets). The bank also stated that if Jose personally guarantees the loan, the company will only require a review engagement, whereas if the loan is only secured by corporate assets, then an audit of the company will be required. Jose understands the differences among the guarantees, but is not sure about the difference between a review and audit engagement. Presently, the company financial statements are prepared using a compilation engagement. Required: Explain to Jose the difference between a review and audit engagement in the context of his present compilation engagement.
60) As part of a loan agreement that it is thinking of obtaining, Always Quick Manufacturing Limited has decided that it will use accounts receivable and inventory as security for working capital funds. The bank has indicated that in addition to an annual financial statement audit, that it would require quarterly assurance on the accounts receivable and inventory amounts. The type of assurance required has not been stated. The bank has told Jose, the owner of the company, that he would need to provide a detailed inventory
list and of each month for the information as at the preceding month end. Jose would like to know what his an aged alternatives are. accounts receivabl Required: e trial balance Your partner is going to meet with Jose next week, and would like you to prepare a memo to file that will be used as part of the meeting. The memo should include a list of alternative types of engagements that could on the fifteenth be used to provide assurance on the accounts receivable and inventory balances.
1) C 2) D 3) A 4) D 5) B 6) C 7) B 8) C 9) D 10) B 11) D 12) B 13) B 14) C 15) D 16) A 17) A 18) B 19) D 20) C 21) C 22) C 23) D 24) B 25) A 26) C
27) B 28) A 29) D 30) C 31) C 32) A 33) B 34) A 35) A 36) B 37) C 38) A 39) C 40) B 41) C 42) A 43) A 44) A 45) A 46) D 47) B 48) C 49) B 50) B 51) An assurance engagement is "an engagement where, pursuant to an accountability relationship between two or more parties, a practitioner is engaged to issue a written communication expressing a conclusion concerning a subject matter for which the accountable party is responsible."
52) Engagements where the auditor expresses a conclusion on a written assertion about a subject prepared by a party accountable for the assertion. 53) Engagements where the auditor expresses a conclusion on his or her evaluation of subject matter using certain criteria. 54) ∙ The work should be adequately planned, and there should be proper supervision. ∙ The practitioner should consider both significance and engagement risk when planning and performing the engagement. ∙ Sufficient evidence should be gathered to support the conclusion the practitioner expresses in his or her report. 55) ∙ ∙ ∙
Obtain knowledge of the client's business. Have discussions with management concerning information received and the information being reported on. Make inquiries of client personnel to determine whether the financial statements are fairly presented.
56) - Awareness of fraud risk: Is leadership organized? Is there volunteer and staff rotation? In the case of Share the Wealth, risk is increased since it appears that only one of the sister is managing the operations now. Risk that she is overwhelmed or unable to run the operations on her own. On the other hand, the risk of fraud is diminished since it appears that the staff changes location each week. This will help early detection of fraud. Further, Yvan should also verify how the revenues (funds) were spent during the year. It should be verified that the funds are spent for valid operating expenses and the remaining spendings are in line with the objective of building recreation spaces in less fortunate communities. - Completeness of revenues: How are the sales accounted for? What are the controls over the sales process at each store? How are the corporate donations recorded? Yvan will have to do more work in this area to ensure that the sales are properly captured and recorded at all stores. - Valuation of donated assets: For the corporate donations, if they are made in cash, there is no valuation issue. However, if corporations are donating assets or inventory, then there could be a valuation issue. As for the clothing and jewelry donated by individuals, the risk of valuation is diminished since the inventory is sold fairly quickly, therefore, by looking at the items being sold currently, Share the Wealth could have a good idea of the value of their inventory. Once the inventory is sold, there would be no more valuation issue since it would be recorded as a sale and not an asset.
57) ∙ The services should be performed and the communication prepared by a person having adequate technical training and proficiency in accounting, with due care. ∙ The work should be adequately planned and properly executed and if assistants are employed, they should be properly supervised. 58) ∙ state that the public accountant compiled the statement from information provided by management ∙ state that the public accountant did not audit, review or otherwise attempt to verify the accuracy or completeness of such information ∙ caution readers that the statement may not be appropriate for their purposes ∙ not express any form of opinion or negative assurance. 59) The compilation engagement does not provide any assurance with respect to the financial statements. For a review engagement, the objective of the review is to determine whether the financial statements are "plausible" whereas for an audit, the objective is to assess whether the financials are "fairly stated."
Movi increases the amount of work that needs to be conducted, as the auditor needs to gather evidence to support the ng opinion. It also requires a greater level of independence, which is required for reviews and audits (but not from compilations). each enga For a compilation engagement, the auditor prepared the financial statements based upon information provided by geme management without assessing the information. For a review engagement, the procedures consist mainly of nt to enquiry, analytical procedures and discussion. For an audit, evidence is obtained through inspection, observation, the and examination of documentation both internal to and external to the organization. Corroborative information, next such as observation of inventory counts, is also required. level that A major difference in an audit is that the auditor needs to document and evaluate internal controls to assess risks provi and plan audit procedures. des great Each type of engagement also has a different type of report that will be attached to the financial statements. The reports reflect the level of assurance provided, i.e. the compilation report indicates that no assurance is provided, er assur the review that nothing has come to the attention of the accountant that could cause him or her to believe that the ance financial statements are misleading, while for an audit an opinion with respect to the fairness of the financial also statements is provided. 60) (1) Audit Report on Financial Information other than Financial Statements (Section 5805) This report would provide a high level of assurance. Materiality would need to set at a lower level than for the audit since it would relate to only the accounts receivable and inventory balances. This would likely be the most costly of the options. (2) Review of Financial Information other than Financial Statements (Section 8500) This report would provide negative assurance. Materiality would be assessed as above. However, less field work is required as the plausibility of the information is addressed. (3) Report on the Results of Applying Specified Auditing Procedures to Financial Information other than Financial Statements (Section 9100). This report does not provide any assurance, so it might not be suitable for the bank. Specific audit procedures would need to be selected and agreed upon with the client.
Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Independence of internal auditors is enhanced by having the internal audit department report to 1) _______ the A) treasurer. B) audit committee. C) external auditor/public accounting firm. D) controller.
2) The Institute of Internal Auditors publishes standards for internal auditors. Which of the following best describes the purpose of the standard for "purpose, authority and responsibility." The A) internal auditors should describe their work and discuss with financial statement users annually. B) internal audit activity should be formally defined in a charter and approved by the Board. C) work conducted and its purpose should be carefully described in each internal audit report. D) purpose and responsibility of the internal auditors should be considered when doing risk assessment planning for the year.
2) _______
3) Darcy's pulp and paper mill is undergoing an operational audit. Their internal auditors are assessing materiality. In the prior year's operational audit, materiality was set at $6,000. Darcy, the manager of the plant, indicated that any errors of $5,000 or more would need to be corrected. However, Darcy indicated that the shareholders would not care for such small errors. Shareholders would be interested in errors of $10,000 or more. What materiality should be used by the internal auditor in the operational audit? A) $10,000 B) $ 5,000 C) $ 6,000 D) $ 7,500
3) _______
4) The CAS require the auditor to understand the internal audit department A) only if the external auditor intends to rely upon the actions of the internal audit for low risk transaction cycles. B) only if the external auditor has not done so in the prior year. C) only if the external auditor intends to rely upon the actions of the internal audit. D) even if the external auditor does not intend to rely upon the actions of the internal audit.
4) _______
5) The external auditor is responsible to financial statement users who rely on the auditor to add credibility to the statements. The internal auditors are responsible to A) the corporate controller. B) management. C) the board of directors. D) shareholders.
5) _______
6) The Institute of Internal Auditors publishes standards for internal auditors. Which of the following is part of the standard for "quality assurance and improvement program." The A) engagements should be performed by internal auditors with proficiency in internal auditing. B) internal auditors should be objective in performing their work. C) internal auditors should provide assurance that the internal audit activity is in conformity with the Code of Ethics.
6) _______
D) purpose, authority and responsibility of the internal audit activity should be identified in a charter.
7) The Institute of Internal Auditors publishes standards for internal auditors. Which of the following is part of the standard for "nature of work." ? A) Develop and maintain a quality assurance program to ensure consistency of reporting B) Contribute to the improvement of risk management, control and governance systems C) Help internal audit add value and improve the organization's operations D) Actively and conscientiously monitor the effectiveness of the internal audit department
7) _______
8) The Institute of Internal Auditors publishes standards for internal auditors. Which of the following is part of the standard for "performing the engagement." A) Effectively manage the internal audit activity. B) Communicate the engagement results promptly. C) Identify, analyze, evaluate, and record sufficient information. D) Develop and record a plan for each engagement.
8) _______
9) Which of the following describes a standard with respect to independence that pertains to both internal and external auditors? A) Report to senior executive management B) Do not conduct both the attest engagement work and business advisory work C) Do not hold any shares or hold a financial interest in the business D) Be competent and remain objective in performing work and reporting results
9) _______
10) Which of the following describes the use of the audit risk model as a planning tool for both internal and external auditors? A) Only the inherent risk and control risk portions of the audit risk model are used B) Use the audit risk model and materiality in deciding the extent of their tests C) Use the audit risk model (materiality is not used) in deciding the extent of tests D) Only the control risk and detection risk portions of the audit risk model are used
10) ______
11) With respect to the financial statement audit, external auditors can significantly reduce control risk and thereby reduce substantive testing if A) internal controls are evaluated on a cyclical basis over five years. B) all internal audit staff are qualified accountants. C) internal auditors are effective. D) the director of internal audit reports to the Vice President, Finance.
11) ______
12) Before using internal audit staff to assist on the external audit engagement, the external auditor must be confident with respect of their A) competence, proficiency, and ability to conduct the audit with due care. B) ability to receive support from the Audit Committee when differences in opinion arise with management. C) competence, independence, and objectivity. D) ability to conduct their work in accordance with their audit charter.
12) ______
13) Operational audits are performed A) cyclically. B) annually.
13) ______ C) randomly.
D) quarterly.
14) Financial auditing emphasizes whether historical information was correctly recorded. Operational auditing emphasizes A) effectiveness and efficiency. B) efficiency and economy. C) efficiency and reliability. D) economy and effectiveness.
14) ______
15) Operational auditing is primarily oriented toward A) past protection provided by existing internal controls. B) the accuracy of data reflected in management's financial records. C) the verification that a company's financial statements are fairly presented. D) future improvements to accomplish the goals of management.
15) ______
16) Before an operational audit for effectiveness can be performed, there must be A) a financial audit by an internal auditor. B) a review performed by either an external or an internal auditor. C) a financial audit by an external auditor. D) specific criteria developed to define effectiveness.
16) ______
17) The primary purpose of internal control evaluation for financial auditing is to determine the extent of substantive audit testing required. The purpose of operational auditing with respect to internal controls is to A) conduct only tests of controls for the controls that were identified by the external auditors. B) identify substandard products that have been produced by the production department. C) actually conduct the substantive testing so that management can be given assurance with respect to the quality of the transaction processing. D) make recommendations to management after evaluating efficiency and effectiveness.
17) ______
18) The scope of internal control evaluation for financial statements is restricted to controls that affect the quality of the financial statements. Operational auditing concerns are A) those controls that are multi-faceted, and affect multiple parts of the business. B) any control affecting efficiency or effectiveness based on risks. C) those controls that affect only the income statement accounts. D) only those controls that affect the production processes.
18) ______
19) Internal auditors may look at internal controls to identify inefficiencies. Which of the following is an example of an inefficiency with respect to the objective of determining whether the acquisition of goods and services is resulting in excessively costly purchases? A) Materials are purchased from the same suppliers every year, at list prices B) Purchasing agents received a bonus for reducing cost of goods sold C) Computers automatically generate purchase orders when inventory falls below economic order quantities D) Receiving compares quantities received to purchase order quantities
19) ______
20) Internal auditors may look at internal controls to identify inefficiencies. Which of the following is an example of an inefficiency with respect to the objective of determining whether raw materials are available for production when needed? A) Raw materials are recorded in perpetual records when received B) An assembly line was shut down due to insufficient quantities of steel C) Raw materials are recorded at cost in the records D) Usage of materials is recorded as materials are moved to the production area
20) ______
21) Internal auditors may look at internal controls to identify inefficiencies. Which of the following is an example of an inefficiency with respect to the objective of determining whether there is a duplication of effort by employees? A) Copies of vendor's invoices and receiving reports are sent to the production department where they are filed without every being used B) Customer address information is recorded by the marketing area, for use in the central customer database C) The production area records receipts of materials into the inventory perpetuals; accounts payable records both prices and quantities received into the accounts payable system D) The data warehouse reads information from all divisions, checks for duplication, and transfers sanitized data into the data warehouse
21) ______
22) What is a key advantage to having an internal auditor perform an operational audit, rather than the external auditor? The internal auditor A) will be able to conduct the audit using a risk-based approach. B) has a greater level of expertise with respect to the company. C) will be able to conduct the audit using statistical methods. D) will likely be more independent than the external auditor.
22) ______
23) When public accounting firms do an audit of historical financial statements, part of the audit usually consists of identifying operational problems and making recommendations that can benefit the audit client. The recommendations would be included in the A) management discussion and analysis. B) financial statement report. C) management letter. D) audit opinion.
23) ______
24) To help ensure that internal auditor investigations and recommendations are made without bias A) all internal auditors should have a professional designation and attend professional development training. B) internal auditors should sell any shares that they own in the company. C) all internal auditors should attend an ethics course. D) the internal auditors should report to the audit committee or president.
24) ______
25) Which of the following responsibilities would negatively affect an internal auditor's independence? A) Working as acting corporate controller in a company B) Conducting an operational review of the payroll processing functions C) Conducting monthly professional development seminars for the accounting personnel D) Attending the same professional development courses as the accounting department
25) ______
26) Which of the following responsibilities would negatively affect an internal auditor's independence? A) Correcting operational deficiencies when ineffective or inefficient operations are found B) Conducting an operational review of the process for collecting delinquent funds C) Participating in social events, such as boat races, with the accounting staff D) Conducting weekly luncheon training sessions for all management on accounting principles
26) ______
27) The internal auditors at the Megapolis Conglomerate Company (MCC) are heavily involved in systems development auditing. MCC has decided to second one of the internal auditors to act as project manager and lead analyst on the next project, which involves the implementation of a new general ledger system. What effect does this have on the internal auditor running the project? A) He/she will be more likely to be promoted to manager of internal audit due to the increased level of expertise B) The internal auditor would not be independent and should not conduct any subsequent audit work on the general ledger systems C) This improves the internal auditor's competence and independence as he/she will be better able to communicate with information systems personnel D) He/she will be receiving advanced training with respect to information systems and will be able to subsequently run computer assisted audit tests on the general ledger system
27) ______
28) Which of the following helps to maintain internal auditor independence when internal auditors provide recommendations that improve operations? A) Operating personnel must have the authority to accept or reject the recommendations. B) The recommendations should require implementation prior to the completion of the financial statement audit. C) The recommendations should be copied to the external auditors so that they can follow up whether they have been implemented or not. D) The recommendations should be published in the annual report to shareholders.
28) ______
29) Operational auditors deal with a wide range of operational problems, including marketing, production, and human resources. Which of the following could be a major problem when conducting such audits? A) Competence in specialized areas B) Developing a format for the final report C) Identifying the appropriate persons to interview D) Documenting the objectives of the department
29) ______
30) At what stage of the operational audit engagement does the internal auditor set criteria? A) During the risk assessment phase B) Prior to the commencement of testing C) After the conduct of preliminary testing D) After the preparation of the report
30) ______
31) Gino is an internal auditor at Tulford Wines. As part of his operational audit, Tulford's management wanted Gino to report on the improvement of the taste of wines as a result of the
ne ferment w ation
process. 31) Althoug h Gino drinks on occasion, he has difficulty tasting the differenc e between the wines fermenti ng under the two different processe s. Gino should A) request the help of the external auditor. B) request the help of an expert sommelier to perform the tasting tests. C) inquire with the production facility manager about any taste improvement noticed. D) indicate to management that this cannot be performed as part of the audit.
___ ___
32) The independence of the internal auditor is enhanced by A) not inviting the internal auditor to social events of the company. B) having the internal auditor report directly to the audit committee. C) having the internal auditor work in a separate office. D) requiring the internal auditor to have a professional designation such as CA or CGA.
32) ______
33) Which of the following best describes the role of risks when setting criteria for an operational audit engagement? A) Risks are not assessed as the criteria used are generally accepted accounting principles B) The audit risk model needs to be completed before establishing criteria C) Detection risk needs to be set before setting criteria D) Risks are considered when setting criteria
33) ______
34) A source of criteria for the operational audit is historical performance. The criteria can be based on actual results from prior periods (or audits). The reason for using such criteria is to A) determine whether performance has become better or worse in comparison. B) provide a variability range that can be statistically analyzed. C) limit the comparison to internal data, as this is the most reliable for the organization. D) assess the overall stability of the organization and its products.
34) ______
35) The advantage of using historical performance as a source of criteria for the operational audit is
that such
criteria are
35) A) cumulative. C) easy to derive.
___ ___ B) statistically sound. D) unbiased.
36) Benchmarking is a source criteria for the operational audit. In this case, the company's performance would be compared to A) management's budget and expectations adjusted for unpredictable economic conditions. B) prior years where similar economic conditions existed. C) management's budget and expectations. D) comparable entities.
36) ______
37) Engineered standards, such as time and motion studies for production output rates, can also be used as criteria. Which of the following is a disadvantage of engineered standards? They are A) clearly linked to the organization or system under study. B) effective in solving operational problems. C) potentially used by entire industries. D) time consuming and costly to develop.
37) ______
38) The three phases of the operational audit are A) planning; criteria development and assessment; evidence accumulation and evaluation. B) planning; evidence accumulation and evaluation; reporting and follow-up. C) risk assessment; criteria development; testing and reporting. D) risk assessment; criteria assessment; testing and follow-up.
38) ______
39) The major difference in planning an operational audit and planning a financial statement audit is A) that the scope of the operational audit is set by the audit committee. B) background information need not be collected for the operational audit, as the operational auditor is already employed by the client. C) the extreme diversity in operational audits. D) risk assessment is used in the financial statement audit only.
39) ______
40) The major difference in planning an operational audit and planning a financial audit is the extreme diversity in operational audits. Because of this diversity, it is often difficult to A) determine the scope of the engagement. B) determine specific objectives of an operational audit. C) gather sufficient background information about the organizational unit. D) effectively communicate with the organizational unit.
40) ______
41) Regardless of the source of the criteria for evaluation, it is essential that the auditee, the auditor, and the sponsor of the engagement be in clear and complete agreement on the objectives and criteria of the engagement. This is accomplished by A) having the management of the unit provide a detailed list of criteria prior to the commencement of the engagement. B) allowing management of the unit to veto objectives that will be difficult to evaluate. C) reaching consensus on the terms of the engagement and the criteria for evaluation.
41) ______
D) having the sponsor (e.g. the audit committee) clearly communicate to the operational unit being audited that it is important to cooperate with the auditors.
42) Internal controls and operating procedures are a critical part of operational auditing. This means that the following types of evidence will be extensively used: A) client enquiry, observation, reperformance B) reperformance, client enquiry, confirmation C) documentation, client enquiry, observation D) documentation, reperformance, client enquiry
42) ______
43) Internal controls and operating procedures are a critical part of operational auditing. This means that the following types of evidence will be less extensively used for most operational audits: A) client enquiry, reperformance B) documentation, confirmation C) confirmation, reperformance D) confirmation, client enquiry
43) ______
44) The operational auditor is conducting an engagement to evaluate the safety of elevators at a group of office buildings owned by his employer. The objective is to determine whether an inspection is made annually at each elevator in every building owned by the company by a competent inspector. To satisfy the completeness objective, the auditor would A) examine blueprints of the buildings and ensure that each elevator in the blueprints was included on the master list of elevators. B) obtain the maintenance schedule to see which elevators required maintenance based upon an annual visit by an inspector. C) obtain a list of inspections and determine that each building was visited by an inspector at least once. D) visit each building, count the number of elevators and trace to the master list of elevators.
44) ______
45) The operational auditor is conducting an engagement to evaluate the safety of elevators at a group of office buildings owned by his employer. The objective is to determine whether an inspection is made annually at each elevator in every building owned by the company by a competent inspector. Which of the following would be an appropriate test to determine whether inspections were actually completed on the required schedule? A) Select a sample of elevators, and review maintenance records to determine whether repairs were required for the elevators B) Contact the inspector and accompany him/her on a selection of visits to observe inspection practices C) Select a sample of elevators, and review inspection reports as to timing and frequency D) Examine security records to determine whether any emergencies (such as stopped elevators) occurred during the prior year
45) ______
46) The operational auditor is conducting an engagement to evaluate the safety of elevators at a group of office buildings owned by his employer. The objective is to determine whether an inspection is made annually at each elevator in every building owned by the company by a competent inspector. How would the auditor consider inherent risk during this engagement? A) Compare inspection reports to maintenance records by building B) Visit the older buildings and observe first hand the quality of the elevators C) Do heavier sampling of newer buildings that have only been up for a year
46) ______
D) Do heavier sampling of older elevators with previous safety defects
47) To afford a reasonable basis for a conclusion about the objectives being tested, the operational auditor must A) use corroborative evidence, such as third party confirmation. B) reduce the risk of control problems occurring in the tested area. C) accumulate sufficient appropriate evidence. D) have specific competence in the area being audited.
47) ______
48) To whom is the operational audit report normally sent? A) unit being audited, management B) management, audit committee, unit being audited C) management, audit committee, external auditors D) management, shareholders, board of directors
48) ______
49) Which of the following is/are the primary factor(s) in the use of non-standardized wording in operational audit reports? A) diversity of operational audits B) need to be creative in the expression of useful recommendations C) a lack of third-party users; diversity of operational audits D) importance to justify audit budget by carefully taking the time in wording
49) ______
50) Follow-up is important in operational auditing when recommendations are made to management. The purpose of follow-up is to A) assess employee competence and provide recommendations for promotion. B) assess management competence and susceptibility to fraud. C) provide an incentive for management to make all the recommended changes on a timely basis. D) determine whether the recommended changes were made and if not, why.
50) ______
ESSAY. Write your answer in the space provided or on a separate sheet of paper. 51) Discuss the differences and similarities between internal and external auditors using the following categories: ∙ Party to whom each is responsible ∙ Standards in performing work and reporting
52) Explain how, when and why the external auditor relies upon the internal auditor during the conduct of the financial statement audit.
53) Discuss three major differences between operational and financial auditing.
54) For each of the categories below, discuss how the role of the internal auditor has changed in recent years. Category
Changes in the Role of the Internal Auditor
A) Tension Between Roles of being the control conscience of the company and to provide strategic and operational input
B) Risk Management to control the operational risk and the integrated financial risk
C) Electronic Commerce and conducting financial activities in paperless environment.
55) Operational auditing is the review of an organization for efficiency and effectiveness. Discuss what is meant by the terms (1) "effectiveness" and (2) "efficiency."
56) Discuss the primary purpose of the auditor's evaluation of internal control in (1) an external audit of historical financial statements, and (2) an operational audit.
57) Explain how independence and competence of operational auditors is achieved.
58) List the sources of criteria that could be used for developing criteria for evaluating efficiency and effectiveness. Explain the advantages and disadvantages of each source.
59) Gustavo is the internal auditor of Fredder communications. Gustavo was asked to evaluated the quality of their new cell phone that was launched in the market in early January. Fredder communication places significant importance on high performance of their cell phones, high customer satisfaction being a first mover in the market of cell phones and staying ahead of the competition in terms of technology. In the form of questions, establish 6 specific criteria that could be used by Gustavo to evaluate the quality of the new cell phone.
60) Discuss each of the three phases in an operational audit.
1) B 2) B 3) B 4) D 5) B 6) C 7) B 8) C 9) D 10) B 11) C 12) C 13) A 14) A 15) D 16) D 17) D 18) B 19) A 20) B 21) C 22) B 23) C 24) D 25) A 26) A
27) B 28) A 29) A 30) B 31) B 32) B 33) D 34) A 35) C 36) D 37) D 38) B 39) C 40) B 41) C 42) C 43) C 44) A 45) C 46) D 47) C 48) B 49) C 50) D 51) Party to whom each is responsible: Here there are differences: External auditor: responsible to financial statement users (e.g. shareholders)
Inter although should also report to the audit committee nal audit Standards in performing work and reporting are similar: or: resp Both external and internal auditors: Must be competent as auditors onsib ∙ Must remain objective in performing their work le to ∙ ∙ Must remain objective in reporting their results man ∙ Follow a similar methodology in performing their audits, including planning and performing tests of controls age ment and substantive tests ∙ Use the audit risk model and materiality in deciding the extent of their tests and evaluating results , 52) How: ∙ The internal audit department performs relevant audit tests of the internal controls or conducts substantive tests under the direction of the financial statement auditors. ∙ External auditor reviews the work of the internal auditor to make certain that it was done to appropriate standards. When: ∙ If internal auditors are effective: 1. independent of the operating units being evaluated 2. objective 3. competent and well trained 4. perform tests that are relevant to the financial statement audit Why: ∙ To reduce control risk and thereby reduce substantive testing ∙ To reduce the client's overall audit fee ∙ The reduced fee helps the auditor retain the client 53) ∙ Purpose of the audit. Financial auditing emphasizes whether historical information was correctly recorded, whereas operational auditing emphasizes effectiveness and efficiency. ∙ Distribution of the reports. For financial auditing, the report typically goes to many users of financial statements, such as shareholders and bankers; whereas operational audit reports are intended primarily for management. ∙ Inclusion of nonfinancial areas in operational auditing. Operational audits cover any aspect of efficiency and effectiveness in an organization, whereas financial audits are limited to matters that directly affect the fairness of financial statement presentations. 54) A) The conflicting roles create and enforce rules and have resulted in tensions that must be effectively managed. They also require the internal auditors to have additional "live" skills in addition to their technical skills. Live skills include communication, decision making and business analysis. B) The internal auditors must plan their audits and link their testing to the risks assessed at the organization under audit. C) As reliance on computer networks increases, institutions must design and implement control systems that can adequately manage risk, particularly in areas such as data security and integrity, and vulnerability to viruses. Internal auditors need to be involved early in designing and developing new data systems and products, allowing institutions to build internal controls into new procedures and systems instead of controlling them after the fact. 55) Effectiveness refers to the degree to which the organization's objectives and goals are accomplished. Efficiency refers to the degree to which costs are reduced without reducing effectiveness.
56) The primary purpose of internal control evaluation for financial auditing is to determine the extent of substantive audit testing required. The purpose of internal control evaluation in an operational audit is to evaluate efficiency and effectiveness of internal control and make recommendations to management. 57) The answer varies, depending upon who conducts the operational audit. Accordingly, we look at the three different categories of auditors that could be conducting operational audits. Internal auditors Independence:
Government auditors
Public accounting firms
∙may not conduct an ∙report to a level above the operational audit for a ∙should report to the audit operating departments, e.g. public company audit client committee or to the Auditor General of Canada if the system or area president (CEO) of the reports to an all-party audited could affect organization. committee of Parliament. independence. ∙ avoid performing ∙ avoid performing ∙ avoid performing operational functions (e.g. operational functions (e.g. operational functions (e.g. acting controller). acting controller). acting controller). Competence: ∙ ensure specialist assistance ∙ ensure specialist assistance ∙ ensure specialist assistance is obtained when needed. is obtained when needed. is obtained when needed.
58) There are five potential sources of criteria listed in the text. 1) Historical performance: advantage: easy to derive disadvantage: may not provide much insight into performance 2) Benchmarking: advantage: easy to obtain if already developed by other organizations disadvantages: may not be specific to the organization; may be idealistic standards that are not achievable 3) Engineered standards: advantage: may be very effective in solving operational problems disadvantage: costly and time-consuming to develop 4) Published standards: advantage: readily available at low cost for certain processes disadvantage: may not be specific to the industry or organization 5) Discussion and agreement: advantage: will be tailored to the objectives and operations of the entity or process under audit disadvantage: time consuming to develop because requires agreement of management, the auditor, and auditee management 59) Note that judgement must be used in grading this question as answers could vary but still represent a valid response. - Has the customer satisfaction rating survey results gone up? - Has the competition launched a similar or more performant cell phone in the past year? If so, was it before or after Fredder? - Has the market share of cell phone sales increased as a result of the new cell phone launch? - What is the number of customer complaints received in the last year? Has it increased from the preceeding year?
the number of returns for defective cell phones? Wha - What type of reasons or defects were stated as the cause of returns? Are these considered major repairs? t was - What was the research expense for developing new cell phones? Is this in line with the competition? 60) ∙ Planning. In the planning phase, the auditor must determine the scope of the engagement, staff the engagement, obtain background information about the organizational unit, understand internal control, and decide on the appropriate evidence to accumulate. ∙ Evidence accumulation and evaluation. In operational auditing, it is common to use documentation, client inquiry, and observation extensively, while confirmation and reperformance are used less extensively for most operational audits than for financial audits. ∙ Reporting and follow-up. The audit report is tailored to address the scope of the audit, findings, and recommendations and is typically sent only to management. When recommendations are made to management, follow-up is done to determine whether the recommended changes were made, and if not, why.