ACCT 350 Final Exam

What are the five types of tests auditors use to determine whether financial statements are fairly​ stated? Identify which tests are performed to reduce control risk and which tests are performed to reduce planned detection risk.

What are the five types of tests auditors use to determine whether financial statements are fairly​ stated?

Identify which tests are performed to reduce control risk and which tests are performed to reduce planned detection risk.

While

risk assessment procedures

help the financial statement auditor obtain information to make an initial assessment of control

risk​,

tests of controls

must be performed to support an assessment of control risk that is below maximum. Because

substantive tests of transactions

provide evidence about whether transactions have been correctly​ recorded, these tests also provide evidence about the effectiveness of controls. Substantive evidence is obtained to

reduce

detection risk. Substantive evidence includes evidence from

substantive tests of transactions, substantive analytical procedures, and tests of details of balances.

Explain the difference among

C3​, C2​, and C1. Explain the circumstances under which it would be a good decision to obtain audit assurance from substantive tests at point C1. Do the same for points C2and C3.

The audit assurance from substantive tests and tests of controls at different levels of internal control effectiveness shows the relationship between substantive tests and control risk assessment. Explain the difference among C3​, C2​, and C1.

C represents the​ auditor’s assessment of the effectiveness of

internal control.

C3

represents the idea that it is not​ cost-effective to test internal controls and all assurance must come from substantive testing. Tests of controls at the

C1

level would support a minimum level of control risk. This would require more testing of the controls than would be required at either

C2 or C3.

Testing controls at the

C1

level allows the auditor to obtain assurance from the​ controls, thereby allowing for a reduction in the amount of substantive testing which must be performed to meet the level of acceptable audit assurance.

Explain the circumstances under which it will be a good decision to obtain audit assurance from substantive tests at point C1. Do the same for points C2and C3.

It would be a good decision to obtain assurance from

test of controls

at point

C1

especially if the cost of substantive testing is considerably greater than tests of controls. At point

C2

​,

the auditor performs some tests of controls and is able to reduce control risk below maximum. Point

C2

would be appropriate if it is cost beneficial for the auditor to obtain a proper level of assurance.

State the​ four-step approach to designing tests of controls and substantive tests of transactions.

The​ four-step approach to designing tests of controls and substantive tests of transactions is as​ follows: ​(Select the steps from the list in the proper​ order.)

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Explain the relationship of performance​ materiality, inherent​ risk, and control risk to planned tests of details of balances.

If performance materiality is​ low, and inherent risk and control risk are​ high, planned tests of details of balances which the auditor must perform will be

high.

An increase in performance materiality or a reduction of either inherent risk or control risk will

lead to a reduction

in the planned tests of details of balances.

What is the purpose of risk assessment procedures and how do they differ from the four other types of audit​ tests? ​(Select all answers that​ apply.)

A.

Risk assessment procedures are performed to assess the risk of material misstatement in the financial statements. Risk assessment procedures include procedures performed to obtain an understanding of the entity and its​ environment, including internal controls.

Your answer is correct.

B.

Risk assessment procedures are performed to assess the risk of material misstatement in the financial statements. Auditors use the results of the risk assessment procedures to design and perform further audit procedures. Further audit procedures​ (not risk assessment​ procedures) provide the auditor sufficient appropriate evidence.

RQ13-2 (book/static) Question Help

What is the purpose of tests of​ controls? Identify specific accounts on the financial statements that are affected by performing tests of controls for the acquisition and payment cycle.

What is the purpose of tests of​ controls?

Audit procedures to test the operating effectiveness of control policies and procedures in support of a reduced assessed control​ risk, and provide the primary basis for the​ auditor’s report on internal controls over financial reporting.

Identify ten specific accounts on the financial statements that are affected by performing tests of controls for the acquisition and payment cycle. ​(Select all that​ apply.)

Cash

Prepaid insurance

Accounts payable

Purchases

Purchase returns and allowances

Purchase discounts

Manufacturing expenses

Selling expenses

Leasehold improvements

Various admin expenses

RQ13-3 (book/static) Question Help

Distinguish between a test of control and a substantive test of transactions. Give two examples of each.

Select the definition of tests of​ controls?

Audit procedures to test the operating effectiveness of control policies and procedures in support of a reduced assessed control risk.

Select two examples of tests of controls.

.

Examination of employee time cards for approval of overtime hours worked.

The examination of vendor invoices for indication that they have been clerically​ tested, compare to a receiving report and purchase​ order, and approved for payment.

Select the definition of a substantive test of transactions.

Audit procedures testing for monetary misstatements to determine the six​ transactions-related objectives have been satisfied for each class of transactions.

Select two examples of a substantive test of transactions.

Examination of vendor invoices in support of amounts recorded in the acquisitions journal for purchases of inventories.

Tracing of selected customer cash receipts to the accounts receivable master​ file, agreeing customer names and amounts.

State a test of control audit procedure to test the effectiveness of the following​ control: Approved wage rates are used in calculating​ employees’ earnings. State a substantive test of transactions audit procedure to determine whether approved wage rates are actually used in calculating​ employees’ earnings.

A test of control audit procedure to test that approved wage rates are used to calculate​ employees’ earnings would be to

examine rate authorization forms to determine the existence of authorized signatures.

A substantive test of transactions audit procedure would be to

compare a sample of rates actually paid, as indicated in the earnings record, to authorized pay rate on rate authorization forms.

Explain how the calculation and comparison to previous years of the gross margin percentage and the ratio of accounts receivable to

sales are related to the confirmation of accounts receivable and other tests of the accuracy of accounts receivable.

When the results of analytical procedures are different from the​ auditor’s expectations and thereby indicate that

there may be a misstatement

in the balance in accounts receivable or​ sales,

the auditor should extend the tests to determine why the ratios are different from expectations.

Confirmation of accounts receivable and cutoff tests for sales

are two procedures that can be used to do this.

If the ratios are approximately what the auditor​ expects,

expansion in planned tests is not required.

This means that the auditor can satisfy the evidence requirements in different ways and that

analytical procedures and confirmation are complementary

when the results of the tests are both good.

Evaluate the following​ statement: “Tests of sales and cash receipts transactions are such an essential part of every audit that I like to perform them as near the end of the audit as possible. By that time I have a fairly good understanding of the​ client’s business and its internal controls because​ confirmations, cutoff​ tests, and other procedures have already been​ completed.” ​(Select all answers that​ apply.)

A.

The auditor should attempt to understand the entity and its​ environment, including internal​ controls, as early as practical through the analysis of the accounting​ system, tests of​ controls, and substantive tests of transactions.

Your answer is correct.

B.

The primary purpose of testing sales and cash receipts transactions is to evaluate the internal controls so that the scope of the substantive tests of the account balances may be set. If the auditor performs the tests of details of balances prior to testing internal​ controls, no benefit will be derived from the tests of controls.

List the eight​ balance-related audit objectives in the verification of the ending balance in inventory and provide one useful audit procedure for each of the objectives.

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RQ13-19 (book/static) Question Help

Why do auditors often consider it desirable to perform audit tests throughout the year rather than wait until​ year-end? List several examples of evidence that can be accumulated before​ year-end.

Why do auditors often consider it desirable to perform audit tests throughout the year rather than wait until​ year-end?

Auditors frequently consider it desirable to perform audit tests throughout the year rather than waiting until​ year-end because

of the CPA firm’s difficulty of scheduling personnel and the client’s need for timely financial statements.

​Additionally, public company auditors must begin their testing of controls earlier in the year to

ensure they are able to test a sufficient sample of controls for operating effectiveness.

Select eight examples of evidence that can be accumulated before​ year-end. ​(Select all that​ apply.)

Review minutes of board of​ directors’ meetings.

Examine new loan agreements and other legal records.

If the client has effective internal​ control, confirmation of accounts receivable balances may be performed with minor review and updating at​ year-end.

If the client has effective internal​ control, confirmation and reconciliation of accounts payable balances may be performed with minor review and updating at​ year-end.

If the client has effective internal​ control, observation of physical inventories may be performed with minor review and updating at​ year-end.

Analyze changes in the​ client’s accounting systems.

Update fixed asset schedules.

Vouch certain transactions.

MC13-20 (similar to) Question Help

The following questions concern types of audit tests. Choose the best response.

a. An​ auditor’s decision either to apply analytical procedures as substantive tests or to perform substantive tests of transactions and account balances usually is determined by the

relative effectiveness and efficiency of the tests.

b. The auditor faces a risk that the audit will not detect material misstatements that occur in the accounting process. To minimize this​ risk, the auditor relies primarily on

substantive tests.

c. A conceptually logical approach to the​ auditor’s evaluation of internal control consists of the following four​ steps:

I.

Determining the internal controls that should prevent or detect errors and fraud.

II.

Identifying control deficiencies to determine their effect on the​ nature, timing, or extent of auditing procedures to be applied and suggestions to be made to the client.

III.

Determining whether the necessary internal control procedures are prescribed and are being followed satisfactorily.

IV.

Considering the types of errors and fraud that can occur.

What should be the order in which these four steps are​ performed?

​IV, I,​ III, and II

The following are independent internal controls commonly found in the acquisition and payment cycle. Each control is to be considered independently.

.

Complete all answers boxes for each audit procedure in the table below.

A considerable portion of the tests of controls and substantive tests of transactions are performed simultaneously as a matter of audit convenience. But the substantive tests of transactions procedures and sample​ size, in​ part, depend on the results of the tests of controls. How can the auditor resolve this apparent​inconsistency? ​(Select all answers that​ apply.)

The auditor assumes an effective system of internal control with few or no exceptions planned. If the results of the tests of controls are as good as or better than the assumptions that were originally​ made, the auditor can be satisfied with the planned extent of substantive tests of​ transactions, unless the substantive tests of transactions themselves indicate the existence of misstatements. If the tests of controls results were not as good as the auditor assumed in designing the original​ tests, expanded substantive tests must be performed.

The auditor resolves the problem by making assumptions about the results of the tests of controls and performing both the tests of controls and substantive tests of transactions on the basis of these assumptions.

RQ13-6 (book/static) Question Help

Distinguish between substantive tests of transactions and tests of details of balances. Give one example of each for the acquisition and payment cycle.

Match the terms with the correct definition.

Tests performed to verify the ending balance in an individual account on the financial

• Test of details of balance

statements.

Tests performed to verify the accuracy of a client’s accounting system. This is

• Substantive test of transactions

accomplished by determining whether individual transactions are correctly recorded

and summarized in the journals, master files, and general ledger.

Select an example of a substantive test of transaction.

Tracing amounts from a file of vouchers to the acquisitions journal.

Select an example of a test of details of balances.

Physically examine a sample of the​ client’s fixed assets.

The auditor of​ Ferguson’s Inc. identified two internal controls in the sales and collection cycle for testing. In the first​ control, the computer verifies that a planned sale on account will not exceed the​ customer’s credit limit entered in the accounts receivable master file. In the second​ control, the accounts receivable clerk matches bills of​ lading, sales​ invoices, and customer orders before recording in the sales journal. Describe how the presence of general controls over software programs and master file changes affects the extent of audit testing of each of these two internal controls.

Control​ #1 — Computer verification of the​ customer’s credit limit.

The presence of effective general controls over software programs and master file changes

can significantly reduce

the​ auditor’s testing of automated controls such as control​ #1. Once it is determined that control​ #1 is functioning​ properly, the auditor can

focus subsequent tests on assessing whether any changes have occurred that would limit the effectiveness of the control.

Such tests might include

determining whether any changes have occurred to the program

and whether

these changes were properly authorized and tested prior to implementation.

Control​ #2 – The accounts receivable clerk matches bills of​ lading, sales​ invoices, and customer orders before recording in the sales journal.

This control is

a manual

control. General controls over software programs and master file changes would have

little effect

on the​ auditor’s testing of control​ #2. If the auditor identifies control​ #2 as a key control in the sales and collection​ cycle, he or she would

examine a sample of the underlying documents for the accounts receivable clerk’s initials and reperform the comparisons.

Indicate the four phases of the audit process. In which phase does the auditor perform tests of​ controls?

State what is meant by a representative sample and explain its importance in sampling audit populations.

A representative sample is one in which the characteristics of interest for the sample are approximately the same as for the population. With a representative​sample, sampled items are similar to the items not sampled.

Explain the major difference between statistical and nonstatistical sampling. Are both methods acceptable according to auditing​ standards?

The major difference between statistical and nonstatistical sampling is that the auditor

quantifies sampling risk when statistical sampling is used but not when nonstatistical sampling is used.

Are both methods acceptable according to auditing​ standards?

Auditing standards permit auditors to use either statistical or nonstatisticalsampling methods.

Explain what is meant by analysis of exceptions and discuss its importance.

Analysis of exceptions is the investigation of individual exceptions to determine the cause of the breakdown in internal control. Such analysis is important because by discovering the nature and causes of individual​ exceptions, the auditor can more effectively evaluate the effectiveness of internal control. The analysis attempts to tell the​ “why” and​ “how” of the exceptions after the auditor already knows how many and what types of exceptions have occurred.                                      

What are the steps of the audit sampling process that differ across statistical and nonstatistical sampling​ approaches? In what ways do they​ differ?

Choose the steps of the audit sampling process that differ across statistical and nonstatistical sampling approaches and then choose the ways in which they​ differ?

Explain what is meant by block sample selection and describe how an auditor can obtain five blocks of 20 sales invoices from a sales journal.

Explain what is meant by block sample selection.

A block sample is the selection of several items in sequence. Once the first item in the block is​ selected, the remainder of the block is chosen automatically.

Describe how an auditor can obtain five blocks of 20 sales invoices from a sales journal.

To select 5 blocks of 20 sales​ invoices, the auditor would select one invoice and the block would be that invoice plus the next 19 entries. This procedure would be repeated 4 other times.

Explain the difference between replacement sampling and nonreplacement sampling. Which method do auditors usually​ follow? Why?

Choose the statements that are true. ​(Select all that​ apply.)

In replacement​ sampling, an element in the population can be included in the sample more than once if the random number corresponding to that element is selected more than once.

In nonreplacement​ sampling, an element can be included only once. If the random number corresponding to an element is selected more than​ once, it is simply treated as a discard the second time.

Which method do auditors usually​ follow? Why?

Although both selection approaches are consistent with sound statistical​ theory, auditors rarely use

replacement

​sampling; it seems more intuitively satisfying to auditors to include an item

onlyonce.

What are the two types of simple random sample selection​ methods? Which of the two methods is used most often by auditors and​ why?

What are the two types of simple random sample selection​ methods?

Two methods of simple random selection are use of a random number table and use of the computer to generate random numbers.

Which of the two methods is used most often by auditors and​ why?

Auditors most often use the computer to generate random numbers because it saves​ time, reduces the likelihood of​ error, and provides automatic documentation of the sample selected.

Describe systematic sample selection and explain how an auditor will select

40numbers from a population of 2,800 items using this approach. What are the advantages and disadvantages of systematic sample​ selection?

In systematic​ sampling, the auditor calculates an interval and then methodically selects the items for the sample based on the size of the interval. The interval is set by dividing the population size by the number of sample items desired. To select 40 numbers from a population of 2,800​, the auditor divides 40into 2,800 and gets an interval of 70. He or she then selects a random number between 0 and 69.

What are the advantages of systematic sample​ selection? ​(Select all that​ apply.)

In most populations a systematic sample can be drawn quickly.

This approach automatically puts the numbers in sequential​ order, and documentation is easy.

Systematic sampling is easy to use.

What are the disadvantages of systematic sample​ selection? ​(Select all that​ apply.)

Systematic sampling has the possibility of bias.

Auditors must consider possible patterns in the population data that can cause sample bias.

Distinguish between probabilistic selection and statistical measurement. State the circumstances under which one can be used without the other.

Distinguish between probabilistic selection and statistical measurement.

Random​ (probabilistic) selection

is a part of statistical sampling, but it is not, by itself,

statistical measurement. To have statistical​ measurement, it is necessary to

mathematically generalize from the sample to the population

.

State the circumstances under which one can be used without the other.

Probabilistic selection must be used if the sample is to be evaluated​ statistically, although it is also acceptable to use probabilistic selection with a nonstatistical evaluation. If nonprobabilistic selection is​ used, nonstatistical evaluation must be used.

What is the purpose of using nonstatistical sampling for tests of controls and substantive tests of​ transactions?

The purpose of using nonstatistical sampling for tests of controls and substantive tests of transactions is to estimate the proportion of items in a population containing a characteristic or attribute of interest.

Define each of the following​ terms:

a. Acceptable risk of overreliance​ (ARO)

b. Computed upper exception rate​ (CUER)

c. Estimated population exception rate​ (EPER)

d. Sample exception rate​ (SER)

e. Tolerable exception rate​ (TER)

For each​ definition, select the acronym of the term that matches the definition.

State the relationship between the​ following:

a. ARO and sample size

b. Population size and sample size

c. TER and sample size

d. EPER and sample size

Select your answers for each of the following​ statements:

a. As the ARO​ increases, the required sample size decreases

.

b. As the population size​ increases, the required sample size normally

is unchanged, or may increaseslightly.

c. As the TER​ increases, the sample size decreases

.

d. As the EPER​ increases, the required sample sizeincreases

.

When the

CUER

exceeds the

TER​,

what courses of action are available to the​ auditor? Under what circumstances should each of these be​ followed?

​(Leave unused cells​ blank.)

The following questions concern sampling for attributes. Choose the best response.

a. An advantage of statistical sampling over nonstatistical sampling is that statistical sampling helps an auditor

measure the sufficiency of the audit evidence by quantifying sampling risk.

b. Which of the following best illustrates the concept of sampling​ risk?

A randomly chosen sample may not be representative of the population as a whole for the characteristic of interest.

c. For which of the following tests would an auditor most likely use attribute​ sampling?

Inspecting employee time cards for proper approval by supervisors.

The following questions concern audit sampling. Choose the best response.

a. As compared to a nonstatistical sampling​ plan, a statistical sampling plan

makes greater use of mathematical methods in determining an appropriate sample size.

b. The diagram below depicts an​ auditor’s computed upper exception rate​ (CUER) compared with the tolerable exception rate​ (TER), and also depicts the true population exception rate compared with the TER.

As a result of tests of​ controls, the auditor assesses control risk too low and thereby decreases substantive testing. This is illustrated by which​ situation?

III

c. In assessing sampling​ risk, the risk of underreliance​ (i.e. the risk of assessing control risk too​ high) relates to the

efficiency of the audit.

For the audit of the financial statements of MercuryFifo​ Company, StellaMasonCPA, has decided to apply nonstatistical audit sampling in the tests of controls and substantive tests of transactions for sales transactions. Based on her knowledge of Mercury’s operations in the area of​ sales, she decides that the EPER is likely to be 3 %And that she is willing to accept a 5 % risk that the true population exception rate is not greater than 6 % Given this​ information, Mason selects a random sample of 150 sales invoices from the 5 comma 0005,000 generated during the year and examines them for exceptions. She notes the following exceptions in her audit schedules. There is no other documentation.

.

Requirement a. Which of the comments should be defined as an​ exception?

For each invoice​ listed, indicate whether the comment associated with the invoice represents an exception by selecting​ “Yes” or​ “No”. ​(Complete all answer​boxes.)

Requirement b. Explain why it is inappropriate to set a single acceptable TER and EPER for the combined exceptions.

Each attribute has a different significance to the auditor and should be considered separately in analyzing the results of the test.

Requirement c​ & d. Calculate SER for each attribute tested in the population.​ (You must decide which attributes should be​ combined, which should be kept​separate, and which exceptions are actual exceptions before you can calculate​ SER.) Then, in the next​ step, calculate TERminus−SER for each attribute and evaluate whether the calculated allowance for sampling risk is sufficiently large given the 5 %ARO. Assume TER is 6 % for each attribute. ​(If a comment is not considered an exception leave all boxes related to that comment​ empty; do not select a label or enter a zero. Round all applicable percentages to the nearest hundreth percent​X.XX%.)

Requirement e. State the appropriate analysis of exceptions for each of the exceptions in the​ sample, including additional procedures to be performed. ​(If a box is not used in the table leave the box​ empty; do not select a​ response.)

The sampling data sheet below is missing selected information for six attributes involving tests of transactions for the sales and collection cycle.

.

Requirement a. Use the tables below to complete the missing information for each attribute. ​(Complete all answer​ boxes.)

Requirement b. For which attributes are the sample results​ unacceptable?

The sample results are unacceptable for

attributes 1 and 6

.

Requirement c. Compare attributes 1 and 3. Why does attribute 1 have the smaller sample​ size?

The sample size for attribute 1 is smaller than the sample size for attribute 3 because the

EPER

is

smaller

for attribute 1 than it is for attribute 3.

Requirement d. Compare attributes 2 and 5. Why is CUER higher for attribute​ 5?

CUER is higher for attribute 5 for the following​ reason:

What are the major differences in the 14 steps used in nonstatistical sampling for tests of details of balances versus the steps for tests of controls and substantive tests of​ transactions?

The steps in nonstatistical sampling for tests of details of balances and for tests of controls are almost identical. The major differences are that

sampling for tests of controls

deals with exceptions and

sampling for tests of details of balances

concerns dollar amounts. This results in differences

in the application of the two methods, but not the steps.

Because of these​ differences, tests of controls and substantive tests of transactions are designed to measure the

occurrence rate of an attribute.

In​ contrast, tests of details of balances are designed to measure the

amount of monetary misstatements in the population being sampled.

What alternative courses of action are appropriate when a population is rejected using nonstatistical sampling for tests of details of​ balances? When should each option be​ followed? ​(Select all that​ apply.)

C.

Request the client to correct the population. In some cases the​ client’s records are so inadequate that a correction of the entire population is required before the audit can be completed.

Your answer is correct.

D.

Increase the sample size. When the auditor increases the sample​ size, sampling risk 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. Increasing the sample​ size, therefore, may allow the auditor to conclude that the population is acceptable.

Your answer is correct.

E.

Refuse to give an unmodified opinion. If the auditor believes the recorded amount in accounts receivable or any other account is not fairly​ stated, it is necessary to follow at least one of the above alternatives or to qualify the audit opinion in an appropriate manner.

Your answer is correct.

F.

Perform expanded audit tests in specific areas. If an analysis of the misstatements indicates that most of the misstatements are of a specific​ type, it may be desirable to restrict the additional audit effort to the problem area.

Your answer is correct.

G.

Adjust the account balance. When the auditor concludes that an account balance is materially​ misstated, the client may be willing to adjust the book value.

Define the sampling interval when using MUS sampling. How is it​ calculated?

.

The sampling interval is the book value of the population being sampled divided by the sample size. An individual dollar that is selected for sampling represents the entire sampling interval.

Distinguish among difference​ estimation, ratio​ estimation, mean-per-unit​ estimation, and stratified​ mean-per-unit estimation. Give one example in which each can be used.

Begin by selecting the definition for each term.

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Select an example in which each can be used.

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What major difference between​ (a) tests of controls and substantive tests of transactions and​ (b) tests of details of balances makes attributes sampling inappropriate for tests of details of​ balances?

Begin by identifying the major difference between​ (a) tests of controls and substantive tests of transactions and​ (b) tests of details of balances.

The most important difference between​ (a) tests of controls and substantive tests of transactions and​ (b) tests of details of balances is

in what the auditor wants to measure. In tests of controls and substantive tests of​ transactions, the primary concern is testing the effectiveness of internal controls and the rate of monetary misstatements. In tests of details of​ balances, the concern is determining whether the monetary amount of an account balance is materially misstated.

This major difference​ (noted above) makes attributes sampling inappropriate for tests of details of balances because attributes sampling measures

the frequency of occurrence,

where details of balances are concerned with

whether the dollar amounts of account balances are materially misstated.

Define stratified sampling and explain its importance in auditing. How can an auditor obtain a stratified sample of 30 items from each of three strata in the confirmation of accounts​ receivable?

Begin by defining stratified sampling and explain its importance in auditing.

Stratified sampling is a method of sampling in which all the elements in the total population are divided into two or more subpopulations. Each subpopulation is then independently​ sampled, tested and the results projected to the population. After the results of the individual parts have been​computed, they are combined into one overall population measurement. Stratified sampling is important when the auditor wants to emphasize testing of certain population items.

How can an auditor obtain a stratified sample of 30 items from each of three strata in the confirmation of accounts​ receivable?

In order for an auditor to obtain a stratified sample of 30 items from each of three strata in the confirmation of accounts​ receivable, he or she must first divide the population into three mutually exclusive strata. A random sample of 30 items is then selected independently for each stratum.

Define what is meant by sampling risk. Does sampling risk apply to nonstatistical​ sampling, MUS, attributes​ sampling, and variables​ sampling? Explain.

Sampling risk is

the risk that the characteristics in the sample are not representative of those in the population.

Does sampling risk apply to nonstatistical​ sampling, MUS, attributes​ sampling, and variables​ sampling? Explain.

The two types of sampling risk faced by the auditor testing an account balance​ are: (a)

The risk of incorrect acceptance (ARIA)

—this

is the risk that the sample supports the conclusion that the recorded account balance is not materially misstated when it is materially​ misstated, and​ (b)

The risk of incorrect rejection (ARIR)

—this

is the risk that the sample supports the conclusion that the recorded account balance is materially misstated when it is not materially misstated.

Sampling risk occurs

whenever a sample is taken from a population

and therefore

applies to all sampling methods.

While

ARIA

applies to all sampling​ methods,

ARIR

is only used in variables sampling and difference estimation.

Explain what is meant by basic precision. How is it​ determined?

Begin by defining basic precision.

Basic precision is the upper limit when no misstatements are found in the​ sample, and represents the minimum allowance for sampling risk inherent in the sample.

How is it​ determined?

It is calculated by multiplying the sampling interval by the confidence factor for zero misstatements at the specified level of ARIA.

Define what is meant by the population standard deviation and explain its importance in variables sampling. What is the relationship between the population standard deviation and the required sample​ size?

The population standard deviation is

a measure of the difference between the individual values and the mean of the population.

It is calculated for  

all variables sampling methods but not for monetary unit sampling.

For the​ auditor, it is usually estimated

before

determining the required sample​ size, based on the previous​ year’s results or on a preliminary sample.

The required sample size is

directly proportional to the square of the population standard deviation

In using difference​ estimation, an auditor took a random sample of 100 inventory items from a large population to test for proper pricing. Several of the inventory items were​ misstated, but the combined net amount of the sample misstatement was not material. In​ addition, a review of the individual misstatements indicated that no misstatement was by itself material. As a​ result, the auditor did not investigate the misstatements or make a statistical evaluation. Explain why this practice is improper.

All of the above.

Explain why difference estimation is commonly used by auditors.

Difference estimation can be very effective and very efficient where

(1) an audited value and a book value is available for each population item

​,

(2) a relatively high frequency of misstatements is expected

​,

and

(3) a result in the form of a confidence interval is desired.

In those​circumstances, difference estimation

far outperforms

both MUS and​ mean-per-unit estimation. It

may or may not

outperform ratio​ estimation, depending on the relationship of misstatement amounts to recorded amounts. If focus on

large dollar value items is required

​,

difference estimation can be used with stratification.

The following questions relate to determining sample size in tests of details of balances. For each​ one, select the best response.

a. Mr. Murray decides to use stratified sampling. The reason for using stratified sampling rather than unrestricted random sampling is to

allow the auditor to emphasize larger items from the population.

b. Which of the following sample planning factors will influence the sample size for a test of details of balances for a specific​ account?

3.

                                                                                              Yes                                                                                                                                                                                                                 Yes

c. How would increases in tolerable misstatement and assessed level of control risk affect the sample size in substantive tests of​ details?

3. Decrease sample sizeIncrease sample size

The following apply to evaluating results of audit sampling for tests of details of balances. For each​ one, select the best response.

a. While performing a substantive test of details during an​ audit, the auditor determined that the sample results supported the conclusion that the recorded account balance was materially misstated. It​ was, in​ fact, not materially misstated. This situation illustrates the risk of

incorrect rejection.

b. In an MUS sample with a sampling interval of​ $5,000, an auditor discovered that a selected accounts receivable with a recorded amount of​ $10,000 had an audit value of​ $8,000. If this is the only error discovered by the​ auditor, the projected error of the sample would be

​$2,000.

c. The accounting department reports the accounts receivable balance as​ $175,000. You are willing to accept that balance if it is within​ $15,000 of the actual balance. Using a variables sampling​ plan, you compute a​ 95% confidence interval of​ $173,000 to​ $187,000. You would therefore

accept the​ $175,000 balance because the confidence interval is within the materiality limits.

The following questions relate to nonstatistical and monetary unit sampling. Choose the best response.

a. A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being​ equal, which of the following would lead to a larger sample​ size?

Smaller measure of tolerable misstatement

b. The risk of incorrect acceptance relates to

substantive tests and affects audit effectiveness.

c. In a​ probability-proportional-to-size sample with a sampling interval of $3,000​, which of the following is​ true?

Both I and II

CC19-1

The emphasis in auditing​ property, plant, and equipment is on the current period acquisitions and disposals rather than on the balances in the account carried forward from the preceding year because

there is an expectation that permanent assets will be kept and maintained on the records for several years.The assets carried over from the preceding years can be assumed to have been verified

in the prior​ years’ audits. If tests of controls and substantive tests of transactions do not show

that all disposals have been​ recorded, additional testingof the prior balance could be required. 

CC19-3

Distinguish between the evaluation of the adequacy of insurance coverage and the verification of prepaid insurance. Explain which is more important in a typical audit. 

The evaluation of the adequacy of insurance is a test of reasonable protection against the loss of existing​ assets; however, the verification of the prepaid insurance is performed to determine whether the balances represent proper charges against future operations. The evaluation of adequacy of insurance coverage is more important because of the potential loss due to​ under-insurance.

CC19-4

In verifying accounts​ payable, it is common to restrict the audit sample to a small portion of the population​ items, whereas in auditing accrued property​ taxes, it is common to verify all transactions for the year. Explain the reason for the difference.

Property tax accruals take little audit time because there are few transactions to test and they are typically material in amount. Accounts payable takes a significant amount of audit time because there are usually a large number of transactions to test and they are typically varied in amount.

CC19-5

What is meant by the analysis of expense​ accounts? List four expense accounts that are commonly analyzed in audits.

The analysis of expense accounts is a procedure by which selected expense accounts are verified by examining underlying supporting​ vendors’ invoices or other documentation to determine if the transactions making up the total are correctly stated.        

The emphasis in most expense account analysis is on the occurrence of recorded​ amounts, accuracy and classification

List four expense accounts that are commonly analyzed in audits                              

Legal​ expense, travel and entertainment​ expense, repair and maintenance​ expense, tax expense

RQ19-1

Identify three asset​ accounts, three expense​ accounts, and three liability accounts typically associated with acquisition and payment cycle transactions.

Begin by identifying three asset accounts typically associated with acquisition and payment cycle transactions.

Now identify three expense accounts typically associated with acquisition and payment cycle transactions.

• Cash,​ (2) Inventory and​ (3) Prepaid insurance

​Finally, identify three liability accounts typically associated with acquisition and payment cycle transactions.

• Cost of goods​ sold, (2) Property taxes and​ (3) Professional fees


​(1) Accounts​ payable, (2) Income taxes payable and​ (3) Accrued professional fees

RQ19-2

Explain the relationship between substantive tests of transactions for the acquisition and payment cycle and tests of details of balances for the verification of​ property, plant, and equipment. Which aspects of​ property, plant, and equipment are directly affected by the tests of controls and substantive tests of transactions and which are​ not?

Begin by explaining the relationship between substantive tests of transactions for the acquisition and payment cycle and tests of details of balances for the verification of​ property, plant, and equipment. Complete the statement below.

Because the source of the debits in the asset account is the acquisitions journal​ (or similar​ record), the current period acquisitions of​ property, plant and equipment have already beenpartially verified as part of the acquisition and payment cycle.

​Next, select which aspects of​ property, plant, and equipment are directly affected by the tests of controls and substantive tests of transactions and which are​ not?  

The​ occurrence, completeness,​ accuracy, cutoff, and classification of acquisitions of​ property, plant, and equipment Wouldhave been examined. The disposal of​assets, depreciation and accumulated depreciation are not testedas a part of the acquisition and payment cycle.

RQ19-3

What is the relationship between the audit of​ property, plant, and equipment accounts and the audit of repair and maintenance​ accounts? Explain how the auditor organizes the audit to take this relationship into consideration.

Many clients accidentally or intentionally record purchases of assets in the repair and maintenance accounts instead of​ property, plant, and equipment account. The auditor can vouch the larger amounts debited to the expense accounts at the same time that property accounts are being audited to uncover unrecorded property purchases.

RQ19-6

Explain the relationship between substantive tests of transactions for the acquisition and payment cycle and tests of details of balances for the verification of prepaid insurance.


Since the source of the debits to prepaid insurance is the acquisitions journal or similar​ record, the current period premiums have already been partially verified as a part of the acquisition and payment cycle. The allocation of premium payments is not tested.

RQ19-9

Explain the relationship between accrued rent and substantive tests of transactions for the acquisition and payment cycle. Which aspects of accrued rent are not verified as part of the substantive tests of​ transactions?


Debits to accrued rent arise from the cash disbursements​ journal, which is verified as a part of tests of controls and substantive tests of transactions for cash disbursements. Tests of controls and substantive tests of transactions do not include verification of the inclusion of accruals on all existing property.

RQ19-10

Which documents will be used to verify accrued property taxes and the related expense​ accounts? ​(Select all that​ apply.)

Invoices from the taxing authority

Cancelled checks

Property tax returns

Deeds to properties

RQ19-11

List three expense accounts that are tested as part of the acquisition and payment cycle or the payroll and personnel cycle. List three expense accounts that are not directly verified as part of the cycle.

List three expense accounts that are tested as part of the acquisition and payment cycle or the payroll and personnel cycle.

Property tax expense

Payroll expense

Rent expense

List three expense accounts that are not directly verified as part of the cycle.

​Year-end bonuses to officers

Depreciation expense

Amortization​ expense, patents

RQ19-12

Explain how expense account analysis relates to the tests of controls and substantive tests of transactions that the auditor has already completed for the acquisition and payment cycle. ​(Select all answers that​ apply.)

The differences are that tests of controls and substantive tests of transactions are selected from all of the acquisitions and cash disbursements journals for the entire period whereas transactions examined for expense analysis are limited to the account being analyzed.

Potentially the same objectives are accomplished in tests of controls and substantive tests of transactions as for expense account analysis.

RQ19-13

How will the approach for verifying repair expense differ from that used to audit depreciation​ expense? Why will the approach be​ different?

How will the approach for verifying repair expense differ from that used to audit depreciation​ expense?

The emphasis for verifying repair expense should be on vouching transactions that may be capital​ items; however, the approach for verifying depreciation expense should emphasize the consistency of the method of depreciaiton used and the related computations.

Why will the approach be​ different?

The approach is different because in repairs and maintenance the primary objective is to locate improperly classified fixed​ assets, whereas in depreciation the emphasis is on consistency from period to period and accurate depreciation calculations.

RQ19-14

List the factors that should affect the​ auditor’s decision whether to analyze an account balance. ​(Select all that​ apply.)

The account is likely to contain misstatements because it is difficult for the client to properly classify or value the transactions.

The test of controls and substantive tests of transactions indicate there is a high likelihood of misstatement in an account.

The analytical procedures indicate there is a high likelihood of misstatement in an account.

The analysis of the account might disclose a contingency.

Tax returns and the SEC require the disclosure of certain​ information, which the account is likely to provide.

The account is likely to contain misstatements because it is difficult for the client to properly classify or value the transactions.

RQ19-15

The following questions concern internal controls in the acquisition and payment cycle. Choose the best response.

a. Which of the following controls will most likely justify a reduced assessed level of control risk for the existence assertion for​ equipment?

Internal auditors periodically select equipment items in the fixed assets master file and locate the related equipment on company premises.

b. Equipment acquisitions that are misclassified as maintenance expense most likely would be detected by an internal control that provides for

investigations of variances within a formal budgeting system.

c. Which of the following questions is an auditor least likely to include on an internal control questionnaire concerning the initiation and execution of equipment​transactions?

Are procedures in place to monitor and properly restrict access to​ equipment?

MC19-16

The following questions concern the audit of asset accounts in the acquisition and payment cycle. Choose the best response.

a. In testing for unrecorded disposals of​ equipment, an auditor most likely will


select items of equipment from the accounting records and then locate them during the plant tour.

b. Which of the following analytical procedure results might suggest that certain repairs and maintenance expenses have been inappropriately​ capitalized?

The balance in the repairs and maintenance expense account is noticeably lower than amounts recorded in the past several years.

c. In connection with the audit of the prepaid insurance​ account, which of the following procedures is usually not performed by the​ auditor?

Confirm premium rates with an independent insurance broker.

MC19-17

The following questions concern the audit of income and expense accounts. Choose the best response.

a. The auditor may note that annual depreciation expense is too low for a class of assets by noting


excessive recurring losses on assets retired.

b. An​ auditor’s principal objective in analyzing repairs and maintenance expense accounts is to

discover expenditures that were expensed but should have been capitalized.

c. Which of the following comparisons will be most useful to an auditor in auditing an​ entity’s income and expense​ accounts?

Current year revenue to budgeted current year revenue

MC19-18

The following questions concern internal controls and tests for​ property, plant, and equipment. Choose the best response.

a. An audit firm performs a preliminary review of the​ client’s internal controls over its​ property, plant, and equipment cycle. Which of the following would represent a weakness in internal​ control?

The purchasing department generates a special requisition form upon oral or written approval by senior management.

b. In searching for unrecorded​ retirements, an auditor selects older fixed assets from the subsidiary ledger and then tries to locate those assets. This procedure primarily relates to​ management’s assertion of

existence

c. When auditing a​ client’s property,​ plant, and equipment​ transactions, which of the following tests of details can be used to support the existence and occurrence​assertion?

Vouch a sample of purchases to the vendor invoice and receiving report.

P19-19

For each of the following misstatements in​ property, plant, and equipment​ accounts, state an internal control that the client can implement to prevent the misstatement from occurring and a substantive audit procedure that the auditor can use to discover the​ misstatement:

(Enter each internal control only​ once.)

Item	Internal Control
1.	Have office manager periodically report whether or not there have been abandonments or replacements.
2.	Internally verify charges for depreciation expenses.
3.	Use of government study depreciation tables.
4.	Establish a policy for deciding which items require capitalization and establish an internal verification procedure.
5.	Require internal verification in the recording of property acquisitions.
6.	Require the deposit of all cash directly into the bank account.
7.	Assign tools to individual foreman and periodically count the tools.

​(Enter each substantive audit procedure only​ once.)

Item	Substantive audit procedures
1.	Trace from equipment recorded on the accounting records to the equipment.
2.	Compare depreciation expense for administration and manufacturing to previous years.
3.	Compare to government study depreciation table.
4.	Test all expense charges to these accounts that exceed a certain amount.
5.	Compare supporting documentation on property acquisitions to the recorded value.
6.	Confirm loans with the bank and perform other tests for unrecorded loans.
	Examine plant asset additions and agree to recorded amounts and date.
7.	Check the client’s physical count of the tools.

P19-20

The following types of internal controls are commonly used by organizations for​ property, plant, and​ equipment:

LOADING…

​(Click

on the icon to view the types of internal​ control.)

Requirements

a.	State the purpose of each of the internal controls just listed. Your answer should be in the form of the type of misstatement that is likely to be reduced because of the control.
b.	For each internal​ control, list one test of control the auditor can use to test for its existence.
c.	List one substantive procedure for testing whether the control is actually preventing misstatements in​ property, plant, and equipment.

Requirement a. State the purpose of each of the internal controls just listed. Your answer should be in the form of the type of misstatement that is likely to be reduced because of the control.

LOADING…

​(Click

on the link to view the type of misstatements that are likely to be reduced because of the​ control.)

	Internal Control	Purpose
1.	Written policies exist and are known by accounting personnel to differentiate between capitalizable additions,	2.
	freight, installation costs, replacements, and maintenance expenditures.
2.	A fixed asset master file is maintained with a separate record for each fixed asset.	3.
3.	Acquisitions of fixed assets in excess of $50,000 are approved by the board of directors.	5.
4.	When practical, equipment is labeled with metal tags and is inventoried on a systematic basis.	4.
5.	Depreciation charges for individual assets are calculated for each asset; recorded in a fixed asset master file	1.
	that includes cost, depreciation, and accumulated depreciation for each asset; and verified periodically by an
	independent clerk.

Requirement b. For each internal​ control, list one test of control the auditor can use to test for its existence.

	Internal Control	Test
1.	Written policies exist and are known by accounting personnel to differentiate between capitalizable additions,	10.
	freight, installation costs, replacements, and maintenance expenditures.
2.	A fixed asset master file is maintained with a separate record for each fixed asset.	9.
3.	Acquisitions of fixed assets in excess of $50,000 are approved by the board of directors.	6.
4.	When practical, equipment is labeled with metal tags and is inventoried on a systematic basis.	8.
5.	Depreciation charges for individual assets are calculated for each asset; recorded in a fixed asset master file	7.
	that includes cost, depreciation, and accumulated depreciation for each asset; and verified periodically by an
	independent clerk.

Requirement c. List one substantive procedure for testing whether the control is actually preventing misstatements in​ property, plant, and equipment.

	Internal Control	Procedures
1.	Written policies exist and are known by accounting personnel to differentiate between capitalizable additions,	12.
	freight, installation costs, replacements, and maintenance expenditures.
2.	A fixed asset master file is maintained with a separate record for each fixed asset.	13.

3. 11

4. 15

5. 14

P19-21

The following audit procedures were planned by Linda​ King, CPA, in the audit of the acquisition and payment cycle for Cooley​ Products, Inc.:

Complete all answers boxes for each audit procedure in the table below. ​

	Requirement
	Type of evidence used (a.)		Type of procedure (b.)		Objectives (c., d.)
1.	Analytical procedure		SAP		Occurrence + Accuracy + Classification

3.	Inspection of external documentation	TDB	Completeness + Accuracy + Cutoff
4.	Inspection of external documentation	TOC + STOT		Occurrence + Accuracy + Timing + Classification

5.	Recalculation	STOT		Posting and summarization
6.	Confirmation		TDB	Existence + Completeness + Accuracy + Cutoff

7.	Inspection of internal documentation		TOC	Completeness
8.	Physical examination	TDB			Existence + Realizable value

9.	Analytical procedure			SAP		Existence + Completeness + Accuracy
Inquiry of client	TDB		Completeness + Accuracy

11.	Inspection of external documentation	STOT		Completeness + Accuracy + Timing
12.	Recalculation		TDB		Accuracy

P19-22

Your​ client, Edgartown​ Corporation, prepared the following schedule of​ land, buildings and equipment for the audit of financial statements for the year ended December​31, 2016:

.

Requirement a. What type of evidence would you examine to support the beginning balances in the​ accounts?


The amount can be verified by examining the ending audited balances in the prior year audit files.

Requirement b. What types of evidence would you use to support the additions to each​ account? How might the sources of evidence differ for additions to the building account and the equipment​ accounts?

To obtain evidence about the items in the additions​ column, the auditor obtains detailed information of

individual additions

for each account category. The equipment accounts are examined for accuracy by

matching the amounts against invoices, purchase contracts, and receiving reports.

For the building​ account, the auditor may examine

property deeds and contracts for purchases.

For large​ purchases, the auditor may want to examine

approvals noted in board of directors minutes.

Requirement c. What types of evidence would you examine to support equipment​ disposals?

To obtain evidence about the items in the disposal​ column, the auditor would obtain detailed information of

individual disposals

for each account category. The disposal schedule is examined for​ accuracy,

matching it against the shipping documents and cash receipts.

Requirement d. What procedures would you perform related to the ending balances in the​ accounts?

The ending balances on the schedule should be tied to the general ledger balances and traced to the line item in the balance sheet. It must also be recalculated for mathematical accuracy.

Requirement e. In the audit of​ property, plant, and equipment​ accounts, auditors should consider whether there are any implications to other accounts in the audit. 1. What other accounts might be impacted by the additions of buildings and​ equipment? 2. What other accounts might be impacted by disposals of​ equipment?

What other accounts might be impacted by the additions of buildings and​ equipment? ​(Select all that​ apply.)

​Long-term debt

Depreciation expense accounts

​Long-term capital leases

Short-term debt

Lease expense

The following accounts may be affected by the disposal of equipment. ​(Select all that​ apply.)

Accumulated​ depreciation, equipment

Other income

Cash

Gain or loss on disposal

P19-23

The following program has been prepared for the audit of accrued real estate taxes of a client that pays taxes on 25 different pieces of​ property, some of which have been acquired in the current​ year:

1. Obtain a schedule of accrued taxes from the client and tie the total to the general ledger.

2. Compare the charges for annual tax payments with property tax assessment bills.

3. Recompute​ accrued/prepaid amounts for all bills on the basis of the portion of the year expired.

Requirements

a. State the purpose of each procedure.

b. Evaluate the adequacy of the audit program.

Requirement a. Select the appropriate purpose of each procedure.

	Purpose of each procedure
1.	To assure that the clients’ detailed schedule equals the total in the general ledger. (Detail tie-in)
2.	To assure that taxes on property included on the schedule of accrued taxes are not over- or underpaid. (Accuracy)
3.	To assure that the accrued/prepaid account is correctly stated. (Accuracy)

Requirement b. Evaluate the adequacy of the audit program.

	Adequacy of Audit Program
1.	This procedure is necessary as a starting point to perform detailed tests.
2.	This procedure is adequate for its purpose.
3.	This procedure is adequate for its purpose.

P19-24

As part of the audit of different audit​ areas, auditors should be alert for the possibility of unrecorded liabilities. For each of the following audit areas or​ accounts, describe a liability that can be uncovered and the audit procedures that can uncover​ it:

a.	Minutes of the board of directors meetings
b.	Land and buildings
c.	Rent expense
d.	Interest expense
e.	Cash surrender value of life insurance
f.	Cash in the bank
g.	​Officers’ travel and entertainment expenses

​(Each liability can be selected more than​ once.)

	Accounts	Liability that could be uncovered
a.	Minutes of the board of directors meetings	Contingent liability related to a lawsuit.
b.	Land and buildings	Building used as collateral for a loan or mortgage tied to the building’s purchase.
c.	Rent expense	Unrecorded lease.
d.	Interest expense	Note payable.
e.	Cash surrender value of life insurance	Loan by borrowing against an insurance policy.
f.	Cash in the bank	Note payable.
g.	Officers’ travel and entertainment expenses	Income taxes payable for nondeductible expenses.

​(Each audit procedure can be selected more than​ once.)

	Accounts	Audit procedure to uncover liability
a.	Minutes of the board of directors meetings	Review minutes of the Board of Directors’ meetings.
b.	Land and buildings	Examine documents of ownership to determine if the loan is collateralized.
		Send confirmations to major banks.
c.	Rent expense	Examine lease agreements.
d.	Interest expense	Examine underlying records for loans related to the interest expense.
		Send confirmations to major banks.
e.	Cash surrender value of life insurance	Obtain a confirmation from the life insurance company.
f.	Cash in the bank	Obtain confirmation from bank for loans.
g.	Officers’ travel and entertainment expenses	Examine a sample of travel and expense reports to ensure IRS compliance

P19-25

You are auditing the financial statements of Austin Software​ Company, which is a​ fast-growing software development company. As part of the​ company’s strategy, management has been aggressively pursuing acquisitions of other companies. Some of the prior acquisitions resulted in the recording of goodwill. During your review of income and expense​ accounts, you noted a material goodwill impairment charge associated with the​ company’s acquisition of Longhorn​ Software, Inc.

.

a. What are the underlying accounting standards requirements that are relevant to your evaluation of the​ company’s charge for the impairment of​ goodwill?

U.S. GAAP and IFRS standards

generally contain similar requirements

for assessing the impairment of​ assets, including goodwill. Both standards require the testing of goodwill for impairment

at least annually or more frequently

if there are indications that impairment exists. When there is​ impairment, both standards require the​write-down of impaired assets and recognition of an impairment loss. Impairment occurs when the recorded value of goodwill exceeds its fair value

.

b. What types of evidence would be relevant to your evaluation of whether​ management’s impairment charge is fairly​ stated?

The auditor would need to examine evidence and assumptions management used to determine its estimate of the fair value of​ goodwill, which is used to determine the impairment amount.

c . How might the use of a business valuation specialist be helpful in this​ year’s audit? ​(Select all that​ apply.)

Valuation of fair value requires consideration of a number of​ factors, such as macroeconomic​ conditions, industry and market​ conditions, anticipated changes in costs of​ business, other relevant​ company-specific events, among a number of other matters. Financial statement auditors may not have the expertise required for business valuations.

Business valuation specialists have unique skills and expertise often necessary to determine if​ management’s estimates of the fair​ (or recoverable) values are reasonable and appropriate.

CC21-1 (book/static)

Question Help

Give the reasons why inventory is often the most difficult and time consuming part of many audits. ​(Select the 5 choices that​ apply.)

Inventory is generally a major item on the balance sheet and often the largest item making up the accounts included in working capital.

Inventory takes many different forms that are difficult for the auditor to fully understand.

The need for organizations to have the inventory in diverse locations makes the physical control and counting of the inventory difficult.

The consistent application of different valuation methods can be fairly complicated.

The valuation of inventory is difficult due to such factors as the large number of different items​ involved, the need to allocate the manufacturing costs to​inventory, and obsolescence.

CC21-2 (book/static)

Question Help

State what is meant by cost accounting records and explain their importance in the conduct of an audit.

Cost accounting records are those which are concerned with the

processing and storage of raw materials, work in process, and finished goods,

insofar as these activities constitute internal transfers within the

inventory and warehousing cycle.

These records generally include electronics​ files, ledgers, worksheets and reports which

accumulate material, labor, and overhead costs by job or process as the costs are incurred.

Cost accounting records are important in conducting an audit because ​(Select all that​ apply.)

they indicate the relative profitability of the various products for management planning and control.

they typically include information about the units of inventory​ acquired, sold, and on hand which is important to the valuation of inventories for financial statement purposes.

CC21-3 (book/static)

Question Help

Explain why a proper cutoff of purchases and sales is heavily dependent on the physical inventory observation. What information should be obtained during the physical count to make sure that cutoff is​ accurate?

A proper cutoff of purchases and sales is heavily dependent on the physical inventory observation because a proper cutoff of sales requires that

finished goods inventory included in the physical count be excluded from sales

and

all inventory received be included in purchases.

To make sure the cutoff for sales is​ accurate, the following information should be obtained during the taking of the physical​ inventory: ​(Select the 4 choices that​ apply.)

The last shipping document number should be recorded in the working papers for subsequent​ follow-up to sales records.

A review should be made of shipping to test for the possibility of shipments set aside for shipping and not counted or other potential cutoff problems.

When prenumbered shipping documents are not​ used, a careful review of the​ client’s method of getting a proper sales cutoff is the first step in testing the cutoff.

A list of the most recent shipments should be included in the working papers for subsequent​ follow-up to sales records.

For the purchase​ cutoff, the following information should be​ noted: ​(Select the 2 choices that​ apply.)

The last receiving report number should be noted in the working papers for subsequent​ follow-up to purchase records.

A review should be made of the receiving department to make sure all inventory has been properly included in the physical inventory.

CC21-5 (book/static)

Question Help

A client applies manufacturing overhead to inventory on the basis of​ $3.47 per direct labor hour. Explain how the auditor will evaluate the reasonableness of total direct labor hours and manufacturing overhead in the ending inventory of finished goods.

The direct labor hours for an individual inventory item would be verified by

examining engineering specifications or similar information to determine whether the number of hours to complete a unit of finished goods was correctly computed.

The manufacturing overhead rate is calculated by

dividing the total annual number of labor hours into total manufacturing overhead.

These two totals are verified as a part of the  

payroll and personnel and acquisition and payment cycles.

Once these two numbers are​ verified, it is not difficult to verify the overhead cost in inventory.

RQ21-1 (book/static)

Question Help

Explain the relationship between the acquisition and payment cycle and the inventory and warehousing cycle in the audit of a manufacturing company. List several audit procedures in the acquisition and payment cycle that support your explanation.

Explain the relationship between the acquisition and payment cycle and the inventory and warehousing cycle in the audit of a manufacturing company. ​(Select all that​apply.)

In a standard cost inventory​ system, the acquisition and payment cycle computes any inventory purchase​ variances, which then enter the inventory system.

The acquisition and payment cycle includes the system for purchasing all goods and​ services, including raw materials and purchased parts for producing finished goods.

Purchase requisitions are used to notify the purchasing department to place orders for inventory items. When inventory reaches a predetermined level or automatic reorder​ point, requisitions may be initiated by stockroom personnel or by computer. In other​ systems, orders may be placed for the materials required to produce a customer​ order, or orders may be initiated upon periodic evaluation of the situation in light of the prior experience of inventory activity.

After receiving the materials​ ordered, as part of the acquisition and payment​ cycle, the materials are inspected with a copy of the receiving document used to book perpetual inventory.

The following audit procedures in the acquisition and payment cycle illustrate the relationship between that cycle and the inventory and warehousing cycle ​(Select all that​ apply.)

Test the purchase cutoff at the physical inventory date and​ year-end to determine whether or not the physical inventory and​ year-end inventory cutoffs are proper from a purchase standpoint.

Compare the inventory cost entered into the inventory system to the supporting invoice to determine that it was properly recorded and the purchase variance​(standard cost​ system), if​ any, was properly reflected.

RQ21-2 (book/static)

Question Help

Many auditors assert that certain audit tests can be significantly reduced for clients with adequate perpetual records that include both unit and cost data. What are the most important tests of the perpetual records that the auditor must make before reducing assessed control​ risk? Assuming the perpetuals are determined to be​accurate, which tests can be​ reduced?

Begin by selecting the most important tests of the perpetual records that the auditor must make before reducing assessed control risk. ​(Select all that​ apply.)

Tests of the cost accounting documents and records by verifying the reduction of the raw material inventory for use in production and the increase in the quantity of finished goods inventory when goods have been manufactured.

Tests of the reduction in the finished goods inventory through the sale of goods to customers.

Tests of the purchases of raw materials and pricing thereof.

Assuming the perpetual records are determined to be​ accurate, which tests can be​ reduced? ​(Select all that​ apply.)

Tests of inventory cutoff may be reduced.

The physical inventory may be tested prior to the balance sheet date.

Physical inventory tests may be reduced.

RQ21-3 (book/static)

Question Help

List the major analytical procedures for testing the overall reasonableness of inventory. For each​ test, explain the type of misstatement that could be identified.

Begin by selecting which major analytical procedures are used for testing the overall reasonableness of inventory. Then select the corresponding letter from the list that identifies what type of misstatement that could occur for each procedure.

Analytical Procedure	Type of Potential Misstatement
Compare gross margin percentage with previous years.	d.
Compare inventory turnover with previous years.	c.
Compare unit costs with previous years.	e.
Compare extended inventory value with previous years.	a.
Compare current year manufacturing costs with previous years.	b.

RQ21-4 (book/static)

Question Help

In the verification of the amount of the​ inventory, one of the​ auditor’s concerns is that​ slow-moving and obsolete items be identified. List the auditing procedures that can be used to determine whether​ slow-moving or obsolete items have been included in inventory. ​(Select the eight choices that​ apply.)

Make observations during the physical inventory for​ rust, damaged​ inventory, inventory in unusual​ locations, and unusual amounts of dust on the inventory.

Ask questions of production personnel during physical inventory observation about the extent of the use or nonuse of inventory items.

Calculate inventory​ ratios, by type of inventory if​ possible, and compare them to previous years or industry standards.

Be aware of inventory that is tagged​ obsolete, spoiled, or​ damaged, or is set aside because it is obsolete or damaged.

Obtain a sufficient understanding of the​ client’s business to aid in recognizing inventory that is no longer useful in the​ client’s business.

Discuss the quality of the inventory with management.

Examine obsolescence​ reports, scrap​ sales, and other records in subsequent periods that may indicate the existence of inventory that should have been excluded from the physical inventory or included at a reduced cost.

Review the perpetual records for​ slow-moving items.

RQ21-5 (book/static)

Question Help

Before the physical​ examination, the auditor obtains a copy of the​ client’s inventory instructions and reviews them with the controller. In obtaining an understanding of inventory procedures for a small manufacturing​ company, these deficiencies are​ identified: Shipping operations will not be completely halted during the physical​examination, and there will be no independent verification of the original inventory count by a second counting team. Evaluate the importance of each of these deficiencies and state its effect on the​ auditor’s observation of inventory.

Evaluate the importance of the following deficiency and state its effect on the​ auditor’s observation of inventory.​ “Shipping operations will not be completely halted during the physical​ examination.”

The continuation of shipping operations during the physical inventory will require the auditor to perform additional procedures to insure that a proper cutoff is achieved. The auditor must conclude that merchandise shipped is either included in the physical count or recorded as a​ sale, but not both.

Evaluate the importance of the following deficiency and state its effect on the​ auditor’s observation of inventory.​ “There will be no independent verification of the original inventory count by a second counting​ team.”

Since no second count is​ taken, the auditor must increase the number of test counts to determine that the counts recorded are accurate.

RQ21-6 (book/static)

Question Help

During the taking of physical​ inventory, the controller intentionally withheld several inventory tags from the employees responsible for the physical count. After the auditor left the​ client’s premises at the completion of the inventory​ observation, the controller recorded nonexistent inventory on the tags and thereby significantly overstated earnings. How could the auditor have uncovered the​ misstatement, assuming that there are no perpetual​ records? ​(Select the 6 choices that​ apply.)

The auditor should have selected certain tags​ (especially larger​ items) and had the client show him or her where the goods were stored.

The tag numbers used and unused should have been recorded in the​ auditor’s working papers for subsequent​ follow-up.

Adequate controls over the use of inventory tags could have uncovered the misstatement.

A comparison of ratios such as gross margin percentage and inventory turnover could have indicated that a problem was present.

The auditor should have assured himself or herself that the client had accounted for all used and unused tag numbers by examining all​ tags, if necessary.

As part of substantive​ procedures, the auditor could have performed analytical tests on the inventory and cost of sales.

RQ21-9 (book/static)

Question Help

Assuming that the auditor properly documents receiving report numbers as a part of the physical inventory observation​ procedures, explain how the proper cutoff of​purchases, including tests for the possibility of raw materials in​ transit, should be verified later in the audit.

Assuming the auditor properly documents receiving report numbers as a part of the physical inventory observation​ procedures, the auditor should

verify the proper cutoff of purchases as a part of subsequent tests by examining each invoice to see if a receiving report is attached. If the receiving report is dated on or before the inventory date and the last recorded​ number, the received inventory must have been included in the physical​ inventory; therefore the invoice should be included in accounts payable. Those invoices that are received after the balance sheet date but shipped F.O.B. shipping point on or before the close of the year would indicate merchandise in transit.

RQ21-10 (book/static)

Question Help

Define what is meant by compilation tests. List several examples of audit procedures to verify compilation.

Define compilation tests.

Compilation tests are the tests of the summarization of physical​ counts, the extension of price times​ quantity, footing the inventory​ summary, and tracing the totals to the general ledger.

Several examples of audit procedures to verify compilation​ are: ​(Select the 4 choices that​ apply.)

Trace the test counts recorded in the working papers to the final inventory summary to make sure they are correctly included.

Test the extensions and footings of the physical inventory summary.

Trace inventory items on the final inventory list to the tags as a test of the existence of recorded inventory.

Trace the tag numbers used to the final inventory summary to make sure they were properly included and the numbers not used to the final inventory summary to make sure no tag numbers have been added.

RQ21-11 (similar to)

Question Help

Included in the December​ 31, 2016inventory of the Cat’s Meow Supply Company are 2,600 deluxe ring binders in the amount of $7,111. An examination of the most recent acquisitions of binders showed the following​ costs: January​ 26, 20172,000 at $2.78each; December​ 6, 20161,700 at $2.69each; November​ 26, 20162,100 at $2.57each. What is the misstatement in valuation of the December​ 31, 2016inventory for deluxe ring​ binders, assuming FIFO inventory​ valuation? What would your answer be if the January​ 26, 2017acquisition was for 2,000 binders at $2.58each?

What is the misstatement in valuation of the December​31,2016​, inventory for deluxe ring​ binders, assuming FIFO inventory​ valuation?

$6,886	.
As such, the ending inventory balance of	$7,111	at December 31, 2016 is	overstated	by	$225	.

What would your answer be if the January​ 26, 2017acquisition was for 2,000 binders at $2.58 each?

$6,699	.		As such, the ending inventory balance of $7,111 at December 31, 2016 would be		overstated
by	$412	.

Each employee for the Gedding Manufacturing​ Co., a firm using a​ job-cost inventory costing​ method, must reconcile his or her total hours worked with the hours worked on individual jobs using a job time sheet at the time weekly payroll time cards are prepared. The job time sheet is then stapled to the time card. Explain how you could test the direct labor dollars included in inventory as a part of the payroll and personnel tests.

With a job cost​ system, labor charged to a specific job is accumulated on a job cost sheet. The direct labor dollars included on the job cost sheet can be traced to the employee​ “job time​ sheet” to make sure the hours are correctly included on the job cost sheet. The labor rate can be verified by comparing it to the amount on the​ employee’s earnings record.

MC21-13 (similar to)

Question Help

The following questions concern internal​ controls, and the testing of internal​ controls, in the inventory and warehousing cycle. Choose the best response.

a. For control​ purposes, the quantities of materials ordered may be omitted from the copy of the purchase order that is

forwarded to the receiving department.

b. Which of the following internal control procedures most likely would be used to maintain accurate inventory​ records?

Periodic inventory counts are used to adjust the perpetual inventory records.

c. Which of the following sets of duties related to inventory and warehousing causes the greatest concern about inadequate segregation of​ duties?

Purchasing agents who arrange for shipment of raw materials from vendors are responsible for verifying actual receipt of the inventory items at the receiving dock.

MC21-14 (book/static)

Question Help

The following questions deal with tests of details of balances and substantive analytical procedures for inventory. Choose the best response.

a. An auditor selected items for test counts while observing a​ client’s physical inventory. The auditor traced the test counts to the​ client’s inventory listing. This procedure likely obtained evidence about which​ balance-related audit objective for​ inventory?

Completeness

b. Which of the following procedures is the auditor least likely to perform on the actual date the physical inventory count is​ observed?

Examine documentation supporting the acquisition of highly material inventory items on hand at the count date.

c. An inventory turnover analysis is useful to the auditor because it may detect

the existence of obsolete merchandise.

MC21-15 (book/static)

Question Help

The following questions deal with internal controls in the inventory and warehousing cycle and tests of details of balances for inventory. Choose the best response.

a. As part of the current​ audit, the auditor begins performing substantive tests on a​ client’s inventory. To test the​ valuation, allocation, and accuracy​ assertion, the auditor should perform all of the following procedures except for

vouching a sample of items from the​ client’s inventory report sheet to the corresponding prenumbered inventory tags.

.

b. In auditing a manufacturing​ entity, which of the following procedures would an auditor most likely perform to determine whether​ slow-moving, defective, and obsolete items included in inventory are properly​ identified?

Tour the manufacturing plant or production facility

c. Alpha Company uses its sales invoices for posting perpetual inventory records. Inadequate controls over the invoicing function allow goods to be shipped that are not invoiced. The inadequate controls could cause an

understatement of revenues and​ receivables, and an overstatement of inventory.

P21-16 (book/static)

Question Help

Items 1 through 8 are selected questions typically found in questionnaires used by auditors to obtain an understanding of internal control in the inventory and warehousing cycle. In using the questionnaire for a​ client, a​ “yes” response to a question indicates a possible internal​ control, whereas a​ “no” indicates a potential deficiency.

Requirements

a.	For each of the preceding​ questions, state the purpose of the internal control.
b.	For each internal​ control, list a test of control to test its effectiveness.
c.	For each of the preceding​ questions, identify the nature of the potential financial​ misstatement(s) if the control is not in effect.
d.	For each of the potential misstatements in part​ c., list a substantive audit procedure to determine whether a material misstatement exists.

Requirement a. For each of the questions​ listed, state the purpose of the internal control.

	Purpose of
Question	internal control
1.	D.
2.	B.
3.	F.
4.	A.
5.	G.
6.	E.
7.	C.
8.	H.

Requirement b. For each internal​ control, list a test of control to test its effectiveness.

	Test of control
1.	Account for a numerical sequence of shipping orders.
2.	Review procedures for determining standard costs.
3.	Read policy and discuss procedures with client.
4.	Examine receiving and requisition documents, trace to perpetual records.
5.	Observe counting personnel and discuss with client.
6.	Observe who compiles the inventory and discuss with client.
7.	Account for a numerical sequence of receiving reports and observe matching invoices received from vendors.
8.	Discuss with client and observe whether personnel prepare shipping documents.

Requirement c. For each of the preceding​ questions, identify the nature of the potential financial​ misstatement(s) if the control is not in effect.​ 

	Potential financial misstatement
1.	Understatement of sales.
2.	Misstatement of inventory.
3.	Misstatement of inventory.
4.	Misstatement of inventory.
5.	Misstatement of inventory.
6.	Misstatement of inventory.
7.	Understatement of inventory or payment for goods not received.
8.	Overstatement of inventory.

Requirement d. For each of the potential misstatements in part​ c., list a substantive audit procedure to determine whether a material misstatement exists. ​(Each selection may be used more than​ once.)

	Substantive audit procedure
1.	Trace quantity and description on bills of lading to recorded sales.
2.	Trace costs from supporting documents to development of standards.
3.	Substantive analytical procedures for inventory.
4.	Compare physical count to perpetual inventory record.
5.	Compare physical count to perpetual inventory record.
6.	Reperform clerical tests of inventory compilation.
7.	Trace quantity and description on vendor’s invoice to receiving report.
8.	Compare physical count to perpetual inventory record.
Question Help

The Frist Corporation has the following internal controls related to​ inventory:

Requirements

For each of the internal​ controls:

a.	Identify the related​ transaction-related audit​ objective(s) affected by the control.
b.	Describe risks the control is designed to mitigate.
c.	Design a test of control to determine if the control is operating effectively.

Requirement a. For each of the internal​ controls, identify the related​ transaction-related audit​ objective(s) affected by the control. ​

Internal	Transaction-related
Control	audit objectives
1.	E.
2.	A.
3.	J.
4.	D.
5.	C.
6.	G.
7.	H.
8.	B.
9.	F.
10.	I.

Requirement b. For each of the internal​ controls, describe risks the control is designed to mitigate. ​

Internal	Related
Control	risks
1.	G.
2.	A.
3.	B.
4.	H.
5.	C.
6.	D.
7.	J.
8.	E.
9.	I.
10.	F.

Requirement c. For each of the internal​ controls, design a test of control to determine if the control is operating effectively.

Internal	Tests of
Control	control
1.	C.
2.	B.
3.	G.
4.	I.
5.	D.
6.	A.
7.	E.
8.	E.
9.	H.
10.	F.
Question Help

The cost accounting records are often an essential area to audit in a manufacturing or construction company.

Requirements

a.	Why should the auditor review the cost accounting records and test their​ accuracy?
b.	For the audit of standard cost accounting records in which 35 parts are​ manufactured, explain how you would determine whether each of the following were reasonable for part no.​ 21:
	​(1) Standard direct labor hours	​(4) Standard units of raw materials
	​(2) Standard direct labor rate	​(5) Standard cost of a unit of raw materials
	​(3) Standard overhead rate	​(6) Total standard cost

Requirement a. Why should the auditor review the cost accounting records and test their​ accuracy? ​(Select all that​ apply.)

In many​ companies, there are many types of inventory items with complex cost structures. The potential for misstatement is great in determining costs. The auditor would need to go to an extreme effort to verify such costs without being able to rely on the cost accounting records which provides the costs.

The cost accounting records also deal with transferring inventories through the production cycle and then from finished goods for sales. These transfers must be handled accurately for inventory to be properly stated.

The cost accounting records determine unit costs that are applied to derive inventory values. Since inventory is usually​ material, unit costs must be verified.

Requirement b. For the audit of standard cost accounting records in which 35 parts are​ manufactured, explain how you would determine whether each of the following were reasonable for part no.​ 21:

Tests to determine reasonableness
A.
D.
B.
C.
F.
E.
P21-19 (book/static)		Question Help

Following are audit procedures commonly performed in the inventory and warehousing cycle for a manufacturing​ company:

Requirements

a. Identify whether each of the procedures is primarily a test of control or a substantive test.

b. State the​ purpose(s) of each of the procedures.

Requirement a. Identify whether each of the procedures is primarily a test of control or a substantive test.

	Test of control or
	Substantive test?
1.	Test of control
2.	Substantive test
3.	Substantive test
4.	Substantive test
5.	Substantive test
6.	Substantive test
7.	Test of control
8.	Both a test of control and substantive test

Requirement b. State the​ purpose(s) of each of the procedures.

	Purpose of each procedure
1.	To make sure that proper controls exist and are being followed in the taking of the physical inventory.
2.	To identify slow-moving inventory that may need to be written down.
3.	To ensure that all inventory represented by an inventory tag actually exists.
4.	To test the accuracy of the client’s perpetual inventory records.
5.	To test client’s final inventory compilation.
6.	To test that the final inventory was valued at its proper cost.
7.	To ensure that no raw material was issued without proper approval.
8.	To ensure that additions recorded on finished goods perpetual records were recorded on books as completed production.
	Question Help

Answer the following questions regarding the situations you encountered during the December​ 31, 2016, physical inventory of Latner Shoe Distributor Company.

.

Requirement a. Latner maintains a large portion of the shoe merchandise in 10 warehouses throughout the eastern United States. This ensures swift delivery service for its chain of stores. You are assigned alone to the Boston warehouse to observe the physical inventory process. During the inventory​ count, several express trucks pulled in for loading. Although​ infrequent, express shipments must be attended to immediately. As a​ result, the employees who were counting the inventory stopped to assist in loading the express trucks. What should you​ do?

The auditor in this situation should observe the recording of the shipments on the day of occurrence and record these details in the working papers so a determination can be made as to whether the shipments affected the physical inventory count.

Requirement b​ (1). In one storeroom of​ 10,000 items, you have​ test-counted about 200 items of high value and a few items of low value. You found no misstatements. You also note that the employees are diligently following the inventory instructions. Do you think you have tested enough​ items? Explain.

There is no​ clear-cut answer to sample size for inventory counts. The answer to the question depends on additional​ factors, such as the randomness of your test counts and whether the values of the merchandise are relatively stratified. It also depends on inherent risk for inventory physical counts and the materiality of inventory compared to total assets.

Requirement b​ (2). What would you do if you​ test-counted 150 items and found a substantial number of counting​ errors?

Request a recount by the client or greatly expand your tests to determine whether a material misstatement exists.

Requirement c. In observing an inventory of liquid shoe​ polish, you note that one lot is five years old. From inspection of some bottles in an open​ box, you find that the liquid has solidified in most of the bottles. What action should you​ take?

The auditor should determine how this inventory is valued and after discussion with the client it may be well to classify it as obsolete. In all​ cases, the auditor must specifically identify the merchandise in the working papers for subsequent evaluation. The auditor should also be aware that this could be an indication of widespread obsolescence problems in other parts of the inventory.

Requirement d. During your observation of the inventory count in the main​ warehouse, you found that most of the prenumbered tags that had been incorrectly filled out are being destroyed and thrown away. What is the significance of this procedure and what action should you​ take?

One of the important tasks the auditor undertakes during the observation is to determine that inventory tags are physically controlled. This assures that the inventory is not understated because tags are​ lost, or overstated because falsified tags are added. In this​ situation, the auditor should recover the discarded tags and request that the practice be​ stopped, and that control of tags be established under the​ auditor’s direct observation.

P21-27 (book/static)

Question Help

In an annual audit at December​ 31, 2016you find the following transactions near the closing​ date:

Requirements

a.	State whether the merchandise should be included in the​ client’s inventory.
b.	Give your reason for your decision on each item.​ (AICPA adapted)

Requirement a. State whether the merchandise should be included in the​ client’s inventory.

	Include or Exclude
Transaction	Merchandise?
1.	Exclude
2.	Include
3.	Include
4.	Exclude
5.	Exclude

Requirement b. Give your reason for your decision on each item.​ (AICPA adapted)

Transaction 1. Merchandise costing​ $625 was received on December​ 28,

2016and the invoice was not recorded. You located it in the hands of the purchasing​agent; it was marked​ “on consignment.”

Goods held​ “on consignment”

do not belong to the consignee, and should not be included in inventory.

2. A packing case containing products costing​ $816 was standing in the shipping room when the physical inventory was taken. It was not included in the inventory because it was marked​ “Hold for shipping​ instructions.” Your investigation revealed that the​ customer’s order was dated December​ 18,

2016but that the case was shipped and the customer billed on January​ 10, 2017. The product was a stock item of your client.

Normally title to a stock item

does not pass to the customer until shipment, even though it has been set aside. Therefore it should be included in inventory.

3. Merchandise received on January​ 3, 2017​, costing​ $720 was entered in the acquisitions journal on January​ 4, 2017. The invoice showed shipment was made FOB​ supplier’s warehouse on December​ 31,2016. Because it was not on hand December​ 31, it was not included in inventory.

Title to goods shipped F.O.B. shipping point normally passes to the buyer

on delivery to the transportation agency, therefore, the goods belong to your client at December 31, 2016.

4. Merchandise costing​ $1,822 was received on January​ 3, 2017and the related acquisition invoice recorded January 5. The invoice showed the shipment was made on December​ 29, 2016FOB destination.

This merchandise should be

excluded because title does not pass to the buyer on an F.O.B. destination shipment until delivery to the buyer, January 3.

5. A special​ machine, fabricated to order for a​ customer, was finished and in the shipping room on December​ 31, 2016. The customer was billed on that date and the machine excluded from​ inventory, although it was shipped on January​ 4, 2017

Title to custom​ made-merchandise

passes to the buyer as materials and labor are appropriated to the job.

The machine

should be excluded from inventory since the job was completed and ready for shipment on December 31, 2016.

P21-28 (book/static)

Question Help

As a part of your clerical tests of inventory for Martin Manufacturing, you have tested about​ 20% of the dollar items and have found the following​ exceptions:

Requirements

a.	State the amount of the actual misstatement in each of the four tests. For any item for which the amount of the misstatement cannot be determined from the information​ given, state the considerations that will affect your estimate of the misstatement.
b.	As a result of your​ findings, what will you do about clerical accuracy tests of the inventory in the current​ year?
c.	What​ changes, if​ any, would you suggest in internal controls and procedures for MartinMartinManufacturing during the compilation of next​ year’s inventory to prevent each type of​ misstatement?

Requirement a. State the amount of the actual misstatement in each of the four tests. For any item for which the amount of the misstatement cannot be determined from the information​ given, state the considerations that will affect your estimate of the misstatement.

Exception 1. Begin by calculating the extension errors.

	Extension		Over
	as	Actual	(Under)
Description	Recorded	Extension	Statement
Wood	$11.04	$110.40	$(99.36)
Metal-cutting tools	1,740.00	1,470.00	270.00
Cutting fluid	240.00	1,040.00	(800.00)
Sandpaper	579.00	5.70	573.30
	$(56.06)

Exception 2.​ Next, let’s discuss the differences located in comparing last​ year’s costs with the current​ year’s costs on the​ client’s inventory lists.

The differences in the previous​ year’s and this​ year’s costs

indicate a problem.

The auditor

should attempt to obtain support for the current year’s costs if the effect of the differences noted seems significant

​(considering that the test only covered​20% of the dollar​ items).

A review for reasonableness of the differences in the current and prior year costs indicate the​ following: ​(Select the 3 choices that​ apply.)

Precision cutting torches are expensive. Maybe $800.00each is a reasonable price. Examine a​ vendor’s invoice or a price list.

Aluminum scrap values may fluctuate significantly. The two prices may be reasonable. Look at sales invoices for the two years.

Lubricating oil cost appears unreasonable for this year and for the previous year. The auditor should examine invoices for both years. If the previous​ year’s costs were​ incorrect, determination of the effect of the misstatements on the prior​ year’s and this​ year’s financial statements must be completed to determine the need for disclosure of the misstatements.

Exception 3. Select which action an auditor should take in the event that test counts are not found when tracing from the test counts to the final inventory compilation.

Investigate the reasons for the omission of these tags from final inventory compilation. If it is determined that the omission of two tags is significant based on the number of tags used and​ tested, the auditor should account for all tags to determine the total extent of omissions.

Exception 4. Page​ total, footing errors are as​ follows: ​(Enter all amounts to the nearest​ cent, $X.XX. Use a minus sign or parentheses for any​ understatements.)

			Over(Under)
Page No.	Client Total	Correct Total	Statement
14	$2,375.36	$2,375.30	$0.06
82	6,721.18	6,421.18	300.00
$300.06

Requirement b. As a result of your​ findings, what will you do about clerical accuracy tests of the inventory in the current​ year? ​(Enter the net misstatement as a positive​ number.)

The net effect of the misstatements for which we were able to compute the actual misstatement was an

overstatement

of inventory by

244.00

​

(from requirement​ a, items 1 and​ 4).

The exceptions resulted from various causes including incorrect decimal​ placement, mathematical​ errors, and unit of measure errors. What action should the auditor take as a​ result?

The auditor should determine that the net effect of the misstatements is not​ significant; in​ addition, to insure against other individual misstatements that might be​ significant, the auditor should review the extensions and other computations for reasonableness and obvious misstatements.

For the items for which the amount of the misstatement could not be​ determined, the auditor​ should:

Follow up by investigating the differences and having discussions with the client. From the results of the​follow-up, the effect of the misstatements noted should be assessed and determination made as to the need for expansion of scope for the tests considered.

Requirement c. What​ changes, if​ any, would you suggest in internal controls and procedures for

MartinManufacturing during the compilation of next​ year’s inventory to prevent each type of​ misstatement?

Prior to compiling the inventory next​ year, MartinManufacturing should implement the following internal​ controls: ​(Select the 3 choices that​ apply.)

Review formulas in schedule for inventory compilation. Accuracy of spreadsheet should be independently reviewed.

All inventory tags should be accounted for prior to posting to the compilation schedules and a control total compared to the total on the compilation sheets after the compilation is complete.

Someone familiar with the inventory should review the compilation schedules for reasonableness of​ quantities, prices, and extensions.

P21-29 (book/static)

Question Help

You have been engaged for the audit of the Upper ACompany for the year ended December​ 31, 2016. The Upper ACompany is in the wholesale chemical business and makes all sales at 25% over cost. Following are portions of the​ client’s sales and purchases accounts for the calendar year 2016. You observed the physical inventory of goods in the warehouse on December​ 31, 2016​, and were satisfied that it was properly taken. When performing a sales and purchases cutoff​ test,you found that at December​ 31, 2016, the last receiving report that had been used was no. 1063 and that no shipments have been made on any sales invoices with numbers larger than no. 968. You also obtained the following additional​ information:

Requirement a. Compute the adjustments that should be made to the​ client’s physical inventory at December​ 31, 2016.

Select descriptions for any items that will require the​ client’s physical inventory to be adjusted at December​ 31, 2016​, then enter the amount of the adjustment and calculate the total adjustments.

	Adjustment
Description of Adjustment	Amount
RR#1063	8,420
SI#966	15,800
Chemicals exposed to rain during transit and deemed unsalable.	(1,075)
Total adjustments	$23,145

Requirement b. Prepare a worksheet of adjusting entries that are required as of December​ 31,

2016. (AICPA adapted) ​

1. Included in the warehouse physical inventory at December​ 31, 2016​, were chemicals that had been acquired and received on receiving report no. 1060 but for which an invoice was not received until the year 2017. Cost was $2,098.

Accounts	Debit	Credit
Dec	31	Purchases	2,098
		Accounts payable		2,098

2. In the warehouse at December​ 31, 2016​, were goods that had been sold and paid for by the customer but which were not shipped out until the year 2017. They were all sold on sales invoice no. 965 and were not inventoried.

Accounts	Debit	Credit
Dec	31	No entry required

3​ (a). On the evening of December​ 31, 2016​, there were two cars on the Upper Acompany​ siding: Car AR38162 was unloaded on January​ 2, 2017​, and received on receiving report no. 1063. The freight was paid by the vendor.

Accounts	Debit	Credit
Dec	31	No entry required

3​ (b). Car BAE74123 was loaded and sealed on December​ 31, 2016​, and was switched off the​ company’s siding on January​ 2, 2017. The sales price was $16,400 and the freight was paid by the customer. This order was sold on sales invoice no. 968.

Accounts	Debit	Credit
Dec	31	Accounts receivable	16,400
		Sales		16,400

4. Temporarily stranded at December​ 31, 2016 on a railroad siding were two cars of chemicals en route to the Z Pulp and Paper Co. They were sold on sales invoice no.​ 966, and the terms were FOB destination.

Accounts	Debit	Credit
Dec	31	Sales	19,750
		Accounts receivable		19,750

5. En route to the Upper ACompany on December​ 31,2016​, was a truckload of material that was received on receiving report no. 1064. The material was shipped FOB​destination, and freight of $25 was paid by the Upper A Company.​ However, the freight was deducted from the purchase price of $1,750.

Accounts	Debit	Credit
Dec	31	No entry required

6. Included in the physical inventory were chemicals exposed to rain during transit and deemed unsalable. Their invoice cost was $1,075​, and freight charges of $300had been paid on the chemicals. ​

Accounts	Debit	Credit
Dec	31	Claims receivable	1,375
		Purchases		1,075
		Freight in		300

Record any entry required to adjust the accounts for changes in physical inventory quantities.

Accounts	Debit	Credit
Dec	31	Inventory	23,145
		Cost of goods sold		23,145

Record any entry required to adjust the sales records for merchandise that was in the warehouse at time of physical count.

Accounts	Debit	Credit
Dec	31	Sales	19,551
		Accounts receivable		19,551

CC23-1 (book/static)

Question Help

Explain the relationships among the initial assessed control​ risk, test of controls and substantive tests of transactions for cash​ disbursements, and the tests of details of cash balances. Give one example in which the conclusions reached about internal controls in cash disbursements will affect the tests of cash balances.

Explain the relationships among the initial assessed control​ risk, test of controls and substantive tests of transactions for cash​ disbursements, and the tests of details of cash balances.

The appropriate tests for the ending balance in the cash accounts

depend heavily on

the initial assessment of control​ risk, tests of​ controls, and substantive tests of transactions for cash disbursements. The​ company’s controls over cash disbursements assist the auditor in determining that cash disbursed is for approved company​ purposes, that cash disbursements are promptly recorded in the proper​ amount, and that

cash cutoff

at​ year-end is proper. If the results of the evaluation of internal​ control, the tests of​ controls, and the substantive tests of transactions are​ adequate,

it is appropriate to reduce

the tests of details of balances for​ cash, especially for the detailed tests of bank reconciliations. On the other​ hand, if the tests indicate that the​ client’s controls are​ inadequate,

extensive year-end testing may be necessary.

Give one example in which the conclusions reached about internal controls in cash disbursements will affect the tests of cash balances.

If controls over the issuance of blank​ checks, the review of​ payees, amounts, and supporting​ documentation, the signing of​ checks, and the reconciliation of bank statements and

vendors’ statements

are​ adequate, the​ auditor’s review of outstanding checks on the​ year-end bank reconciliation may be

greatly reduced.

The​year-end outstanding checks can be verified by testing a sample of checks returned with the

cutoff

bank statement rather than tracing all paid outstanding checks and the final monthly checks in the cash disbursements journal to the last​ month’s cleared checks and the bank reconciliation.

CC23-2 (book/static)

Why is the monthly reconciliation of bank accounts by an independent person an important internal control over cash​ balances? Which individuals will generally not be considered independent for this​ responsibility?

Why is the monthly reconciliation of bank accounts by an independent person an important internal control over cash​ balances?


It provides an opportunity for an internal verification of the cash receipts and cash disbursements​ transactions, investigation of reconciling items on the bank​reconciliation, and the verification of the ending cash balance.

Which individuals will generally not be considered independent for this​ responsibility?

Anyone responsible for the following duties would not be considered independent for the purposes of preparing monthly bank​ reconciliations:

All of the above

CC23-3 (book/static)

Question Help

Explain why an auditor compares the​ “date of deposit according to the​ books” to the​ “date of disbursement according to the​ books” on an interbank transfer schedule to detect kiting.

Begin by selecting the choice that describes how kiting could be carried out.

A client may write a check on December 31 from the general checking account to a payroll account. If the client records the deposit into the payroll account on December​ 31, but does not record the disbursement out of the general checking account until January​ 1, the cash will be counted in both accounts at December 31. This is typically carried out by first crediting another account such as revenue for the first journal entry to record the cash​ deposit, and then debiting an account such as an expense​ (or reversing the first​ entry) for the second journal entry to record the cash disbursement.

Explain why an auditor compares the​ “date of deposit according to the​ books” to the​ “date of disbursement according to the​ books” on an interbank transfer schedule to detect kiting.

When comparing the dates of deposit and​ disbursement, the auditor is looking to ensure both were recorded

in the same fiscal period.

The auditor will also

verify

the dates of deposit and disbursement according to the

bank

when testing the interbank transfer schedule. 

CC23-4 (book/static)

Question Help

Briefly explain why accounting standards related to fair value estimates make the audit of financial instruments more complex.

Accounting standards related to fair value estimates make the audit of these estimates difficult due to

the significant amount of management judgment involved. Management first applies judgment to determine whether the fair value estimate will be a level​ 1, 2 or 3 estimate. If the fair value estimate is level 2 or level​ 3, there is significant judgment involved in estimating the fair value. Level 3 fair value estimates may have several unobservable inputs used to determine fair value.

RQ23-1 (book/static)

Question Help

Explain the relationships among the initial assessed control​ risk, tests of controls and substantive tests of transactions for cash​ receipts, and the tests of details of cash balances.

The appropriate tests for the ending balance in the cash accounts

depend heavily on

the initial assessment of control​ risk, tests of​ controls, and substantive tests of transactions for cash receipts. If the results of the evaluation of internal​ control, the tests of​ controls, and the substantive tests of transactions are​ adequate,

it is appropriate to reduce

the tests of details of balances for​ cash, especially for the detailed tests of bank reconciliations. If the tests indicate that the​ client’s controls are​ deficient,

extensive year-end testing may be necessary.

RQ23-2 (book/static)

Question Help

What is meant by an imprest bank account for a branch​ operation? Explain the purpose of using this type of bank account.

What is meant by an imprest bank account for a branch​ operation?

An imprest bank account for a branch operation is one in which a fixed balance is maintained. After authorized branch personnel use the funds for proper​disbursements, they make an accounting to the home office. After the expenditures have been approved by the home​ office, a reimbursement is made to the branch account from the home​ office’s general account for the total of the cash disbursements.

Explain the purpose of using this type of bank account.

The purpose of using this type of account is to provide controls over

cash receipts

and

cash disbursements

by preventing the

branch operators

from disbursing their cash receipts​ directly, and by providing

review and approval

of cash disbursements before more cash is made available.

RQ23-3 (book/static)

Question Help

Evaluate the effectiveness and state the shortcomings of the preparation of a bank reconciliation by the controller in the manner described in the following​ statement:

​

“When I reconcile the bank​ account, the first thing I do is review the sorted list of returned checks and find which numbers are missing. Next I determine the amount of the uncleared checks by referring to the cash disbursements journal. If the bank account reconciles at that​ point, I am all finished with the reconciliation. If it does​ not, I search for deposits in​ transit, checks from the beginning outstanding check list that still have not​ cleared, other reconciling​ items, and bank errors until it reconciles. In most​instances, I can do the reconciliation in 20​ minutes.”

The​ controller’s approach is to reconcile until the balance agrees. The shortcoming of this approach is that it

does not include a review of the items that flow through the account and it opens the door for the processing of improper items.

Such items as checks payable to improper​ parties, reissuance of outstanding checks to improper​ parties, and

kiting of funds would not

be discovered with the​ controller’s approach.

The​ controller’s procedures should include the​ following:

Examination of all checks clearing with the statement​ (including those on the previous​ month’s outstanding check​ list) and comparison of payee and amount to the cash disbursements journal.

​Follow-up on old outstanding checks to determine why they are still outstanding.

Test of cash receipts to determine that they are deposited within a reasonable amount of time.

RQ23-4 (book/static)

Question Help

How do bank confirmations differ from positive confirmations of accounts​ receivable? Distinguish between them in terms of the nature of the information​ confirmed, the sample​ size, and the appropriate action when the confirmation is not returned after the secondrequest. Explain the rationale for the differences between these two types of confirmations.

Begin by selecting which type of confirmation each item below describes—Bank confirmations or Positive confirmation of accounts receivable.

Requests the balances in all bank accounts.	Bank confirmation
If this type of confirmation is not returned, they must be pursued until the
auditor is satisfied as to what the requested information is.	Bank confirmation
Information regarding liabilities to the bank for notes, mortgages, or other debt.	Bank confirmation
The interest rate on interest-bearing accounts.	Bank confirmation
Confirmation of an account balance stated on the confirmation form or
designate a different amount with an explanation	Positive confirmation of Accounts receivable
This type of confirmation is normally requested only for a sample of accounts.	Positive confirmation of Accounts receivable
Information regarding restrictions on withdrawals.	Bank confirmation
If this type of confirmation is not returned, second and maybe third requests
may be made, but thereafter, follow-ups are not likely to be pursued.	Positive confirmation of Accounts receivable

Explain the rationale for the differences between these two types of confirmations.

The reason why more importance is placed on

bank confirmations than accounts receivable confirmations

is that​ cash, being the most liquid of​ assets,

must be more closely controlled than accounts receivable.

In​ addition, other​ information-such as liabilities to the bank must be known for purposes of the

financial statements.

​Finally, there are usually

only a few

bank accounts and most bank accounts have a

large volume of transactions

during the year.

RQ23-5 (book/static)

Question Help

Evaluate the necessity of following the practice described by an​ auditor: “In confirming bank​ accounts, I insist upon a response from every bank the client has done business with in the past 2​ years, even though the account may be closed at the balance sheet​ date.”

This is a good auditing procedure that attempts to discover if any accounts that should have been closed are still being​ used, such as by a company employee to deposit customer remittances. The procedure may also discover unrecorded and contingent liabilities.

RQ23-7 (book/static)

Question Help

Why are auditors usually less concerned about the​ client’s cash receipts cutoff than the cutoff for​ sales? Explain the procedure involved in testing for the cutoff for cash receipts.

Why are auditors usually less concerned about the​ client’s cash receipts cutoff than the cutoff for​ sales?

The cutoff of cash receipts affects only cash and

accounts receivable

and not the

income statement

​,

whereas a misstatement in the cutoff of sales affects

accounts receivable

and the

income statement.

Explain the procedure involved in testing for the cutoff for cash receipts.

For the purpose of detecting a cash receipt cutoff​ misstatement, there are two useful audit procedures.

The first is to trace the

deposits in transit

to the

cutoff

bank statement to determine the date they were deposited in the bank account. Because the recorded cash will have to be included as

deposits in transit

on the bank​reconciliation, the auditor can test for the number of days it took for the

in transit items to be deposited.

If there is more than a two or three day delay between the balance sheet date and the subsequent deposit of all

deposits in transit

​,

there is an indication of a cutoff misstatement.

The second audit procedure requires being on the premises at the

balance sheet

date and counting all cash and checks on hand and recording the amount in the

audit files.

When the bank reconciliation is​ tested, the auditor can then check whether the  

deposits in transit

equal the amount recorded.

RQ23-9 (book/static)

Question Help

How will a​ company’s bank reconciliation reflect an electronic deposit of cash received by the bank from credit card agencies making payments on behalf of customers purchasing products from the​ company’s online Web​ site, but not recorded in the​ company’s records?

The company does not have the electronic deposit

recorded in the general ledger.

The​ company’s

bank reconciliation

should include an adjustment for this​transaction, which would increase the book balance of

cash

and decrease

accounts receivable from credit card agencies

RQ23-10 (book/static)

Question Help

Explain the purpose of a​ four-column proof of cash. List two types of misstatements it is meant to uncover.

Explain the purpose of a​ four-column proof of cash.

The purpose of the​ four-column proof of cash is to​ verify: ​(Select all that​ apply.)

Whether all amounts that were paid by the bank were recorded as cash disbursements in the accounting records.

Whether all recorded cash disbursements were paid by the bank.

Whether all recorded cash receipts were deposited.

Whether all deposits in the bank were recorded in the accounting records.

List two types of misstatements it is meant to uncover.

Cash received that was not recorded in the cash receipts journal and checks that cleared the bank but have not been recorded in the cash disbursements journal.

RQ23-11 (book/static)

Question Help

Distinguish between lapping and kiting. Describe audit procedures that can be used to uncover each.

Distinguish between lapping and kiting. ​(Match a description with each​ term.)

a.	Lapping
e.	Kiting

Describe audit procedures that can be used to uncover lapping. ​(Select all that​ apply.)

Make a surprise count of the cash and customers checks on hand. The deposit of these funds should be made under the​ auditor’s control, and the details of the deposit should later be compared with the cash receipts book and the accounts receivable records.

Confirm accounts receivable and give close attention to exceptions made by customers about payment dates. The confirmation procedure is better applied as a surprise at an interim date so that if a person is engaged in​ this, he or she will not have been able to bring the affected accounts up to date.

Compare the check vouchers received with the​ customers’ checks with stamped duplicate deposit​ slips, the entries in the cash​ book, and postings to the accounts receivable records. If the client stamps the voucher with the date it was​ received, the auditor should make careful comparisons of the stamped dates to the dates recorded in the cash receipts journal.

Compare the details of remittance lists​ (if prepared), stamped duplicate deposit​ slips, and entries in the cash receipts book. Because deposit slips are easily​ altered, some auditors prepare duplicate deposit slips made a few days before and after the audit date and have these slips authenticated by the bank. These authenticated duplicate deposit slips are compared to remittance lists and to entries in the cash book.

Describe audit procedures that can be used to uncover kiting. ​(Select all that​ apply.)

Obtain cutoff bank statements directly from the bank covering the seven to ten day period after the balance sheet date. Examine the checks returned with the cutoff statements and pay attention to dates of the transactions stamped by the banks on the backs of the checks. These stamped dates should not be earlier than the dates of the checks or the dates of cash disbursements recorded on the books. Protested​ (N.S.F.) checks should be investigated to determine they are not fictitious checks deposited temporarily to cover a shortage.

As a surprise count of cash and​ customers’ checks on hand is made as a test for one type of​ embezzlement, determine that checks representing transfers of funds are properly recorded on the books.

Prepare a schedule of the interbank transfers made for a few days before and after the audit date. The schedule should​ show, for each​ check, the date that the cash disbursement was recorded on the​ books, and the dates of withdrawal and deposit shown on the bank statements.

RQ23-12 (book/static)

Question Help

Why is there a greater emphasis on the detection of fraud in tests of details of cash balances than for other balance sheet​ accounts? Give two specific examples that demonstrate how this emphasis affects the​ auditor’s evidence accumulation in auditing​ year-end cash.

Why is there a greater emphasis on the detection of fraud in tests of details of cash balances than for other balance sheet​ accounts?

The amount of cash flowing into and out of the cash account is frequently larger than for any other account in the financial statements.​ Furthermore, the susceptibility of cash to misappropriation is greater than other types of assets.

Give two specific examples that demonstrate how this emphasis affects the​ auditor’s evidence accumulation in auditing​ year-end cash.

​(1) Verifying whether cash transactions are properly recorded and​ (2) obtaining bank confirmations

RQ23-13 (book/static)

Question Help

How would an auditor test the realizable value audit objective for a financial instrument classified as a level 3 fair value​ estimate?


All of the above

MC23-14 (similar to)

Question Help

The following questions deal with auditing​ year-end cash and financial instruments. Choose the best response.

a. A CPA obtains a January 10 cutoff bank statement for a client directly from the bank. Very few of the outstanding checks listed on the​ client’s December 31 bank reconciliation cleared during the cutoff period. A probable cause for this is that the client

transmitted the checks to the payees after​ year-end.

b. In establishing the existence and ownership of an investment held by a corporation in the form of publicly traded​ stock, an auditor should inspect the securities or

confirm the number of shares owned that are held by an independent custodian.

c. The auditor should ordinarily send confirmation requests to all banks with which the client has conducted any business during the​ year, regardless of the​ year-end balance, because

the confirmation form also seeks information about indebtedness to the bank.

MC23-15 (similar to)

Question Help

The following questions deal with discovering fraud in auditing​ year-end cash. Choose the best response.

a. The auditor should control and verify all liquid assets simultaneously to prevent

conversion of assets to conceal a shortage.

b. Which of the following is one of the better auditing techniques to detect​ kiting?

Prepare a schedule of bank transfers from the​ client’s books.

c. Which of the following cash transfers results in a misstatement of cash at December​ 31, 2016?

Transfer	Recorded in books	Paid by bank		Recorded in books	Received by bank

4.

                                               

          ​1/4/17

                                                                   

     ​1/5/17

                                                                                       

          ​12/31/16

      

                      ​1/4/17

MC23-16 (book/static)

Question Help

The following questions concern auditing​ year-end cash and financial instruments. Choose the best response.

a. Which of the following controls would most likely detect a kiting​ scheme?

Preparing a bank transfer schedule

b. All of the following are effective ways to prevent​ and/or detect​ lapping, except for

preparing a bank transfer schedule.

c. Which of the following discovered by the auditor would be a weakness in the​ client’s internal control over its​ investments?

Investments not held by an independent​ third-party custodian are kept in the​ Treasurer’s office.

P23-17 (book/static)

Question Help

The following are misstatements that might be found in the​ client’s year-end cash balance​ (assume that the balance sheet date is June​ 30):

.

a. Assuming that each of these misstatements was intentional​ (fraud), state the most likely motivation of the person responsible.

	Requirement a
Misstatement	Motivation
1.	D.
2.	A.
3.	A.
4.	E.
5.	A.
6.	B.
7.	C.

b.  What control can be instituted for each fraud to reduce the likelihood of​ occurrence?

	Requirement b
Misstatement	Internal Control
1.	H.
2.	I.
3.	G.
4.	F.
5.	I.
6.	F.
7.	F.

c. List an audit procedure that can be used to discover each fraud.

	Requirement c
Misstatement	Audit Procedure
1.	M.
2.	P.
3.	L.
4.	J.
5.	N.
6.	K.
7.	O.

P23-18 (book/static)

Question Help

The following audit procedures are concerned with tests of details of general cash and financial instruments​ balances:

Requirement

Explain the objective of each audit procedure.

Match each audit procedure with the corresponding letter​ (from the list​ below) that best explains its objective. Use each letter only once. Begin with audit procedures 1 through​ 5, then complete 6 through 9.

	Audit procedure	Objective
1.	Obtain a standard bank confirmation from each bank with which the client does business.	a.
2.	Compare the balance on the bank reconciliation obtained from the client with the bank confirmation.	c.
3.	List the check number, payee, and amount of all material checks not returned with the cutoff
	bank statement.	d.
4.	Review minutes of the board of directors meetings, loan agreements, and bank confirmation for interest-
	bearing deposits, restrictions on the withdrawal of cash, and compensating balance agreements.	b.
5.	Prepare a four-column proof of cash.	g.
6.	Compare the bank cancellation date with the date on the cancelled check for checks dated on or shortly
	before the balance sheet date.		e.
7.	Trace deposits in transit on the bank reconciliation to the cutoff bank statement and the current year cash
	receipts journal.		f.
8.	Compare the price per share on an equity investment at year-end according to the schedule of
	investment activity to the quoted market price according to an outside pricing source.		i.
9.	Confirm the balance of financial instruments at year-end with the broker-dealer service organization
	used by the client to manage their investment portfolio.		h.

P23-19 (book/static)

Question Help

You are auditing general cash for the

PittsburghPittsburgh

Supply Company for the fiscal year ended

JulyJuly

​31,

20162016.

The client has not prepared the

JulyJuly

31 bank reconciliation. After a brief discussion with the​ owner, you agree to prepare the​ reconciliation, with assistance from one of

PittsburghPittsburgh

​Supply’s clerks. You obtain the following​ information:

LOADING…

​(Click

the icon to view info for

JulyJuly​.)

                                                     

LOADING…

​(Click

the icon to view the

JuneJune

3030

bank​ rec.)

Additional information obtained is as​ follows:

LOADING…

​(Click

the icon to view the additional​ information.)

Read the

requirements

LOADING…

.

Requirement a. Prepare a bank reconciliation that shows both the unadjusted and adjusted balance per books. ​(If a box is not used in the​ table, leave the box​ empty; do not select a label or enter a​ zero.)

$1,522
Add:
Deposits in transit	2,000
Check erroneously charged to Pittsburgh Supply	646	2,646
Deduct:
Outstanding checks	(2,218)	(2,218)
Balance per bank, adjusted		$1,950
Balance per books before adjustments		$10,103
Add:
Deduct:
Unrecorded bank service charge	(107)
Note payment	(6,400)
NSF check	(516)
Unrecorded check	(1,130)	(8,153)
Balance per books, adjusted		$1,950

Requirement b. Prepare all adjusting entries. ​(Prepare a single compound entry. Record debits​ first, then credits. Exclude explanations from any journal​ entries.)

Accounts	Debit	Credit
Jul	31	Miscellaneous expense	107
		Interest expense	400
		Note payable	6,000
		Allowance for doubtful accounts	516
		Purchases	1,130
		Cash in bank		8,153

Requirement c. What audit procedures would you use to verify each item in the bank​ reconciliation?

	Reconciling Item	Audit Procedure
1.	Deposits in transit	Trace to duplicate deposit slip and entry on cutoff bank statement.
2.	Erroneous check	Examine correction notice received from bank in August.
3.	Outstanding checks	Obtain cutoff bank statement. Trace enclosed checks to outstanding
		check list. Trace uncleared items to supporting documentation.
4.	Bank service charge	Examine advice returned with July bank statement.
5.	Note payment	Examine cancelled note. Recompute interest. Check for absence of
		note on 7/31 bank confirmation.
6.	NSF check	Examine advice returned with July bank statement. Examine other
		related evidence from credit manager to determine if account is
		uncollectible.
7.	Unrecorded check	Examine check returned with July bank statement. Trace number
		to absence in July cash disbursements journal and recording in
		August. Examine supporting documentation. Investigate why
		unrecorded.

Requirement d. What is the cash balance that should appear on the July31, 2016financial​ statements?

The cash balance that should appear on the July 31, 2016 financial statements is $	1,950	.

P23-20 (book/static)

Question Help

In the audit of the Regional Transport​ Company, a large branch that maintains its own bank​ account, cash is periodically transferred to the central account in Cedar Rapids. On the branch​ account’s records, bank transfers are recorded as a debit to the home office clearing account and a credit to the branch bank account.​Similarly, the home office account is recorded as a debit to the central bank account and a credit to the branch office clearing account. Gordon Light is the head bookkeeper for both the home office and the branch bank accounts. Because he also reconciles the bank​ account, the senior​ auditor, CindyMarintette, is concerned about the internal control deficiency. As a part of the​ year-end audit of bank​ transfers, Marintetteasks you to schedule the transfers for the last few days in 2016and the first few days of 2017. You prepare the following​ list:

.

Requirement a. In verifying each bank​ transfer, state the appropriate audit procedures you should perform.

In addition to creating a list of interbank transfers made a few days before and after the balance sheet

date, which has already been​ done, the auditor​ should:

Trace interbank transfers to the appropriate accounting​ records, bank​ reconciliations, and bank records to verify proper recording.

Requirement b. Prepare any adjusting entries required in the home office records.

Begin by preparing any adjusting entry required in the home office records for the $17,000 transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the home office records for the $28,000 transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the home office records for the $16,000 transfer.

Accounts	Debit	Credit
Dec	31	Cash in bank	16,000
		Branch bank clearing account		16,000

Prepare any adjusting entry required in the home office records for the $10,000 transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the home office records for the $21,000 transfer.

Accounts	Debit	Credit
Dec	31	Cash in bank	21,000
		Branch bank clearing account		21,000

Prepare any adjusting entry required in the home office records for the $22,000 transfer.

Accounts	Debit	Credit
Dec	31	Cash in bank	22,000
		Branch bank clearing account		22,000

Prepare any adjusting entry required in the home office records for the $39,000 transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Requirement c. Prepare any adjusting entries required in the branch bank records.

Begin by preparing any adjusting entry required in the branch bank records for the $17,000 transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the branch bank records for the

$ 28 comma 000$28,000

transfer.

Accounts	Debit	Credit
Dec	31	Home office clearing account	28,000
		Cash in bank		28,000

Prepare any adjusting entry required in the branch bank records for the

$ 16 comma 000$16,000

transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the branch bank records for the

$ 10 comma 000$10,000

transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Prepare any adjusting entry required in the branch bank records for the

$ 21 comma 000$21,000

transfer.

Accounts	Debit	Credit
Dec	31	Home office clearing account	21,000
		Cash in bank		21,000

Prepare any adjusting entry required in the branch bank records for the

$ 22 comma 000$22,000

transfer.

Accounts	Debit	Credit
Dec	31	Home office clearing account	22,000
		Cash in bank		22,000

Prepare any adjusting entry required in the branch bank records for the

$ 39 comma 000$39,000

transfer.

Accounts	Debit	Credit
Dec	31	No entry required

Requirement d. State how each bank transfer should be included in the December​ 31,

20162016​,

bank reconciliation for the home office account after your adjustments in part b. ​(Complete all answer​ boxes.)

	Date Recorded in	Date Recorded in	Date Deposited	Date Cleared	Included in the
Amount	the Home Office	the Branch Office	in the Home	the Branch	Home Office
of	Cash Receipts	Cash Disbursements	Office Bank	Bank	December 31
transfer	Journal	Journal	Account	Account	Bank Reconciliation?
$17,000	12-27-16	12-29-16	12-26-16	12-27-16	Not included
28,000	12-28-16	01-02-17	12-28-16	12-29-16	Not included
16,000	01-02-17	12-30-16	12-28-16	12-29-16	Not included
10,000	12-26-16	12-26-16	12-28-16	01-03-17	Not included
21,000	01-02-17	01-02-17	12-28-16	12-31-16	Not included
22,000	01-07-17	01-05-17	12-28-16	01-03-17	Not included
39,000	01-04-17	01-06-17	01-03-17	01-05-17	Not included

Requirement e. State how each bank transfer should be included in the December​ 31,

20162016​,

bank reconciliation of the branch bank account after your adjustments in part c. ​(Complete all answer​ boxes.)

	Date Recorded in	Date Recorded in	Date Deposited	Date Cleared	Included in the
Amount	the Home Office	the Branch Office	in the Home	the Branch	Branch Bank
of	Cash Receipts	Cash Disbursements	Office Bank	Bank	December 31
transfer	Journal	Journal	Account	Account	Bank Reconciliation?
$17,000	12-27-16	12-29-16	12-26-16	12-27-16	Not included
28,000	12-28-16	01-02-17	12-28-16	12-29-16	Not included
16,000	01-02-17	12-30-16	12-28-16	12-29-16	Not included
10,000	12-26-16	12-26-16	12-28-16	01-03-17	Included as an outstanding check
21,000	01-02-17	01-02-17	12-28-16	12-31-16	Not included
22,000	01-07-17	01-05-17	12-28-16	01-03-17	Included as an outstanding check
39,000	01-04-17	01-06-17	01-03-17	01-05-17	Not included

partial credit,P23-21 (book/static)

Question Help

The following are various potential misstatements due to errors or fraud​ (1 through​ 7), and a list of auditing procedures​ (a. through​ h.) the auditor would consider performing to gather evidence to determine whether the error or fraud is present.

For each possible​ misstatement, identify one audit procedure that would be most effective in providing evidence regarding the potential misstatement. Listed auditing procedures may be used​ once, more than​ once, or not at all.

P23-22 (book/static)		Question Help

You are doing the​ first-year audit of ShermanSchool District and have been assigned responsibility for doing a​ four-column proof of cash for the month of October2016. You obtain the following​ information:

.

Requirement a. Prepare a​ four-column proof of cash for the month ended October31. It should show both adjusted and unadjusted cash. ​(If a box is not used in the​table, leave the box​ empty; do not enter a​ zero.)

Cash
9/30/16
$6,915
5,621
(1,811)
$10,725
$10,725
$10,725
Receipts
$28,792
(5,621)
996
(600)
$23,567
$20,271
3,296
$23,567

Cash
10/31/16
$8,276
996
(2,615)
1,144
735
$8,536
$5,836
(596)
3,296
$8,536

Requirement b. Prepare all adjusting entries.

Prepare the entry for the $596 interest charged by the​ bank, but not recorded. ​(Record debits​ first, then credits. Exclude explanations from any journal​ entries.)

Accounts	Debit	Credit
Oct	31	Interest expense	596
		Cash in bank		596

Prepare the entry for the $3296 note proceeds that was collected by the​ bank, but not recorded. ​(Record debits​ first, then credits. Exclude explanations from any journal​entries.)

Debit	Credit
Oct	31	Cash in bank		3,296
		Notes receivable			2,900
		Interest income			396

McNeil​ Company, a​ medium-sized manufacturer of microwave​ ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in​ actively-traded equity​ securities, but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute​ trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell.

In planning for the current​ year’s audit​ engagement, you note the following related to the investments in financial​ instruments:

.

Requirement a. Identify the inherent and control risks related to the financial instruments accounts for McNeil Co.

Begin by identifying which statements below are correct in regards to the inherent risks related to the financial instruments accounts for McNeil Co.​ (Select all that​apply.)

Inherent risk is increased by the fact that the CEO does not have prior experience investing in such complex financial instruments.

Exposure to risk is significant because the financial instruments account represents approximately​ 15% of total assets which is a material​ amount, and many of the equity investments are considered high risk stocks.  

Inherent risk is increased by the fact that the CEO has been given an incentive bonus based on return on assets.

Inherent risk is increased by the investment in speculative derivative financial instruments due to the potential complexity of the derivative​ contracts, the complexity of the relevant accounting​ standards, and the potential volatility of the fair value.

​Next, identify which statements below are correct in regards to the control risks related to the financial instruments accounts for McNeil Co. ​(Select all that​ apply.)

Control risk is increased by the fact that the CEO is making investment decisions without any monitoring. He is discussing his strategy with the board of directors and using a brokerage firm to execute​ trades, but the board does not approve the investments in advance.

Control risk is increased because no limits are placed on the​ CEO’s ability to enter into investment transactions.

The use of a brokerage firm to execute trades lowers the control risk assuming internal controls at the brokerage firm have been tested and are considered effective.   

Requirement b. Identify at least two audit procedures the auditor would perform to test the existence​ balance-related audit objective for the trading and​available-for-sale securities.

The auditor would test the existence​ balance-related audit objective by

confirming with the broker any equity investments held at year end.

For the derivative financial​instruments, the auditor would

review the underlying agreements.

Requirement c. How would the auditor test the completeness​ balance-related audit objective for the speculative derivative financial​ instruments? ​(Select all that​ apply.)

To search for unrecorded derivative​ contracts, the auditor could request information from all counterparties the company has transacted with during the year even if the records do not indicate any agreements outstanding at the end of the fiscal year.

The auditor would search following​ year-end for settlement of any contracts that should have been recorded at year end.

The auditor would read other financial instruments contracts to search for embedded derivatives and would read board of director meeting minutes for discussion of derivative contracts that are not recorded.  

Requirement d. Identify at least two audit procedures the auditor would perform to test the realizable value​ balance-related audit objective for the financial instruments accounts. Assume the investments in stock are all​ actively-traded in a liquid​ market, but the derivative financial instruments require a level 3 fair value estimate. ​(Select all that​ apply.)

The auditor must gain an understanding of the method used by management to develop the fair value estimate.

The auditor will verify the ending market value as listed on the​ client’s schedule of equity investment activity by referring to quoted market prices from a source such as a financial publication or the stock exchange.

The auditor should obtain evidence by performing procedures such as assessing the appropriateness of the model used and the reasonableness of estimates.

Requirement e. In your​ opinion, would the audit of financial instruments require the use of a valuation​ specialist? Why or why​ not?

It is highly likely the auditor

would

use a valuation specialist for the audit of financial instruments when level 3 fair value estimates are involved. It is

unlikely

the auditor will have the valuation expertise necessary to develop an independent estimate. If management uses a specialist to develop their fair value​ estimate, the auditor must ensure the specialist is

objective and qualified and the auditor must understand the methods used by the specialist to develop the estimate.

The auditor may choose to use their own valuation specialist to develop an estimate in order to corroborate the estimates developed by management or their specialists.

CC25-1 (book/static)

Question Help

Distinguish among engagements to​ prepare, compile, and review of financial statements. What is the level of assurance for​ each?

Select the answer that defines a preparation of financial statements.

Preparation is defined in SSARS as a service where the CPA is engaged by the client to prepare or assist in preparing financial​ statements, but the CPA does not provide any assurance on the financial statements or issue a​ report, even if the financial statements are expected to be used​ by, or provided​ to, a third party.

Select the answer that defines a compilation of financial statements

A compilation is defined as a​ service, the objective of which is to assist management in presenting financial information in the form of financial statements without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with the applicable financial reporting framework.

Select the answer that defines a review of financial statements.

A review is defined as a​ service, the objective of which is to obtain limited assurance that there are no material modifications that should be made to the financial statements in order for the statements to be in conformity with the applicable financial reporting framework. In a review​ engagement, the accountant should accumulate review evidence to obtain a limited level of assurance.

What is the level of assurance for a​ preparation, a compilation or a​ review?

There is no level of assurance provided by a preparation or compilation. Reviews provide limited​ assurance, but considerably less than a typical audit.

CC25-2 (book/static)

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What procedures should the auditor use to obtain the information necessary to give the level of assurance required of reviews of financial​ statements? ​(Select all that​ apply.)

Read the financial statements. The accountant should read the financial statements to determine whether they conform with the financial reporting framework.

Perform analytical procedures. The analytical procedures are meant to identify relationships and individual items that appear to be unusual.

Obtain a letter of representation. The accountant is required to obtain a letter of representation from members of management who are knowledgeable about financial matters.

Obtain knowledge of the client. The information should be about the nature of the​ client’s business​ transactions, its accounting records and​ employees, and the​basis, form, and content of the financial statements. The level of knowledge should be higher than that for compilation.

Obtain agreement on engagement terms with management or those charged with governance. This is generally in the form of an engagement letter or other suitable form of written agreement.

Make inquiries of management. The objective of these inquiries is to determine whether the financial statements are fairly​ presented, assuming that management does not intend to deceive the accountant.

Obtain knowledge of the accounting principles and practices of the​ client’s industry. The level of knowledge for reviews should be somewhat higher than that for compilation.

Reconcile the financial statements to the underlying accounting records. The accountant should obtain evidence that the financial statements agree or reconcile with the accounting records.

Prepare documentation. The accountant should prepare documentation of procedures​ performed, sources of evidence​ obtained, and conclusions reached.

CC25-3 (book/static)

Question Help

Define what is meant by attestation standards. Distinguish between attestation standards and auditing standards.

Select the best definition for attestation standards.

Attestation standards provide a general framework for and set reasonable boundaries around the attestation function. They provide guidance to AICPA​standard-setting bodies for establishing detailed standards and interpretations of standards for specific types of services. They also provide practitioners useful guidance in performing new and evolving attestation services where no specific guidance exists.

Distinguish between attestation standards and auditing standards.

The attestation standards provide a conceptual framework for

various types of services.

Auditing standards provide a conceptual framework for

the ordinary audit of financial statements

prepared in accordance with accounting standards.

CC25-4 (book/static)

Question Help

Distinguish the three types of service organization reports.

Select the three types of service organization​ reports, then select the description of each report from the following​ list:

Report	Description
SOC 1	c.
SOC 2	a.
SOC 3	e.

RQ25-1 (book/static)

Question Help

What is meant by the term level of assurance​? How does the level of assurance differ for an audit of historical financial​ statements, a​ review, a​ compilation, and a preparation​ engagement?

What is meant by the term level of​ assurance?

Levels of assurance represent the degree of certainty the practitioner has​ attained, and wishes to​ convey, that the conclusions stated in his or her report are correct.

Select the level of assurance for an audit of historical financial​ statements, a​ review, a​ compilation, and a preparation engagement.

	Level of assurance
Audit	e.
Review	a.
Compilation	g.
Preparation	d.

RQ25-2 (book/static)

Question Help

What is negative​ assurance? Why is it used in a review engagement​ report?

What is negative​ assurance?

A negative assurance​ states, along with factual​ statements, that nothing came to the​ accountant’s attention that would lead the accountant to believe that the financial statements were not prepared in accordance with accounting standards.

Why is it used in a review engagement​ report?

The reason for including such a statement in a review report is to provide financial statement users

with some level of assurance that the financial statements are fairly stated.

RQ25-3 (book/static)

Question Help

Distinguish the three forms of compilation reports that a CPA can provide to clients. ​(Select all that​ apply.)

Compilation With Full Disclosure Compilation of this type requires disclosures in accordance with accounting​ standards, the same as for audited statements.

Compilation That Omits Substantially All Disclosures This type of compilation is acceptable if the report indicates the lack of disclosures and the absence of disclosures is​ not, to the​ CPA’s knowledge, undertaken with the intent to mislead users.

Compilation Without Independence A CPA firm can issue a compilation report even if it is not independent with respect to the​ client, as defined by the Code of Professional Conduct.​ However, the CPA firm must state its lack of independence in the report.

RQ25-4 (book/static)

Question Help

List five things that are required of an auditor by SSARS for a compilation.

The preparer of the statements​ must: ​(Select five that​ apply.)

Establish an understanding with the client in a written engagement letter about the objectives of the nature of the engagement.

Disclose in the report any omissions or departures from accounting standards of which the accountant is aware. This requirement does not apply to a compilation that omits substantially all disclosures.

Possess knowledge of the accounting principles and practices of the​ client’s industry.

Know the​ client, the nature of its business​ transactions, accounting records and​ employees, and the​ basis, form, and content of the financial statements.

Read the compiled financial statements and be alert for any obvious omissions or errors in arithmetic and generally accepted accounting principles

RQ25-8 (book/static)

Question Help

What are the differences between the review reports for a private company under SSARS and for the interim financial statements of a public​ company?

Compilations and reviews under SSARS can only be issued for

nonpublic companies for which an audit has not been performed.

They may be for

monthly, quarterly, or annual statements.

Reviews are issued on

quarterly

information of publicly held companies as a part of the​ client’s reporting requirements to the SEC and are subject to PCAOB standards. The wording on a review report for a nonpublic company and a public company review report are

substantively the same.

RQ25-9 (book/static)

Question Help

Explain why a review of interim financial statements for a public company may provide a greater level of assurance than an SSARS review.

The review procedures are

essentially the same for public company and SSARS reviews.

Some additional procedures are required for public company reviews that are beyond the scope of SSARS as​ follows: ​(Select all that​ apply.)

Under​ SSARS, the auditor makes inquiries about actions of directors and stockholder​ meetings; for public companies the auditor reads the minutes of those meetings.

The level of knowledge the accountant has about the​ client’s internal control is likely to be higher for public company reviews. Because an annual audit is done for public companies that have an interim​ review, the accountant must also obtain sufficient information about the​ client’s internal control for both annual and interim financial information.

The​ auditor’s knowledge of the results of the audit procedures performed during the annual audit will affect the scope of the procedures performed during the review of interim financial information.

For public​ companies, the accountant must also obtain evidence that the interim financial information agrees or reconciles with the accounting records.

The accountant will also have a good idea whether the quarterly statements were accurate after the annual audit is complete. This information will be useful in determining the review procedures in subsequent years.

RQ25-10 (book/static)

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You have been asked to provide assurance on information contained in New​ Dominion’s Corporate Sustainability Report. What standards would you use to perform this​engagement?

In response to a request to provide assurance on information contained in New​ Dominion’s Corporate Sustainability​ Report, the accountant would conduct the engagement in accordance with

Statements on Standards for Attestation Engagements (SSAEs).

The accountant would most likely be engaged to conduct

an examination

level attestation engagement whereby the accountant would issue an opinion on the presentation of ​ management’s assertions about compliance with specific sustainability criteria.

RQ25-11 (book/static)

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Describe the five Trust Service Principles.

Select the five Trust Services principles.

Confidentiality​ – Confidentiality​ practices, ensuring that information designated as confidential is protected as committed or agreed.

Availability​ – Availability​ practices, ensuring that the system is available for operation and use as committed or agreed.

Security​ – Security practices ensuring that the system is protected against authorized access​ (both physical and​ logical).

Online Privacy​ – Online privacy​ practices, ensuring that personal information obtained as a result of​ e-commerce is​ collected, used,​ disclosed, and retained as committed or agreed.

Processing Integrity​ – Processing​ integrity, ensuring that system processing is​ complete, accurate,​ timely, and authorized.

RQ25-12 (book/static)

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Describe the key difference between a type 1 and type 2 SOC 1 report.

In a Type 1 SOC 1​ report, the accountant provides an opinion about the fairness of the description of the service​ organization’s system and opinion about the suitability of the design of the controls in that system. In a Type 2​ report, the accountant provides the opinions contained in a Type 1​ report, plus an opinion on the operating effectiveness of controls at the service organization.

RQ25-14 (book/static)

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An audit client has engaged a third party service organization to host its payroll software package on servers located at the service organization. What options do you have to obtain assurance about the controls embedded in the payroll​ application? ​(Select all that​ apply.)

The service organization can engage its auditor to provide a Type 1 report that provides an opinion about the fairness of the description of the service​organization’s system and opinion about the suitability of the design of the controls in that system.

You can visit the service organization to obtain evidence about the design and operating effectiveness of internal controls at the service organization.

The service organization may engage its auditor to provide a Type 2 report that provides the opinions contained in a Type 1​ report, plus an opinion on the operating effectiveness of controls at the service organization.

RQ25-15 (book/static)

Question Help

Explain what is meant by prospective financial statements and distinguish between forecasts and projections. What four things are involved in an examination of prospective financial​ statements?

A prospective financial statement

is a predicted or expected financial statement in some future period or at some future date.

A forecast is a prospective financial statement that

presents an​ entity’s expected financial​ position, results of​ operations, and cash flows for future​ periods, to the best of the responsible​ party’s knowledge and belief.

A projection is a prospective financial statement that

presents an​ entity’s financial​ position, results of​ operations, and cash​ flows, to the best of the responsible​ party’s knowledge and​ belief, given one or more hypothetical assumptions.

What four things are involved in an examination of prospective financial​ statements?

Evaluating the preparation of the prospective financial statements.

Evaluating the presentation of the prospective financial statements for conformity with AICPA presentation guidelines.

Issuing an examination report.

Evaluating the support underlying assumptions.

RQ25-16 (book/static)

Question Help

The Absco Corporation has requested that Herb​ Germany, CPA, provide a report to the Northern State Bank as to the existence or nonexistence of certain loan conditions. The conditions to be reported on are the working capital​ ratio, dividends paid on preferred​ stock, aging of accounts​ receivable, and competence of management. This is​Herb’s first experience with Absco. Should Herb accept this​ engagement? Substantiate your answer.

It would be appropriate for Germany to provide a report to Northern State Bank on

all the conditions except the competency of management.

Reporting

on the competence of management is highly subjective

and should not ordinarily be in a debt compliance letter. All the other conditions

are factual matters within a normal auditor’s competence.

MC25-17 (book/static)

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The following are miscellaneous questions about compilation and review services. Choose the best response.

a. A CPA is performing review services for a​ small, closely held manufacturing company. As a part of the​ follow-up of a significant decrease in the gross margin for the current​ year, the CPA discovers that there are no supporting documents for​ $40,000 of disbursements. The chief financial officer assures her that the disbursements are proper. What should the CPA​ do?

Modify the review opinion or withdraw from the engagement unless the unsupported disbursements are satisfactorily explained.

b. Which of the following best describes the responsibility of the CPA in performing compilation services for a​ company?

The CPA must understand the​ client’s business and accounting methods and read the financial statements for reasonableness.

c. The standard compilation report includes which statement or​ phrase?

Management is responsible for the financial statements.

MC25-18 (book/static)

Question Help

The following questions concern attestation engagements. Choose the best response.

a. A Type 1 service​ auditor’s report on internal controls at a service organization

includes an opinion about the suitability of the design of controls at the service organization.

b. Which of the following professional services would be considered an attestation​ engagement?

Preparing the income statement and balance sheet for one year in the future based on client expectations and predictions.

MC25-19 (book/static)

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The following questions concern reports issued by​ auditors, other than those on historical financial statements. Choose the best response.

a. An auditor is reporting on cash basis financial statements. These statements are best referred to in the opinion of the auditor by which of the following​ descriptions?

Cash receipts and disbursements and the assets and liabilities arising from cash transactions

b. When asked to perform an audit to express an opinion on one or more specified​ elements, accounts, or items of a financial​ statement, the auditor

may not describe auditing procedures applied.

MC25-20 (book/static)

Question Help

The following questions concern engagements other than the audit of financial statements performed by accountants. Choose the best response.

a. Which of the following procedures would most likely be performed during an engagement to compile the financial statements of a​ nonissuer?

Read the financial statements and consider whether they are appropriate in form and free from obvious material errors

b. Which of the following procedures would most likely be performed during the engagement to review the annual financial statements of a​ nonissuer?

Comparison of the current financial statements with prior period financial statements

c. Which of the following is a prospective financial statement for general use upon which an accountant may appropriately​ report?

Financial forecast

P25-22 (book/static)

Question Help

You are doing a review services and related tax work engagement for Murphy Construction Company. You have made extensive inquiries of management about their financial statements and have concluded that management has an excellent understanding of its business and is​ honest, but lacking in knowledge of technical accounting issues. In doing the review you determine the​ following:

.

Requirement a. Beyond inquiries and analytical​ procedures, what are the​ accountant’s responsibilities in performing review service​ engagements?

Perform additional procedures if the accountant becomes concerned that information is​ incorrect, incomplete or otherwise unsatisfactory.

Obtain a letter of representation.

Issue the review report.

Obtain knowledge of the​ client’s business

Read the financial statements.

Obtain knowledge of the accounting principles and practices of the​ client’s industry.

Prepare documentation of procedures​ performed, evidence​ examined, and conclusions reached.

Requirement b. Describe what you should do in each of the preceding​ situations, assuming each one is material.

Situation	Description of Procedure
1.	f.
2.	a.
3.	c.
4.	h.
5.	d.
Question Help

Jennifer Branson is a new staff auditor on the audit engagement of Greenville Light​ & Sound, which is a publicly traded company with a calendar​ year-end. The engagement team has completed its review of the​ third-quarter financial​ statements, and the firm has been asked to issue a review report on those statements. As the senior auditor on the​ engagement, you asked Jennifer to draft the​ firm’s report for her review.​ Here’s what she provided​ you:

Requirement

1. What changes are needed to the report draft provided by​ Jennifer?

Should this report contain a​ title? If​ so, what should it​ be?

Yes. Report of Independent Registered Public Accounting Firm.

The first paragraph changes​ are: ​(Select four that​ apply.)

The financial statements reviewed would include reference to the financials prepared for the​ three-month period and​ nine-month period ending at the end of the third quarter. This reference should be included in the first sentence to the report.

The word​ “examined” in the first sentence should be replaced with​ “reviewed” since this is a review level engagement.

The second and third sentences should be deleted and moved to the next​ paragraph, and the phrase​ “testing internal controls over financial​ reporting” should be deleted.

The first sentence needs to include a reference to the Statement of Retained Earnings and Statement of Cash Flows.

The second paragraph changes​ are: ​(Select four that​ apply.)

A final sentence must also be added stating that the accountant is not expressing an opinion on the financial statements.

The review would be conducted in accordance with PCAOB​ standards, not the SSARS standards issued by the AICPA.​ Therefore, the opening sentence should be modified.

The second sentence needs to be deleted from the report.

A sentence needs to be added to describe that a review consists primarily of applying analytical procedures and inquiries and a second sentence saying a review is substantially less in scope than an audit in accordance with PCAOB standards.

The final paragraph changes​ are: ​(Select two that​ apply.)

The phrase​ “it is our​ opinion” should be deleted and replaced with​ “we are not aware of any material modifications that should be made to the accompanying interim financial​ statements.”

The financial reporting framework used by management to present the financial statements is GAAP in the​ U.S., and the reference to the SEC should be removed.

What​ item(s) are included in the closing of the review​ report?

The closing should include the audit​ firm’s signature and be dated as of the end of fieldwork for review.

P25-27 (book/static)

Question Help

With the rapid growth of cloud​ computing, many organizations are contracting with​ third-party service providers to process and store all kinds of data off site. In doing​ so, entities are now dependent on the effectiveness of controls provided by external software providers and data centers that are used to generate and store a huge volume of important information for making critical business decisions.

.

Requirement a. How might the use of an external service provider to process financial statement transactions affect the audit of the​ entity’s financial​ statements?

When clients outsource some or all of their IT needs to an independent computer service organization rather than maintain an internal IT function or data​ center, their auditors may face difficulty when obtaining an understanding of the​ client’s internal control over financial reporting because many of the controls reside at the service​ organization, and the auditor cannot assume that the controls are adequate since they are provided by an independent IT provider. It has become increasingly common for the service center to engage a CPA firm to obtain an understanding and test internal controls of the service organization and issue a report for use by all customers and their independent auditors.

Requirement b. What options are available to the auditor of the user​ entity’s financial statements to obtain information about the design of internal controls over financial reporting at the service​ organization?

Their auditors could examine a Type 1 SOC 1 report on​ management’s description of a service​ organization’s system and the suitability of the design of controls to obtain information about the design of controls at the service organization. In a Type 1​ report, the service auditor expresses an opinion about the fairness of the description of the service​ organization’s system and an opinion about the suitability of the design of controls in that system.

Requirement c. What kind of report could the auditor of the user entity obtain from the service​ organization, if the user auditor needed information about the operating effectiveness of controls at the service​ organization?

When clients outsource some or all of their IT needs to an independent computer service​ organization, their auditors could examine a Type 2 SOC 1 report on​management’s description of a service​ organization’s system and the suitability of the design and operating effectiveness of controls. In a Type 2​ engagement, the service auditor performs tests of the operating effectiveness of the controls at the service​ organization, in addition to procedures performed in the Type 1 engagement. The service​ auditor’s Type 2 report contains the two opinions about the description and suitability of the design of controls that are provided in a Type 1​ report, plus an additional opinion about the operating effectiveness of controls throughout the period.

Requirement d. What type of report might the service organization provide to management of an entity that uses the service center to process quality control reports related to the user​ entity’s manufacturing​ processes?

SOC 1 reports address internal controls over financial reporting.​ But, in this​ situation, management of a service organization that processes quality control reports related to the user​ entity’s manufacturing processes could engage their auditor to provide an SOC 2​ report, Report on Controls at a Service Organization Relevant to​ Security, Availability, Processing​ Integrity, Confidentiality, or

Privacy. A SOC 2 report is intended to meet the needs of a broad range of users who need information and assurance about controls at a service organization that affect the​ security, availability, and processing integrity of the systems the service organization uses to process​ users’ data and the confidentiality and privacy of the information processed by these systems.

P25-28 (book/static)

Question Help

Carl​ Monson, the owner of Major Products Manufacturing​ Company, a​ small, successful,​ long-time audit client of your​ firm, has requested you to work with his company in preparing​ 3-year forecasted information for the year ending December​ 31, 2017, and two subsequent years. Monson informs you that he intends to use the​ forecasts, together with the audited financial​ statements, to seek additional financing to expand the business. Monson has had little experience in formal forecast preparation and counts on you to assist him in any way possible. He wants the most supportive opinion possible from your firm to add to the credibility of the forecast. He informs you that he is willing to do anything necessary to help you prepare the forecast.

Requirement a. Explain circumstances under which it is and is not acceptable to undertake the engagement.

It would be acceptable to undertake the engagement only if all of the following conditions exist. ​(Select all that​ apply.)

The accountant has sufficient competence to properly complete an examination of the forecasted financial statements.

The client is willing to take responsibility for preparation​ (with the​ accountant’s assistance) of the forecast in accordance with​ guidelines, established by the AICPA in Statements on Standards for​ Accountant’s Services on Prospective Financial

Statements.

The accountant believes a reasonably accurate forecast is practicable in the circumstances.

The client understands and agrees to the examination procedures and reporting requirements the accountant must comply with.

Requirement b. Why is it important that Monson understand the nature of your reporting requirements before the engagement​ proceeds?

If Monson believes the accountant can issue an opinion about the achievability of the​ forecast, but later finds that

such an opinion cannot be given,

Monson is likely to be unhappy.

The result would be a loss of fee, loss of a client for other services, and perhaps even a lawsuit

.Similarly, Monson must understand his responsibilities concerning the forecast of the assumptions and other aspects of the​ report, again to avoid a misunderstanding later.

Requirement c. What information will Monson have to provide to you before you can complete the forecasted​ statements? Be as specific as possible.

The primary information the CPA firm will need to help in completing the forecast are the​ following: ​(Select all that​ apply.)

Information about the economic conditions of the industry. The CPA firm will likely need knowledge beyond that required for performing the audits.

Information about the offer he has made for the new business and the offer he has received for the existing assets. Because the financial statements will be a​forecast, and not a​ projection, it is necessary to determine that there is a reasonable likelihood of the transaction being completed and the forecasted​ result, assuming both transactions are finalized.

Audited financial statements for the past several years.

Requirement d. ​Discuss, in as specific terms as​ possible, the nature of the report you will issue with the​ forecasts, assuming that you are able to properly complete them.

The report will be a report on a forecast and will include the following​ components: ​(Select all that​ apply.)

A statement that the examination of the prospective financial statements was made in accordance with AICPA standards and a brief description of the nature of such examination.

A caveat that the prospective results may not be achieved.

An identification of the prospective financial statements presented.

A statement that the accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report.

The​ accountant’s opinion that the prospective financial statements are presented in conformity with AICPA presentation guidelines and that the underlying assumptions provide a reasonable basis for the forecast.

P25-29 (book/static)

Question Help

​Bengston, CPA, is conducting the audit of Pollution Control​ Devices, Inc. In​ addition, a supplemental negative assurance report is required for a major mortgage holder. The supplemental report concerns indenture agreements to keep the client from defaulting on the mortgage. Total assets are​ $14 million and the mortgage is for​ $4 million. The major provisions of the indentures are as​ follows:

Requirement a. Write the appropriate supplemental report if all three indenture agreement provisions have been satisfied.

We have

audited

​,

in accordance with

generally accepted auditing standards

in the United States of​ America, the financial statements of Pollution Control​ Devices, Inc., which comprise the balance as of​ (date inserted​ here) and the related statements of​ income, retained​ earnings, and cash flows for the year then​ ended, and have issued our report thereon dated.

In connection with our

audit

​,

nothing came to our attention that caused us to believe that the Company failed

to comply with any of the provisions of the indenture dated​ (date inserted​ here) with​ (lender) insofar as they relate to accounting matters.​ However, our

audit

was not directed primarily toward obtaining knowledge of such noncompliance.​ Accordingly, had we performed

additional procedures

​,

other matters may have come to our attention regarding the​ Company’s noncompliance with the​ above-referenced provisions of the indenture insofar as they relate to accounting matters.

                                                                                                                                             

This report is intended solely for the information and use of the

boards of directors and management

of Pollution Control​ Devices, Inc., and​ (lender) and is not intended to be and should not be used by anyone other than these specified parties.

Requirement b. How would the supplemental report change if net earnings after taxes were​ $1,010,000 and dividends paid were​ $60,000?

The supplemental report would have to state that the company was not in compliance with the provisions of the indenture because net earnings did not exceed dividends by at least​ $1,000,000.

Requirement c. Assume the same situation as in part b. and also assume that the client refuses to modify the financial statements or disclose the violation of the indenture agreement provisions on the grounds that the amount is immaterial. What is the nature of the appropriate​ auditor?s report?

The supplemental report

would be

the same as discussed in b. Assuming that a default in the provisions of the indenture results in the loan becoming due​immediately, the​ auditor’s report

would have to include either an adverse or qualified opinion depending upon the materiality of the misstatement

.

Because the mortgage is for​ $4 million, which is

material

to the​ client, violation of the indenture and potential default

cannot

be dismissed as being immaterial.

Requirement d. What is the nature of the appropriate supplemental report if all the indenture agreement provisions have been satisfied but there is a lawsuit against the company that has resulted in disclosure of the lawsuit in a footnote to the financial​ statements?

Contingencies due to a lawsuit

may

affect the liabilities of the client that affect the indenture provisions. The auditor will be

unable

to express an opinion in the debt compliance letter. This

should be

disclosed in the supplemental report.